Solicitor-client privilege prevails over CRA information gathering powers

At issue

The earliest incarnation of solicitor-client privilege was as a rule of evidence.  It served as a shield against confidential professional communications between a lawyer and client being tendered as evidence in a court proceeding.

Over time, privilege has progressed beyond being mere procedure.  Indeed, it is now considered to be a substantive legal right (whether in or out of court), and indeed a principle of fundamental justice.  But there have always been and continue to be limits.  For example, the client must be seeking legal advice and must intend the communications to be kept in confidence.  Furthermore, communications in furtherance of a criminal purpose are not protected at all.

Earlier this year, the Supreme Court of Canada (SCC) released rulings in two cases involving privilege claims invoked to resist disclosure demands from the Canada Revenue Agency (CRA).

Solosky v. The Queen, [1980] 1 SCR 821 

This judgment marked an explicit acknowledgement from the SCC that case law had progressed such that privilege could be claimed outside court evidence matters, bringing it to a “new plane”.  Solosky was an inmate in a federal penitentiary whose correspondence – including that with his lawyer – was being opened by corrections officers.  While accepting the evolution of privilege, the Court expressed that limits remain, denying the instant claim in the face of overriding security concerns of the institution. 

Section ss. 231.2(1), 231.7 and 232(1) of the Income Tax Act (ITA)

ITA s.232(1) defines solicitor-client privilege as “the right … to refuse to disclose an oral or documentary communication on the ground that the communication is one passing between the person and the person’s lawyer in professional confidence, except that for the purposes of this section an accounting record of a lawyer … shall be deemed not to be such a communication.” [Emphasis added]

This is known as the ‘accounting records exception’, and is brought within CRA’s power to require documentary disclosure under ITA s. 231.2(1).  And if there is a refusal to produce the document/communication, the CRA may seek court assistance pursuant to ITA s.231.7.

Canada (Attorney General) v. Chambre des notaires du Québec, 2016 SCC 20

Over recent years, many Quebec notaries in the course of law practice had been served with a “requirement to provide documents or information” relating to one or more of their respective clients who were the subject of tax audits.  The Chambre des notaires du Québec was unable to negotiate a compromise with CRA, so it launched a court action which eventually made its way to the SCC.  

The top court noted that information in accounting records could be subject to solicitor-client privilege, with the client name alone sufficing in some situations.  Accepting that the requirement scheme is a legitimate tax collection tool for CRA generally, the intrusion on privilege nonetheless went too far.  The SCC ruled the ITA sections were unconstitutional with respect to accounting records of lawyers and notaries (as had the lower courts), as an unreasonable search and seizure of information under s.8 of the Charter.  

Canada (National Revenue) v. Thompson, 2016 SCC 21

Both Chambre and this case dealt with the accounting records exception, and the two judgments were released on the same day.  But whereas in the former it was the clients whom CRA pursued, in this case Mr. Thompson himself was the subject of an income tax audit, the CRA having served him a requirement to produce the accounts receivable of his law practice in addition to personal finance documents.

Though constitutionality was not argued here, the finding followed from the Chambre ruling, ironically allowing Mr. Thompson to prevail due to his clients’ rights, not his own.  This was emphasized by the Court in noting that privilege is that of the client, not the lawyer, and could only be waived by the client.  It went on to remark that if Parliament decided to rectify the disclosure scheme, it would have to build in a process for clients to participate and protect their rights in a situation such as Thompson. 

Practice points

  1. Solicitor-client privilege is the right of a client in the course of obtaining confidential professional legal advice, and for clarity it is not a right of the lawyer consulted.
  2. Pursuant to Chambre, it is unconstitutional for CRA to require production of accounting records from lawyers and notaries, as that would presumptively compromise clients’ privilege rights.  As regards the accounting records of other professionals, the relevant ITA sections remain in effect.
  3. Parliament may act to amend the ITA to enable access to accounting records of lawyers and notaries, but will have to do so in a manner that continues to protect solicitor-client privilege.

In a field of their own: Targeted tax treatment for farmers and fishers

While each of us is unique in any number of ways, as taxpayers, we have much more in common than that which distinguishes us. Even so, those earning a living from the land or sea face very different challenges than do other occupations.

