New realities are creating renewed need for in-house legal teams outside counsel and tax functions to work more closely together day to day. We’re used to seeing these multidisciplinary functions team up around large-scale transactions. But more often than not, gaps recur in the regular course of business. In Canada, a changing regulatory landscape and evolving tax legislation mean silos like these can expose entire organizations to additional risk, assessments and costs. Dismantling barriers between functional areas can help.
Slowly but surely, a steady change has redefined the tax authority’s focus in Canada and around the world. Tax authorities have become exponentially more sophisticated in recent years, digitizing and increasing scrutiny as businesses wrestle with a broad range of emerging stakeholder demands around disclosure, long-term societal value, digital and more. Layer in the difficult and unpredictable post-pandemic economic climate, and the tax landscape becomes even more complex.
Tax authorities face mounting pressure to generate revenues. Meanwhile, Canadian businesses are working to understand anti-avoidance and mandatory disclosure rules that trigger new requirements around when a transaction must be flagged to the Canada Revenue Agency, which types of scenarios merit that heads up and much more.
Two decades ago, tax authorities were primarily focused on assessing “aggressive tax avoidance.” Today they’re doubling down on a wider range of technical or bookkeeping errors in calculations, documentation and electronic form filing. Looking back, many of these issues would have been of no consequence. Fast forward to now and they represent a plethora of risk that comes to life in all sorts of ways.
Consider if a company entered into an internal restructuring transaction in 2017. Human error resulted when calculating the value of interest on dividends owing and preferred shares being transferred. The individual thought those preferred shares had been issued in July 2012 and calculated the dividend accordingly. But the shares were actually issued in May 2011. That bookkeeping error resulted in a $15 million assessment. Layered on top, there ended up being $7 million in interest.
We see similar examples cropping up in the contract side of our work as well. What might otherwise be considered minor oversights — say, forgetting to list a delivery point on an invoice — has led to a multimillion-dollar assessment over sales tax controversy. What’s more, it cost the company in question hundreds of thousands in legal fees.
Any discrepancy or inconsistency in contracts, commercial papers and other documentation is now more likely to become the basis for assessments as stricter interpretations of tax legislation become the rule of the day. Enter the need for legal and tax teams to work together at every stage of operations. Why?
When tax and legal come together systematically and embrace a new way of working, every aspect of operations benefits from both these perspectives at the front end. Contracts are compliant by design by virtue of having tax and legal input from the get-go. Commercial documentation is more likely to withstand tax authority scrutiny because it’s benefited from in-house legal insight and the fresh perspective of external counsel with a multi-client view on the market.
The real question isn’t whether working more closely together can benefit the business. It’s what’s the best way to encourage this approach? At EY Law, we recommend focusing on three key steps to kick-start this shift:
- Prioritize critical connection points across the business. Moving towards a more collaborative way of working across departments doesn’t have to feel like boiling the ocean. To make solid progress quickly, identify key integration points around commercial documentation where you anticipate tax controversy could occur. Using that list as a guide, map out a process for assessing these contracts in the initial phases — and then through regular, ongoing touchpoints that give legal and tax consistent ways of coming together to gut check progress and review.
- Think beyond precedent to ask better questions. It’s no longer enough to assess a contract as “good enough to get the deal done.” Instead, aim to be two steps ahead of intensifying tax authority scrutiny by creating a framework of questions tax and legal teams will ask together when assessing contracts, commercial papers and other documents. For example, how is this document likely to be characterized from both the income tax and sales tax perspectives? What’s the outcome we hope to achieve, and do we need to change the wording to reach that objective?
Textbooks tell us there are two parties to a contract. Reality reminds us in Canada there are four: the buyer, the seller, the Canada Revenue Agency and the provincial tax authority. The last two won’t be involved when you create a contract, but they will have an opinion on it three or four years later when that contract crosses their desks.
Consider the tax and legal questions those parties are likely to ask earlier on, and collaborate internally to ensure your answers are sound. Leverage external counsel relationships here to gain fresh perspective and an industry-wide view that reveals what else is happening in the market and surfaces additional scenarios to consider.
- Make consistency your top priority. Contracts are just one piece of the tax controversy puzzle. To stand up effectively over time, contract wording must repeat consistently — and be categorized properly — on invoices, purchase orders, order acknowledgements, receipts, packing slips and shipping documents. Anything less can trigger unwanted assessments, penalties or interest down the line. Legal teams can support the tax function in minimizing those risks by drafting contracts and then ensuring those contracts are properly effectively implemented throughout the organization.
This is bigger than simply asking different teams to provide input. You want to work in a way that brings tax and legal back to the table again and again, so everyone has a chance to weigh in and make sure language and details are applied effectively across every channel of business operations.
