A perspective on the BP Canada Inc. judgement at the Federal Court of Canada, including an analysis of the use of solicitor-client privilege and US developments on the same subject matter.

1. tax
®
notes international
Volume 84, Number 10 December 5, 2016■
Why the Law Supports the Canada
Revenue Agency’s Right to Access
Tax Accrual Papers
by Theodora Cudritescu
Reprinted from Tax Notes Int’l, December 5, 2016, p. 921
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2. Why the Law Supports the Canada Revenue Agency’s
Right to Access Tax Accrual Papers
by Theodora Cudritescu
Last year, Canada’s Federal Court of Appeal (FCA)
ruled in BP Canada that the Canada Revenue
Agency is entitled to have access to taxpayers’ tax ac-
crual papers.1 While many have criticized this decision,
there are several strong arguments supporting it.
Public reaction appears to center on the CRA’s rea-
son for requesting the papers, namely to plan its audit
of the company. The general concern is that the deci-
sion may permit the CRA to use taxpayers’ documents
in future audit planning efforts. However, a decision at
the Tax Court level, and even the FCA level, is un-
likely to serve as precedent. Further, it is worth empha-
sizing that the underlying principle in the case is not
that the CRA should be allowed to use these types of
documents to initiate an audit. Rather, the concept is
that the CRA should be able to plan an audit independ-
ently and, during an audit, be allowed to examine
documents that support a reported tax position.
This article argues that the CRA should be entitled
to tax accrual papers, discusses when that entitlement
should arise, and examines the implications of the spe-
cific context in which the BP Canada ruling arose. It
also looks at the solicitor-client privilege and how it
applies to this situation. Finally, this article reviews tax
developments in the United States regarding uncertain
tax positions, a topic that may prove instructive as
Canada and the CRA move forward.
Financial Statements and Tax Practice
How Financial Statements and Tax Laws Interact
UTPs are financial statement figures that represent a
provisional tax liability or tax asset. They are estimates
and are recorded based on the probability of their real-
ization. International Accounting Standard 37 requires
providing for UTPs for international financial reporting
standards purposes. The rationale for computing a
UTP amount is the existence of a future contingency
involving the application of the Income Tax Act
(Canada). It is their occurrence that is in question, not
whether the item itself is considered to be tax or finan-
cial in nature. A UTP is a tax item required to be
financially reported, and therefore both a tax and a
financial item at the same time.
A tax amount, as dictated by the application of a
tax statute, is recorded in a taxpayer’s financial state-
ments due to the probability of its occurrence. Any-
thing recorded in the financial statements is reported
on the tax return, even when the item is merely a prob-
ability. There seems to be confusion among the public
as to the relationship between the amounts reported in
financial statements and the amounts reported on a tax
return, with some people viewing the two as distinct
and unrelated. The added confusion likely arises be-
cause the UTP financial item is derived by application
of a tax statute.
There is a strong correlation between financial state-
ments and tax returns. Tax returns present the financial
statement position as modified to account for differ-
ences in tax law and accounting treatment. Every
1
Canada (Minister of National Revenue) v. BP Canada Energy Co.,
2015 FC 714 (June 5, 2015).
Theodora Cudritescu is the founder of The Tax
Network in Toronto.
In this article, the author defends a recent
judgment by the Canadian Federal Court of
Appeal that held the Canada Revenue Agency
is entitled to have access to taxpayers’ tax
accrual papers.
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3. amount included in the taxpayer’s financial statement,
including amounts on the balance sheet, must be re-
ported on some supplementary schedule of a tax re-
turn; therefore, every financial statement figure has a
corresponding tax return line number assigned to it.
Thus, every financial statement figure can be audited at
any time by the CRA. For example, current tax accrual
is reported on line 101 of T2 Schedule 1 and deferred
tax accrual on line 102 of the same schedule. This
makes the tax accrual a tax return amount and not
solely a financial statement amount, giving the CRA
authority to inspect working papers that determine how
the amount is obtained.
