Accountant’s Draft Due Diligence Report Subject to Production

Section 231.1 of the Income Tax Act (“ITA”) provides the Canada Revenue Agency (“CRA”) with broad powers to examine records of taxpayers that may be relevant for audit and for the administration or enforcement of the legislation.   If a taxpayer fails to provide the required information, the CRA may seek a compliance order from the Federal Court (“FC”) pursuant to section 231.7(1).  (Parallel provisions in the Excise Tax Act are sections 288 and 289.1.) 

As section 231.1(a) says “any document of the taxpayer or of any other person that relates or may relate to the information that is or should be in the books or records of the taxpayer or to any amount payable by the taxpayer”, what is the legal test for relevance?  In The Minister of National Revenue v. Atlas Canada ULC (2018 FC 1086), the FC confirmed that the Minister is only required to meet the very low threshold for relevance in respect of production of documents.

On the facts of Atlas, Atlas was being audited by the CRA.  The CRA brought an ITA s. 231.7 application to obtain a draft “due diligence report” prepared for Atlas by Ernst & Young, relating to a proposed acquisition transaction (the “Report”).  Altas refused to provide the Report on the basis that the CRA had not established its relevance of it, and that the Report was protected by solicitor-client privilege.

The matter was heard in the FC, and centered on prior jurisprudence in the following three cases:  Saipem Luxembourg,  Amdocs, and Fraser Milner Casgrain LLP.  There the courts had previously determine that the test for relevance was simply whether the document might “be relevant in determining a taxpayer’s tax liability”, not whether the document was relevant to any specific issue under audit.  In Atlas, both parties agreed with the low threshold of relevance test, but diverged on whether the CRA had met that threshold.

After considering the evidence, the FC accepted the CRA position that the Report was prepared for purposes of a transaction that was subject to audit, and that was enough to meet the low threshold of relevance.

In dealing with Atlas’s submission that the Report was protected by solicitor-client privilege, the FC considered Redhead Equipment v. Canada (Attorney General), which indicated that in certain circumstances, solicitor-client privilege could apply to a document generated by a third party (e.g. an accountant) – for example, where an accountant was engaged to assemble information provided by the client and explain the information to the solicitor.

After reviewing the evidence, the FC concluded that although the information in the Report also informed the giving of legal advice by Atlas’ lawyers, the dominant purpose of the Report was to inform the business decision (i.e., whether or not to proceed with the transaction).  The FC, therefore, concluded that the Report was not subject to solicitor-client privilege.  In the end, the FC issued the compliance order, compelling Atlas to produce the Report to the Minister.

By way of commentary, there is now an abundance of caselaw in this area supporting the CRA’s efforts in “data mining” and obtaining taxpayer records prepared and/or held by third parties.  The CRA has also published a communiqué AD-19-02R, “Obtaining Information for Audit Purposes” (June 3, 2019), setting out its administrative policy in this respect.  

Rather than being left in the unenviable position of having to challenge the CRA’s efforts to obtain these types of records after-the-fact, it may be advisable for a taxpayer to spend more time at the front-end planning for protection of their tax sensitive information. 

In a multi-disciplinary team involving both lawyers and accountants, it is quite possible to obtain this type of protection, particularly where the lawyers are running the show, and perhaps directly engaging the work of accountants and other third-parties.  In these cases, the criteria for establishing solicitor-client privilege (as set out in Redhead, supra) can often be squarely met, and the work product prepared by the accountants fully protected – and fully insulated from possible disclosure to the CRA (and rightly so).  Solicitor-client privilege is sacrosanct. 

Remember:  when it comes to tax matters, the cost of prevention is usually always cheaper than the cost of the cure! 

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