A case recently decided by the Federal Court of Appeal reiterates the very high standard of good faith to which the Minister of National Revenue (the “Minister”) must be held when dealing with the courts in the context of an ex parte application provided by the Income Tax Act(“ITA”). For example, the Minister cannot ignore and omit to mention internal evidence which it knows weakens its position, or hide ulterior motives.
Context: Third-Party Information Concerning “10-8” Plans
In Canada (National Revenue) v. RBC Life Insurance Company, 2013 FCA 50 (“RBC Life”)1, the Minister sought authorization under subsection 231.2(3) of the ITA to issue a demand for information from third parties concerning an “unnamed person” or “group”. Prior to issuing such authorization, a judge needs to be satisfied that the person or group is ascertainable and that the information is sought in order to verify compliance with any duty or obligation under the ITA.
Judicial oversight encompasses the process provided by section 231.2 of the ITA, both at the initial ex parte stage and later if there is a review of the initial decision under subsection 231.2(6) of the ITA. Intrusion into the privacy of individuals is a sensitive matter which Parliament appeared to have in mind when it decided to require that the Minister obtain a court authorization confirming the satisfaction of the matters specified in subsection 231.2(3).
In RBC Life, the authorization required RBC Life Insurance Company, Industrial Alliance Pacific Insurance and Financial Services Inc., Industrielle Alliance Assurance et Services Financiers Inc., and BMO Life Assurance Company (the “Insurance Companies”) to produce information and documents relating to certain of their customers who had purchased an insurance product known as the “10-8 plan.”
Briefly, a “10/8 plan” involves investing in a life insurance policy with a view to borrowing against that investment for the purpose of creating an annual interest expense tax deduction. While the interest tax deduction simply results from a circular flow of funds, the interest income earned from the amount invested in the policy is not included in the taxpayer’s income.
First instance Federal Court: the Scope of the Minister’s Disclosure Obligation
The Federal Court initially issued the authorizations to the Minister who, in accordance with the ITA, applied for them on an ex parte basis. When notified about the authorizations under subsection 231.2(4) ITA, the Insurance Companies applied to have them reviewed pursuant to subsection 231.2(5) ITA. The Federal Court sided with the Insurance Companies and cancelled the authorizations obtained by the Minister. Justice Tremblay-Lamer gave two main grounds in her decision of November 1, 2011.
First, she found that the Minister had failed to disclose a significant amount of relevant evidence on the ex parte applications. Among other things:
- Information contained in an advance income tax ruling request, which was relevant to determining whether there was compliance with the ITA;
- The Canada Revenue Agency’s decision to “send a message to the industry” by refusing to answer the advance income tax 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 General Anti-Avoidance Rule (“GAAR”) Committee’s determination that the 10-8 plans likely complied with the letter, if not the spirit, of the Act. The GAAR Committee’s analysis could have been perceived as an acknowledgement that the 10/8 plans could not be successfully challenged in court and that a legislative action would be required to deny the tax benefits.
Second, she found that by virtue of the undisclosed evidence, the Minister had failed to satisfy the condition that the information be sought in order to verify compliance with the Act. Although Justice Tremblay-Lamer accepted that the Minister had a valid audit purpose, she found that this purpose was subordinated to its primary goal, which was to discourage the Insurance Companies’ 10-8 plan business, a business that on policy grounds the Minister disliked.
Federal Court of Appeal: More on the Minister’s Full and Frank Disclosure Obligations
In confirming Justice Tremblay-Lamer’s decision, the Federal Court of Appeal reiterated the importance of the Minister making a full and frank disclosure of all relevant information in the context of an ex parte application under subsection 231.2(3) of the ITA.
