Canada’s compliance challenge

October 1, 2013

In 2011, the Canada Revenue Agency (CRA) announced that it would begin phasing in a new risk-based Approach to Large Business Compliance (ALBC). The roll-out is now well under way.

The new approach is of interest and relevance far beyond Canada because it shares a number of new audit characteristics with other tax authorities, particularly in other Organisation of Economic Co-operation and Development (OECD) countries.

This article reviews the approach and taxpayer reaction to date, sets out the likely implications for large taxpayers with operations in Canada and provide some advice on what steps they should consider taking in response.

Which taxpayers are affected?

The CRA uses an administrative definition of “large business” for purposes of corporate tax audit selection and coverage. Any business with C$250m or more in annual gross revenues is considered to be a large business for audit purposes. At present, this large taxpayer audit population comprises about 1,100 businesses in Canada.

The new ALBC

Under this new approach, the CRA assesses the risk of non-compliance associated with each large taxpayer, beginning with internal information drawn largely from the tax returns filed by the taxpayer. This internal information is largely quantitative and does not necessarily provide much insight into the company’s internal controls, corporate culture and appetite for tax risk.

For this reason, it is supplemented by information that is more qualitative and behavioral in nature, which is obtained from the company’s answers to a questionnaire sent by the CRA and accompanied by a letter addressed to a senior executive of the company, sometimes the CEO.

The questionnaire focuses on the company’s tax risk management approach and corporate governance. Among other things, it asks whether the company has a formal framework for identifying and assessing major tax risks associated with its normal ongoing operations; how material risk is reported, managed and monitored; what steps are taken when material risk is identified; whether its tax strategy is consistent with its overall business strategy; and whether it has a risk management committee.

With the information it has assembled, the CRA assesses the risk for each large business using the National Risk Assessment Model (NRAM) to consider the following main risk factors:

  • Audit history
  • Corporate governance (tax and or audit committee, oversight)
  • Corporate structure (e.g., controls)
  • Openness and transparency
  • Participation in aggressive tax planning schemes
  • Unusual and/or complex transactions
  • Major acquisitions or disposals
  • Industry sector issues
  • International transactions

Companies in a given industry are divided into high-risk, medium-risk or low-risk categories.

The letter accompanying the questionnaire requests a follow-up meeting with company executives, sometimes requesting the attendance of one or more members of the C-suite, including the CEO, CFO or a member of the audit committee. During the meeting, the CRA provides a general overview of the new ALBC and then shares its initial risk rating with the company officials.

The risk rating exercise and meeting is intended to be a recurring event with each large business, and is designed to improve transparency and build a more collaborative, less adversarial relationship with the tax administration.

Reaction to the ALBC

This new approach is somewhat unconventional and is purely administrative in nature. So it is not surprising that taxpayer reaction to the new approach has been mixed. It is neither based on nor supported by any accompanying changes in legislative power or authority.

For this reason, some taxpayers don’t think the ALBC will change much. Others feel that it may be a passing fad, in which it is not worth investing much time. But few are openly cynical about the whole exercise.

A majority believes that this new approach represents a significant improvement over the past that should result in a more businesslike approach to tax compliance. Many believe it is possible to establish a more transparent and less adversarial relationship, which in turn should result in lower compliance costs, more audit currency and greater tax certainty.

Recommendations

The ALBC is a similar concept to the OECD’s enhanced relationship initiative. But the CRA itself acknowledges that it has not yet implemented a full-featured enhanced relationship program covering all aspects of annual compliance obligations, such as the Compliance Assurance Process program in the US or the Horizontal Monitoring program in the Netherlands.

Unlike the ALBC, which is being applied universally across the entire large business audit population, participation in the latter two programs is voluntary. They also have entry requirements, promise immediate benefits and are based on a formal memorandum of understanding or compliance covenant between the two parties.

The CRA should reorient the ALBC in the direction of these programs, or initiate a smaller pilot program, in order to move more quickly to reward compliant taxpayers with tangible results in the form of more certainty, fewer and less intrusive audits, and lower compliance costs. At the same time, it should reallocate the audit resources that are freed up to those taxpayers and areas of concern that represent higher risk.

EY’s periodic tax risk and controversy surveys of tax directors and corporate executives in large businesses have shown that corporate boards and their audit committees are spending more time on a wide range of tax concerns as increase and have a higher profile and priority.16 Initiatives such as the CRA’s ALBC provide an additional incentive for them to increase this oversight.

Large businesses should continue to make managing global tax risks a higher priority. They should also implement formal tax risk management frameworks with the capacity to identify and manage key tax risks across the tax life cycle, making sure that they become a standard part of tax governance. This is, perhaps, more important than ever given the current volume and complexity of global change.

Ultimately, success will be measured by whether tax risk is managed in a way that meets the needs of business and the expectations of revenue authorities. The goal is to achieve a level of certainty about tax positions, reporting and planning that aligns with the principles of good corporate governance and satisfies the concerns of both parties.

The full version of this article is published in EY´s Global Tax Policy and Controversy Briefing, issue 12 (PDF, 7.39 MB)

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