Articles November 2005

The standard rule that comes from the Income Tax Act (“ITA”) and the Supreme Court of Canada in the Jarvis decision is that auditors must be given broad powers in administering the tax regulatory scheme and the ability to inspect all records which may be relevant to the preparation of these returns.

Objectively, the ambit of documents relevant to the preparation of tax returns is quite extensive. The CRA sets out its position at Information Circular IC71-14R3. The Agency feels that an audit may extend to examination of the taxpayer's ledgers, journals, bank accounts, sales invoices, shipping and receiving records, purchase vouchers, expense accounts, inventories, investments, agreements, contracts, appointment books, share records and minutes.

In a recent BC decision (Egmond), the CRA required information from a taxpayer which had the effect of disclosing his client list. The taxpayer failed to provide the information requested, and he was convicted for that failure pursuant to section 238 of the ITA. The BC Court of Appeal advised that the CRA's request dealt with the provision of information respecting Mr. Van Egmond's own tax liability, which was permissable and the fact that other names would be exposed was incidental.

Now that I’ve scared you, here’s what I recommend.

Get involved. Ask the auditor which years are being examined. How long do they anticipate the audit will last? Who are the people involved in the audit. Get the name of the field auditor, supervisors and technical experts. Get the auditor to reduce all information requests to writing. In other words, get information from the auditor before you start giving out information about your clients. Evaluate the auditor’s requests for breadth and ease of compliance. I’ve seen some audit requests that amount to “give me all of the documents in your office.” Overly broad requests are just not practical. You are allowed to tell an auditor that the request is too broad. If they are unwilling to refine such a request you should complain to their boss. Sometimes the CRA needs to be reminded that an advisor is running a business. The CRA’s policy as set out in the Audit Techniques Handbook(at 14(47)(5.2) for those of you who are looking) is to only request what is necessary for immediate audit purposes and to be considerate of a taxpayer’s business operations.

Next, I am very reluctant to let any client documents leave my office. If an auditor wants to take something with them, my automatic response is “you can look at it here; would you like a coffee?” If a document does go out, I want to know why it has to leave my office and I ask for documentation (the CRA has a form) showing that the Agency has taken the document. I ask for the document to be returned by a specific date. I also want to know if it has been copied.

One thing advisors do not do enough is ask auditors why they are interested in a particular client. Audits rarely happen without reason. The dismay an advisor feels when confronted with a CRA letter requesting a bushel of documents should be tempered by the knowledge that the advisor is likely reading a form letter. Some of the material requested may not even be necessary. Asking an auditor what triggered an audit is quite reasonable. For example, a client’s income may have dropped to nil or large losses may have shown up on a tax return. An advisor may be able to get to the heart of the audit quickly and efficiently just by asking “what’s up?” If an auditor is not forthcoming, be more than normally cautious in your dealings.

I suppose expense receipts for business trips to Disneyworld might qualify as apocalyptic documents, but what auditors really like to find are tax opinion and planning letters. If a client is not going to hire a tax lawyer to give tax advice then these letters are not privileged. The auditor has a right to demand such letters if they are prepared by a non-lawyer since they may assist in the determination of tax liability. The only realistic way I can see of dealing with this type of document is to destroy it before an audit takes place. Of course, destroying such letters after an audit starts might cause minor problems like those experienced by the Enron advisors. Destroying documents before an audit starts is also problematic where a client has not taken an advisor’s advice. If the client does something wacky the advisor will want some proof that they did not advise that course of conduct. Liability insurers tend to get upset when they find out that a protective planning letter was shredded.

The answer to the question posed in the first paragraph is that taxpayers are obligated to share relevant information with an auditor. Try to figure out what is relevant instead of panicking. You’ll be fine. It’s only a tax audit. What could go wrong?

-- J. Andre Rachert

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