Client-donors involved in buy-low, donate-high “art flip” tax shelters have received assurance from the Federal Court of Appeal that the Canada Revenue Agency can’t get at them by auditing the shelter promoter. Now, the CRA will have to undertake a longer legal process if it intends to pursue client-donors.

In its recently released decision, Artistic Ideas Inc. v. Canada Revenue Agency, the FCA confirmed a lower court decision that the tax agency should not be allowed access to the names and addresses of each promoter’s donor-clients — arguably the CRA’s real target.

“This is an important decision,” says tax litigator Cliff Rand, a partner in the Toronto office of national law firm Stikeman Elliott LLP. “There has been some uncertainty whether the CRA could obtain a promoter’s client list if it’s doing the audit of a promoter.”

At issue was a “requirement” letter issued by the CRA seeking documents containing the names and address of both the charities and donors involved in the tax shelter.

Receiving such a letter can be an
intimidating experience, since it’s the equivalent of being served with a search warrant, says Rand: “If you don’t comply, you can be subject to criminal sanctions. It gets your attention.”

However, taxpayers are permitted to challenge the lawfulness of a requirement by making an application to the Federal Court of Canada.

The CRA is generally not allowed to issue requirements against a taxpayer that involve “one or more unnamed [other] persons” without first getting a court order.
Traditionally, however, the CRA has tried to bypass the court order process by seeing if the audited taxpayer will simply comply with its demand.

“This is very welcome news,” says Heather Evans, senior partner in the Toronto office of Deloitte & Touche LLP. “The CRA has been doing a lot of fishing.”

The FCA decision means the CRA cannot go on fishing expeditions. The Supreme Court of Canada says an audit must be “genuine and serious.”

The case began in the summer of 1991, when the CRA’s tax avoidance headquarters in Ottawa unveiled a broad investigation into art flips that it dubbed the “art project.” The mandate for the project was and continues to be identifying and reassessing all donors involved in art flips.

At the same time, the CRA began its audit of Artistic Ideas. A CRA auditor issued the requirement to provide documents. Artistic Ideas decided to fight the portion of the requirement asking for the names and addresses of its charities and donors. It brought an application in Federal Court stating that the CRA should have obtained a court order before requesting the names.

Despite the necessity for a court order, however, the SCC has allowed the CRA to use requirements in which “unnamed persons are not themselves under investigation.” In the lower court, the CRA did not dispute its intention to audit the donors, but there was no evidence it wished to audit the charities. The court decided, therefore, that the documents requested “may be relevant” to the CRA audit but, to prevent a fishing expedition, it ruled that the CRA was not entitled to the names and addresses of the donors without a court order; only the names of the charities should be turned over by Artistic Ideas.

The CRA appealed the decision to the FCA, arguing the Income Tax Act does not enable required documents to be handed over with information edited out. The FCA disagreed.
The “only reasonable way” for Artistic Ideas to comply with the CRA requirement, it says, was to delete the names of the donors.
Deletion of this type of information “is always possible in appropriate circumstances.”

If the CRA wants to get at donor-clients, the next step is to go after charities, but they, too, could fight any requirements served upon them, says Rand.

However, Rand adds, the CRA could also obtain the necessary court order. Under the act, it would have to prove that the “unnamed persons” are “ascertainable” and show that the requirement has been issued “to verify compliance by the person or persons in the group.” Both demands are achievable in the case. The CRA will probably take this route, without going after the charities.

Generally, it is difficult for a promoter or charity’s lawyer to argue against CRA evidence that a requirement was issued for legitimate enforcement purposes. As the FCA notes, donors obtain tax deductions based on appraised values that exceed the amounts that they paid for the art. These art flips should not be funded on taxpayers’ backs.