The distinctive nature of farming and fishing is acknowledged through a variety of targeted tax rules. These range from assisting farmers and fishers in their year-to-year operations through to facilitating continuity of their operations down generations. Here are the key measures.

How and when to report income

The fiscal period for reporting income is usually 12 months. For employees and self-employed individuals, the general tax rule is that the fiscal period is the calendar year, though a farmer or fisher may apply to have a non-calendar year-end. 

Farmers and fishers are also entitled to choose between accrual or cash accounting. Under accrual accounting (the general rule), income is reported when earned and expenses when incurred. Comparatively, cash accounting reports when amounts are respectively received or paid. Farmers and fishers may move from accrual to cash accounting simply by filing their next tax return in the new manner. However, permission to return to the accrual basis is required from the local tax-services office. 

Farming losses

If someone has a farming or fishing loss in a year, it may be carried back up to three years or carried forward up to 20 years. As such farm losses may be taken against any other income, this has been an area of much contention between so-called hobby farmers and the Canada Revenue Agency (CRA) over the years. 

Just because someone lives on a farm does not make that person a farmer. If the farm was not run as a business, the person cannot deduct any farm-related losses. Where the farm activity was run as a business but was not a main income source, part of the loss may be deductible under the “restricted farm loss” formula. The details are beyond the scope of this article, but the topic is covered in CRA Guide T4003, Farming Income.

Succession and capital gains

Farming and fishing are capital-intensive businesses, many being at the heart of communities dependent upon their continuity. Absent there being laws to recognize this condition, those operations, their expertise and the communities themselves may be at risk. Capital gains rules have been modified in a number of ways to accommodate. 

Lifetime capital gains exemption (LCGE)

Likely the most commonly known capital rule for farmers and fishers is the LCGE on qualified farm or fishing property (QFFP). Its value was raised from $813,600 to $1 million in 2015. It is shared with the LCGE on small business shares (i.e., the maximum is $1 million in total). The latter continues to be annually indexed from that 2015 value, and once it exceeds $1 million, the two will index in lockstep once again.

QFFP covers capital property used and owned by the taxpayer, spouse or common-law partner, including

  • real property, such as land and buildings;
  • shares of the capital stock of a family-farm or fishing corporation;
  • interest in a family-farm or fishing partnership; or
  • eligible capital property, such as milk and egg quotas.

Transfer to a child

When farming or fishing property is transferred to a child, the transferor may postpone tax on any taxable capital gain and any recapture of capital cost allowance until the child sells the property. To qualify, the child must be resident in Canada, and the property itself must be in Canada and have been actively engaged in farming or fishing activity on a regular and ongoing basis before the transfer. 

The transferee may be one’s child or that of a spouse or common-law partner, and further includes 

  • a natural or adopted child;
  • a grandchild or great-grandchild;
  • a child’s spouse or common-law partner; or
  • another person who is wholly dependent on the transferor for support and who is, or was immediately before the age of 19, in that person’s custody and control.

Extended reserve claim

The general rule for recognizing capital gains is that they are recognized in the year of disposition. If payment is deferred, the taxpayer may elect to recognize the gain across as many as five years, being the year of closing plus four years. 

For disposition of a family farm, a fishing property or small business corporation shares to a child (using the same extended definition outlined above for transfers), the reserve period may be as long as 10 years. 

CRA guides

Beginning in 2017, CRA Guide T4004, Fishing Income, will no longer be published. It will be replaced by Guide T4003, Farming and Fishing Income. The T4003 will include tax information for both farmers and fishers. [Postnote – As of 2018, guide T4003, Fishing and Farming Income, is no longer published. Instead, use guide T4002, Self-employed Business, Professional, Commission, Farming, and Fishing Income.]

Selling an advisor’s book [4/8] – Tax issues overview

[Eight-part series, current to publication date only]
1 – Why and how do we prepare
2 – Finding the right buyer
3 – Getting the best price
4 – Tax issues overview
5 – Incorporation issues overview
6 – Caveats and limitations
7 – Selling when incorporated vs. unincorporated?
8 – Ways to get paid

4 – Tax issues overview

Last time we reviewed valuation and negotiation.  This article will discuss issues that can affect the tax treatment of a book sale for one or both parties.

The legal nature of parties involved in the transfer of an advisory practice is one of the central determinants of the transaction’s tax outcome. It comes down to clarifying whether the parties are employees, self-employed or incorporated.

