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1993 Report of the Auditor General of Canada

Assistant Auditor General: Shahid Minto
Responsible Auditor: Barry Elkin

Main Points


20.1 The Department of National Revenue provides an advance income tax rulings service to facilitate voluntary compliance with the Income Tax Act, uniformity of application and self-assessment by taxpayers.

20.2 Advance income tax rulings provide certainty to a taxpayer by guaranteeing the income tax effect of specific transactions contemplated by the taxpayer. They involve some of the most complex tax issues, and their tax revenue implications can be significant.

20.3 The processing of requests for advance rulings requires expert analysis of tax law and policy. At times, it also requires clarification of tax policy intent from the Department of Finance.

20.4 One of the main outcomes of the ruling process is the clarification or development of National Revenue's interpretation of the law. These interpretations are critical to facilitate compliance with the Act . In that sense, the ruling process generates information that may be of interest to other taxpayers.

20.5 The Department publishes selected advance income tax rulings that it considers to be of particular interest to taxpayers. However, since 1985, it has published only 58 advance rulings out of an estimated 4300 issued. Recent rulings have been published with a delay of about two years.

20.6 Making more advance income tax rulings available would increase certainty among taxpayers and improve the transparency of the tax system. Consequently, equity among taxpayers would be enhanced and compliance with the Income Tax Act facilitated.


20.7 National Revenue also provides an advance rulings service for Goods and Services Tax (GST) registrants. The rulings service is decentralized among 34 district offices and involves about 400 interpretation officers across the country. In the Province of Quebec, the issuance of GST rulings and interpretations has been the responsibility of the Quebec Ministry of Revenue since 1 July 1992.

20.8 The legislation is new and was substantially modified in 1993. As a result, the Department has limited experience in interpreting and applying the GST. The fact that the system has not matured, as well as the decentralization of interpretation services, increase the risk of issuing inconsistent and inaccurate rulings and interpretations.

20.9 Inconsistent and inaccurate rulings and interpretations may create situations where registrants producing and selling similar goods or services are treated differently. Such unfair treatment could also affect the public's perception of the GST and reduce its motivation to comply with the tax.

20.10 To mitigate the risk of inconsistent and inaccurate rulings, National Revenue provides training for its interpretation officers and has developed an automated database to facilitate research before issuing GST rulings. It also established a formalized Quality Assurance Program in January 1993.

20.11 Initial data from the new Quality Assurance Program reveal a global error rate of 15 percent in rulings and interpretations issued between February and June 1993. About 6 percent were technically inaccurate and 9 percent were unclear or incomplete. This shows a need to enhance current training efforts, including the provision of additional training in legislative interpretation.

20.12 Progress was made in implementing the sections of the Canada-Quebec GST agreement relative to rulings and interpretations. However, the Department has not yet received the results of the Province's quality assurance activities and copies of interpretation and information letters issued by Quebec field offices.

20.13 National Revenue makes available to the public the policy content of its rulings and interpretations. However, we believe there is a need to release more information on rulings and interpretations, in order to provide greater certainty and equity to all registrants who collect the GST on behalf of the government.



20.14 An advance ruling is a written statement given by the Department to a taxpayer; it outlines how the Department will interpret specific provisions of existing Canadian income tax law as it applies to a specific proposed transaction or transactions to be carried out by the taxpayer.

20.15 National Revenue issues on average about 600 rulings a year. An additional 200 rulings are issued to supplement previously issued rulings. An advance ruling may be either favourable or unfavourable. Where an unfavourable ruling is to be issued, the taxpayer is given the opportunity to withdraw the advance ruling request (see Exhibit 20.1 ).

20.16 The provision of advance rulings is an administrative service. Although the Department is not legally required to issue them, it considers itself bound by advance rulings, provided that the statement of relevant facts or proposed transactions submitted by the taxpayer contains no material omissions or misrepresentations and that these facts and transactions do not change after the issuance of the ruling. An advance ruling applies only to the taxpayer who requested it. Tax accountants and tax lawyers are the main users of the ruling service (see Exhibit 20.2 ).

20.17 The Department charges a fee for time spent in connection with advance ruling requests. The fee is set by order-in-council and is currently $90 for each hour or part thereof. As the aim here is to recover costs, the Department will review the fee periodically to make sure that it is appropriate.

