Revenue Minister Can’t Use Audit to‘Chill’ Business, Court Rules

by Patrick Lindsay

Reprinted from Tax Notes Int’l, March 11, 2013, p. 913

Volume 69, Number 10 March 11, 2013

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Revenue Minister Can’t Use Audit to‘Chill’ Business, Court Rules

Canada’s Federal Court of Appeal (FCA) on Febru-ary 21 in MNR v. RBC Life Insurance Co. et al. (2013 FCA50) held that the minister of national revenue couldnot use her authority to demand information for theprimary purpose of ‘‘chilling’’ a business. The ministerwas held to have acted improperly by using audit pow-ers primarily for ‘‘sending a message to the industry’’rather than for a valid audit purpose, and for failing toprovide full and frank disclosure to the court.

The decision is an important precedent that helpsset reasonable limits on the minister’s authority to de-mand information. The demand at issue directed RBCLife Insurance Co. to disclose records that would iden-tify clients who had an insurance product referred to asthe ‘‘10-8 plan.’’

When the revenue minister demands records thatwill identify unnamed persons with the intention ofauditing those persons, the minister must obtain judi-cial authorization before serving the demand. The min-ister may obtain judicial authorization on an ex partebasis, meaning that the minister may apply to the courtwithout notifying any other party. The obligation toobtain judicial authorization is an important safeguardon the privacy rights of the unnamed persons. (Relatedanalyses of Canadian tax audit practices: Tax NotesInt’l, June 11, 2012, p. 1043; and Tax Notes Int’l, Mar.12, 2012, p. 833.)

The minister obtained judicial authorization on anex parte basis and then served the demand on RBC.Concerned for its clients’ privacy rights, RBC appliedfor a review of the minister’s ex parte court applicationto ensure that RBC did not disclose confidential infor-mation in response to a demand that was improperlyissued and could be canceled.

To proceed with the judicial review, RBC requestedfile materials from the minister in order to assesswhether the minister provided full and frank disclosureto the Federal Court at the ex parte hearing. The min-ister refused to disclose any of its records. RBC appliedto the Federal Court, and the minister was ordered todisclose the relevant records. The minister partially

complied with this order but refused to disclose recordsrelating to a review of the 10-8 plan by the general an-tiavoidance rule committee. RBC again applied to theFederal Court, this time to compel the minister to com-ply with the order to disclose relevant records. Afteragain being ordered by the Federal Court to disclosethe materials, the minister finally provided records thatmade it clear that the minister had failed to providefull and frank disclosure when the minister first at-tended court on an ex parte basis.

Two other insurance companies were involved in thesame dispute, and the separate cases were consolidated.Regarding the absence of full and frank disclosure, theFederal Court decision (2011 FC 1249) provides (paras.39 and 40):

In my opinion, the Minister fell short of her obli-gation to make full and frank disclosure in tworespects. First, she did not disclose the significantvolume of information that the Insurers had al-ready provided to her before the ex parte applica-tions were commenced.

The second, and more troubling, omission is theMinister’s failure to disclose internal documentsand information suggesting that the 10-8 planscomply with the letter of the Act, if not with itsspirit. These documents — the bulk of which were onlydisclosed to the Insurers after two separate motions —are undoubtedly material and, had they been dis-closed to the Court, could certainly have affectedthe outcome of the ex parte applications. [Empha-sis added.]

Because of the minister’s failure to provide full andfrank disclosure, the Federal Court canceled the judi-cial authorizations obtained by the minister. The Fed-eral Court went on to consider a further basis to cancelthe judicial authorizations — whether the minister hadacted with an improper purpose (paras. 59 and 62):

I do not believe that the Minister’s central pur-pose in issuing the requirements is sufficientlytied to her valid audit purpose. Contrary to theMinister’s pretension, I did find evidence that thetargeted audit of specific 10-8 plan holders wasnot only done to test the reasonableness of the

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Reprinted from Tax Notes Int’l, March 11, 2013, p. 913

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TAX NOTES INTERNATIONAL March 11, 2013 • 1

