Tax & Trade Blog
An Auditor's Standard of Care
For years it was an open question as to whether or not a Canada Revenue Agency ("CRA") auditor owed a duty of care to a taxpayer under audit. In the recent case of Leroux (2014 BCSC 720) the Supreme Court of British Columbia (BCSC) concluded that, on the facts, the CRA auditors owed a duty of care to the taxpayer. But what is the appropriate standard of care a CRA auditor must meet to avoid a finding of negligence?
Briefly, Leroux was the case of a taxpayer who was assessed by the CRA, had the majority of his assessment overturned, and then brought a civil action for damages against the CRA. The BCSC determined that a duty of care was owed to the taxpayer based on recent SCC cases about when a public official owes duty of care. Paralleling the standard imposed on police officers in Hill v. Hamilton-Wentworth Regional Police Services Board (2007 SCC 41), the BCSC stated that the standard of care which was owed to the taxpayer was "that of a reasonably competent tax auditor in similar circumstances".
Such a standard should not be a surprise to the CRA because one would presume that the CRA would expect that all of its auditors would meet the threshold of a "reasonably competent tax auditor". The CRA often speaks of the high quality of its auditors, and how few of their audits are
overturned on objection or appeal. This also accords with the Taxpayer's Bill of Rights which includes a "Right to expect the CRA to be accountable" and a "Right to be treated professionally, courteously, and fairly".
The BCSC found that the CRA auditor met the standard of the "reasonably competent auditor in similar circumstances" in the GST audit and in the characterization of the receipts (income versus capital) for income tax purposes; however, the BCSC also held that the standard was not met with respect to the imposition of penalties and the assessing of statute barred years - two areas which often arise in tax audits.
The BCSC found three specific areas of negligence.
First, the CRA auditor was found to have applied the wrong standard for imposing penalties. A penalty was imposed under section 163(2), which requires the taxpayer either made a false statement "knowingly" or "under circumstances amounting to gross negligence". However, the auditor's Penalty Recommendation Report said the taxpayer "ought to have known" – which he BCSC held was insufficient foundation for a section 163(2) penalty. Accordingly, the CRA auditor did not meet the standard of care of a reasonably competent auditor on this issue.
Secondly, the CRA auditors applied penalties to all taxes assessed in all years. The BCSC noted that this was inappropriate because the penalty should only apply to the issue where the CRA auditor felt the taxpayer had been grossly negligent – not on the entirety of the tax assessed. In other words, penalties should be considered by CRA auditors and imposed on an "issue by issue" basis rather than being applied "holus-bolus". After noting the CRA auditor "thought this did not matter" when imposing penalties, the BCSC found the CRA auditor did not meet the standard of care of a reasonably competent auditor on this issue.
Lastly, the BCSC held that it was unacceptable that the taxpayer was threatened with "gross negligence" penalties if he did not sign a statute barred waiver for 1993. The BCSC found the auditor did not meet the standard of care of a reasonably competent auditor and should "not have threatened the taxpayer with a punitive quid pro quo." Additionally, the BCSC noted that because the tests for gross negligence requires higher threshold than for opening up of statue barred years, the auditor should not have equated the two tests.
We are particularly hopeful that the CRA will take note of the BCSC's comments regarding the conduct of its auditors when dealing with penalties and requests for waivers. We understand from speaking to other practitioners that the approach taken by the CRA auditors in Leroux is not uncommon. In our experience, auditors typically apply a penalty to the entire assessment, rather than on an "issue by issue" basis. Likewise, we have seen a CRA auditor on a recent file threaten and ultimately impose gross negligence penalties when the waivers offered were not to their liking. It is a breath of fresh air to see that a judge has found these common audit actions to be in appropriate.
If such situations arise in the future, practitioners should consider raising the BCSC's standard of care comments with the auditor and/or with senior CRA officials as may be required. Irrespective of whether a duty of care is owed to all taxpayers in all circumstances, we would expect the CRA's position to be that all of its auditors must meet the standards of a reasonably competent auditor in all audits conducted and