Misrepresentation of a tax matter by a third party.

On January 14, 2000, Tax Executives Institute submitted the following comments to the Canadian Ministry of Finance concerning income and goods and services tax measures. TEI's comments were prepared under the aegis of the Institute's Canadian Income and Commodity Tax Committees, whose chairs are, respectively, John M. Allinotte of Dofasco Inc. and Glen S. Pye of Nortel Networks Corporation. David V. Daubaras of GE Capital Canada contributed substantially to the development of TEI's comments. Also contributing were David M. Penney of General Motors Corporation, Gary G. Penrose of TransCanada Pipelines Limited, and Alan Wheable of Toronto Dominion Bank.

On September 10, 1999, the Department of Finance released draft legislation of income and goods and services tax measures that were first announced in the February 1999 federal budget. A Notice of Ways and Means Motion to implement the draft legislation was introduced in the House of Commons on December 7, 1999. On behalf of Tax Executives Institute, Inc., I am writing to express TEI's serious concerns about, and objections to, several provisions relating to the proposal captioned Misrepresentation of a Tax Matter by a Third Party. The provisions, which respond to the call of the Auditor General of Canada for new legislation imposing civil penalties against individuals who promote abusive tax shelters,(1)(*) reach far beyond any legitimate purpose by imposing onerous penalties on company employees for "false statements" or omissions relating to tax matters on their employers' corporate income and excise tax returns.(2) TEI believes the draft legislation is misguided and seriously flawed and, hence, should be withdrawn or substantially revised.

Background

Tax Executives Institute is the preeminent association of business tax executives. The Institute's 5,000 professionals manage the tax affairs of the leading 2,800 companies in Canada, the United States, and Europe and must contend daily with the planning and compliance aspects of Canada's business tax laws. Canadians make up 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our eight geographic regions. Our non-Canadian members (including those in Europe) work for companies with substantial activities in Canada. In sum, TEI's membership includes representatives from most major industries including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; telecommunications; and natural resources (including timber and integrated oil companies). The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

TEI is concerned with issues of tax policy and administration and is dedicated to working with government agencies in Ottawa (and Washington), as well as in the provinces (and the states), to reduce the costs and burdens of tax compliance and administration to our common benefit. We are convinced that the administration of the tax laws in accordance with the highest standards of professional competence and integrity, as well as an atmosphere of mutual trust and confidence between business and government, will promote the efficient and equitable operation of the tax system. In furtherance of this principle, TEI supports efforts to improve the tax laws and their administration at all levels of government. That we have undertaken to prepare these comments is a measure of our serious concern over draft legislation imposing personal civil penalties on company employees for statements or omissions on corporate tax returns that are determined to be false and that lead to the reduction of the corporation's tax liability.

Summary of Draft Legislation

Draft section 163.2 of the Income Tax Act (ITA) and draft section 285.1 of the Excise Tax Act (ETA) would impose penalties on any person who contributes to the making of a "false statement" on income and excise tax returns, respectively. Specifically, draft subsection 163.2(2) provides that "[e]very person who makes or furnishes, participates in the making of or causes another person to make or furnish a statement that the person knows, or would reasonably be expected to know but for circumstances amounting to culpable conduct, is a false statement that could be used by another person ... for a purpose of this Act is liable to a penalty in respect of the false statement."(3) Moreover, under draft subsection 163.2(4) of the ITA"[e]very person who makes, or participates in, assents to or acquiesces in the making of, a statement to, or by or on behalf of, another per son ... that the person knows, or would reasonably be expected to know but for circumstances amounting to culpable conduct, is a false statement that could be used by or on behalf of the other person for a purpose of this Act is liable to a penalty in respect of the false statement." (Emphasis added.) The differences between subsections 2 and 4 are very subtle -- indeed, the confusingly similar provisions can apply simultaneously to the same conduct or false statement(4) -- but the latter subsection applies to officers, directors, and employees of corporate taxpayers in respect of the corporation's income (and excise) tax returns, whereas the former is aimed primarily at promoters, appraisers, and third-party tax practitioners.(5)

