Court grants injunction to exclude legal professionals from mandatory disclosure requirements under the Income Tax Act

On November 24, the Supreme Court of British Columbia (B.C. Supreme Court) in Federation of Law Societies of Canada v. Canada (Attorney General)¹, granted an interlocutory injunction prohibiting the application of certain amendments to the Income Tax Act (the Act) that require legal professionals to report confidential—and potentially privileged—client information to the Canada Revenue Agency (the CRA), pending determination of the constitutionality of such provisions under the Charter. The B.C. Supreme Court held that irreparable harm to the public and to legal professionals would result if the injunction were not granted.

What you need to know

• For the time being, legal professionals are exempt from the Act’s mandatory disclosure requirements with respect to “reportable transactions” and “notifiable transactions”.
• The decision reflects an appropriate level of concern to protect the lawyer-client relationship, including in the context of legal advice on taxation matters.
• The ultimate status of the constitutionality of these amendments relating to disclosure by legal professionals remains to be determined.

Background

On September 11, 2023, the Federation of Law Societies of Canada (the Federation) filed an application with the B.C. Supreme Court challenging the constitutionality of certain amendments to the Act that expand the mandatory reporting obligations of legal professionals.

The amendments—which came into force on June 22, 2023—lower the threshold requirements for “reportable transactions” and introduce new reporting obligations for “notifiable transactions” under sections 237.3 and 237.4 of the Act, respectively. These reporting rules require taxpayers and their advisors, including legal counsel, to report to CRA certain transactions undertaken by the taxpayer so that CRA can further investigate whether such transactions might contravene the Act. The amendments further remove a provision that relieved advisors from the mandatory reporting obligations when such reporting had been fulfilled by another party to the transaction, such as the legal professional’s client. Notably, the amendments increase the penalties imposed on legal professionals who fail to comply with the mandatory reporting obligations with fines of up to $100,000. The Federation submits that the amendments represent an unconstitutional attempt to turn legal professionals into agents of the state and seeks a declaration that the amendments to the mandatory disclosure regime, as they apply to legal professionals, contravene section 7 and 8 of the Charter.

As stated by the Federation in its submissions to the government before the amendments were adopted, “Compelling legal professionals to disclose confidential client information under threat of penalty if they fail to do so creates an irreconcilable conflict between the legal professionals’ personal interests and those of their clients. Such reporting is antithetical to the solicitor-client relationship and would undermine the duty of loyalty that legal professionals owe to their clients as a function of their fiduciary relationship”².

Decision

The ruling released on November 24 in Federation of Law Societies of Canada is the outcome of a further petition by the Federation to the B.C. Supreme Court requesting an interlocutory injunction as part of its underlying constitutional challenge. If granted, the interim order would exempt legal professionals from the application of the new mandatory reporting provisions of the Act pending a determination of the constitutional challenge.

In its decision to grant the injunction, the Court outlined the three-part test for determining when a court should exercise its discretion to grant an interlocutory injunction in a constitutional case: 1) is there a serious issue to be tried? 2) would irreparable harm result if the injunction is not granted? and 3) is the balance of convenience, taking into account the public interest, in favour of granting the interlocutory injunction or denying it³?

The Court established that irreparable harm to the public and to legal professionals would result if the injunction were not granted, and that the balance of convenience, taking into account the public interest, was in favor of granting injunctive relief. Specifically, the Court stated that the amendments to the reporting provisions would require lawyers to disclose client information to CRA that is subject to the broad duty of confidentiality under a lawyer’s Code of Professional Conduct. As a result of these amendments, lawyers would be required to file a prescribed form with CRA indicating, among other things, the identity of their client, the fees they received from their client in respect of the transaction and detailed information describing the transaction. Further, the Court determined that the amendments may also require lawyers to disclose potentially privileged client information: the reporting regime requires lawyers to apply their legal judgement by providing an assessment of the transaction and whether it may be reasonably considered that one of the main purposes of their client’s transaction is to obtain a tax benefit. As stated by the Court, a legal professional’s opinion on their client’s transaction is likely privileged information. Further, once such information is disclosed, CRA could use the lawyer’s knowledge and analysis of the transaction against the lawyer’s client.

While the mandatory reporting provisions of the Act provide an exemption from disclosure “if it is reasonable to believe that the information is subject to solicitor-client privilege”, the Court viewed the exemption as insufficient due to the numerous conflicts of interest the amendments create between a lawyer and their client. For example, because the lawyer must determine what client information is subject to privilege, and because the penalty that could be imposed on the lawyer is so steep for failure to report, it would be in the lawyer’s best interest to err on the side of disclosing information where there is a close call as to determining whether certain information is privileged or not. Also, if CRA disagrees with a lawyer’s conclusion that certain client information does not need to be reported because it is privileged, the best evidence the lawyer may have to challenge any penalty imposed could be the privileged information in question.

As such, the Court established that irreparable harm to the public and to legal professionals would result if the injunction were not granted, for the following reasons:

• If confidential or privileged information is disclosed as a result of legislation that is ultimately found to be unconstitutional, individual clients will be irreparably harmed by the loss of professional secrecy, which cannot be undone, and the prospect of that occurring will have a chilling effect on the ability of individual clients to consult with their lawyers fully and freely pending a final determination of the constitutional challenge.
• The potential for the unconstitutional reporting of confidential and privileged information, and the conflicts of interest between lawyers and their clients that will arise as a result of potentially unconstitutional legislation, would irrevocably damage the solicitor-client relationship and harm the public interest by undermining the public’s confidence in an independent bar⁴.

In constitutional cases, consideration of the public interest is an important factor in considering the granting of an injunction. Generally speaking, legislation enacted by a democratically elected government is assumed to serve a valid public interest and common good; therefore, it is only in compelling and clear cases that a court will grant an interlocutory injunction that will suspend a validly enacted law. The Court noted that the injunction will deprive the public of the benefit of duly enacted legislation but that the impact here is minimal because i) the injunction grants an exemption for legal professionals as opposed to a wholescale suspension of the legislation—other advisors, promotors and taxpayers will still be required to report; and ii) the Federation has committed to move expeditiously to have the constitutional challenge heard on the merits and the government did not demonstrate any specific urgency to expand the reporting requirements to make disclosure by legal professionals mandatory. This was one of those rare cases in which the Court determined a far more compelling public interest weighed in favor of the Federation due to the high importance of the public’s confidence in an independent bar, which is essential to the integrity of the administration of justice and to the professional secrecy within the lawyer-client relationship—an interest that, as has been stated by the Supreme Court of Canada, is a principle of fundamental justice under the Charter. For these reasons, the Court concluded that it was just and equitable to grant an injunction pending the determination of the Federation’s petition on the merits.