On February 21 2013 in MNR v RBC Life Insurance Co (2013 FCA 50) the Federal Court of Appeal held that the minister of national revenue could not use her authority to demand information for the primary purpose of 'chilling' a business. The minister was held to have acted improperly by using audit powers primarily for "sending a message to the industry" rather than for a valid audit purpose, and for failing to provide full and frank disclosure to the court.

The decision is an important precedent that helps to set reasonable limits on the minister's authority to demand information. The demand at issue directed RBC Life Insurance Co to disclose records that would identify clients who had an insurance product referred to as the '10-8 plan'.

When the revenue minister demands records that will identify unnamed persons with the intention of auditing those persons, the minister must obtain judicial authorisation before serving the demand. The minister may obtain judicial authorisation on an ex parte basis, meaning that the minister may apply to the court without notifying any other party. The obligation to obtain judicial authorisation is an important safeguard on the privacy rights of the unnamed persons.

The minister obtained judicial authorisation on an ex parte basis and then served the demand on RBC. Concerned for its clients' privacy rights, RBC applied for a review of the minister's ex parte court application to ensure that RBC did not disclose confidential information in response to a demand that was improperly issued and could be cancelled.

To proceed with the judicial review, RBC requested file materials from the minister in order to assess whether the minister provided full and frank disclosure to the Federal Court at the ex parte hearing. The minister refused to disclose any of her records. RBC applied to the Federal Court, and the minister was ordered to disclose the relevant records. The minister partially complied with this order but refused to disclose records relating to a review of the 10-8 plan by the General Anti-avoidance Rule (GAAR) Committee. RBC again applied to the Federal Court, this time to compel the minister to comply with the order to disclose relevant records. After again being ordered by the Federal Court to disclose the materials, the minister finally provided records that made it clear that the minister had failed to provide full and frank disclosure when the minister first attended court on an ex parte basis.

Two other insurers were involved in the same dispute and the separate cases were consolidated. Regarding the absence of full and frank disclosure, the Federal Court decision (2011 FC 1249) provides (paragraphs 39 and 40):

"In my opinion, the Minister fell short of her obligation to make full and frank disclosure in two respects. First, she did not disclose the significant volume of information that the Insurers had already provided to her before the ex parte applications were commenced.

The second, and more troubling, omission is the Minister's failure to disclose internal documents and information suggesting that the 10-8 plans comply with the letter of the Act, if not with its spirit. These documents — the bulk of which were only disclosed to the Insurers after two separate motions — are undoubtedly material and, had they been disclosed to the Court, could certainly have affected the outcome of the ex parte applications."

Because of the minister's failure to provide full and frank disclosure, the Federal Court cancelled the judicial authorisations obtained by the minister. The Federal Court went on to consider a further basis to cancel the judicial authorisations – whether the minister had acted with an improper purpose (paragraphs 59 and 62):

"I do not believe that the Minister's central purpose in issuing the requirements is sufficiently tied to her valid audit purpose. Contrary to the Minister's pretension, I did find evidence that the targeted audit of specific 10-8 plan holders was not only done to test the reasonableness of the 10% payable interest rate or the possible application of the GAAR but to send a message to the industry. I am not satisfied that the Minister's attempt to 'send a message' is a valid enforcement purpose such that subsection 231.2(3)(b) of the Act is satisfied or that this goal is sufficiently connected to the Minister's valid audit purpose.

If, as the Minister's delegates claimed in the internal emails, 'Policyholder taxation is an area long overdue for attention,' then the manner in which it should receive this attention is through legislative amendment. It is a misuse of the Minister's powers — powers which the Courts have repeatedly called 'intrusive' — to use section 231.2 to pursue policy objectives rather than to enforce tax obligations. It was not open to the Minister to seek ex parte authorization under the pretence of verifying compliance with the Act when her true purpose was to achieve through audits what the Department of Finance refused to do through legislative amendment."