Under draft subsection 162.2(3), the penalty for a false statement under subsection 162.2(2) is the greater of $1,000 or 100 percent of the "gross entitlements" (essentially the fees payable to the third party). Under draft subsection 162.2(5), the penalty for a false statement under subsection 162.2(4) is the greater of $1,000 and 50 percent of the tax reduction attributable to the "false statement." Regrettably, the proposed legislation fails to define the term "statement," but, in addition to the tax returns and statements therein, the term likely includes invoices, purchase orders, books of account, and any other record that forms the basis for the information reported in a company tax return or tax election. The very broad nature of what constitutes a statement, in turn, means that any "false" statement, which includes an omission or failure to act, of an employee that "could be used by or on behalf of the other person [the corporation] for a purpose of the Act" will potentially give rise to a penalty where the false statement is made either knowingly or under circumstances amounting to "culpable conduct."

"Culpable conduct" includes "conduct, whether an act or a failure to act, that (a) is tantamount to intentional conduct; (b) shows an indifference as to whether this Act is complied with; or (c) shows a wilful, reckless or wanton disregard of the law." (Emphasis added.) The first and third prongs of the definition of culpable conduct embody legal standards with well-established meanings. Indeed, the two provisions impose a burden on the government to prove the elements of substantial malfeasance that is similar to the elements for establishing criminal conduct (i.e., knowledge that an act or statement is wrongful or false, coupled with intentional or reckless commission of an act or the making of a statement).(6) Nevertheless, the broad scope of the potential application of the first and third prongs to every employee in a corporate setting will prove troublesome. More important and surprising is that, because of interpretations of the standard adopted by the courts, the second prong of the definition -- the "indifference" standard -- could arguably be invoked by the Canada Customs and Revenue Agency (CCRA) to assert penalties against corporate employees for acts or omissions that are tantamount to mere negligence.(7) Moreover, under the expansive provisions, multiple corporate employees (and not just those in the corporate tax department) would be liable to penalties for a single "false statement."

Discussion

In view of the tremendous complexity of both the Income and Excise Tax Acts, TEI is highly concerned that even the slightest misstep -- a mere foot fault -- by a corporate employee could lead to Draconian personal penalties. Corporate transactions frequently involve millions of dollars in reported tax liabilities. Consequently, employees involved in the tax planning for, or the mere reporting of, transactions on company tax returns would be exposed to an enormous penalty of 50 percent of the tax reduction if they are found to have been "indifferent" in participating or acquiescing in the making of the slightest "false statement" that contributes to a tax reduction that is subsequently re-assessed by CCRA.s Moreover, the dollar amount of a transaction and the corresponding tax reduction may be quite small in many cases (e.g., repair expenses that should have been capitalized), but the frequency of the transactions for a particular company might still result in a very large reduction in tax liabilities and a corresponding risk of ruinous penalties to affected employees.

TEI strongly urges the government to withdraw or substantially amend draft sections 163.2 of the ITA and 285.1 of the ETA because:

1. The law would violate longstanding principles of corporate law.

Business entities generally organize in the corporate form in order to provide limited liability to shareholders, officers, directors, and employees. Corporate law does not ordinarily hold corporate shareholders, officers, and directors personally liable for debts of the corporation. Employees are similarly protected under common law principles.

Protecting shareholders, officers, directors, and employees from potential liability for the debts of the business is the primary advantage of doing business as a corporation. Draft sections 163.2 of the ITA and section 285.1 of the ETA pierce the corporate shield by treating employees with direct or indirect involvement in their corporation's tax return as partners in the business (or as guarantors) -- without any of the advantages offered to partnerships.

Moreover, unlike tax-shelter promoters and third-party tax advisors, whose remuneration often depends directly or indirectly upon the level of success of a tax-shelter scheme, corporate employees generally earn salaries. In other words, they generally do not benefit directly from the tax-planning activities (whether of a legitimate or questionable nature) that reduce their company's tax liabilities. Hence, it is ironic that the draft legislation limits the penalty for third-party advisors and shelter promoters to the "gross entitlements" or fees earned from the tax-shelter arrangements, whereas corporate employees are potentially subject to personal penalties of 50 percent of the corporate tax reduction -- an amount that could far exceed an employee's lifetime earnings.