20.18 The purpose of the advance rulings service is to promote voluntary compliance, uniformity and self-assessment by providing certainty with respect to the income tax implications of proposed business transactions. By removing doubt as to the tax consequences of a particular transaction, advance rulings provide certainty for business and facilitate commercial transactions.

20.19 Advance rulings often deal with the most complex tax issues or can have significant tax revenue implications. Many Canadian corporations consider it necessary to refer their more significant proposed reorganizations and other complex transactions for an advance ruling before going ahead with them. A large number of corporate reorganizations involving the tax-free transfer of assets worth several billion dollars have been the subject of an advance ruling.

20.20 The Department publishes selected advance rulings that it considers to be of particular interest to taxpayers. It takes care to preserve confidentiality by deleting ("severing") details that would identify the taxpayer concerned. The taxpayer or representative who requested the ruling is informed in advance of the intention to publish. Since 1985, only 58 advance rulings have been published out of an estimated 4300 issued.

Audit Objective and Scope

20.21 The objective of our audit was to assess the appropriateness of procedures put in place by the advance rulings service of the Department of National Revenue to maximize certainty, as well as voluntary compliance and self-assessment.

20.22 Our audit was limited to the advance income tax rulings service, and included a review of advance rulings and supporting documentation. We conducted interviews at head office and certain district offices; we also interviewed private sector tax experts.

Observations and Recommendations

The rulings process requires expert analysis of tax law and policy
20.23 Reviewing an advance ruling request and issuing an advance ruling is not a mechanical process. It requires judgment and in-depth knowledge and understanding of the Income Tax Act .

20.24 The review of the ruling request is undertaken by one of the four specialized divisions within the rulings group. All rulings are reviewed by a supervisor and director and signed by the supervisor. Contentious rulings and those involving new issues are referred to an internal review committee of directors and the Director General. The contentious issues that cannot be resolved at this level are referred to the departmental policy committee. The Department may also refuse to rule on a proposed transaction, though this is rare.

20.25 When the legislative provision is vague or ambiguous, the Department seeks clarification of the underlying policy intent from the Department of Finance. In 1992-93, this happened about 50 times. The review of the ruling request may result in the Department of National Revenue recommending technical amendments to the Income Tax Act. National Revenue advised us that, of the technical amendments released in December 1992, 56 of the 180 proposed amendments arose as a result of issues they had raised. These data also show that the advance ruling service constitutes an early warning system for tax policy and administration.

The rulings process generates information that is of interest to other taxpayers
20.26 As well as providing certainty to the specific taxpayer, the rulings process may clarify or develop the Department's position on specific technical matters of interest to other taxpayers. Departmental positions are an agreed-upon way of treating similar situations in the same manner or on a consistent basis. They are critical in determining what the taxpayer needs to do to comply with the Income Tax Act .

20.27 One example is the interpretation of the reorganization rules, commonly called "butterfly" rules, where the Department developed complex positions on such matters as types of property, net equity method, etc., through a series of rulings decisions. Another example is the definition of "financial difficulty" that was likewise expanded through rulings decisions, allowing more flexibility in refinancing troubled companies through the issue of preferred shares.

20.28 Newly developed positions or changes in existing positions have also been noted by tax professionals at various tax conferences and in tax journals. Many practitioners have analyzed and commented on the evolution of "butterfly" reorganization rules and related positions developed as a result of rulings.

20.29 The importance of positions and changes in positions for taxpayers and tax advisors is reflected in the fact that each year National Revenue is invited to answer tax practitioners' questions at various tax conferences, such as those of the Canadian Tax Foundation.

Published advance income tax rulings are not timely
20.30 The Department has endeavoured to communicate to some extent the positions taken in rulings. It publishes severed versions of selected advance rulings considered to be of particular interest to taxpayers. However, it publishes only one percent of all rulings issued, and the information is not timely. For example, each of the five published rulings we examined came out at least two years after it had been issued.

20.31 We believe that making more advance income tax rulings available would result in a more consistent and uniform application of the law among taxpayers and would improve the transparency of the tax system. All taxpayers, not only those who are issued advance rulings, would have access to sources of law and to knowledge of how the law is applied. This in turn would facilitate compliance.

Department's comment: We publish all rulings that we believe will be of general interest. However, it is not clear that publishing more rulings, containing information already available, will improve compliance. Making publications more timely is a continuing priority of the Department.

