Is your company on Canada Revenue Agency’s (CRA’s) target list? Are you prepared for a CRA audit?
CRA has changed the way it audits large businesses by targeting high-risk taxpayers. CRA’s new audit strategy, called "Approach to Large Business Compliance" (ALBC), tailors the level of audit scrutiny that taxpayers face according to their risk of non-compliance. Under ALBC, taxpayers are grouped into high-, medium- and low-risk categories. Taxpayers identified as high risk are subject to annual audits and overall increased audit scrutiny; medium-risk taxpayers are subject to more limited and targeted audits; and taxpayers that have been identified as low-risk face infrequent audits. ALBC was launched in 2011 and initially involved 50 large businesses. It is expected to be fully implemented in five years.
Under ALBC, more businesses may find themselves facing increased audit scrutiny. Historically, CRA audits of large businesses focused primarily on corporate taxpayers and were driven by gross income. Under the new approach, CRA will widen its focus to include trusts, partnerships and high-net wealth groups. All large businesses will be grouped into risk categories on the basis of the results of a two-pronged assessment strategy to be conducted by CRA.
The purpose of the risk-based audit approach is to identify taxpayers who have
- high-risk, large transactions that will provide additional tax revenue on assessment;
- aggressive transactions for which CRA is likely to challenge either valuations (including transfer pricing) or the technical risk for taxpayers; and
- cavalier or uncooperative attitudes.
The first step involves an initial risk assessment of all large businesses using a variety of risk factors, including the use of aggressive tax-planning schemes and tax intermediaries, participation in unusual or complex transactions, major acquisitions or disposals and participation in international transactions. CRA has also identified specific risk transactions that will attract greater audit scrutiny, including those involving sophisticated off-shore planning, repatriation of funds and specific tax arrangements involving off-shore trusts. We understand that CRA is using statistical tools to analyze risk profiles, including reviewing effective tax rates and gross margins compared across taxpayers within an industry.
CRA has started interviewing senior management of large businesses and will use these interviews to explain how ALBC will affect their businesses and to share findings from the initial risk assessment. At an interview, CRA expects to cover
- its approach to large-business compliance,
- its findings and observations noted during its initial internal risk assessment,
- corporate governance as it relates to the management of tax risk,
- an "engaged approach" to compliance and corresponding benefits,
- issues of concern for the next audit cycle, and
- delivery of a more open and transparent relationship.
Further topics for discussion will include the involvement of senior management and tax intermediaries in tax-risk management, the taxpayer’s systems with respect to tax compliance and the handling of non-compliance, and the taxpayer’s internal framework for identifying tax risks and tax reviews.
Managing and monitoring these "risk interviews" will be an important step in companies’ setting the agenda with CRA. It appears that the degree of openness with CRA during this assessment will be a factor in developing a taxpayer’s risk profile; notably, CRA has indicated that if a taxpayer is extremely cooperative, it will be categorized at a lower risk. Moreover, having good explanations of your company’s tax compliance and tax-risk profile will facilitate meaningful discussions with CRA as to why your company does not warrant intense scrutiny. As a result, as CRA rolls out its new audit strategy, tax managers will need to ensure that they can provide the best information to CRA to indicate a clean bill of health. To this end, tax departments should ensure that they have material that demonstrates strong corporate governance and an understanding and analysis of the types of tax risks that that are undertaking. These materials may include internal risk assessments, identification of their outside tax and legal advisers as well as a description of the types of major transactions they undertake and their frequency.
We recommend that large taxpayers generally be proactive in managing their relationship with CRA. The first step is to know and understand which areas might invoke CRA scrutiny and to maintain good analysis for those transactions with easy to digest explanations. This can include ensuring that the transactions are documented, that outstanding issues or deliveries are completed and that appropriate analysis is performed and maintained about the transaction and how it fits within the company’s tax profile: Was it an ordinary course transaction? Did it involve any unique or uncertain tax positions? Did it involve foreign affiliate or other non-resident entities? If privileged tax opinions were obtained, is there a summary that can be provided to CRA auditors to give an overall explanation of the tax analysis (without creating a road map for CRA). Firms should maintain lists of transactions that are likely to be reviewed as well as a description of how each fits into the firm’s compliance governance model.
Being proactive means managing the process. It does not mean doing CRA’s audit for the agency. Audits often lead to assessments and litigation. A taxpayer’s disclosure (including its employees’ statements) can be used in later proceedings. The goal should be to provide open and forthright answers with enough preparation and detail so that the auditor’s basic questions are satisfied without the auditor having to inquire further. While CRA has indicated that taxpayers are obligated to disclose "concerns with regard to tax at risk," taxpayers have no legal duty to generally "risk weigh" their tax positions or disclose that their view of a particular claim for deduction or inclusion has a degree of uncertainty or that it may be expressed at less than a "certainty." In this regard, maintaining privilege will be important.
Torys’ tax-controversy and litigation lawyers have experience in dealing with all levels of CRA and with all phases of tax controversy: from the planning and implementation of specific transactions to tax filings, initial audits, assessments and appeals. We can assist in the ALBC process by helping senior management prepare for interviews, develop a "disclosure strategy" and marshal effective advocacy and messaging. We are also available to review existing transactions and provide advice regarding the likelihood of success on audit and how to present transactions to CRA to reduce the risk of reassessment.
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This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
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