Pandora Papers: More smoke than fire? CRA VDP operations manual: Top 10 takeaways

Stevan Novoselac and John A. Sorensen of Gowling WLG on the nuances of the CRA's VDP Operations Manual

Nov 16, 2021 Author: Stevan Novoselac & John Sorensen

THE publication of the so-called Pandora Papers is the biggest tax haven data leak in history. As with the Panama and Paradise Papers leaks that preceded it, extensive media reports on the Pandora Papers essentially allege that the ultra-wealthy use offshore tax havens to avoid paying taxes and question whether the line has been crossed from legal tax avoidance to illegal tax evasion. Time will tell, however, whether this is more smoke than fire.

Anyone with offshore entities and/or structures that have been used for evading taxes should of course take immediate steps, with experienced legal counsel, to regularize their tax reporting. On the other hand, it is certainly not a foregone conclusion that this current data leak will result in successful criminal tax evasion prosecutions. In fact, results so far from previous data leaks have not been overwhelming. The first data leak like this was the Panama Papers in 2016 that, according to reports, revealed almost 1,000 Canadians using offshore structures. Despite all of those cases being investigated, apparently there have been no successful prosecutions for criminal tax evasion, although there has been some recovery of previously unpaid tax, presumably with penalties and interest, through settlements of Canada Revenue Agency ("CRA") reassessments. Foreign banking secrecy has been significantly diminished over the years, due in large measure to enhanced foreign information exchange agreements, including primarily the United States Foreign Account Tax Compliance Act and the OECD Common Reporting Standards, resulting in a significant reduction in the use of offshore entities and/or structuring to evade tax. This could mean that it may again be challenging for the CRA to secure convictions for tax evasion arising from investigations into the Pandora Papers.

The release of the Pandora Papers has certainly refocused attention on CRA tax administration and enforcement, including the CRA's Voluntary Disclosures Program ("VDP"). Obtained through an access to information request, the VDP Operations Manual ("Manual")¹ is the internal document used by CRA officials to operate the VDP, with its stated objective being to provide them with all of the necessary extensive and detailed processing information. To our knowledge, the Manual is not publically available. While not all of it may be important for taxpayers or their representatives to know, we found the Manual helpful to inform how to approach voluntary disclosures ("VDs"). Here are our top ten takeaways from the Manual.²

1. Enhanced CRA discretion

The CRA VDP Information Circular IC00-1R6 (effective March 1, 2018) gave CRA officials significantly enhanced discretion when evaluating VDs. The Manual is replete with references to different and new ways CRA officials have enhanced discretion, including whether:

An intake extension should be granted and, if so, the length of any such extension (typically limited to 90 days);
VDs should be rejected or relief granted under the General or Limited Program;
VDs should be partially accepted and partially rejected;
VDs meet the voluntariness condition;
There has been an enforcement action, including previous CRA correspondence, that vitiates the voluntariness condition;
An enforcement action against the taxpayer or a third party is sufficiently related to the VD, such that it would vitiate the voluntariness condition;
A previously completed audit is sufficiently related to the VD, such that it would vitiate the voluntariness condition;
A discrepancy in what has been reported is sufficient to vitiate the completeness condition; and
The payment condition can be relaxed.

It is important that all of these enhanced areas of discretion be considered carefully, since they each create potential opportunities for persuasive advocacy in VDP submissions.

2. Internal CRA referrals, including regarding large corporations

The Manual appears to call for more frequent referrals from the VDP to other specialist areas, including for VDs involving "offshore tax issues," which are referred to the Offshore Voluntary Disclosures Program Section, as well as for large corporations. VDs by corporations with gross revenues in excess of $250M in two of their last five years, and related entities, would generally be considered for relief under the Limited Program. The Manual requires that VDs for such large corporation are to be brought to the attention of the relevant large case file manager for discussions. In our view, how a large corporation might access General Program relief is a challenging question. Typically, the likelihood that a large corporation engaged in non-compliance knowingly or in circumstances amounting to gross negligence is limited. Thus, the penalties that a large corporation would likely have to deal with should ordinarily be strict liability penalties only. The Limited Program does not relieve strict liability penalties. Consequently, one wonders whether there would ever be any point for a large corporation to enter the VDP to remediate an innocent mistake. The reasonableness of putting a large corporation into the Limited Program, where no practical relief is available, even when the large corporation has made a complete and accurate VD in good faith, is dubious. Accordingly, a strict application of the large corporation guidance, without giving due consideration to granting General Program relief, would arguably constitute a reviewable error.

