2019-0816111C6 2019 CPTS CRA Round Table Questions and Responses

Principal Issues: Various questions.

Position: See below.

Reasons: See below.

Author: Wharram, Kimberley
Section: Sections 9, 18(1)(b), 20, 66.2(5), 231.2(1), Class 14.1

2019 Canadian Petroleum Tax Society CRA Roundtable- June 6, 2019

Question #1

Does the Canada Revenue Agency (“CRA”) accept the recent decision in Canada (Revenu national) v. Les Développements Béarence Inc., 2019 DTC 5017 (FCTD) (“Les Développements Béarence”) which states generally that a taxpayer cannot be compelled by the CRA to provide information in an alternate form if the taxpayer provides the CRA with all the information relevant to the computation of its tax liability?

CRA Response to Question #1

Briefly, in the course of the audit, the CRA sent the taxpayer, a small business, a requirement for information under subsection 231.2(1) of the Income Tax Act (Canada) (the “ITA”), including a copy of the general ledger.  The CRA was of the view that the taxpayer did not fully respond to the requirement and therefore sought and obtained a court order to compel the taxpayer to provide the general ledger including (i) an excel spreadsheet containing all the daily transactions and (ii) a report of all transactions, by account, for each of the accounts in the trial balance. The taxpayer failed to comply with the Court’s compliance order and the CRA brought a motion to have the taxpayer held in contempt of court.

The Court denied the CRA’s motion for contempt. The Court was not persuaded beyond a reasonable doubt that the taxpayer violated the compliance order. The Court found that the taxpayer had provided all the information in its possession and that the CRA could not compel a taxpayer to provide such information in another format.

The CRA’s newly issued communiqué AD-19-02 – Obtaining Information for Audit Purposes, provides guidance to auditors on the CRA’s policy for the purpose of administering the ITA. Parliament has provided the Minister with broad information gathering powers in the course of an examination to verify tax obligations.  The Supreme Court of Canada has confirmed that these include the power to “inspect, audit, or examine a wide array of documents, reaching beyond those that the ITA otherwise requires the taxpayer to prepare and maintain”. (footnote 1) Any relevant information that exists, subject to privilege, may be requested by the CRA. Notwithstanding the breadth of the authority, CRA officials are expected to exercise their powers in a reasonable and supportable manner and with due consideration to audit scope, relevance and reasonableness, and transparency in carrying out their mandate.

Taxpayers have access to the information pertaining to their tax obligations and are expected to cooperate with CRA officials and to respond to reasonable requests for information.  The CRA encourages taxpayers to maintain openness and transparency in the course of an examination because complete and substantive information will lead to an efficient audit and may provide earlier tax certainty.

In summary, the CRA policy is not at odds with the decision in Les Développements Béarence. CRA officials are expected to be reasonable in their requests for the information and documentation.

Response prepared by:

Zul Ladak, Cam Morash and Barb Bjarnason
Oil and Gas Industry Specialists
International and Large Business Directorate

In consultation with:
Henry Gluch
General Counsel
|Department of Justice

Question # 2

In light of the accelerated capital cost allowance (“CCA”) rules, can the CRA provide examples of what it considers manufacturing or processing properties in the oil and gas context?

CRA Response to Question #2

Properties used in manufacturing or processing activities are included in Class 29, 43 or 53. The enhanced first year allowance for qualifying property does not affect the depreciable class of a property.

Examples of the activities in the oil and gas context that are considered manufacturing or processing include:

*    the processing of natural gas at a straddle plant in Canada; and
*    the processing of natural gas in a plant in Canada that is devoted primarily to the recovery of ethane.

Income Tax Folio S4-F15-C1, Manufacturing and Processing lists the following activities in the oil and gas context that are not considered manufacturing or processing activities: :

*    operating an oil or gas well or extracting petroleum or natural gas from a natural accumulation of petroleum or natural gas;
*    processing natural gas as part of the business of selling or distributing gas in the course of operating a public utility;
*    processing heavy crude oil recovered from a natural reservoir in Canada to a
stage that is not beyond the crude oil stage or its equivalent; and
*    “Canadian field processing” as defined in subsection 248(1).

Response prepared by:
Zul Ladak, Cam Morash and Barb Bjarnason
Oil and Gas Industry Specialists
International and Large Business Directorate

Question #3

It seems like most Interpretation Bulletins (“IT Bulletins”) have now been cancelled.  However, not many have been replaced by Income Tax Folios. Does the CRA intend to replace most IT Bulletins that have been cancelled, and if so, when can we expect them to be replaced? In the meantime, can taxpayers continue to rely on the positions expressed in the IT Bulletins in circumstances where there have been no court cases or changes in legislation?

More specifically, Interpretation Bulletin IT-179R, Change of Fiscal Period (“IT-179R”), provides the process to follow to request a change in the fiscal period of a partnership. Does the CRA intend to follow the process outlined in IT-179R for taxpayers to request a change of the fiscal period of a partnership?

CRA Response to Question #3

When the Income Tax Folio initiative began in 2013, there were about 266 still-active IT Bulletins. The Income Tax Rulings Directorate undertook a long-term project to replace these remaining IT Bulletins with Folios. There are no plans to revive all cancelled IT Bulletins, such as IT-179R, with a Folio.