2. The law would violate sound tax policy.

All other Canadian taxes that impose personal liability on a corporate officer or director(9) involve taxes (such as payroll taxes) that are deducted at source from a third party and remitted to the government on behalf of the true taxpayer. Consequently, there may be good and just reasons to impose personal liability on individuals charged with the collection and payment of such taxes since these individuals are under a fiduciary obligation to truthfully account for and pay over taxes owed by a third party. In practically all such cases, both the amount of the tax and the obligation to pay are indisputable, and an individual's violation of the statutory and fiduciary duty is akin to embezzlement.

The same cannot be said for imposing personal penalties on company employees for "false statements" that improperly reduce the company's income and excise tax liabilities. The vagaries of both tax regimes' multitudinous provisions and their application to myriad business transactions and structures make the determination of a company's tax liability far from indisputable. In-house tax professionals are required to advise on hundreds of routine transactions every year and rarely have time to document their oral advice sufficiently to protect against a charge of acting with "indifference" to compliance with either Act. In addition, in-house tax professionals routinely provide advice to non-tax employees who can easily, albeit unintentionally, misunderstand or misapply the advice provided by the tax professional. Finally, the legislation seemingly does not include a reasonable cause or good faith exception that would permit abatement of penalties imposed on an employee? It is odd that the draft legislation would permit third-party advisors to invoke a "reliance in good faith" defense under draft subsection 163.2(6) for factual statements made by clients, but that corporate employees who seek advice from third-party advisors in respect of the proper tax treatment of a complex transaction would not be accorded a similar "good faith" exception.

The purpose of penalty provisions is to promote compliance with the tax law and deter wilful, culpable conduct. TEI submits that a penalty imposed on individual employees for an improper reduction in the corporate tax liability simply misses the mark. Under some circumstances, an employee may face public opprobrium and sanctions, including termination of employment, where "false statements" lead to an improper reduction in corporate tax liability, but it is wholly inappropriate for employees to be subject to a personal financial penalty for the company's noncompliance.(11) As a result, we believe that the recruiting and retention of qualified company employees would be significantly impaired by the enactment of these provisions. An unstable company workforce, in turn, will likely diminish rather than enhance the accuracy of the tax liabilities reported on company returns. In addition, since most TEI member companies are subject to audit scrutiny on a continuing basis, the efficiency of the government's tax audits would be impeded by increased company employee turnover. Consequently, we urge the government to consider carefully whether the policy evinced by the provisions would perversely diminish company tax compliance.

Finally, some commentators have suggested that the draft rules apply to CCRA employees.(12) While we believe that (1) the same standards of conduct should apply generally to taxpayers and government employees alike and (2) the provisions are sufficiently ambiguous to raise the question whether CCRA employees are covered by the provisions, TEI submits that employees of CCRA would likely resign from public service rather than risk financial penalties for acts of "indifference" to compliance with the Acts they are obliged to enforce. Again, we urge the government to consider whether these provisions will, if applicable to CCRA employees, hinder rather than promote the purposes of the Income and Excise Tax Acts.

For the foregoing reasons, the draft penalty provisions reflect unsound tax policies and should be withdrawn.

3. The vague scope of the proposed law and its application to myriad situations will create uncertainty, disrupt routine business processes, exacerbate the degree and magnitude of tax controversies, and increase the costs of tax compliance and administration.

The Revised Explanatory Notes released with the Ways and Means Motion state that the application of the draft provisions turns on the facts of any given case. Indeed, the most significant problems with the proposed legislation are its vague scope and, consequently, the uncertainty of its application to the myriad facts and circumstances that arise in connection with the determination of the income or excise tax liability for large commercial enterprises.

