Tax lawyers fear new reporting obligations for aggressive tax avoidance transactions may compromise solicitor-client privilege.
Back in March, the federal government announced it was looking at amendments to the Income Tax Act to weed out aggressive tax plans it said were undermining the fairness of the tax system.
Then in August, the Department of Finance put some flesh on the bones of its proposals with draft legislation that would impose reporting obligations for “aggressive transactions” on taxpayers and their advisers, including stiff penalties for both parties for any omissions.
Suzana Popovic-Montag, managing partner at trusts and estates firm Hull & Hull LLP, can’t see any way to report transactions without revealing information passed in confidence between clients and lawyers.
“It seems quite clear that we’re being asked to breach the solicitor-client privilege,” she says.
With the vagueness of the definitions in the act, lawyers could find themselves at odds with their clients when they disagree over whether a transaction is reportable.
“We encourage clients to tell us everything in confidence and tell us everything they can so we can assist in the best way we can,” says Popovic-Montag. “They have an expectation that we’re not going to repeat that, let alone use it against them.”
It’s not just tax lawyers who should be worried about the legislation, according to Popovic-Montag, because any move that erodes solicitor-client privilege will have a spillover effect on public confidence in the legal profession.
“I’m ultimately afraid they’re opening up a Pandora’s box of issues that compromise everything we’ve held so important and untouchable for so many years,” she says.
“If people start suddenly thinking, ‘My lawyer might use things I tell them against me,’ they won’t tell us anything anymore or they’ll tell us less. It compromises the fundamental tenets of our relationship.”
The Canadian Bar Association has also stepped into the fray to make its concerns known in a letter to the federal minister of finance.
Although the association’s tax section composed its submission on the legislation, it was CBA president Rod Snow who addressed the minister, noting the issue was “of importance to the legal profession as a whole.”
“We have singled out the information reporting measures because, if adopted in their current form, they will create a serious incursion into solicitor-client privilege and will compromise the independence of the legal profession,” he wrote.
“These are fundamental and foundational elements of the Canadian justice system and the preservation of these elements benefits all Canadians.”
In an interview, Elaine Marchand, chairwoman of the CBA’s national taxation law section, tells Law Times she would like to see lawyers excluded altogether from the reporting obligation.
At the moment, when a transaction takes place primarily to achieve a tax benefit with no other bona fide purpose, the government labels it an aggressive transaction.
But it only becomes reportable by both advisers and taxpayers when it has two out of three hallmarks: the adviser’s fee was contingent on the tax benefit achieved; the adviser required a confidentiality agreement; and contractual protection was an element of the transaction.
In Marchand’s view, the contingency provision is too broad to be indicative of a reportable transaction because lawyers are increasingly using fees that take into account the success and importance of a matter.
“Lawyers are increasingly pressured by the market to offer alternative billing arrangements to clients,” she says, noting she fears counsel are being “transformed into agents of the state” to help with the collection of tax revenues.
Marchand adds it’s important to remember that tax avoidance isn’t illegal in Canada. “You’ve got law-abiding citizens consulting lawyers on their rights and obligations.
And all of a sudden, those lawyers are statutorily bound to disclose some of the information passed from the client under threat of penalty.”
Stephanie Rubec, a spokeswoman with the Department of Finance, says the government has considered a number of submissions that raised concerns about solicitor-client privilege.
“Where a solicitor has taken reasonable steps to determine whether particular information is subject to privilege and to ensure that any reporting obligation he or she may have will otherwise be satisfied, the proposed rules are not intended to impose either a reporting obligation or penalty.”
There’s also a due diligence defence that exempts advisers from penalties when they’ve taken steps to prevent a failure to report, but questions remain over whether a good-faith judgment that a transaction wasn’t reportable would be enough to trigger that provision.
Bruce Russell, head of the regional tax service group at McInnes Cooper in Halifax, says any exceptions for solicitor-client privilege need to be written into the legislation to ensure it has the full force of the law rather than relying on extensive explanatory notes in the act.
Russell was a panellist at a recent webcast on the new legislation by the Society of Trust and Estate Practitioners.
The organization has also written to the minister of finance to express its concerns with the amendments. “It’s just some of the effects seem out of proportion and inappropriate,” Russell says. “The penalties are quite strong for advisers, promoters, and taxpayers.”
The legislation would make advisers jointly and severally liable with taxpayers subject to a limit of the total amount of fees they charged.
Where the avoidance activity is part of a series, the penalty appears to apply to the fees received for the whole series even when other actions taken aren’t avoidance transactions.
In its submission to the government, the society said penalties could quickly escalate well beyond the amount of any tax benefit a client obtained in the reportable transaction.
“An adviser should not be jointly and severally liable with a client to pay the penalty for non-disclosure of a reportable transaction,” the submission maintains. “There is no legal principle that would justify an adviser having to underwrite a client’s failure to comply with the law.”
According to Marchand, lawyers’ own reporting obligations would inevitably influence them when advising clients given the threat of a penalty hanging over their heads.
“If they’re divided and thinking what are the consequences to them as advisers of a given opinion or result while at the same time giving advice to the client, that’s not a place where lawyers should be,” she says.