20.32 Other options exist to communicate, on a more timely basis, advance rulings to taxpayers or their tax representatives. The Department could simply release the rulings and let tax practitioners, who are its clients, analyze them and draw their own conclusions.

20.33 The Department currently releases severed versions of all 3000 written technical interpretations it gives each year. These severed documents are released under contract with commercial publishers, who obtain, for a fee, the copyright to the information. They then distribute it to taxpayers in electronic and in printed format. This appears to be an efficient way of releasing important information to taxpayers and improves the timeliness of the information provided. We believe the Department should consider adopting this process for releasing the advance income tax rulings, as well.

20.34 Severed versions of advance income tax rulings could also be released accompanied by the technical discussion sheet prepared by the ruling officer who processed the ruling request.

20.35 The Internal Revenue Service in the U.S. has been using this severing and release process since 1977. The release of the ruling is a condition under which it is issued. The publisher selects and comments on the rulings.

20.36 It is important for National Revenue to instil in its public three important characteristics of the tax administration process: integrity, equity and fairness.

(a) Integrity - the tax administration process operates with the basic expectation that everyone must and does pay his or her fair share of taxes due under the law.

(b) Equity - the tax enforcement process is applied impartially to all citizens.

(c) Fairness - the tax collector does not act capriciously or unreasonably in enforcing the law.

20.37 We believe that the tax administration process would be well served by making more advance income tax rulings available. Its transparency would be improved.

20.38 The Department of National Revenue should release to taxpayers, in severed form, issued advance rulings.

Department's response: The Department is committed to ensuring that its administration is not only fair and transparent but also responsive to clients' needs and responsible with government funds. In this respect, our research to date has indicated that taxpayers do not want to receive copies of all advance rulings if they are repetitive. If, after further consultation with the tax community, it is determined that a service similar to that provided by the American Internal Revenue Service is desired, the Department will provide such service to the extent that resources permit.



20.39 The Goods and Services Tax (GST) was introduced in January 1991 and substantially amended in June 1993. As part of its efforts to promote voluntary compliance and self-assessment, National Revenue introduced a formal ruling procedure for administering the GST in November 1991. Prior to that date, written advice was given to registrants in the form of interpretations.

20.40 The ruling procedure is similar to the one used in the area of income taxation except that it defines an additional type of ruling, called an application ruling. Summarized below are the definitions of the types of rulings covered under the GST procedure.

20.41 Advance GST rulings are written statements issued by the Department to a registrant or other person, stating how specific provisions of the Excise Tax Act will be interpreted with respect to a specific proposed transaction that the person intends to carry out. GST application rulings involve the application of the GST to certain supplies of goods or services, to the status of persons as registrants, and to the determination of commercial activities; they relate to the person to whom they are given and to a specific, factual situation. Both types of rulings are considered binding on the Department.

20.42 The Department provides interpretations in response to requests for general explanations of how the Act would apply in clearly defined circumstances. These are not binding.

20.43 It is important to keep in mind that GST registrants, not taxpayers as is the case with the Income Tax Act , are the prime users of GST rulings. As agents of the Crown, registrants are required to collect GST on behalf of the government. Their interest in requesting a ruling is to be certain whether the goods and services they produce and sell are either taxable or not. If they do not collect taxes on taxable goods and services, they risk having to reimburse the government in the amount that should have been collected, and having to pay penalties and interest.

20.44 As of January 1993, the Department had issued only six advance rulings and 295 application rulings, and had replied to about 48,000 interpretations and information requests. The low volume of advance and application rulings may reflect the limited experience of registrants and tax advisors with the GST's application. It may also reflect the policy of the Department, which is to not issue rulings when there are pending amendments to the legislation; instead, interpretations are issued.

20.45 The delivery of GST rulings is more decentralized than that of advance income tax rulings. Thirty-four district offices and about 400 interpretation officers across the country issue application rulings and interpretations. Headquarters issues GST advance rulings, application rulings and interpretations. Since 1 July 1992, the Quebec Ministry of Revenue has been responsible for administering the GST in the Province of Quebec.

Audit Objective and Scope

20.46 The objective of our audit was to assess the appropriateness of procedures put in place by the Department to ensure the consistency and accuracy of GST rulings and interpretations.

20.47 Our audit was limited to GST rulings and interpretations. It included a review of GST rulings and interpretations and supporting documentation. We conducted interviews at head office and in certain regional and district offices; we also interviewed private sector tax experts.