In response to public comments about the February Budget message, government representatives explained that the draft legislation is not intended to apply to conduct that involves an honest error of judgment or an honest difference of opinion about the interpretation of the Acts.(13) Similar statements are incorporated in the Revised Explanatory Notes. In addition, two examples explaining the application of the provisions were included in Annex 7 of the February 1999 Budget and five more were added in the Revised Explanatory Notes released in December. While the public statements are heartening, TEI submits that the legal threshold for invoking the penalty -- "indifference as to whether [the] Act is complied with" -- is potentially so low and its interpretation and application to factual circumstances so highly subjective that the examples raise as many questions as they answer.(14)

As another example, example three states that, where an Accountant has a reasonable basis to conclude that a Tax Court opinion adverse to a client's position may be overturned by a higher court, the penalty will not apply. Again, the example is helpful and we do not quarrel with the outcome, but we do not understand how the Accountant reasonably concluded that the Tax Court decision would be reversed. Is it relevant that the Accountant was involved in preparing the tax return involved in the Tax Court's tax shelter test case? Finally, in example three it is unclear whether the Accountant is subject to the penalty for the preparation of Client B's tax return (the client involved in the tax shelter test case) or in respect of Client C's return, which was prepared subsequent to the decision in Client B's test case. As important, the words of the Act should be clear and unambiguous on their face and not depend on reassurances from the tax administrators of the day for their proper interpretation. Leaving the interpretation of the penalty provision to a limited number of simple examples and relying on the discretion of CCRA to administer the provision reasonably will, we believe, prove both unsound and unworkable.

Corporate executives are responsible for signing hundreds, even thousands, of income and excise tax returns and statements annually. Under the standard of care in the Venne and Malleck decisions, the return signer is expected to read and understand each item on the return. The question that arises is: what level of review of each individual return item is necessary in order to achieve certainty that the executive does not risk substantial personal penalties for inadvertent errors or omissions on the corporate returns? The determination of the corporate income and excise tax liabilities for large commercial enterprises is a complex and challenging endeavour requiring the full-time attention of many individuals throughout the company. Nonetheless, resource constraints prevent a detailed review of all the items included in the return by the date of the filing deadline. Hence, tax executives are required to employ judgment and make risk assessments to ensure that the company returns are in substantial compliance with the Acts. In addition, because of the intricacies of the tax laws and the complexity of their application to the taxpayer's facts and circumstances, companies frequently disagree with CCRA about the application of the laws. As a result, while re-assessments of large company returns are common, that fact alone is not evidence that the employees (or the company for that matter) are indifferent "as to whether [the] Act is complied with.... " We believe, however, that the mere threat of the assertion of civil penalties against a corporate employee for any re-assessment will significantly alter the conduct and tenor of corporate tax audits,(15) exacerbate the scope and degree of tax controversies, and increase taxpayer and government litigation costs. Indeed, even though CCRA indicated during recent liaison meetings with TEI that the administration of the proposed penalty provision would be centralized in the Head Office, we remain concerned that the provisions of the draft legislation might be used improperly as a lever to extract settlement concessions.

To illustrate the uncertain application of the provisions and the potential for confusion or abuse, we submit several examples with questions and comments. The confusion engendered by the draft legislation even among skilled tax practitioners highlights the many interpretative difficulties that will surely arise should the draft legislation be enacted. Even if the government is able to provide definitive answers to the questions, there are many, many more facts and circumstances to which the penalty might apply. Indeed, we submit that CCRA may well expend more time on a search for bad actors than it spends examining the facts disclosed on the return and verifying the amount of the taxpayer's reported liability.

Example 1. A member of the corporate tax department provides oral advice to a field engineer who misunderstands the information and incorrectly documents an SR&ED project expenditure. The tax return is filed on the basis of the directions provided to the engineer by the tax department, but the paper trail of documentary evidence created by the engineer is at variance with the directions and, hence, indicates that the tax return includes a "false statement." How will the tax department employee defend against a charge of "indifference"?

Example 2. A tax professional resigns his employment with a company under circumstances involving considerable rancor and animosity toward the company and the other members of the corporate tax department. The remaining members of the tax department subsequently discover errors on previously filed returns and attribute the errors to the "indifference" of the former employee. How does the former employee defend against this? Indeed, piercing the corporate veil to impose personal liability for penalties for corporate tax reductions raises a plethora of questions about due process of law for employees and the companies by which they are employed. Examination of corporate tax returns may well degenerate into witch hunts against individual employees (or scapegoating of former employees) that may render the Act, not just the penalty, unworkable.

