Tax law is a strange and mysterious world for many people, even most lawyers. The law is constantly changing, the concepts are challenging and the results are often counter-intuitive, making it a source of frustration for those forced to deal with it. Many businesses treat Tax (which is really just another area of law) as a completely separate department from Legal, making it that much more difficult to integrate the work of the two.
In over 30 years of practice, I have had the privilege of working with many in-house legal and tax departments, and have seen what works well and what could be improved. To help businesses and their legal groups get the most out of their tax advisors (internal and external) in a productive and cost-efficient way, I am sharing a series of three articles with tips and best practices. (Click on the links below for the other two articles.)
Part 2: Practice Points
Getting the most out of your tax advisors for the least cost requires practical expertise in managing people, which GCs are generally good at. Set out below are a number of useful practice points for managing tax advisors.
Call Early, Call Often
In many, many cases tax problems arise simply because no one involves the tax people until it is too late (“We’re closing tomorrow: this works, right?”) or at all.
An experienced tax advisor can usually perform a high-level issue check for likely/evident issues in under an hour: not a complete scrub, but flagging the most obvious concerns. This is time very well spent (virtually everything has a tax angle to it), and the best corporate/commercial lawyers engage their tax colleagues as early as possible to surface potential problems and opportunities for optimal results.
The cost of an hour or less of a tax advisor’s time ought not to be a material consideration, but if you’re a good client and your tax advisor isn’t willing to give you half an hour off the meter to vet something, you have the wrong tax advisor. Trusted advisors (tax or otherwise) invest in relationships with their clients.
Specify Scope, Deliverable and Timing
It is always helpful to specify what it is you want from any particular tax advisor, and how and when you want it. Simply forwarding a document or a slide deck to a tax person could be a request for a full scrub to identify and resolve issues requiring several hours, a 15-minute high-level scan or anything in between, depending on the client’s immediate needs and budget and what other tax advisors the client may be using.
Instructions to a tax advisor should make clear what is being requested, what the scope of the advisor’s tax mandate is (e.g., on an M&A transaction, planning, tax diligence, documentation, a specific technical issue, etc.), what form of deliverable is required (e.g., detailed memo, short email, phone call) and by when. Tell me what you want, and I’ll do my best to give to you the way that is most useful to you.
Other than in very simple cases and on very clear instructions, experienced tax advisors will generally decline to review just an excerpt from a particular document, as opposed to reading the entire document. This is because the rest of the document may contain definitions of terms used in the excerpt, exceptions to or overrides of the excerpt’s contents, interpretational rules or other things that affect the excerpt’s correct interpretation, making partial document reviews an accident waiting to happen.
Privilege, Privilege, Privilege
One unique feature of tax law is that there is always a third party with its own interest (typically adverse to yours) in what you are doing: the Canada Revenue Agency (CRA). The CRA has extensive information-gathering powers (strengthened further still in the 2021 federal budget), which it uses aggressively.
In the vast majority of cases, there is only one reliable basis for not providing the CRA with the documents, answers or information that it typically demands during an audit: solicitor-client privilege.
Canadian courts have routinely upheld the sanctity of solicitor-client privilege in a tax context as essential to the legal system. Key points about privilege in dealing with Canadian tax authorities:
- Accountants and other non-lawyers have no independent privilege of their own: prima facie, their work product and communications are fully exposed to CRA demands, which the CRA knows and uses to its advantage when conducting audits and similar investigations;
- In limited circumstances, non-lawyer work product prepared for the use of legal counsel in the formulation and delivery of counsel’s bona fide legal advice may come within the scope of solicitor-client privilege, but only where the relevant legal advice is really being generated by the lawyer, not the non-lawyers. Hence, tax advice prepared by an accounting firm and simply forwarded to the client’s lawyer is not protected, but accounting firm work product generated for the purpose of being used by a tax lawyer as in input in the tax lawyer’s own privileged advice to the client can be;
- In Canada, privileged communications can be provided to the client’s auditors for the limited purposes of allowing the client’s financial statements to be completed without thereby losing (“waiving”) the protection of the privilege, under the concept of “limited waiver”; and
- If asserted, common interest privilege allows two parties with a common interest in the subject matter to share privileged materials without thereby the privilege.
Canada’s version of solicitor-client privilege is more robust than is found in most other countries, and counsel within a multinational group should be aware that tax authorities in different countries share information and will make information demands on behalf of one another to find weak links.
Counsel should understand that tax authorities will routinely demand to see sensitive materials and communications that could impact their organization’s taxes, and ensure that solicitor-client privilege (and where relevant, litigation privilege) is created, asserted and maintained over all such material wherever possible. This may include routing privileged communications with outside tax lawyers through in-house counsel knowledgeable in the rules of privilege to prevent inadvertent waiver.
Preventing Tax Disputes is Far Cheaper Than Defending Them
When I began my career, tax controversy (dealing with the tax authorities on audits, objections and before the courts) was a relatively small area of tax practice compared to tax planning. Today, tax controversy is without doubt the biggest growth area of tax practice and something that consumes an ever-increasing amount of time for businesses and their tax advisors.