Employees

From the selling side, amounts received by an employee are taxed at the person’s marginal tax bracket. Those amounts are generally taxable in the year received, without the ability to defer recognition or to take a reserve or a portion into income in a future year. This applies to a payment received from a succeeding advisor/buyer for making a recommendation to clients to continue with the successor, including any portion received under a non-competition agreement (also known as a restrictive covenant).

The amount of the non-competition payments and their timing (e.g., if extending past the year of closing) must be reasonable.

If the buyer is an employee, few tax deductions are available, and specifically, no deduction is allowed for payments made to acquire another advisor’s clientele. As well, for tax purposes, an employee cannot generally acquire capital property for which annual depreciation might otherwise be claimed. Similarly, acquiring a client list as goodwill does not qualify as eligible capital property, for which annual amortization charges might otherwise be claimed

Finally, if the buyer has borrowed funds to assist in the purchase, any interest charges will not be deductible.

Much of this summary reflects the Supreme Court of Canada’s 2004 ruling in Gifford (see “Relevant cases”).

Self-employed

A self-employed taxpayer is not subject to the same tax treatment as an employee. Payments made and amounts received will generally fall under the rules applicable to the earning of business or property income.

Advisory practices are capital in nature, so a self-employed buyer cannot claim a current deduction; nor must the seller/receiver generally record a current income inclusion. The payments are instead under the eligible capital property regime, allowing a buyer to claim amortization. A seller is entitled to “capital-gains-like” treatment in the year of sale.  [New regime – The 2016 Federal Budget will replace the eligible capital property (ECP) tax regime with a capital cost allowance class. Draft legislation was released July 29, 2016, and the comment period closes September 27, 2016. There is a transition period, so we’ll still discuss the legacy ECP regime, but be aware that new rules are coming in 2017.]

Relevant cases

Gifford v. the Queen, 2004 SCC 15

Gifford and Bentley were financial advisors employed with Midland Walwyn in North Bay, Ont. In 1995, Bentley (who was departing the practice) agreed to provide a written endorsement of Gifford to his clients, supported by a 30-month restrictive covenant. Gifford borrowed the funds for the agreed price of $100,000.  Gifford subsequently claimed deductions for depreciation and interest. Those deductions were denied, and the appeals eventually made their way to the Supreme Court.  The court held that the payment for the accumulated goodwill and the agreement for Bentley not to compete were made to create an enduring benefit for Gifford. This amounted to a payment on account of capital, and the Income Tax Act (ITA) s. 8(1)(f)(v) prevents an employee deduction from being made for such an expense. Furthermore, interest payments therefore would be a payment on account of capital, and are expressly denied deductibility under s. 8(1)(f)(v).

Morrissette v. the Queen, 2006 TCC 284 (translated from French)

Morrissette was an advisor with Laurentian Bank Securities (LBS). In October 2002, LBS advised Morrissette that it was terminating his employment. A payment of $20,000 was made at that time, with a further $5,000 to be paid six months later as a “final payment—sale of clientele” if LBS had retained 75% of the assets under management.  The court found that Morrissette was indeed an employee, and that the $20,000 was severance pay, not a capital gain as Morrissette had claimed. The court referred to Gifford in discussing the $5,000 payment, determining that this amount was “in respect of a certain right of [Morrissette] in his clientele.” Note that this case proceeded under the informal procedure, and is therefore not binding on any court.

Desmarais v. the Queen, 2006 TCC 417

Desmarais accepted a $350,000 payment from Valeurs mobilières Desjardins (VMD) to move from Nesbitt Burns. He took on the role of branch manager, overseeing 24 advisors. A colleague joined him, and was making ongoing payments as a commission split to acquire the clientele of Desmarais.  Desmarais claimed the payment as a capital gain, was reassessed by CRA and appealed to the court. The court determined that the VMD payment was an incentive to sign the employment contract, and taxable as income pursuant to ITA s.6(3).

Bouchard v. The Queen, 2008 TCC 462

These were three appeals involving a couple, Danielle and Jacques Bouchard, and their daughter Jacinthe. The couple retired as advisors from National Bank Financial (NBF), receiving in part what was described as “retiring allowances.”  The central issue was whether the payments were capital or employment income. The reasons are quite detailed, but the court arrived at the conclusion that all amounts at issue were employment income.