The minister appealed the Federal Court's decision, arguing first that her failure to provide full and frank disclosure was not a reason to cancel the judicial authorisations. The Federal Court of Appeal rejected this argument (paragraphs 28, 29, and 32):

"Under the Minister's interpretation, the Minister could withhold important information from the authorizing judge under subsection 231.2(3) — information that would have caused the authorizing judge to exercise the discretion to deny authorization — but on a review under subsection 231.2(6), that same judge must uphold the authorization if he or she finds the two statutory preconditions to be met. The judge — despite knowing of the non-disclosure of important information that would have caused her to deny authorization — is nothing more than a cipher, powerless to act, forced to leave the ill-gotten authorization in place.

On the Minister's interpretation, the authorizing judge could be induced to grant an authorization on the basis of bald lies but, on review, if the statutory preconditions are met, that same judge, having discovered she was deceived, can do nothing about it.

In effect, the Minister says that subsections 231.2(3) and 231.2(6) constitute a complete code, ousting the Court's ability to redress such an abuse of process. I disagree."

The minister also argued that the Federal Court erred in finding that the minister failed to provide full and frank disclosure. The appeal court disagreed, noting that the Federal Court concluded that the minister had withheld information from the court such that "the Court was not in a position to appreciate the full context in which the Minister brought the ex parte applications" and, in reaching this conclusion, specifically identified the following material facts that were not disclosed to the court on the ex parte applications:

  • the Department of Finance's refusal to amend the Income Tax Act to address outdated provisions;
  • information contained in an advance income tax ruling request – information that was relevant to determining whether there was compliance with the act;
  • the Canada Revenue Agency's decision to "send a message to the industry" by refusing to answer an advance income ruling request and to take measures to chill the 10-8 plan business, in part by undertaking an "audit blitz"; and
  • the Canada Revenue Agency's GAAR Committee had determined that the 10-8 plans likely complied with the letter of the Income Tax Act, if not the spirit.

A further argument advanced by the minister was that the Federal Court erred in law because there was a valid audit purpose. The Federal Court of Appeal did not agree that there was such an error (paragraph 43):

"The Federal Court did find that a valid audit purpose existed, but it found it to be a secondary or subservient purpose to the primary purpose of chilling the respondent's business concerning the 10-8 plans. Based on evidence before it, the Federal Court found that the Minister's 'primary goal' was to chill this business — a purpose that was not 'sufficiently tied to her valid audit purpose' — and the Federal Court was 'not satisfied that the requirements [were] actually necessary for the Minister to verify compliance with the Act'."

The Federal Court of Appeal noted that even if the Federal Court had concluded that there was a valid audit purpose, the Federal Court had discretion to cancel the authorisations based on the minister's non-disclosure of relevant information. The Federal Court of Appeal concluded that the Federal Court had properly exercised that jurisdiction; the Federal Court identified that the cancellation of authorisations is sometimes necessary to deprive the minister of an "advantage improperly obtained" (paragraphs 29-30) and concluded that in this case, the culpability of the minister was significant: "The nondisclosure was 'undoubtedly material' and 'could certainly have affected the outcome of the ex parte applications'." (Paragraphs 39-40 and 44-45.)

Finding no error by the Federal Court, the Federal Court of Appeal dismissed the minister's appeal. The minister has until April 22 2013 to seek leave to appeal to the Supreme Court of Canada.

Since this court decision was released, the Canadian government tabled its 2013 federal budget, in which it proposed new rules to deny the tax benefits of 10-8 insurance arrangements after 2013. Also, the 2013 budget proposed eliminating the ability of the minister to obtain a court order for a third party demand on an ex parte basis. This change will streamline the court order process by eliminating the need for review of the court order, since the third party will have to be notified of the application for the court order and would be required to make its representations at the hearing of the application for the court order.

For further information on this topic please contact Patrick Lindsay at Borden Ladner Gervais LLP by telephone (+1 403 232 9500), fax (+1 403 266 1395) or email (plindsay@blg.com).

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.

An earlier version of this update first appeared in Tax Notes Int'l, Volume 69, No 10, March 11 2013, p 913.