By Cristin Schmitz for Law360
Legal advisers across Canada, including Quebec notaries and Ontario paralegals, do not have to comply with constitutionally-impugned Income Tax Act (ITA) mandatory reporting obligations with respect to clients’ tax avoidance, following the Federation of Law Societies of Canada’s (FLSC) success in obtaining a nationwide interlocutory court injunction until its Charter challenge to last June’s ITA amendments is determined.
On Nov. 24, Supreme Court of British Columbia Justice Lisa Warren granted the umbrella group for the country’s 14 law societies an injunction suspending the application to legal advisers of the ITA’s expanded mandatory reporting of clients’ tax avoidance transactions — measures that came into force at the end of June and were to apply to legal professionals as of Dec. 1, 2023: Federation of Law Societies of Canada v. Canada (Attorney General) 2023 BCSC 2068.
A temporary injunction, obtained on consent, was granted by the court last October after the federation launched its constitutional challenge Sept. 11, 2023.
The impugned ITA amendments expand to legal professionals the mandatory reporting obligations that are imposed on taxpayers, and on clients’ other fee-earning advisers, such as accountants. Importantly, they repeal s. 237.3(4) of the ITA, which provided a limited out for lawyers in that legal professionals required to file an information return with respect to a reportable transaction were not required to do so if the taxpayer or another adviser filed a return.
The challenged amendments were part of Bill C-47, which received royal assent June 22, 2023. They require advisers to file an information return with Ottawa about clients’ “reportable” transactions (i.e. tax avoidance transactions under the general anti-avoidance rule (GAAR), with specified statutory hallmarks) and “notifiable” transactions (i.e. tax avoidance transactions and other transactions of interest to tax authorities that the latter may wish to investigate for “abuse”), under penalty of up to one year in prison and a $110,000 fine for failing to do so.
The federation seeks to exempt legal professionals, arguing that for legal professionals to disclose clients’ confidential information so that the state can investigate those clients’ tax affairs violates the Charter by placing legal professionals in a conflict of interest, thereby compromising the s. 7 Charter-protected duties of lawyers’ undivided loyalty to clients and commitment to their clients’ cause. The reporting requirements also amount to an unreasonable search and seizure, in violation of s. 8 of the Charter, the federation argues in its petition.
The FLSC, whose members collectively regulate 141,000 lawyers, 3,825 Quebec notaries and Ontario’s 10,600 paralegals, seeks a declaration that ss. 237.3 and 237.4 of the ITA are inconsistent with the Constitution as they apply to legal professionals and that the term “adviser” in the ITA’s provisions should be read down to exclude legal professionals.
In granting the injunction pending the determination of the FLSC's constitutional challenge — which case the federation is expected to take up to the Supreme Court of Canada, if necessary — Justice Warren said the federal government conceded that there is “a serious issue” to be tried in the constitutional litigation.
The federation thereby surmounted the first hurdle in the three-pronged test for injunctive relief.
Justice Warren went on to accept that the federation had established that “at least two types of irreparable harm” would result if the interlocutory injunction were not granted: (1) if confidential or privileged information is disclosed as a result of legislation that is ultimately found to be unconstitutional, individual clients will be irreparably harmed by the loss of professional secrecy, which cannot be undone, and the prospect of that occurring will have a chilling effect on the ability of individual clients to consult with their lawyers fully and freely pending a final determination of the constitutional challenge; and (2) “the potential for the unconstitutional reporting of confidential and privileged information, and the conflicts of interest between lawyers and their clients that will arise as a result of potentially unconstitutional legislation, would irrevocably damage the solicitor-client relationship and harm the public interest by undermining the public’s confidence in an independent bar.”
Turning to the third requirement, Justice Warren concluded that the balance of convenience, taking into account the public interest, favoured granting injunctive relief.
While the judge did accept “that the proper administration and enforcement of the ITA is in the public interest,” she held that “this is one of those rare cases where there is a far more compelling public interest in favour of granting” interlocutory injunctive relief.
“The harm to the public interest if the injunction is not granted is significant and serious,” Justice Warren reasoned. “I have found that the potential for the unconstitutional reporting by lawyers of confidential and privileged client information, and the conflicts of interest between lawyers and their clients that will arise as a result of potentially unconstitutional legislation, would irrevocably damage the public interest by undermining the public’s confidence in an independent bar. This is a public interest that has repeatedly been recognized as extremely important.”
The Supreme Court of Canada has also called the professional secrecy of legal advisers an interest “which is a principle of fundamental justice and a legal principle of supreme importance,” the judge wrote. Moreover, the apex court has “emphasized that both clients and the broader public must feel confident that lawyers are committed to serving their clients’ legitimate interests free of other obligations. This confidence was said to be ‘essential to the integrity of the administration of justice’ and ‘of high public importance’.”
Justice Warren said she wasn't persuaded by the federal government’s argument that legal professionals have been complying with mandatory reporting rules since 2013, i.e. the ITA amendments do not amount to a new intrusion on privacy or on the solicitor-client relationship.
“Prior to the new amendments, a client could prevent their lawyer from disclosing anything by ensuring someone else reported,” the judge pointed out. “Put another way, the ability to prevent the harm that has been identified was within the client’s control. This is no longer the case.”
The judge was also not persuaded by the government’s argument that legal professionals are protected because information reasonably considered to be subject to solicitor-client privilege is exempt from disclosure; as well, clients have the same obligation to report, so it cannot be said that the information reported was intended to be kept confidential, and legal professionals will not be penalized for failing to report if they exercise the degree of skill to prevent such failure that a reasonably prudent person would have exercised in comparable circumstances.
“Whether the exemption for privileged information or the penalty exception applies in a given case is a matter about which reasonable people might disagree,” Justice Warren observed. “The uncertainty inherent in the Federation of Law Societies of Canada v. Canada (Attorney General), 2015 SCC 7, exemption as a result of the words ‘reasonably considered’ and in the exception as a result of the words ‘reasonably prudent person’ creates a conflict of interest between lawyers’ interest and those of their clients," she said. "The fact that clients also have to report does not eliminate the harm because it is not likely that a client and their lawyer will share an identical body of information about a particular transaction, particularly the aspects that require the application of legal judgment. This reality appears to be implicit in government’s purpose for requiring legal professionals to report; that is, as a check on the information reported by the clients.”
Justice Warren rejected the government’s argument that legal professionals have had sufficient notice to adapt their legal practice to mitigate the risk of harm, by advising clients upfront about the reporting obligations and addressing in their retainer agreements the consequences of any disagreement between the lawyer and client over what is reportable.
“These steps would merely identify the harm in advance; they would not eliminate the harm, particularly the chilling effect on the ability of individual clients to consult with their lawyers fully and freely pending a final determination of the constitutional challenge,” the judge wrote.