Coping with tax controversy in Canada
The Canada Revenue Agency (CRA) is narrowing its audit focus, and will be paying more attention to large taxpayers in specific industries undertaking higher-risk transactions in 2013. Paul Lynch and Gerald Grenon, of KPMG, look at how taxpayers should respond.
International Tax Review: What advice would you give to companies operating in Canada about how to reduce the risk of becoming involved in a tax dispute with the CRA?
Paul Lynch (PL) (pictured right): The CRA is moving from 100% audit coverage of large taxpayers – groups with revenues exceeding C$250 million ($252 million) – to a risk-based audit process targeting perceived higher-risk taxpayers and higher-risk issues.
Factors that will attract the attention of the CRA include participation in aggressive tax planning, unusual or complex transactions, major acquisitions or disposals and international transactions – both structuring and transfer pricing.
Certain industries, perceived as higher-risk by the CRA, also attract attention. These industries include financial institutions, pharmaceuticals, oil and gas and automotive.
Factors that will lower your risk profile with CRA include strong corporate governance over taxes and openness and transparency when dealing with CRA.
CRA is using systems-based risk modelling to identify risks of non-compliance based on comparables to taxpayers in similar industries.
CRA audit staff also carefully review all documents in the public domain including all disclosures to regulatory agencies and all corporate and investor relations documents on web sites.
Although these disclosures are required for corporate reporting purposes, they are also used by CRA to identify items of interest, particularly when tax motivations are mentioned or when tax havens appear to be involved.
When a tax audit commences, it is important to appreciate that CRA auditors have been asked to use all of the legislative powers at their disposal to acquire information. Engaging effectively with CRA through this process mitigates the risks of unwanted audit reassessments.
Obtaining a binding tax ruling or advance pricing arrangement with the CRA is an option and may be advisable when tax certainty is a high priority.
ITR: What options do taxpayers in Canada have to resolve tax disputes with the authorities other than litigation? What are the positives and negatives of these options?
Gerald Grenon (GG): The dispute process typically commences at the audit stage, which can involve review and engagement on numerous issues.
Near the end of the audit process, CRA will issue a letter outlining their proposed adjustments. Through this entire process, taxpayers can work with CRA officials to scope down or eliminate tax adjustments.
Following audit, taxpayers can use an administrative appeals process. The Appeals Branch is a separate unit within the CRA. Its mandate is to provide a fair and impartial process to resolve disputes.
A settlement process is in place at this stage. Appeals officers often engage in informal settlement discussions and taxpayers can propose settlement offers. These exchanges are typically conducted on a without prejudice basis.
The CRA believes resolving factual disputes in court adds little value to subsequent interpretation of the law by taxpayers or the CRA and therefore encourages settlement of disputes that are factual in nature, rather than seeking litigation.
Disputes involving interpretive issues can also be settled, but this is less likely if the issue is significant for CRA compliance operations. It is also more difficult for the CRA Appeals function to settle issues that are contrary to CRA’s public pronouncements on tax matters.
Alternative dispute resolution mechanisms such as mediation have been reviewed by the CRA but have not been adopted and thus no mediation or arbitration approaches are available regarding domestic tax issues in Canada.
Formal litigation is the next stage in the dispute resolution process. However, approximately one third of appeals filed are settled before the case hearing. In some situations, strategically planning to initiate litigation, but with a view to settlement, is an attractive option.
ITR: Are you seeing any trends in the types of dispute cases the CRA is taking up, and those where it is succeeding in the courts?
PL: CRA is taking up cases on the goods and services tax (GST) and the harmonised services tax (HST) front and the income tax front.
On the GST/HST side, CRA is looking at cases involving allocation of input tax credits for situations involving mixed taxable and exempt supplies, transactions of financial services, imported supplies and in the area of reinsurance.
On the income tax side, CRA is focusing on reorganisations, transactions involving losses, international structures involving cross-border capitalisation and repatriation.
For multinationals, transfer pricing generates the most proposed reassessments. Transfer pricing also accounts for many of the largest cases in terms of potential reassessments by dollar value.
Relatively few GST/HST cases have proceeded to court but we expect more in the future.
Transactions involving the creation or use of losses are more frequent in the court system, and CRA has recently been successful at the Federal Court of Appeal on three cases involving the creation of losses on common shares through value-shifting dividends of preferred shares and the transfer of the now valueless common shares to related parties.
Taxpayers have generally been successful in treaty-shopping and other international transactions cases, but recently lost a significant cross-border capitalisation case in the Supreme Court of Canada.
Relatively few transfer pricing cases have proceeded to court so far, likely owing to dispute resolution available through Canada’s network of tax treaties.
Cases involving Canada’s general anti-avoidance rule (GAAR) continue to be of interest to taxpayers and the CRA, with the CRA successful in the most recent GAAR case heard by the Supreme Court. However, there is no clear trend for GAAR cases generally.
ITR: What do you think taxpayers can expect from the CRA in future?
GG (pictured below): The CRA likely faces audit staff reductions as part of a broader government cost reduction agenda.
CRA’s new “Approach for Large Business Compliance” is expected to continue, with CRA better identifying and targeting taxpayers and issues that are most at risk for non-compliance while undertaking fewer compliance actions in other areas.
CRA will also be more aggressive in information gathering domestically and expanding information sharing with other tax jurisdictions through tax treaty mechanisms and additional tax information exchange agreements.
Recent legislative changes have attempted to close what the government perceives as unfairness in the tax system and we can expect CRA to review taxpayers for ongoing compliance with these new rules. Pursuing perceived aggressive tax plans also remains a high priority.
CRA has indicated it would be open to more real-time dialogue with large taxpayers. However, CRA has also set an objective to become more up-to-date with its audit workloads. This goal, coupled with diminishing resources, does not hold out much hope for a robust facility for real-time exchanges in the near term.
CRA will continue to offer self-service and electronic tools to assist taxpayers to comply with the rules, involving as little interaction with CRA staff as possible, to reduce consumption of CRA’s resources.
Resource constraints are also unlikely to open up any new alternative dispute resolution approaches, although joint audits are being actively pursued.
We expect the government’s litigation strategy will focus more on establishing leading decisions that can apply more broadly to other cases thereby reducing multiple cases of litigation on the same or similar issue.
Paul Lynch (email@example.com) is national leader of KPMG’s tax dispute resolution and controversy practice and Gerald Grenon (firstname.lastname@example.org) is a partner in the firm’s Calgary office, focusing on tax dispute resolution and litigation.