United States: Can Tax Authorities Demand Access To Audit Workpapers? Canadian Experience Follows U.S. Rule

Last Updated: March 8 2019
Article by Stanley C. Ruchelman


When a Canadian or U.S.-based multinational finds itself under audit, the taxpayer and the tax authority are often at odds over what documentation is subject to disclosure and what remains beyond the prying eyes of the tax authority. In a landmark series of recent court cases in Canada, the Canada Revenue Agency ("C.R.A.") was given access to accounting workpapers and background documentation for transfer pricing reports to verify a position taken in a client's tax return. This is a major development in Canada. In the U.S., in contrast, the I.R.S. has been given access to workpapers and other information for many years. A comprehensive look at the long history of U.S. transparency may provide a roadmap of what Canadian-based multinationals should expect regarding matters of transparency.


Whether a taxpayer is resident in Canada or the U.S., it may be subject to an administrative examination to determine whether tax liability has been calculated correctly in the tax return.

When the taxpayer is a large multinational, that tax audit involves a significant investment by the tax authorities in terms of staffing and resources. The examination portion of the audit may involve the issuance of information requests and possibly follow-up summonses that are intended to obtain data that may be used to test whether the taxpayer's claimed positions are justified under relevant tax law.

In a sense, the multinationals begin their investment long before the audit begins. They have sophisticated tax lawyers on staff and also retain sophisticated outside tax advisors. At the close of the year, the books and records of the enterprise are audited by a major accounting firm for the purpose of providing certification of the reported results.

When a tax examiner requests information regarding a specific transaction, the taxpayer may object on the grounds that the requested documentation is protected – either by attorney-client privilege or under the work product doctrine of privilege. The attorney-client privilege is a common law concept that dates back several centuries. The privilege protects information disclosed by the client to the attorney for the purpose of obtaining legal advice. The work product doctrine states that a party may not discover documents and tangible things prepared in anticipation of litigation or trial by a party or its representative. The work product privilege does not cover material assembled in the ordinary course of business or pursuant to public requirements that are unrelated to litigation or for other non-litigation purposes.1

A flash point for disclosure not covered by the work product doctrine is the tax provision analysis that forms part of the audit workpapers in support of a corporate taxpayer's published financial statements. When prepared by the audit firm, the tax provision analysis represents an outside professional's view regarding the expected tax exposure of a corporation in order to arrive at after-tax net profits. The analysis is designed to provide assurance that that the tax provision in the financial statement accurately portrays the financial condition of the company.


Source of C.R.A.'s Audit Powers

Subsection 231.1 of the Canadian Income Tax Act ("Act") grants broad powers to the C.R.A. to inspect, audit, or examine books, records, and inventory of a taxpayer. In carrying out its examination, the C.R.A. may issue a notice to a taxpayer requiring it to furnish information specified in the notice.2 If a taxpayer refuses to comply, the C.R.A. may apply to the courts for a compliance order, if the requested information or document is not protected by solicitor-client privilege.3

Focus of C.R.A. Information Requests

In 2017 and 2018, a series of cases came before the Canadian Federal Court addressing the validity of a C.R.A. application for a compliance order seeking the production of tax workpapers and requesting the right to interview individuals who were officers and employees of the taxpayer.

In MNR v. Cameco,4 the C.R.A. sought to interview 25 employees of Cameco to verify the information contained in its transfer pricing reports prepared by KPMG for tax years 2010 through 2012. In BP Canada Energy Company v. MNR,5 the C.R.A. sought access to the taxpayer's tax accrual workpapers setting out its uncertain tax position for a specific year, not for the purpose of the initial examination of the tax return for that year but for the examination of tax returns filed for subsequent years. In Canada (National Revenue) v. Atlas Tube Canada ULC,6 the C.R.A. sought access to a draft due diligence report prepared by EY, which had been prepared as part of an acquisition and reorganization of Atlas' corporate group.

Access to Interview Key Personnel of the Taxpayer

Cameco is one of the world's largest uranium producers and is headquartered in Saskatoon, Saskatchewan. Cameco has several foreign subsidiaries. In the Cameco case, the C.R.A. sought to interview 25 employees of Cameco and its related non-Canadian subsidiaries for purposes of substantiating a transfer pricing report prepared by KPMG for tax years 2010 through 2012. The employees were situated in Switzerland, the U.S., Barbados, and Canada. The C.R.A. offered to interview these individuals at their locations or by videoconference.

In the past, Cameco had granted the C.R.A. access to its personnel for assessment of tax years 2003 through 2006. The oral information obtained from the personnel led to a reassessment of those years that was subsequently challenged by Cameco. The matter was pending before the Tax Court of Canada when the C.R.A. applied for a compliance order seeking access to a larger number of Cameco's personnel for assessment of tax years 2010 through 2012. The Federal Court refused to issue a compliance order on the basis that issuing such order would prejudice Cameco:

When the first audits were performed, Cameco agreed to have its personnel interviewed only by a CRA official. Those interviews were not recorded, though Cameco lawyers were allowed to be present during the interviews. Both the CRA and Cameco personnel took notes of the interviews. When the matter for those years proceeded to the Tax Court of Canada and Notices to Admit were served, it was found that the two parties had very different recollections of what was said at the oral interviews. . . . If the Minister's position is accepted, the CRA can compel oral interviews from as many persons as they see fit without any procedural limits. Oral interviews as sought on these facts at the audit stage would undermine procedural safeguards provided at the appeal stage. Furthermore, the Minister could use an isolated statement by an employee which the taxpayer would be forced to disprove at trial.