The Court first addressed the Minister’s argument concerning the limited jurisdiction of a judge reviewing the grant of the authorization. For ease of reference, subsection 231.2(6) ITA is reproduced here:
(6) On hearing an application under subsection 231.2(5), a judge may cancel the authorization previously granted if the judge is not then satisfied that the conditions in paragraphs 231.2(3)(a) and 231.2(3)(b) have been met and the judge may confirm or vary the authorization if the judge is satisfied that those conditions have been met. (emphasis added)
Essentially, the Minister contended that while a judge ex parte could refuse to grant an authorization even where the above-mentioned conditions were met, a reviewing judge under subsection 231.2(6) ITA did not have that discretion. According to the Minister, the reviewing judge could only verify whether the conditions were satisfied and could not set aside an authorization on the ground that the Minister had not made full and frank disclosure of relevant information on the ex parte application.
Writing for a unanimous Court, Justice Stratas disagreed with the Minister’s interpretation of subsection 231.2(6) ITA. According to Justice Stratas, authorizations under subsection 231.2(3) ITA can be granted where the statutory preconditions are met and where, in the Court’s discretion, the granting of the authorizations is warranted in the circumstances. Therefore, in seeking an authorization under subsection 231.2(3) or 231.2(6),
the Minister could not “leave a judge in the dark on facts relevant to the exercise of discretion, even if those facts are harmful to the Minister’s case” (para. 26, emphasis added).
The Court then addressed another argument put forward by the Minister, i.e. that any relevant non-disclosure or misinformation at the ex parte application stage of subsection 231.2(3) could always be cured by the reviewing judge and that any undisclosed matters should thus be put before the court at this point.
The Federal Court of Appeal disagreed once again with the Minister and stressed that the information can be relevant to the judicial discretion under subsection 231.2(3), not only to the two statutory preconditions.
The next consideration for the Court was whether the Minister had made full and frank disclosure of relevant information on the ex parte application to the Federal Court. The Federal Court of Appeal concluded that the Minister had not demonstrated a palpable and overriding error in Justice Tremblay-Lamer’s findings.
Finally, Justice Stratas considered whether the Federal Court had erred in law by holding that a valid audit purpose, although “secondary”, did not save the authorization (Justice Tremblay-Lamer had concluded that the Minister’s primary purpose had been to discourage the Insurance Companies’ business concerning the 10-8 plans). The Federal Court of Appeal found that even if the Minister had had a valid audit purpose, it was still open to the Federal Court, on review, to cancel the authorizations because of the Minister’s non-disclosure of relevant information.
Government Reaction to the Decision and Potential Impact
It should be noted that the 2013 federal budget proposes to eliminate the tax benefits relating to the commonly named “10-8 plan” by introducing rules for leveraged insured annuities.
Furthermore, in order to streamline the court order process, the 2013 federal budget proposes to eliminate the ex parte aspect with regard to subsection 231.2(3) ITA. Instead, the Canada Revenue Agency will have to give notice to the third party when it seeks a court order from a judge of the Federal Court. As a result, the third party will have the opportunity to make representations at the hearing, thus eliminating the need for an eventual review.
The main message sent by the Federal Courts remains, however, that the obligation to make full and frank disclosure of information relevant to the Court’s exercise of discretion must be taken very seriously. In striking down the authorization previously granted to the Minister pursuant to subsection 231.2(3) ITA for failure to make full and frank disclosure, the Federal Courts clearly relied on their discretion to punish the Minister for having abused the judicial process.
In the words of Justice Stratas, a breach of the obligation “can hobble the Court’s ability to act properly and judicially” and “result in the making of orders that should not have been made” (para. 31), which amounts to an “abuse of process”. This last comment is important since it widens the potential impact of the decision beyond applications under the ITA. As Justice Stratas concludes, “the Federal Courts’ power to investigate, detect and, if necessary, redress abuses of its own processes is a plenary power that exists outside of any statutory grant, an immanent attribute part of its essential character as a court, just like the provincial superior courts with inherent jurisdiction” (para. 36).
Canada (National Revenue) v. RBC Life Insurance Company, 2013 FCA 50
FCA Docket: A-447-11
Date of Decision: February 21, 2013