The Manual also provides VD officers with guidance as to when to seek technical resources for files that involve small and medium-sized enterprises. A referral for specialist advice may be made where a VD involves relatively complex issues, including surplus stripping, capital gains stripping, rollovers, stop-loss rules, debt forgiveness and debt parking, windups, non-competition payments and flow-through shares. Complexity is, of course, in the eye of the beholder, but one might imagine that many VDs involve failures to file tax and information returns, as well as straightforward failures to report income. By comparison, a VD engaging questions of tax law and interpretation may be more complicated than the usual fare.

3. Pre-disclosure discussions

The Manual provides further details on pre-disclosure informal discussions with a CRA official, done on an anonymous basis, and intended for taxpayers uncertain about making a VD. For these discussions, the Manual lists questions that could be posed by the CRA official. Unlike under the VDP before March 1, 2018, initiating this contact on an anonymous basis does not establish an effective date of disclosure ("EDD"), for determining whether the voluntariness condition has been met. Accordingly, these discussions have no effect whatsoever on the taxpayer's potential jeopardy to be audited or subjected to criminal prosecution for tax evasion. While the CRA acknowledges that it is permissible for taxpayers and their representatives to record pre-disclosure discussions for their own reference, the Manual advises CRA officers to be circumspect in their comments and offers examples of equivocal language that may be used during a pre-disclosure discussion. Therefore, whether recording carefully hedged quotes would be useful is an open question.

Whenever a VD is advisable, we accordingly always strongly recommended launching a formal VDP application as soon as possible. Further, engaging tax counsel with VDP experience should enable an uncertain taxpayer to understand the parameters of making a VD and navigating the process, without the need to seek CRA advice.

4. Reasons for making VD

Before March 2018, the reasons for making a VD were not especially relevant to the CRA's determination of whether relief should be granted under the VDP (unless, of course, those reasons touched on voluntariness). Now, the CRA official codes the reasons the VD was made. These codes include:

Publicity;
A special CRA project;
A CRA outreach program initiative;
Audit action;
Conscience;
Advice of a professional;
Legislative or policy changes;
Death or Illness; and
The settlement of an estate.

The stated reason(s) for making a VD will inform the CRA's determination of whether it should be rejected, or whether relief should be granted under the general or limited program. Taxpayers contemplating VDs, together with their advisors, should carefully consider how to frame their reasons for making a VD to ensure that their truth is well told.

5. Extensions more difficult to obtain and shorter

For VDs filed before March, 2018, the CRA was generally flexible in granting reasonable extensions of time to provide all of the information and documents, including tax filings, needed to support a VD. This was especially apparent when a taxpayer experienced unavoidable delays in retrieving the relevant documents or where preparing the requisite tax filings to support the VD was preconditioned on the outcome of legal proceedings that could sometimes take months or even years to resolve.

Now, an intake extension is typically available only up to 90 days and requires extraordinary circumstances, which is obviously a very stringent standard. A taxpayer seeking an extension may be required to demonstrate how the extraordinary circumstances are preventing the necessary information and documents from being submitted, explain what has already been done to gather the documents and advise how long it will reasonably take to provide the remaining information or documents.

Later in the VDP process, where the CRA official requires further information or documents, for example, bank statements relating to a taxpayer's spouse, a supplementary extension may be granted. The duration of this extension is generally no more than 90 days from the EDD. This presupposes, however, that the VD has been processed on a timely basis, such that 90 days have not already passed from the EDD, by the time the CRA official requests the additional information or documents.

6. One strike and you're out

The five validity conditions are considered in the following sequence:

Is the information being disclosed sufficiently past due;
Is there a penalty or interest exposure;
Is the VD voluntary;
Has payment been included; and
Is the VD complete?

The five conditions appear to be generally sequenced in the order of ease of determination. To expedite VDP reviews, as soon as it is determined that a VD does not satisfy any one of these conditions, an analysis of the remaining conditions becomes unnecessary and the VD may be rejected.