On August 1, 2013 a standardized Treasury Board of Canada Secretariat “Archived Content” notice was added to all IT Bulletins on the CRA website. A link to the explanation of the meaning of “Archived Content” was added at the top of the IT Bulletins on the CRA website in order to avoid confusion with the concept of an “archived” IT Bulletin that the tax community had become familiar with over the years.

The “Archived Content” notice has no effect on the status or reliability of the IT Bulletins. They are current up to the effective date stated in each publication. Taxpayers and their representatives may continue to refer to the IT Bulletins for explanations of the CRA’s interpretation of the federal income tax law, keeping in mind the caution that has always applied:

While the comments in a particular paragraph in an IT may relate to provisions of the law in force at the time they were made, such comments are not a substitute for the law. The reader should, therefore, consider such comments in light of the relevant provisions of the law in force for the particular taxation year being considered, taking into account the effect of any relevant amendments to those provisions or relevant court decisions occurring after the date on which the comments were made.

IT‑179R was archived in 2004 on the basis that little of the content was interpretive and because it was rarely referred to in the CRA’s technical interpretations. With respect to changing the fiscal period of a partnership, the 2018 T4068 “Guide for the Partnership Information Return (T5013 Forms)” (the “T4068 Guide”) outlines the process that a partnership should follow to change its fiscal period end. The T4068 Guide indicates that to change an established fiscal period, a partnership should write a letter to its tax services office to ask for approval to change its fiscal period end and explain the reasons for the change.

Response prepared by:
Zul Ladak, Cam Morash and Barb Bjarnason
Oil and Gas Industry Specialists
International and Large Business Directorate

In consultation with:
Renée Leger
Manager, Income Tax Technical Publications
Income Tax Rulings Directorate

Question #4

Can the CRA discuss any changes in its internal audit processes that could impact taxpayers? In particular, it appears that auditors now need to forecast their tax earned by audit (“TEBA”). Is this the case?

CRA Response to Question #4

CRA auditor performance is not based on forecasted TEBA.  From time to time auditors will give an update to management on the audit issues identified in their case, including the dollar magnitude.  This audit process has not changed. The Integrated Large Business Audit Teams led by the International and Large Business Case Managers (“ILBCM”) are evaluated on the quality and timeliness of their compliance activities. Historically, tax authorities, including the CRA have relied upon Audit Yield performance measures to determine their impact on compliance. Audit Yield is generally the difference between the amount of tax self-assessed by the taxpayer and the additional tax identified and reassessed as a result of compliance activities. Audit Yield can be easily measured given the direct correlation between audit effort and audit results, and indicates the level of efficiency of audit activities. However, Audit Yield does not necessarily capture the tax authority’s impact on voluntary compliance nor does it reflect the final outcome of tax audits and disputes. The CRA’s general Audit Yield performance measures include TEBA and Fiscal Impact. TEBA includes the federal tax equivalent of adjustments to taxable income, the net present value of the federal tax equivalent to adjustments to tax pools, and certain penalties assessed. Fiscal Impact includes TEBA plus the provincial/territorial equivalent of current audit adjustments. Audit Yield is evaluated at the program and senior management level.

The Large Business Audit Program is updating its performance measures by developing a Compliance Measurement Framework. As part of this initiative, the International and Large Business Directorate has commenced the introduction of a performance measure similar to “Tax Assured” or “Justified Trust” used by other tax authorities. The CRA refers to this measure as Validated Risk. Validated Risk is an outcome measure that indicates the level of confidence and assurance in the tax system based on the CRA’s risk assessment process and taxes being paid voluntarily. Validated Risk can indicate, over time, the effectiveness of the tax authority in achieving the desired compliance outcome. This measure requires a certain amount of monitoring and validation to conclude that the tax authority has a level of justified trust in a certain proportion of the tax base. It generally requires a well-defined population segment that is subject to a risk-based approach to compliance, similar to the CRA’s Approach to Large Business Compliance (“ALBC”), for the large business population segment. The CRA conducts a risk assessment and validation of the highest risk taxpayers nationally at the early stage of the audit process. A quality risk validation of a large business taxpayer at this stage will qualify for the Validated Risk outcome measure.

Large business taxpayers are seeking earlier tax certainty with respect to their tax filing positions. At the same time, through its compliance activities, the CRA examines and validates the level of compliance in order to obtain a certain level of assurance that the taxpayer has in fact reported and paid the correct amount of tax. Validated Risk allows the audit function to take recognition for a quality risk validation even if it may result in a “no change” case from an Audit Yield perspective. This contributes to more timely case closure, earlier tax certainty, and lower compliance burden for low-risk cooperative taxpayers. The Validated Risk performance metric will be implemented in the coming year.

Response prepared by:
Gord Parr
Director, Large Business Audit Division
International and Large Business Directorate

Question #5

Can the CRA provide its position with regards to the characterization for income tax purposes of pre-Final Investment Decision (“FID”) expenses? In light of various projects that have recently been either postponed or cancelled, could the CRA confirm that it will view expenses incurred prior to the approval of a project generally to be deductible to a taxpayer?