Example 3. Assume that errors are discovered on previously filed GST returns. Owing to the large volume of transactions and frequency of filing GST returns, the company pays the additional taxes due on a subsequent period return rather than file amended GST returns. While technically incorrect, the practice is common among large companies. Is the voluntary correction of the tax payments an indication of "indifference" in respect of either the previously filed returns or the tax returns that include the voluntary payment?

Example 4. Assume an intercompany asset sale of a business division between related, taxable members of a corporate group. The sale is effected by using book value as a proxy for the fair market value of the assets. A standard "price adjustment" clause is included in the purchase and sale agreement to account for changes in valuation between the contract and closing date as well as for valuation challenges from the tax authorities. A full-blown appraisal of the assets is not undertaken because the risk of a significant adjustment to the assets' individual or aggregate value is considered immaterial. In other words, the corporate group is prepared to accept the risk of additional interest and penalty cost should the price be successfully challenged on audit. Under the circumstances, can the corporate employees involved in the transaction, whether as decision-makers or facilitators who acquiesce in the transaction or its reporting, shield themselves from liability for a proposed penalty?

Example 5. Assume that an employee in the corporate accounting group who is unfamiliar with tax rules inadvertently deletes certain critical ledger files before a tax audit is completed. The company is likely subject to a penalty for exercising inadequate controls over its records. Is the individual who deleted the files subject to penalties for an "act of indifference" as well?

Example 6. Assume that a CCRA help-line employee gives incorrect advice to a taxpayer about the treatment of certain items and the taxpayer subsequently prepares a return on the basis of the statements made. Is the CCRA employee liable for the penalty for an "act of indifference"? If the return is a corporate tax return, is the individual who relies on the advice subject to a penalty for an "act of indifference"?

Example 7. Assume that a company determines that the costs (in terms of time and money) of documenting its transfer-pricing policy for some transactions is prohibitive. The number of such transactions is large but the dollar amount of each transaction is de minimis and the company has some evidence, but less than the quantum required by the statutes or information circular, suggesting that the price reasonably approximates an arm's-length price. Assume the company is re-assessed by CCRA and the assessment is affirmed at Appeals or in litigation. Which employees in the company (if any) are liable for the penalty--the senior tax executive, the tax professional providing the transfer-pricing advice, the return signer (if different from the others), a business unit decision-maker who decides against the advice of his tax department to eschew full documentation, or others who "acquiesce" in the decision?

4. The law would unwisely make Canada one of the few jurisdictions with a sophisticated economy and complex tax system that imposes such disproportionate and Draconian penalties on employees.

TEI is unaware of any other sophisticated tax jurisdiction that imposes similar penalties on employees for positions taken on the corporate employer's tax returns. In the United States, for example, there are currently no civil penalties where a comparable "indifference" standard is employed to subject a corporate taxpayer's employees to penalties for conduct related to preparation of their employers' tax returns.(16)

Under section 6700 of the U.S. Code, any person who organizes or participates in the sale of an interest in (1) a partnership or other entity, (2) any investment plan or arrangement, or (3) any other plan or arrangement, and makes or furnishes a statement (that the person knows or has reason to know is false or fraudulent) with respect to securing a tax benefit by reason of such statement is liable to a penalty of the lesser of $1,000 or the amount of the gross income derived from the activity. Again, the key distinctions of this provision from the Canadian legislation are the knowledge-based standard of conduct and a significantly lower cap on the penalty amount. Third-party tax return preparers who are compensated for performing return preparation are subject to penalties under Internal Revenue Code section 6694 only where a position has no realistic possibility of being sustained on its merits. In other words, the penalty is imposed on paid third-party return preparers where the return position is essentially frivolous. The amount of the penalty is generally limited to $250 per return, but rises to $1,000 if the understatement of tax is attributable to (1) a wilful attempt to understate the tax liability of another person or (2) for a reckless or intentional disregard of rules and regulations.

