On March 30, 2017, the Federal Court of Appeal (“FCA”) rendered a taxpayer-friendly decision in BP Canada Energy Company (“BP”) with important implications for companies required by law to prepare audited financial statements. In brief, the FCA held that the CRA’s audit powers do not authorize general and unrestricted access to a corporation’s tax accrual working papers (“TAWPs”).
As a publicly traded company, BP was required to prepare audited financial statements in accordance with GAAP. This included evaluating potential liability for future tax exposures and establishing related financial reserves as necessary. The underlying tax analysis is described as TAWPs: accounting documents contemplating uncertain tax positions taken in tax returns and opinions on the likely outcome if the CRA challenged the filing position. The dispute before the Courts started with a CRA audit during which the CRA sought copies of BP’s TAWPs. Obviously, from the CRA’s perspective, TAWPs are a “roadmap” through the “soft spots” in a taxpayer’s return.
BP’s refusal to turn over all of the requested information led to a contested “compliance order” application before the Federal Court (“FC”). The FC held that the TAWPs must be disclosed to the CRA, but fortunately for BP (and all entities producing audited financials) the FCA reversed the FC decision and held that BP’s information did not have to be disclosed.
While a Crown appeal to the Supreme Court of Canada is possible, for the time being taxpayers’ analyses of their tax risk cannot be conscripted against them without restriction by a CRA auditor and the short-lived trend towards “self-auditing” has been limited if not terminated.
The FCA’s analysis commenced with an overview of the nature and purpose of TAWPs:
- TAWPs are created by or for independent auditors to assist in the process leading up to the certification of financial statements prepared under GAAP;
- The obligation to issue financial statements certified by independent auditors is imposed by provincial securities legislation;
- TAWPs identify uncertain tax positions and provide a basis for financial reserves to enable independent auditors to certify that the statements fairly and accurately reflect the financial situation of the company; and
- Consequently, TAWPs identify tax positions that may be successfully challenged in the future, an opinion as to the likely outcome and an amount of a reserve (which would be re-evaluated each year).
BP’s TAWPs identified:
- Tax issues that might be challenged by the CRA;
- The underlying analysis leading to the selection of issues as “uncertain”;
- The tax risk quantified as amounts and related interest that could be assessed; and
- The aggregate reserves for the tax-related contingent liabilities for the year in question.
The FCA agreed with the FC that ss. 231.1(1) of the Income Tax Act (Canada) (“ITA”) is broadly worded. For the purpose of administering and enforcing the ITA, the provision allows the CRA access to documents that relate or may relate to information that is or should be in the books or records of a taxpayer. Using TAWPs as an audit roadmap appears to be an authorized purpose, based on a literal interpretation of the statutory provisions. However, this conclusion was not determinative: the real issue was whether ss. 231.1(1) allowed general and unrestricted access to TAWPs. In this regard, BP was decided on the particular facts of the situation and the manner in which the CRA audit was conducted, summarized as follows:
- Initial CRA enquiries for 2005 led to a request for BP’s working papers for certain accounting entries;
- BP produced redacted TAWPs that showed “tax at risk” amounts associated with uncertain tax positions for 2005 through 2007;
- The CRA auditor adopted the view that the tax at risk amounts were materially larger than the proposed audit adjustments so disclosure of the uncertain tax positions was sought;
- However, it was later demonstrated that the opposite was true – BP’s tax at risk amounts were smaller than the audit adjustments determined by the CRA auditor; and
- Nonetheless, the CRA auditor continued to demand BP’s information to complete the 2005 audit and to expedite the auditing of later years.
The FCA characterized the situation as one in which BP put to rest concerns about the initial apparent gap between BP’s “tax at risk” and the CRA auditor’s conclusions. Thus, the FCA described the CRA’s continued request for BP’s TAWPs as being advanced on the sole basis that TAWPs should be compellable by the CRA without restriction. According to the FCA, the FC’s decision essentially authorized the CRA to use its audit powers for general access to TAWPs without justification. That outcome would require BP to routinely disclose its uncertain tax positions each year – which demand would surely be extended to all taxpayers who are required to produce audited financial statements. The FCA was not willing to interpret ss. 231.1(1) to allow the CRA such broad and unrestricted access to a taxpayer’s own analysis of its tax filing positions.
On the topic of self-assessment versus self-audit, the FCA affirmed that in a self-assessing system the person who generates income is in the best position to compute and report taxable income. However, the self-assessment system does not require taxpayers to compute their tax to include amounts they believe are non-taxable and taxpayers are entitled to file their returns on the basis most favourable to them, which is why CRA auditors must engage in extensive auditing. While auditors are statutorily entitled to all reasonable assistance, this does not extend to conscripting taxpayers’ own analyses against them.
The FC judge did not believe he was ordering BP to self-audit because he was ordering the production of documents that already existed. The FCA called this a distinction without a difference, because BP had no choice but to document its uncertain tax positions each year – thus BP would consequentially be forced to self-audit if its TAWPs were automatically producible.
The FCA also expressed concerns about the impact on financial reporting that may occur if the CRA had unrestricted access to TAWPs. The perceived risk was that corporations subject to external audit may be less candid in disclosing their tax risks if they knew their analyses would essentially be automatically disclosed to the CRA. In the Court’s view, the CRA’s audit powers were not provided for by Parliament to allow the CRA to “ride roughshod over provincial laws”, namely, provincial securities legislation. An interpretation of the CRA’s audit powers should lead to a result that is harmonious with provincial law.
As noted above, a further appeal (this time by the Crown) is possible, but as of the date of this article no leave to appeal has been filed. It will be interesting to see if BP stands and whether the CRA will seek to find circumstances that are distinguishable from this case to demand TAWPs to guide future audits.