CRA Response to Question #5

The income tax treatment of an expense is always based on the nature and purpose of the expense.  FID is dependent on many things including a particular taxpayer’s circumstances, critical time path, availability of equipment, and resources. Additionally, the extent of work done prior to making a FID will generally depend on the taxpayer’s policies respecting capital projects and may not necessarily be the same for all taxpayers.  Consequently, the CRA does not accept that there is bright line test, such as FID, to determine the characterization of expenses for income tax purposes.

As noted above, the categorization of outlays and expenses is based on the nature and purpose of the activity.  For example, expenditures in respect of research in determining economic viability may be considered to be on income account, deductible under section 9 of the ITA.  The economic viability determination of a project may include preliminary designs for tangible assets and estimating capital and operating expenses.

There are a variety of activities undertaken subsequent to the preliminary economic viability study.  These may include government approval, equipment specification, contract negotiations, stakeholder consultations, refinement of the economic viability study, etc. In determining the correct classification of expenses incurred for each activity, the CRA ascertains the purpose of the expenditure and whether the expenditure brings into existence an asset or advantage that has an enduring benefit.  If so, it is denied current deduction pursuant to paragraph 18(1)(b) unless it is specifically allowed under other provisions of the ITA, such as section 20 or the rules applicable to Canadian exploration expenses (“CEE”), Canadian development expenses (“CDE”) or depreciable property (including Class 14.1 which has replaced the eligible capital property regime). If the expenditure represents the cost of a depreciable property, CCA deductions will be available according to the provisions of the ITA, including the available for use rules.

The cost of a property is the laid down cost including site preparation, delivery, testing, legal, accounting, engineering or other fees incurred to acquire the property. Refer to Income Tax Folio S3-F4-C1, General Discussion of Capital Cost Allowance, for further guidance.

The postponement or cancellation of a project does not alter the nature of an expense incurred in connection with such project. For cancelled projects the taxpayer may be required to pay amounts for cancellation of contracts and the income tax treatment will depend on the nature of payments.

Response prepared by:
Zul Ladak, Cam Morash and Barb Bjarnason
Oil and Gas Industry Specialists
International and Large Business Directorate

In consultation with:
Judith Gorman
Senior Rulings Officer
Income Tax Rulings Directorate

Question #6

The proposed definition of “accelerated Canadian development expense” (“Accelerated CDE”) in subsection 66.2(5) excludes from Accelerated CDE “a cost in respect of a Canadian resource property acquired by the taxpayer, or a partnership in which the taxpayer is a member, from a person or partnership with which the taxpayer does not deal at arm’s length” (“Exclusion”).  The phrase “in respect of” has been interpreted very broadly in Canadian tax law, such that the Exclusion could be interpreted, for example, as excluding from the definition of Accelerated CDE drilling costs incurred on a property acquired from a related party, even if the drilling costs are paid to an arm’s length third party.  Could the CRA please confirm that the foregoing interpretation would be unreasonable in light of the context and purpose of the Accelerated CDE rules, and that the Exclusion generally should apply only in the context of Canadian resource property acquired by a taxpayer from a non-arm’s length party?

CRA Response to Question #6

The CRA would generally not deny deductions for Accelerated CDE that are otherwise permitted to be deducted under the ITA for drilling or completion expenses, solely because they were incurred on lands acquired from a person with whom a taxpayer does not deal at arm’s length.

Response prepared by:
Zul Ladak, Cam Morash and Barb Bjarnason
Oil and Gas Industry Specialists
International and Large Business Directorate

In consultation with:
André Payette
Senior Rulings Officer
Income Tax Rulings Directorate

Question #7

We are aware of at least one instance of fraud committed against a company by utilizing the CRA’s Form RC366, Direct Deposit Request for Businesses (“RC366”), to change the bank account used for direct deposits out of a GST account.  What is the CRA doing to prevent frauds of this nature?  What are the CRA’s verification procedures and are they being strengthened to ensure this does not happen again?

CRA Response to Question #7

The CRA takes the protection and security of systems and processes seriously. More specifically, the CRA has strengthened internal processing procedures pertaining to direct deposit forms. To protect the integrity of the enhanced procedures, the CRA is unable to disclose the internal enhancements publicly. These efforts are ongoing as we continue to evaluate and identify external risks. Any suspicious direct deposit activity is referred to the Criminal Investigations Directorate at the CRA.

The CRA also promotes and encourages businesses to sign up for direct deposit through the online secure portal. A business owner can complete this action through the My Business Account (“MyBA”) portal. Further, for those businesses signed up for email notification, whenever there is a change made to the direct deposit information on that business account, they will receive an email notification. Upon receiving an email notification, the business can log into the MyBA account to see what changes were made to the account.

Response prepared by:
Tina Flichel Fawcett
Director, Business Number and Authorization Division
Business Returns Directorate

Kimberly Wharram
2019-081611
June 6, 2019

FOOTNOTES

Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:

1  Jarvis v. The Queen et al, 2002 DTC 7547 (S.C.C.).

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