The requirement to report financial statement items
on a tax return is not just an administrative rule. The
ITA requires taxpayers to report financial statement
amounts. The requirement is not to prepare, but to re-
port. This requirement is found in subsection 9(1) of
Division B: ‘‘The taxpayer’s income from business or
property for a taxation year is the taxpayer’s profit from
business or property for the year’’ (emphasis added). In
this context, profit is largely accepted and practiced to
be the amount reflected on a financial statement. Profit
is computed under generally accepted accounting prin-
ciples, such as the IFRS. This turns the financial state-
ment amounts into tax amounts and, for this reason,
the CRA has access to audit and inspect financial
statements at any time.
The Impact of BP Canada
There has been a lot of talk about a court decision
allowing the CRA to inspect financial working papers.
The CRA is entitled to inspect financial papers by the
very nature of its duties; no decision is necessary to
provide it with that access. Taxpayers have always pro-
vided financial statements to the CRA, attaching the
statements to their filed tax returns, and have always
reported financial statement data on a General Index
of Financial Information line. All the CRA needs to
do is quote that line, and it can inspect how the
amount was derived. The fact that financial statements
must be prepared in accordance with financial rules
makes no difference. Tax rules require taxpayers to dis-
close financial statements and the information therein
to tax authorities; this has always been the case. Simply
put, the CRA does not need a court decision to require
financial statement disclosure for tax purposes.
There could be one area of potential concern arising
out of the BP Canada decision, but it becomes less
meaningful when given context. Canada uses a com-
mon law system, which means court rulings can have
future impact. It is not just the final verdict but the en-
tirety of the court’s discussion and arguments that can
be used to promote undesirable future outcomes. That
is what scares people. However, in this instance, that is
also where the CRA’s explanation is informative.
Reading the discussion and arguments presented in
the current case reveals that the decision to provide the
CRA with access to the taxpayer’s financial papers was
made in the context of the CRA planning an audit.
The CRA was not auditing a tax return and requesting
backup for financial information reported, even though
it could have done so, and it would probably be viewed
as a reasonable request. Instead, the CRA specifically
states that the reason it needs the taxpayer’s papers is
to plan a tax audit.
The concern is that this decision may allow the
CRA to make use of taxpayer information in planning
future tax audits. However, it is unlikely that this par-
ticular decision will do that. First, this is an FCA case
and hence has no power of precedent. Future court
cases cannot rely on BP Canada, including the CRA’s
cited reason for its request, unless the decision is up-
held by the Supreme Court of Canada. If the Supreme
Court agrees with both the decision and the rationale
behind the ruling, there might be cause for concern.
That time has not yet come.
Consider the possibility that this decision is further
appealed to the Supreme Court, which agrees that the
CRA should have access to the tax accrual papers, but
the judge overturns the reason for the request when
presenting the decision. The Supreme Court might de-
cide the CRA should have access to the tax accrual
working papers, not to plan an audit but instead to in-
spect the UTP amounts reported on the tax return.
When cases are decided by the Supreme Court, they
establish common law. Hence, judges are very particu-
lar about the details of the case and not just the ulti-
mate decision. Every argument expressed in the Court
can be quoted in a future case. But that isn’t the case
with the FCA. At that level, judges may be less fo-
cused on the proceedings than the final decision.
Another reason why concern over BP Canada should
be muted is that the CRA should have access to tax
accrual papers as part of its regular investigations. If
(as discussed below) the Canadian tax requirements
follow the U.S. system, then UTP paperwork will be
available to the CRA by other means. The CRA will
be able to use the papers for audit planning purposes
without the taxpayer’s knowledge. Ultimately, the CRA
is likely to have access to the papers; its reason for
wanting the documents becomes less meaningful.
Solicitor-Client Privilege
Some commentators have suggested that the
solicitor-client privilege could be used to protect tax
accrual papers from CRA examination. Taxpayers
should understand the substantive and procedural as-
pects of the privilege in order to benefit from its appli-
cation.
