Much has already been written about the proposed addition of section 237.4 to the federal Income Tax Act (“ITA”), which would impose mandatory reporting in respect of “notifiable transactions.” The purpose of this post is not to explain the notifiable transaction regime in any great detail, nor do we intend to address the merits of the underlying tax policy. Instead, the purpose is to set out practice and ethical issues that will arise for lawyers should the proposed changes be enacted.
On November 3, 2022, the federal government announced in a news release that implementation of these rules will be delayed until a bill formally introducing the rules receives Royal Assent. Notwithstanding this delay, the issues set out in this post remain significant for lawyers and their clients.
Brief Overview of the Notifiable Transactions Regime
In brief, mandatory reporting would apply to transactions, or series of transactions, that are designated as “notifiable” or “substantially similar” to a notifiable transaction. As contained in the legislative proposals released on August 9, 2022, the term “substantially similar” includes any transaction, or series of transactions, in respect of which a person is expected to obtain “the same or similar types of tax consequences” and that is “either factually similar or based on the same or a similar tax strategy.” The legislation expressly states that “substantially similar” should be “interpreted broadly in favour of disclosure.”
Disclosure requirements would generally be imposed upon taxpayers who have participated in a notifiable transaction as well as persons, including lawyers, who have provided advice or assistance in respect of that transaction.
According to a Backgrounder released on February 4, 2022, “notifiable transactions would include both transactions that the CRA has found to be abusive, and transactions identified as transactions of interest (i.e., where more information is required to determine if a transaction is abusive).” Significantly, the proposed transactions which would be notifiable are not illegal and not necessarily transactions which a court has found to be abusive under the ITA’s general anti-avoidance rule.
Practice and Ethical Issues for Lawyers
As noted above, the proposed amendments would impose reporting obligations upon lawyers amongst others. Neither the draft legislation nor the Backgrounder contains a finalized list of what would have to be reported but it is anticipated that the information would be extensive. Severe penalties would apply to both taxpayers and lawyers for non-compliance.
The proposed amendments recognize a carve-out for information protected by lawyer-client privilege. Such a carve-out is not an act of generosity – it is simply what the law unequivocally requires. However, precisely what is protected by lawyer-client privilege is not always clear. Therefore, if enacted, lawyers who are advising clients on transactions which are potentially notifiable should pay close attention, at the outset, to identify those communications protected by privilege and to ensure that communications made during the course of a transaction do not create risk that privilege has been waived.
Next, if enacted, lawyers who are advising clients on transactions which are potentially reportable should communicate with their clients to inform them, at the outset, what the lawyer’s disclosure and reporting obligations might be (even if unknown at such early stage). A client whose details might be disclosed to the CRA should know what might be disclosed, under what circumstances, and what risks might flow from such disclosure.
If the proposed amendments are enacted, the result would be a significant intrusion upon and interference with the lawyer-client relationship. Under the threat of significant penalty for non-compliance, lawyers would be faced with a legal obligation to report on certain transactions their clients have participated in. Further, given the uncertainty of what is captured by the phrase “substantially similar”, and in light of the risk of significant penalties for non-compliance, the proposed amendments would create a strong incentive for over- rather than under-reporting (by all parties involved, including clients) in order to avoid the risk of non-compliance.
Given the purpose of the proposed amendments, which is to detect transactions suspected of being abusive, a report from a lawyer could trigger an audit against a client. An auditor could compare the information contained in the lawyer’s report to information provided by the client or other advisor and discrepancies could be interpreted by the CRA unfavourably as against the client/taxpayer.
An audit might result in a taxpayer/client being reassessed for tax, penalties and interest. In some circumstances, auditors may pass information to the CRA’s Criminal Investigations Division, which could lead to criminal investigation, prosecution and conviction. It is therefore possible that a report filed by a lawyer could become a piece of evidence against a client in a criminal prosecution.
These possibilities are not fanciful. A report filed by a lawyer, compelled under the threat of penalty for non-compliance, could result in harm to a client’s interests. This creates the risk of conflict between lawyers and their clients and could undermine the trust and loyalty which is fundamental to the lawyer-client relationship.
In Canada (Attorney General) v. Federation of Law Societies of Canada, 2015 SCC 7, the majority of the Supreme Court of Canada affirmed that “[l]awyers must keep their clients’ confidences and act with commitment to serving and protecting their clients’ legitimate interests. Both of these duties are essential to the due administration of justice” (para. 1). The majority also affirmed that lawyers have a fiduciary duty to guard against conflicts of interest and to avoid “the risk of the misuse of confidential information and the risk of impairment of the lawyer’s representation of the client” (para. 81). Further, a lawyer’s fiduciary and ethical duties have a “constitutional dimension” (para. 83).
In the result, the Court held that it should be recognized as a principle of fundamental justice that “the state cannot impose duties on lawyers that undermine their duty of commitment to their client’s causes” (para. 84). This principle is fundamental to the administration of justice because:
“Clients – and the broader public – must justifiably feel confident that lawyers are committed to serving their clients’ legitimate interests free of other obligations that might interfere with that duty. Otherwise, the lawyer’s ability to do so many be compromised and the trust and confidence necessary for the solicitor-client relationship may be undermined” (para. 96).
The Minister and the CRA will always want greater visibility into the affairs of taxpayers. It is obvious that lawyers will often hold information, some of which is public, some of which is confidential, and some of which is protected by lawyer-client privilege with respect to their clients. However, to compel lawyers under the threat of penalty in the manner that is proposed is an extraordinary step and likely a step that trips over the protections of the lawyer-client relationship recognized by the Supreme Court of Canada.
Rather than face the litigation that the proposed amendments might invite, it is hoped that the government will re-consider the necessity, wisdom and legality of compelling lawyers to operate against the interests of their clients in the manner proposed. Even if it is good tax policy to provide the CRA with greater visibility into certain transactions, which has not been considered in this post, that policy is not justifiably advanced by compelling lawyers to act as state agents against their clients.