Observations and Recommendations

The risk of issuing inaccurate and/or inconsistent GST rulings and interpretations is high in a new system
20.48 Experience in interpreting and applying the GST is fairly recent and therefore limited. Administrative guidelines or positions, which facilitate the interpretation of the GST legislation by district office staff, do not always exist and must be developed before staff can respond to ruling and interpretation requests. The necessary technical expertise, which is acquired mainly through experience in dealing with ruling and interpretation requests and through formal training, is not fully developed. In an unmatured system such as GST, the risk of issuing inconsistent or inaccurate rulings and interpretations is relatively high. The decentralization of interpretation services - along with other GST administration - to 34 district offices and about 400 interpretation officers increases the risk of inconsistencies and inaccuracies in rulings and interpretations.

Department's comment: The appropriate tools and processes are in place or in the process of being put in place to ensure that the risk is minimized. These include improved training, the availability of expanded research tools for the field offices, and an ongoing quality control process. The Department considers that, given the state of maturity of the GST system, the incidence of inaccurate rulings or interpretations has been minimal.

20.49 Inconsistent and inaccurate rulings and interpretations may create situations where registrants producing and selling similar goods or services are treated differently. Such unfair treatment could also affect the public's perception of the GST and reduce compliance with the tax legislation.

20.50 In January 1993, the Department implemented a standardized Quality Assurance Program to ensure accuracy, consistency and uniformity in providing interpretations and application rulings across Canada. Prior to 1993, rulings and interpretations were reviewed in regions and at headquarters on an ad hoc basis.

20.51 Initial data from the new Quality Assurance Program revealed a global error rate of 15 percent in rulings and interpretations issued between February and June 1993. About six percent of issued rulings and interpretations were technically inaccurate, and nine percent were unclear or incomplete.

20.52 Both types of errors can be serious. Incomplete or unclear interpretations will be relied upon by other registrants and can lead to further errors in the future. It is also possible that the registrant requesting the interpretation will be misled by the incomplete or unclear response and will thus handle the response incorrectly.

Department's comment: The purpose of having a decentralized ruling system is to make registrant-specific advice at the local district office very accessible, with the view to eliminating the need to rely on a non-specific interpretation that might have been provided to another registrant.

20.53 Our interviews with staff in district offices and our review of application rulings and interpretations also revealed inconsistency about when to issue an application ruling versus an interpretation. In some instances, interpretations were issued, as requested by registrants, even though application rulings could have been provided. In other instances, interpretations were issued, even though an application ruling was requested and all relevant facts were provided. Also, due to the numerous changes proposed to the legislation, there were many instances where interpretations should have been given instead of application rulings. Specific training is being given to district offices with respect to when application rulings and interpretations are to be given.

20.54 Registrants issued an interpretation do not receive a binding commitment from the Department that it will not change its position when it audits them. As a result, an inequity exists, that is to say, registrants issued an interpretation do not enjoy the same benefit as registrants issued a ruling.

Department's comment: The right to obtain a ruling is not restricted and, in part, depends on the degree of detailed fact the registrant is willing to provide. If all of the facts are provided, a ruling will be given. In many cases, interpretations are issued because changes to the law have not been adopted by Parliament. In this situation, rulings would not be issued to any registrant, so the perceived inequity would not be relevant.

20.55 The Department has advised us that, in the case of an interpretation error, it would maintain its interpretation until the error was found and the registrant advised; that way, the registrant would not suffer any hardship. The Crown would bear the cost of the error.

20.56 While the registrant would not suffer any harm in such a case, competitors and customers may well be affected. Competitors charging the GST may lose customers to registrants not charging the GST as a result of an interpretation or ruling error. If the tax is collected erroneously, remitting the tax to customers who paid it may be a problem because they cannot be identified.

There is a need to enhance current training efforts
20.57 The Department recognizes that there is a need to increase the technical expertise of its staff in regional and district offices. It has developed tools to enhance staff expertise in applying the GST legislation. An automated database that contains advance and application rulings, precedent-setting rulings and interpretations, and policy statements issued by headquarters was developed to facilitate research in processing ruling and interpretation requests. These documents are made available electronically to regional and district offices. Training manuals in the areas that present major interpretation difficulties - real property and financial institutions - have been and are being developed. Seminars have also been given by head office personnel in these specialized areas.