The powers of the Minister of National Revenue
(MNR) and the rights of taxpayers can be found in
Part XV of the ITA, ‘‘Administration and Enforce-
ment,’’ which contains the section under dispute in BP
Canada. In this case, the MNR asked the court to apply
section 231.7(1) of the ITA. This section can be used
to compel a taxpayer to provide documents, but Part
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4. XV also allows the judge to protect the taxpayer from
the production requirement if the judge finds the docu-
ment is protected by solicitor-client privilege within the
meaning of Part XV. It is important to emphasize that the
privilege is specifically defined in the ITA. The general
rules governing the legal practice privilege may not be
the same as those under the ITA. Professionals must be
careful not to confuse the two.
Solicitor-client privilege is defined in subsection
232(1) of the ITA as a right ‘‘that a person has in a
superior court in the province where the matter arises
to refuse to disclose an oral or documentary communi-
cation on the ground that the communication is one
passing between the person and the person’s lawyer in
professional confidence.’’
Notable points in this definition include that:
• the right to the privilege arises in superior court;
• it applies to a communication between a taxpayer
and its lawyer specifically; and
• the communication needs to be one of profes-
sional confidentiality.
While a privileged communication must be between
the company and a lawyer (not an accountant), not
every exchange between a taxpayer and its lawyer is
confidential.2 The procedures for invoking the privilege,
as well as the recourse available, are found in sections
232(3.1) and 232(4) of the ITA. The solicitor-client
privilege must be claimed by a lawyer and requested in
superior court. Once the claim is made, the CRA may
not examine the document(s). The disputed docu-
ment(s) will be made available to a court in a sealed
package for examination, and a judge will examine the
facts to determine whether such privilege applies.3
It is important to emphasize that the right to refuse
to disclose information to the CRA in accordance with
the privilege rests with the lawyer. In other words, a
taxpayer itself cannot assert the solicitor-client privi-
lege. As Canadian tax practitioner Gloria Geddes
notes:
Where possible, a lawyer should invoke the seal-
ing provisions in subsections 232(3) and (3.1) in
preference to relying on the statutory defence of
solicitor-client privilege in subsection 232(2). The
defence requires the lawyer to prove that he or
she had reasonable grounds to believe that the
document was privileged; failing this, the lawyer
is subject to prosecution. If a court finds that a
document is not privileged, the lawyer may be in
the difficult position of having to show reason-
able grounds for believing the document was
privileged. This issue should not arise if the docu-
ments are sealed in accordance with the statutory
procedures in the Act until they are produced to
a judge who determines whether solicitor-client
privilege protects them from disclosure.4
Further, for privilege to apply, the communication
must be provided and sought for the purpose of
obtaining legal advice, not any other purpose.
Geddes provides the following useful guidelines for
establishing whether a solicitor-client privilege exists:
In determining whether the document is privi-
leged at common law, a lawyer must address the
following questions:
— Is the document a communication or inciden-
tal to a communication?
— Is the communication between the lawyer and
the client or through agents of the lawyer or
the client?
— Is the communication made for the purpose
of seeking or giving legal advice?
— Is the communication intended to be confi-
dential?
Turning to BP Canada, the first thing to note is that
it is not clear that the disputed documentation passed
between the taxpayer and its lawyers as opposed to any
other party. Even assuming that it did it is not clear
that the lawyers properly requested privileged treatment
in accordance with section 232(1) of the ITA, nor is it
clear that the privilege was actually established and
granted by a judge.
Furthermore, BP Canada is refusing to disclose ac-
counting working papers used to compute uncertain
tax positions. As the taxpayer itself asserts, those re-
cords are not prepared in accordance with law, but
rather as dictated by accounting standards. Therefore, it
will be very difficult to argue the communication con-
stitutes legal advice, even if it was part of a lawyer-
client interaction. In short, the substance of the docu-
ments is not legal in nature. It is also difficult to view
accounting records as a true communication in accord-
ance with the ITA’s privilege rules.
Additional Support From Canadian Courts
The following cases5 and their conclusions further
support the argument that the CRA may request
records like those at issue in BP Canada:
2
See also Belgravia Investments Ltd. v. R., [2002] 3 C.T.C. 482
(FCTD), in which mere possession of a document by a lawyer
does not make it privileged, and not all communications are
privileged.