7. Voluntariness — Too late if included in information leak

VDs may be rejected as not having met the voluntariness condition whenever a taxpayer (or those related to a taxpayer) were involved in tax non-compliance that has already become known to the CRA through a leak of offshore banking or other information. With the seemingly continuing publication of documents, like the Pandora Papers, taxpayers who have engaged in offshore tax planning that may be subject to CRA scrutiny would be well advised to seek legal advice proactively, before it becomes too late.

Although the CRA cites an information leak as an event that may vitiate voluntariness, the criterion is wider than that, and could include other sources of information concerning a taxpayer's non-compliance, such as information obtained by way of governments exchanging information (as noted above) or from whistleblowers.

Any enforcement action on a single year will generally be considered as an enforcement action on all years for which the error or omission persisted. Computer generated notices are also generally considered to constitute an enforcement action, although this may not include a letter from the CRA to a specific category of taxpayers, designed to nudge them towards tax compliance.

Finally, and tangentially related to voluntariness, the Manual seems to indicate that the VDP is more attuned to CRA "project files" and whether actions in connection with a project may affect the viability of a VD. For example, although partially redacted, text in the Manual suggests that the CRA might check a taxpayer's postal code and account number against databases containing information that might be associated with non-compliance by an identifiable group.

8. Payment required

The new VDP condition, effective for VDs filed since March 1, 2018, is that payment must be submitted. The correctness of the payment amount submitted with a VD is typically not verified at the intake stage. Alternatively, this condition can be satisfied, without payment being made, if a satisfactory payment arrangement is negotiated with CRA collections. This normally must include full financial disclosure being provided, as well as security, where appropriate. It is possible however that a VD could be accepted, without payment or a satisfactory payment arrangement, in certain limited circumstances, such as where small amounts are owing, a refund is expected or where frozen accounts or public trustees are involved. Finally, an earlier acceptance of a VD may be reversed, if a payment arrangement is not fulfilled.

9. Completeness

To be considered complete, taxpayers are expected to make all reasonable enquires, including with related entities within a corporate group, to ensure compliance with all tax obligations. The extent to which any enquiries are "reasonable" may be determined on a case-by-case basis. Where a taxpayer is a member of a large corporate group, due consideration may be given to the nature of the VD, the size of the entity and the internal relationships amongst business lines.

10. Years required to be disclosed

The number of years to include with a VD has always been one of the most important aspects considered by taxpayers. Now, taxpayers are expected to submit documents and/or estimates of unreported amounts for all applicable taxation years. Detailed bank record retention information, for 55 listed countries, informs this analysis. For these 55 countries, record retention periods generally range from five to ten years.

However, the CRA can only reassess years going back beyond the normal reassessment period in the limited circumstances prescribed by the Income Tax Act. The criteria for reassessing statute-barred years must be analyzed. In considering whether to reassess years beyond the applicable normal reassessment period, the CRA officials may need to rely heavily on the information and documents provided by the taxpayer and will review a number of factors, including:

The quantum of the omissions that relate to the earlier years;
The taxpayer's compliance history;
The taxpayer's level of sophistication;
The duration and complexity of the non-compliance; and
Whether trust funds, such as GST/HST and source deductions, are involved.

In previous practice, the CRA would sometimes seek to include income amounts from such prior years and assess tax on all of that income in the oldest non-statute barred year. This practice was not authorized by the Income Tax Act and is now expressly prohibited in the Manual.

Conclusion

With Canadians refocusing on tax compliance in the wake of the Pandora Papers, the Manual sheds light on vital nuances explaining how the CRA will address VDs. We recommend that anyone considering making a VD consult with experienced legal counsel to help effectively navigate the current VDP. More than ever, succeeding with a VD application is an exercise in persuasive advocacy. Similarly, non-specialists should seek specialist advice before attempting VD work, as in-depth knowledge, thorough consideration and care are now more important than ever.

Should you have any specific questions about this article or would like to discuss it further, you can contact the authors or a member of our Tax Dispute Resolution Group.

Stevan Novoselac is the Canadian leader of Gowling WLG's Tax Dispute Resolution team. John A. Sorensen is a partner at Gowling WLG in Toronto, where he specializes in tax and tax dispute resolution. Read the original article on GowlingWLG.com.