Recommendations

For the foregoing reasons, TEI strongly urges the Department of Finance to withdraw the draft legislation or substantially revise it to make it inapplicable to corporate employees acting within the scope of their employment at the direction of the employer. At a minimum, the "indifference" standard for "culpable conduct" should be eliminated (or made inapplicable to corporate employees in respect of their employer's liability) and the civil penalty for corporate employees who knowingly make "false statements" that lead to an improper corporate tax reduction should be capped at $1,000 per instance of culpable conduct.

Conclusion

TEI's comments were prepared under the joint aegis of the Institute's Canadian Income and Commodity Tax Committees, whose chairs are John M. Allinotte and Glen S. Pye, respectively. If you should have any questions about the submission, please do not hesitate to call Mr. Allinotte at [phone] (ext. 6821), Mr. Pye at [phone], or Marlie R.M. Burtt, TEI's Vice President for Canadian Affairs, at [phone].

* Notes appear on page 70.

Notes

(1) Report of the Auditor General of Canada (May 1996), at [paragraph] 11.70 (Revenue Canada should consider recommending to Finance an additional penalty for promoting abusive tax shelters). See also Report of the Technical Committee on Business Taxation (December 1997), at 10.12.

(2) The penalties would be in addition to current civil and criminal fraud penalties.

(3) The Excise Tax Act penalty provisions generally mirror the Income Tax Act penalty provisions. Thus, draft subsection 285.1(2) of the ETA is substantially similar to draft subsection 162.2(2) and draft subsection 285.1(4) is substantially similar to draft subsection 162.2(4).

(4) Since the two penalty provisions can apply simultaneously to the same conduct or statements, draft subsection 163.2(14) provides that a person subject to both subsections 163.2(2) and (4) for income tax matters is liable to pay the greater of the two. Draft subsection 285.1(14) provides a similar tiebreaker for penalties arising from excise tax matters.

(5) Under draft subsections 285.1(4) and (5), corporate employees would be similarly liable for penalties for misstatements on their corporate employers' excise tax returns.

(6) For civil tax penalties, such as that imposed by draft sections 163.2 and 285.1, the government must establish the elements of culpable conduct by a preponderance of the evidence whereas the elements of culpable criminal conduct must be proven beyond a reasonable doubt.

(7) The law already provides penalties against a corporate taxpayer for negligence in the reporting of its tax liabilities. Those penalties are not at issue. Rather, our concern is with the employee's liability to penalties under the definition of "culpable conduct." The Revised Explanatory Notes state that "culpable conduct" standard is defined with reference to the types of conduct to which the courts have applied civil penalties in the past. By incorporating this standard, the Notes imply that the issue of determining whether the culpable party acts with "gross" or "ordinary" negligence becomes moot. We disagree. At best, we are uncertain whether the second prong of the proposed standard ("indifference as to whether the Act is complied with") clarifies or obscures the requisite standard of conduct to which tax advisors and others must adhere. A person may be purposely, knowingly, or negligently indifferent about compliance with the Act, but the degree of wilfulness among the three standards is substantial. Moreover, the determination of whether the person acts with "indifference" will, as the Notes acknowledge, turn on all the facts and circumstances. As a result, substantial uncertainty about the scope of the provision and the standard of conduct will obtain until the courts apply the new "indifference" standard to decide actual cases. Indeed, as the Notes confirm, tax advisors, CCRA, and ultimately the courts must depend on extant jurisprudence to interpret the new standard. The leading decisions on the difference between ordinary negligence and gross negligence for purposes of the civil penalty in subsection 163(2) of the Income Tax Act (on which the Department of Finance based its draft legislation) are Malleck v. Her Majesty the Queen, 98 DTC 1019 (Tax Court of Canada), and Venne v. Her Majesty the Queen, 84 DTC 6247 (F.C.T.D.). Regrettably, Venne is internally inconsistent, referring in one part to the standard of neglect as being equivalent to ordinary negligence (for purposes of determining the applicable statute of limitations) and, at another point, to the higher standard of gross negligence for purposes of imposing a civil penalty. Indeed, subsequent decisions interpreting Venne have blurred the distinction between gross and ordinary negligence substantially. See, for example, Wiese v. Her Majesty the Queen, 2 C.T.C. 2247 (Tax Court of Canada), where the taxpayer's failure to review various lines in his tax return, an act of ordinary negligence in Venne, was determined to constitute gross negligence.