3
Once established, the privilege will continue to apply unless
it is waived. See Geddes, ‘‘The Fragile Privilege: Establishing and
Safeguarding Solicitor-Client Privilege’’ 47(4) Canadian Tax Jour-
nal 799 (1999).
4
Id.
5
Stikeman Income Tax Act Annotated 2014 — 56th edition
(2014).
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5. • MNR v. Cormack Securities Inc., [2012] 3 C.T.C. 49
(FC), which suggests section 231.2 permits fishing
expeditions to facilitate the MNR’s access to
information;
• London Life, cie d’assurance vie v. Canada (A.-G.),
[2010] 1 C.T.C 150 (FC), which holds there is no
obligation for the MNR to show reasonableness of
proceeding by way of requirements; and
• Tower v. MNR, [2003] 4. C.T.C. 263 (FCA), hold-
ing there is no policy reason to elevate accountant
confidentiality to level of privilege.6
Tax Reporting of UTPs in the U.S.
The tax authorities of other jurisdictions, including
the United States, are able to scrutinize UTPs. The IRS
has made significant progress over the past few years in
establishing rules for U.S. companies to report UTPs
for tax purposes. Financial statement UTP amounts are
specifically reported on a tax form to the IRS. Since it
is reported on a tax form, the IRS can subsequently
audit the amount, without the need to demonstrate
how the financial statement figures are tied to income
tax reporting or how the request comports with the tax
law. The IRS has made significant strides in this area
in terms of tax reporting and agency reviews, as well
as educational memoranda from the agency.
Beginning in tax year 2010, the IRS began request-
ing that certain corporations7 file Schedule UTP (Form
1120) to report financial statement reserves (or accru-
als) with respect to uncertain tax positions. Working
papers for uncertain tax positions are now examined
and requested by the IRS on a regular basis in support
of Schedule UTP.8 Effective tax year 2014, the IRS
lowered the asset threshold, above which companies
must file the form, thus expanding the UTP reporting
scope and increasing the scrutiny of UTPs.9
Announcement 2010-76, issued to the public by the
IRS in October 2010, and IRS directives issued to IRS
personnel in the Large Business and International Divi-
sion (also available to the public via the IRS website)
address the planned treatment of UTPs. Although
titled in part, ‘‘Policy of Restraint,’’ Announcement
2010-76 makes it clear that UTPs must be identified by
covered corporations in the course of preparing finan-
cial statements under applicable accounting standards,
including FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an Interpretation of
FASB Statement No. 109 (FIN 48).10 Corporations that
file Schedule UTP are required to report for each UTP
for which the corporation or a related entity has
recorded a reserve in its financial statements.
Conclusion
Canada has not established a regular reporting pro-
cedure dealing with UTPs. Given the response it has
created, BP Canada may be the first time the CRA
looked at UTPs. Contrary to the U.S., this is not an
issue Canadian taxpayers are accustomed to seeing,
and they are not used to responding to these requests.
Notably, if the BP Canada case is further appealed to
the Supreme Court of Canada, then the resulting deci-
sion would serve as legal precedent for the treatment of
UTPs. ◆
6
Based on legal research, it seems an ‘‘agency’’ relationship
may be considered for establishing solicitor-client privilege in the
case of an accountant, where communication was passing be-
tween the accountant (on behalf of the taxpayer) and the lawyer.
Again, the aforementioned considerations (lawyer’s onus and
legal advice purpose) need to be applied to establish privilege. See
Geddes, supra note 3.
7
Corporations that issue audited financial statements or
whose tax positions are included in audited financial statements
and that meet an asset threshold. IRS, 2015 Instructions for
Schedule UTP (Form 1120) — Uncertain Tax Position State-
ment.
8
‘‘(3) Under current procedures, examiners request tax recon-
ciliation workpapers as a matter of course.’’ IRS Announcement
2010-76, 2010-41 IRB 432 (citing Internal Revenue Manual
4.10.20.3).
9
See discussion at https://www.irs.gov/businesses/
corporations/uncertain-tax-positions-schedule-utp.
10
Id. (Note: The relevant portions of FIN 48 are now con-
tained in Accounting Standards Codification subtopic 740-10,
Income Taxes. FASB ASC 740-10.)
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