This is because the resources and powers allocated to tax authorities increase every year, governments are searching for revenues more than ever, and the tax element of social justice and equity has taken on a higher profile in the public’s consciousness. The CRA has trained auditors specializing in particular industries and areas of tax (e.g., payroll, GST/HST, international, “aggressive tax planning”) who have been told what to look for, and is more willing than ever to litigate knowing that many taxpayers have neither the time or the money to go to court.
This has a number of important consequences:
- Businesses of any significant size operating in Canada are virtually certain to be audited at some point;
- CRA audit kickoff letters now make very onerous information demands as a matter of routine in order to generate audit leads, and tax authorities are much more willing to go to court to force recalcitrant taxpayer to comply (making solicitor-client privilege especially important);
- CRA auditors are very quick to assert that taxpayers have been not merely incorrect but negligent (or grossly negligent), allowing the CRA to re-assess otherwise statute-barred years and impose costly penalties on top of taxes and interest; and
- CRA (Audit) is generating more re-assessments today than ever, leading to a huge backlog of taxpayer objections in CRA (Appeals) and a longer and more costly resolution process.
Given how aggressively the CRA audits and re-assesses taxpayers, the benefit of avoiding or reducing the scope of costly and time-consuming disputes with the CRA now typically far exceeds the upfront cost of getting good advice and properly documenting transactions.
Draft for Concepts, Not Amounts
To minimize the risk of creating unplanned taxable benefits, documents should reflect the legal result that the parties are seeking to achieve, rather than being expressed as particular amounts that may or may not be accurate.
For example, when a corporation makes a dividend or return of capital payable in property other than money, the corporate action should be described in the relevant documentation as the distribution of that property (e.g., shares of a subsidiary), not a distribution of a particular dollar amount in the form of property. The difference is that in the event the value the parties ascribed to that property turns out to be different than what they thought it was at the time, there is no deficiency or excess: what was authorized and distributed was that property (whatever its value), not a particular amount.
Any dollar amount the parties feel the need to record can be described as merely their estimate of the property’s value. Counsel should make sure their tax advisors understand precisely the commercial objectives sought to be achieved, and that the planning and documentation expresses those clearly.
Tax planning frequently involves tax-specific actions such the filing of tax returns and elections with tax authorities, remitting payments to tax authorities, preparing transfer pricing documentation, computing and tracking certain tax attributes, and responding to CRA communications. Unless all tax functions for a business are performed by a single tax group, it may not be clear which set of tax advisors is responsible for a particular action, and the consequences of failing to file a tax election on time may be severe.
Make sure that your organization’s various tax advisors have identified whatever tax-specific actions need to be done to achieve the desired results, and that someone specific has taken ownership for doing them. Things fall between the cracks more frequently than you might think where multiple tax advisors are involved, each of whom think someone else is doing it.
Blacklining software is a tremendous help in document drafting by allowing a reader to quickly see what changes have been made and where, making it faster and cheaper to review revised documents. However, a tax advisor receiving a blacklined document will generally assume that the “old” document against which the new one was compared to generate the blackline was in fact the last version of the document he or she reviewed.
Transactions move quickly, sometimes different versions of documents are sent to different groups, and people are not always working at their desks with immediate access to their files. Please make sure whoever has the pen is sending your tax colleagues is the right blackline for them.
Price Adjustment Clauses
A vastly overused feature of many agreements are price adjustment clauses, requiring the parties to adjust the consideration paid in the event that a tax authority challenges whether the price paid equals the fair value of what is received in exchange.
To begin with, the CRA can challenge the values that arm’s-length parties ascribe to the components of their transactions only where “no reasonable businessman would have contracted to pay such an amount having only the business consideration of the appellant in mind” (Gabco Limited v. M.N.R., 68 DTC 5210 (Ex. Ct.)).
Moreover, such clauses are often inserted in situations where they are not needed because any variations in value effectively self-correct (e.g., transferring property to a wholly-owned subsidiary in exchange for the issuance of shares). In other cases, they are inserted without sufficient thought being given as to exactly how a price adjustment could practically be implemented (e.g., a transfer in exchange for shares of a corporation that is shortly thereafter to be liquidated or sold).
Finally, parties using a price adjustment clause must be willing to actually implement it in the event of a tax authority challenge, which again is often not given sufficient thought.
Counsel should carefully consider whether a price adjustment clause being proposed by tax advisors really is both practical and necessary.
Tax Risk Management
In-house counsel are by necessity experienced managers of risk, actively spotting, categorizing, tracking and reporting potential trouble spots and reporting to the board of directors as needed. Quite often tax and other areas of law overlap, meaning that a non-tax development can create a tax law risk or vice versa. Create an ongoing dialogue with your tax advisors to share intelligence and keep each other informed about what’s going on and how to respond to it (ideally within a protected solicitor-client relationship).
Steve Suarez is Partner at BLG. He works exclusively on income tax matters, focusing on mergers and acquisitions, inbound and outbound investment, corporate restructurings and audit management, and tax dispute resolution. He is also the creator of www.businesstaxcanada.com, a website that describes Canadian business tax issues for non-tax people.