(8) Draft paragraph 163.2(9) helpfully excepts from penalties persons who provide clerical or secretarial services to third-party advisors, promoters, etc. Whether the exception applies for purposes of subsections 163.2(4) and (5), however, is far from clear. Moreover, the exception for clerical activities does not extend to "bookkeeping" services. Since many corporate employees could be considered to be engaged in "bookkeeping services," the narrow exception for clerical activities (and the bookkeeping exception to that exception) can only serve to heighten our concern about the application of the penalty to corporate employees generally.

(9) The draft provisions apply to all persons and are not limited to corporate officers and directors. This is yet another illustration of the overbroad scope of the statutory language.

(10) It is unclear whether or how the "reliance in good faith" exception to penalties set forth in subsection 163.2(6) can apply to corporate employees, all of whom are acting on behalf of the employer-taxpayer.

(11) Current law already levies civil penalties on the corporate taxpayer rather than employees where a corporation's tax liability is improperly reduced.

(12) Consider whether a CCRA employee who concedes a small issue to a taxpayer in order to obtain a settlement concession on an issue with a significantly greater dollar amount in issue might not be considered to have acted "with indifference as to whether [the] Act is complied with." Would not the CCRA employee have participated in the making of a "false statement" under circumstances involving "culpable conduct" where the treatment of the small issue is incorrect?

(13) Letter from Len Farber, Director of the Policy and Legislation Division, Department of Finance, to the Canadian Bar Association and Canadian Institute of Chartered Accountants Joint Committee on Taxation, July 30, 1999.

(14) For instance, example one in the Revised Explanatory Notes assumes without explanation that there is a bona-fide uncertainty about the application of the law and concludes that a tax professional who interprets a tax provision in a fashion that improperly reduces the client's tax liability is not subject to a penalty for culpable conduct where the Supreme Court of Canada sides with CCRA's interpretation of the disputed provision. Regrettably, the example begs the question that TEI members must address daily: How does the law apply to a particular set of facts? In other words, how in example one did the taxpayer know that CCRA would be expected to disagree?

In addition, in order to minimize the risk that a personal penalty will be imposed in any particular case, the example seemingly invites taxpayers to litigate and appeal issues to ever-higher courts rather than settle disputes at the lowest level possible. Why, to avoid penalties, did the case in example one have to be decided by the Supreme Court of Canada? Were the decisions of the lower courts adverse or favorable to the taxpayer? Are those questions relevant in the inquiry? Example three suggests that TEI's questions are relevant, but we are uncertain about how much legal authority is required in order to avoid liability to a penalty.

(15) This, in turn, will lead to significant disruptions in day-to-day operations and procedures for Canadian companies. At a minimum, knowledgeable employees will demand indemnification from their employers for even the most mundane duties and quotidian activities.

(16) Under section 6701 of the U.S. Internal Revenue Code, a penalty for aiding and abetting the understatement of tax liability is imposed where a person aids, assists, procures, or advises with respect to the preparation or presentation of any portion of a return or other document if (1) the person knows or has reason to believe that the return or other document will be used in connection with any material matter arising under the tax laws, and (2) the person knows that if the portion of the return or other document were so used, an understatement of the tax liability of another person would result. The penalty is $10,000 if the matter relates to the determination of a corporate tax liability. Several key distinctions from the draft Canadian legislation should be noted about the U.S. formulation of the penalty. First, both prongs of the penalty standard require that the culpable individual have direct knowledge or a reason to know that a statement or document is false and will lead to a reduction in tax liability. Second, the aiding and abetting of the understatement of tax liability must be in respect of a material matter. Finally, the amount of the penalty is wholly unrelated to the tax reduction and is capped.