The C.R.A. requested to have a court reporter present during the interview process to prevent misinterpretation of information. However, the court rejected the request, as it would result in replicating an examination for discovery in a Tax Court proceeding with the C.R.A. hand picking interviewees instead of Cameco choosing its own officers for examination.

Access to Tax Workpapers for Future Audits

The BP Canada case is the first Canadian case to address an attempt by the C.R.A. to access a taxpayer's tax accrual workpapers without advancing any particular justification for their production. Tax accrual workpapers are papers created by or for independent auditors in order to assist in the process of certifying financial statements in accordance with Generally Accepted Accounting Principles ("G.A.A.P."). Tax accrual workpapers are used to identify uncertain positions and provide for reserves that will allow an independent auditor to certify that financial statements fairly and accurately reflect the financial situation of the corporation under audit.

In the course of the C.R.A.'s examination of BP Canada for 2005, the examiner identified an issue relating to refund interest paid by the C.R.A. to BP Canada. The accounting turned out to be erroneous, as the refund interest payment should have been booked in 2005. During the examination process, several accounting entries in an account entitled "Interest Expense Taxes Payable – Disputed Accruals Account" came to surface. The C.R.A. examiner sought access to the tax accrual workpapers from BP Canada to support the entries in that account. BP Canada refused on the basis that the disclosure of tax accrual workpapers was unnecessary in the fact pattern as only refund interest was questioned by the examiner. That issue was resolved, leading BP Canada to contend in effect that the C.R.A. examiner was partaking in a "fishing expedition." Further, BP Canada argued that disclosure of its tax accrual workpapers would not only provide the C.R.A. with a roadmap to its uncertain tax positions but would also allow access to the analysis behind those positions.

BP Canada, therefore, appealed to the Federal Court of Appeal and the Chartered Professional Accountants of Canada ("C.P.A.C.") participated as an intervener in light of the broad scope of the issue. The C.P.A.C. argued that the formal requests for the production of tax accrual workpapers should not be routine and uncontrolled, and that the obligation to produce these papers to the C.R.A. would undercut the public interest role of C.P.A.C. members in certifying financial statements. The court summarized the concerns of the C.P.A.C. in the following language

Professional accountants have a direct role in ensuring a degree of confidence in publicly-traded corporations' financial statements through independent auditing. Because they act in the public interest, they are subject to professional and ethical obligations, such as an obligation of integrity, a duty of care, and a duty of objectivity. . . . In keeping with those obligations, professional accountants have to review [tax accrual workpapers] prepared by the corporations which they audit in addition to preparing their own [tax accrual workpapers].

[The C.P.A.C.] thus fears that the order, if allowed to stand, will cause corporations to 'hesitate to voluntarily and fully disclose their tax risks.' Moreover, routine access by the Minister to subjective opinions on tax risks may 'discourage corporations from preparing such analysis in order to protect it from disclosure.'

[The C.P.A.C.] invites the Court to interpret subsection 231.1(1) of the Act in light of 'the global context of rules of professional ethics and financial reporting.' This means that only objective information would be subject to production, such as the 'disclosure of all transactions that could have a material impact on the corporation's tax liability, without identifying the degree of tax risk that any of those transactions may have.'

Notwithstanding the legal arguments submitted by the C.P.A.C., the Federal Court of Appeal held that a taxpayer could be ordered to produce tax accrual workpapers where the tax accrual workpapers pertain to a specific issue under an existing audit. However, the deeper issue was whether subsection 231.1(1) allows general and unrestricted access to this information. In the BP Canada case, the C.R.A.'s request was specific to an existing audit. However, there was no existing audit pertaining to the information requested, and the C.R.A. sought access to BP Canada's uncertain tax positions for the purpose of using these positions to facilitate future audits. Therefore, the court held that BP Canada could not be compelled to produce the tax accrual workpapers.

Access to Workpapers in an Ongoing Audit

In the Atlas Tube case, the C.R.A. sought a compliance order application before the Federal court seeking the release of a due diligence report prepared by EY pursuant to a reorganizational transaction in 2012 which included the purchase of an unrelated company by Atlas's parent corporation, a U.S. entity. The due diligence report was prepared by the accounting firm, EY, to understand whether the Canadian sister corporations and Atlas had sufficient tax losses to offset the future revenue of the newly acquired entity. The C.R.A. initiated an examination of the tax return of Atlas. in the course of which it requested a copy of the due diligence report. Atlas argued that the report was cloaked under solicitor-client privilege and therefore could not be released.

The Federal Court concluded that dominant purpose of the report was to inform the decision whether to proceed with the transaction and at what price. Because the purpose of the report was not to obtain legal advice, the court held that the solicitor- client privilege did not apply. The report included, inter alia, the tax attributes of the target corporations and the material tax exposures resulting from the prior Canadian tax filings including an assessment of the probability that the filing positions leading to the tax exposures would be sustained if challenged by the C.R.A. The court concluded that the assessment and evaluation represent accounting opinions by EY, which cannot be characterized as prepared for the purpose of obtaining legal advice on the structuring of the transaction.

The court also distinguished the BP Canada case on the basis that the report requested in the Atlas case was made in the context of an active examination of particular issues unlike the BP Canada case where the purpose was to facilitate future audits.

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1 Hickman v. Taylor; 329 U.S. 495 (1947); Wells Fargo v. U.S., Civil No. 10-mc- 57 (D. Minn., June 4, 2013).

2 Section 231.2 of the Act.

3 Section 231.7 of the Act.

4 2017 F.C. 763.

5 2017 F.C.A. 61.

6 2018 F.C. 1086.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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