20.58 The Department also provides various types of training, ranging from formal training courses such as "Basic GST Legislation" to seminars and videos on the impact of GST amendments. However, during our interviews with staff from district offices, interpretation officers expressed a need for more training in how to interpret GST legislation. Although the Department has included such training in its 1993-94 training plan, no training course has been developed yet.

20.59 National Revenue should ensure that all relevant training is provided to its staff on a timely basis.

Department's response: The Department recognizes the importance of training in maintaining a consistent, timely and accurate rulings and interpretation service. Various training tools have been produced for use by staff dealing with rulings and interpretations. These range from videos on specific topics to in-depth seminars on difficult technical areas and timely training materials on the amendments package related to Bill C-112.

Furthermore, a course on how to interpret GST legislation is now being developed as is a project to update the Basic GST Legislation course. National Revenue is committed to providing up-to-date technical training.

Sections of the Canada-Quebec agreement on GST rulings and interpretations issued by the Province of Quebec are not fully implemented
20.60 Under the Canada-Quebec agreement on the administration of the GST, the Province has agreed to process all requests for interpretations or advance rulings relating to the GST; this is to be done in accordance with interpretations already issued in similar matters or with Canada's tax policy. Quebec has also agreed to provide Canada with a copy of all rulings and interpretations issued. And it has agreed that, before informing the applicant, it will submit all precedent-setting interpretations or advance rulings to Canada for approval.

20.61 Our examination revealed that Canada and Quebec have taken actions to implement the sections of the agreement related to GST rulings and interpretations issued by Quebec.

Department's comment: The basic rules regarding the exchange of information and statistics necessary to perform effective quality control with respect to rulings and interpretations in the Province of Quebec are provided for in the agreement. Revenue Quebec has been very co-operative in providing any information requested, and full implementation of required processes and procedures is expected to be attained in the near future.

20.62 Quebec has provided Canada with a description of the quality control procedures it has established to ensure that its rulings and interpretations are consistent and accurate. However, quality control reports have not yet been provided to Canada.

20.63 Canada receives precedent-setting interpretations on a regular basis and has requested that interpretations and information letters issued by Quebec field offices be forwarded to it. At the time of our audit, Canada had not yet received the information requested.

Communicating more information on rulings and interpretations to the public would increase equity among GST registrants
20.64 In its GST Memorandum of Rulings, the Department of National Revenue indicates that it has no plans to publish specific GST rulings. Rather, the policy content of any GST ruling that sets a precedent will ultimately be incorporated into other departmental publications, such as GST memoranda.

20.65 The Department makes policy statements available to the public and to commercial tax publishers. Indeed, 37 policy statements have been released since 1 June 1993. It is the intention of the Department to use the policy database to isolate and clarify the main policy content of rulings and interpretations given.

20.66 Regional offices have access to specific GST rulings and interpretations. We believe that, since it is important for the Crown to have access to these documents in issuing rulings and interpretations, it is equally important that registrants, who are agents of the Crown, have access to them.

Department's comment: Rulings that are accessible at the regional office level for research purposes are limited to those issued by head office and the database is appropriately caveated with respect to possible changes in law and position, etc. It is intended that the Policy Issues database, the Question and Answer database, and other relevant research material that is available to the public will be the basic research tools used in providing interpretations at the district offices.

20.67 National Revenue should make available to registrants and other interested members of the public all issued GST rulings and technical interpretations.

Department's response: Releasing more rulings and interpretations to the public may not achieve the desired results of providing greater certainty and equity to all registrants. The application of GST is very often fact-specific. To encourage registrants to determine their GST liability by referring to decisions based on others' fact situations may cause misapplication of the tax, with subsequent problems of assessment and enforcement. The approach we have followed is to publish policy guidelines with examples of their application and to provide individual, fact-specific rulings where registrants want specific guidance.

The decentralized rulings structure whereby the District Offices issue rulings is meant to facilitate client service. Further, there is a substantial amount of public information available that outlines the Department's policies and positions. In addition to memoranda and technical information bulletins, there is a Question and Answer database and a Policy Issues database that set out departmental policy positions that, in effect, distil and condense the main issues that arise from ruling requests. Specific sectors have also been targeted with published information pamphlets.

Nevertheless, we will explore the benefits of publishing all GST rulings and interpretations in the course of integration of Revenue Canada's Excise and Taxation rulings and interpretation service. If publication is considered beneficial by the tax community, we will provide this service to the extent that our resources permit.