10% payable interest rate or the possible applica-tion of the GAAR but to send a message to theindustry. I am not satisfied that the Minister’s attemptto ‘‘send a message’’ is a valid enforcement purpose suchthat subsection 231.2(3)(b) of the Act is satisfied or thatthis goal is sufficiently connected to the Minister’s validaudit purpose. [Emphasis added.]If, as the Minister’s delegates claimed in the in-ternal emails, ‘‘Policyholder taxation is an arealong overdue for attention,’’ then the manner inwhich it should receive this attention is throughlegislative amendment. It is a misuse of the Min-ister’s powers — powers which the Courts haverepeatedly called ‘‘intrusive’’ — to use section231.2 to pursue policy objectives rather than toenforce tax obligations. It was not open to the Minis-ter to seek ex parte authorization under the pretence ofverifying compliance with the Act when her true purposewas to achieve through audits what the Department ofFinance refused to do through legislative amendment.[Emphasis added.]The minister appealed the Federal Court’s decision,

arguing first that her failure to provide full and frankdisclosure was not a reason to cancel the judicial au-thorizations. The FCA rejected this argument (paras.28, 29, and 32):

Under the Minister’s interpretation, the Ministercould withhold important information from theauthorizing judge under subsection 231.2(3) —information that would have caused the authoriz-ing judge to exercise the discretion to deny autho-rization — but on a review under subsection231.2(6), that same judge must uphold the autho-rization if he or she finds the two statutory pre-conditions to be met. The judge — despite know-ing of the non-disclosure of importantinformation that would have caused her to denyauthorization — is nothing more than a cipher,powerless to act, forced to leave the ill-gotten au-thorization in place.On the Minister’s interpretation, the authorizingjudge could be induced to grant an authorizationon the basis of bald lies but, on review, if thestatutory preconditions are met, that same judge,having discovered she was deceived, can do noth-ing about it.In effect, the Minister says that subsections231.2(3) and 231.2(6) constitute a complete code,ousting the Court’s ability to redress such anabuse of process. I disagree.The minister also argued that the Federal Court

erred in finding that the minister failed to provide fulland frank disclosure. The FCA disagreed, noting thatthe Federal Court concluded that the minister hadwithheld information from the court such that ‘‘theCourt was not in a position to appreciate the full con-

text in which the Minister brought the ex parte applica-tions’’ and, in reaching this conclusion, specificallyidentified the following categories of material facts thatwere not disclosed to the court on the ex parte applica-tions:

• the Department of Finance’s refusal to amend theIncome Tax Act to address outdated provisions;

• information contained in an advance income taxruling request — information that was relevant todetermining whether there was compliance withthe ITA;

• the Canada Revenue Agency’s decision to ‘‘send amessage to the industry’’ by refusing to answer anadvance income ruling request and to take mea-sures to chill the 10-8 plan business, in part byundertaking an ‘‘audit blitz’’; and

• the Canada Revenue Agency’s GAAR committeehad determined that the 10-8 plans likely com-plied with the letter of the ITA, if not the spirit.

A further argument advanced by the minister wasthat the Federal Court erred in law because there was avalid audit purpose. The FCA did not agree that therewas such an error (para. 43):

The Federal Court did find that a valid audit pur-pose existed, but it found it to be a secondary orsubservient purpose to the primary purpose ofchilling the respondent’s business concerning the10-8 plans. Based on evidence before it, the Fed-eral Court found that the Minister’s ‘‘primarygoal’’ was to chill this business — a purpose thatwas not ‘‘sufficiently tied to her valid audit pur-pose’’ — and the Federal Court was ‘‘not satis-fied that the requirements [were] actually neces-sary for the Minister to verify compliance withthe Act’’.The FCA noted that even if the Federal Court had

concluded that there was a valid audit purpose, theFederal Court had discretion to cancel the authoriza-tions based on the minister’s nondisclosure of relevantinformation. The FCA concluded that the FederalCourt had properly exercised that jurisdiction; the Fed-eral Court identified that the cancellation of authoriza-tions is sometimes necessary to deprive the minister ofan ‘‘advantage improperly obtained’’ (paras. 29-30) andconcluded that in this case, the culpability of the min-ister was significant: The nondisclosure was ‘‘undoubt-edly material’’ and ‘‘could certainly have affected theoutcome of the ex parte applications’’ (paras. 39-40 and44-45).

Finding no error by the Federal Court, the FCAdismissed the minister’s appeal. The minister has untilApril 22 to seek leave to appeal to the Supreme Courtof Canada. ◆

♦ Patrick Lindsay, Borden Ladner Gervais LLP, Calgary

COUNTRY DIGEST Reprinted from Tax Notes Int’l, March 11, 2013, p. 913

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2 • March 11, 2013 TAX NOTES INTERNATIONAL