Law Times

Page 8 January 14, 2019 • Law Times www.lawtimesnews.com Decisions examine companies' right not to self-audit BY JULIUS MELNITZER Law Times T o many observers, the Federal Court's No- vember 2018 decision in Canada (National Revenue) v. Atlas Tube Can- ada ULC has tempered the en- thusiasm that arose in the busi- ness community following the Federal Court of Appeal's earlier ruling in BP Canada Energy Company v. Canada (Nation- al Revenue). Lawyers say BP Canada lim- ited Canada Revenue Agency's attempts to force taxpayers to "self-audit" by providing the Agency with the very ammuni- tion it needed to challenge tax returns. In its 2017 decision in BP, the FCA ruled that CRA could not force the company to disclose the reserves it was tak- ing for contingent liabilities, a decision widely hailed as es- tablishing taxpayer's right not to be required to self-audit. In Atlas, by contrast, Justice Rich- ard Southcott ruled that CRA could compel taxpayers to dis- close sensitive due diligence re- ports prepared by accountants in the context of an active audit. The due diligence report, prepared by Ernst & Young LLP (Canada) was commissioned by the general counsel of At- las's U.S. parent on the advice of Stikeman Elliott LLP and in the context of an M&A transaction that led to the acquisition of At- las. The evidence was not clear as to whether the actual report, as opposed to the information in the report, was subsequently provided to Stikeman. In the course of the transac- tional audit that followed, CRA requested the report, but Atlas resisted, claiming a lack of rel- evance, solicitor-client privilege and an infringement of the com- pany's right not to self-audit. The Federal Court rejected the argu- ments, and ordered Atlas to turn over the report to CRA. But according to James Mo- rand, a tax partner in Cassels, Brock & Blackwell LLP's Toron- to office, close examination of the two decisions suggests that Atlas does not herald a return to open season for the CRA in seeking corporate records. "This decision does not expand the prior jurisprudence on when the minister is per- mitted to examine taxpayer re- cords," says Morand. "Previous decisions have established, and Atlas followed, the low thresh- old of 'potential relevance' to be met by CRA." In Atlas, Morand says, the evidence was clear that the due diligence report was prepared for the purposes of the transac- tion that was under audit. "That was enough of a nexus for the court to conclude that the threshold had been met," Mo- rand said. According to Morand, Southcott's conclusion that the principal purpose of the report had to be ascertained to deter- mined whether privilege applied was also consistent with prior jurisprudence. Southcott acknowledged that the report was prepared for the dual purposes of "inform- ing both the business decision, whether to proceed with the transaction and at what price, and the decision about how to structure the transaction". The court also accepted "that both purposes were engaged as of the time EYC [Ernst & Young LLP (Canada)] was retained and gen- erated the Report." But Southcott also found that the dominant purpose of the report was not the provision of tax information to Stikeman to inform the structuring of the transaction. "With respect to the deci- sion that JMC [the purchaser and Atlas' subsequent parent, JMC Steel Group Inc.] made to proceed with the transaction, the tax-related assets were a con- sideration, but no more so than other non-material assets, and the effect of tax-related liabilities was similarly limited, as JMC identified no 'nuclear bombs' associated with tax attributes or other aspects of the transaction," Southcott wrote. "However, this outcome was not known at the time the re- port was commissioned. Nor does the evidence establish that this outcome was known when the Report came into existence, which is the relevant time at which to analyse its purpose." Southcott distinguished BP Canada on the basis that the request in Atlas to review the report arose in the context of an active audit of particular issues. As Southcott noted, BP did not extend the self-audit pro- hibition to all circumstances, but only outside the context of a particular audit, with the aim of precluding "general and unre- stricted access . . . on a prospec- tive basis". As the BP court observed: "The issue in this case is not whether the information re- vealed by BP Canada's Tax Reserve Papers could be acces- sible under the Act. After all, everyone is agreed that it is, if required, in order to respond to a specific inquiry made in the context of an audit." The upshot is that Atlas does not restrict BP's application. "Rather, it is consistent with the scope of that decision re- garding the self-audit prohibi- tion," Morand said. Besides, it appears that the facts of Atlas hardly favoured the taxpayer. "So much so that the court was concerned that the only the information in the report, as op- posed to the actual report, had been provided to the lawyers," says Laurie Goldbach, in Borden Ladner Gervais LLP's Calgary office. "The law is clear that it is in fact open season for CRA when accounting firms provide reports without the involvement of lawyers." Margaret Nixon, a partner in the tax group at Stikeman Elliott LLP who represented Atlas Tube Canada ULC, said she couldn't comment on the decision be- cause it has been appealed to the Federal Court of Appeal. LT James Morand says a Federal Court ruling from November 2018 turned on the fact that the due diligence report's dominant purpose was not to assist in providing legal advice. 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