by Stevan Novoselac, John Sorensen and Michelle McBride of Gowling Lafleur Henderson LLP

In a recent decision of the Ontario Superior Court, Lemberg v. Perris,¹ Eric and Valerie Lemberg successfully sued their loyal accountant, Michael Perris (“Perris“), for breach of fiduciary duty.  Over the course of their almost twenty-year relationship, Perris provided tax and accounting advice to the Lembergs and performed their tax compliance work.

Perris advised the Lembergs to engage in a so-called “art-flip” tax reduction scheme.  The Lembergs accepted Perris’ advice and enjoyed their large tax savings.  However, they were reassessed by the Canada Revenue Agency (“CRA“) to disallow all of the benefits they received.  Subsequently, the Lembergs learned that Perris had received a “secret commission”

By Pierre Alary of Gowling Lafleur Henderson LLP 

I.   Introduction 

Sometimes, two is better than one. A company in dire straits can potentially attain success by dividing itself into two separate entities. Whether the issues plaguing the company are financial or philosophical in nature, a separation of the business should be considered by corporations and practitioners alike. In addition to making good business sense, a divisive reorganization, or “corporate divorce”, can be structured to benefit both parties from a tax perspective. In other words, a corporate divorce does not need to be a painful experience. This article will conduct a brief overview of the well-known butterfly transactions, but will primarily focus on an alternative method, the “McMullen Method”, which was approved by the Tax Court of Canada in recent years.

In Comtronic Computer Inc. v. The Queen, the taxpayer who is appealing a GST reassessment is a wholesaler of computer parts with annual revenues of about $65 million. During the five-year period in question, it purchased approximately 15% of its parts inventories from five Canadian companies (the “Vendors”) which appeared to be connected to a single individual. Although the Vendors sent invoices bearing various tradenames and addresses, the taxpayer never suspected anything was amiss. However, following an audit, it was determined that the invoices issued by the Vendors contained GST registration numbers that, while validly issued, had been issued to persons other than the Vendors. As a result, the taxpayer’s claims for input tax credits (ITCs), for GST of approximately $500,000 paid to these suppliers, were denied. The taxpayer was also assessed a 6% penalty.

The taxpayer’s appeals to the Tax Court of Canada and the Federal Court of Appeal were denied on the basis that the legislative requirements for an ITC mandated the use of the GST registration number assigned to the particular supplier. The courts acknowledged that the result can be unfair to a business that pays the GST in good faith reliance on an invoice. However, the courts concluded that the legislative scheme dictated that the unsuspecting business, rather than the government, bears the risk of supplier identity theft and other wrongdoing in GST collection and remittance matters. The courts also stated that businesses must implement risk management systems when dealing with new and continuing suppliers, to identify supplier information that may require further investigation.

While the Court recognized that no online GST registration verification system existed at the time, it determined that there was an ability to verify registration numbers with the Canada Revenue Agency by telephone. The Court found that the taxpayer had not taken any positive steps to verify that the registration numbers provided by the Vendors were correct and denied it relief from the penalty on that basis.

I’ve hear no word yet on whether the taxpayer’s accountant has been attacked for any shortcomings in the advising of this client or in the detection of a material unrecorded liability.

A supplier’s GST registration may be verified at the following site: http://www.cra-arc.gc.ca/esrvc-srvce/tx/bsnss/gsthstrgstry/menu-eng.html. Be sure to keep a printed copy of the verification, and if a segregation of duties is possible, then have the printed verification checked by someone else.

By: Stevan Novoselac and John Sorensen of Gowlings

Introduction

In early June, 2010, the Canada Revenue Agency (“CRA”) released its long awaited administrative policy on gaining access to taxpayer information and documents.  The policy reaffirms the CRA’s position that is entitled to virtually unrestricted access to taxpayer’s information and documents, subject only to solicitor-client and litigation privilege.  As a result, obtaining tax advice from accountants, without involving tax lawyers, puts the confidentiality of the advice, and all of the related information and documents, in jeopardy.

Background

The Income Tax Act (Canada) (“Act”) requires taxpayers to maintain “books and records” to enable taxes payable to be ascertained and to determine other amounts that should have been deducted, withheld or collected.  The Act also confers extremely broad powers on the CRA to access taxpayer information and documents, subject only to the protection of solicitor-client or litigation privilege. 

The CRA first discussed its intention to draft an administrative policy on access to taxpayer information and documents at the Canadian Tax Foundation national conference in 2004 and periodically updated the tax community on the progress of the policy.  As early as 2004, the Canadian Institute of Chartered Accountants (“CICA“) wrote to the Minister of National Revenue (“Minister”) urging that CRA access to accountant’s and auditor’s working papers be restricted to “exceptional and well-defined circumstances”, because untrammeled access would have a chilling effect on communications between taxpayers and their advisors.  The CICA’s position was that if the CRA can pry into taxpayers’ private communications with their advisors, taxpayers will be reluctant to seek advice.  This may deprive corporations and ultimately their shareholders of valuable advice, which jeopardizes the integrity of financial reporting, the audit function and corporate governance.

The New Policy

A pre-publication draft of the new CRA policy was released for comments in late 2008.  Unfortunately, the most troubling proposals in the draft remain in the final policy.  For example, both the draft and final policies state that CRA personnel are authorized to request relevant documents during an inspection, audit or examination for any purpose related to administering or enforcing fiscal statutes, where “any purpose” includes “acquiring information for the purpose of substantiating the taxpayer’s position on a specific issue, and identifying audit issues and concerns with regards to tax at risk.” 

Further, both versions of the policy state that CRA officials are authorized to inspect, audit, review or examine both “the books and records of a taxpayer” and any document of the taxpayer or any other person that relates or may relate to the information in a taxpayer’s books and records.  The phrase “any document” includes accountants’ and auditors’ working papers, including “working papers created by or for an independent auditor or accountant in connection with an audit or review engagement, advice papers, and tax accrual working papers (including those that relate to reserves for current, future, potential or contingent tax liabilities).”  Tax accrual workpapers are essentially a roadmap through all of the “soft spots” in a taxpayer’s tax return, prepared for the purpose of calculating reserves for uncertain tax filing positions.  In the draft version of the policy, the CRA acknowledged that tax accrual workpapers may be requested by auditors to expedite the audit and focus the examination on the most significant issues.  Although this language does not appear in the final version, it is obvious that the reason any tax authority seeks to obtain tax accrual workpapers is to have a guided tour of the taxpayer’s tax planning.