A “highly reprehensible” and illegal probe by the Canada Revenue Agency that failed to draw the distinction between a civil tax audit and a criminal tax investigation has put into jeopardy several tax evasion criminal cases involving Quebec construction companies and corruption charges against former federal civil servants, according to tax experts.
In a precedent-setting ruling that appears to bring more clarity to the leading Supreme Court of Canada decision in R. v. Jarvis ,  3 SCR 757, Court of Quebec Justice Dominique Larochelle held that the evidence produced to charge the owner and three other company officials of a Montreal company, B.T. Céramiques, was obtained illegally because federal tax officials crossed the “Rubicon” and failed to inform the taxpayers that the inquiry had turned into a criminal investigation, thereby breaching their right to freedom from self-incrimination and right to reasonable expectation of privacy guaranteed under s.7 and s.8 of the Charter of Rights and Freedoms.
In Jarvis, the SCC stated that a CRA officer may shift his focus during an inquiry into a taxpayer’s affairs from a civil tax audit to an investigation. But once the “predominant purpose” of the CRA’s inquiry becomes investigative, an adversarial relationship between the taxpayer and the state takes hold because “of the liberty interest that is at stake.” CRA officials are then obliged to caution taxpayers and make them aware of their right to remain silent and the right to counsel under the Charter. If the CRA believes that the taxpayer has documents that are necessary to its investigation, the tax authority must obtain warrants in order to lawfully search and seize taxpayer records.
““The issue in Jarvis was a very simple one: when do those powers of constraint against taxpayers that an auditor has can no longer be used because the objective is now to gather evidence for the purpose of prosecution,” explained Montreal tax lawyer Christopher Mostovac who successfully plead the case. “In this particular case, it obviously deals with when an audit becomes an investigation but it also examines if the actual warrant was legal and deals with what happens with information obtained through a warrant and. Jarvis had nothing to do with getting a search warrant.”
CRA’s probe into B.T. Céramiques and its officials overstepped the boundaries from an audit into a criminal investigation when a tax official obtained information that some civil servants working for the tax authority might have been corrupted. On April 2008, CRA officials asked the RCMP for assistance because they expected search warrants would be needed. Defence argued however that before the RCMP became involved in the matter two different CRA divisions – one that investigated civil tax matters and another that handled criminal investigations, both of which were headed by the same person – worked closely together.
Justice Larochelle held that the defence proved by a “preponderance of the evidence” that the purpose of the CRA investigation, which eventually became known as Project Legaux, was to investigate B.T. Céramiques as well as to conduct a criminal investigation into certain CRA civil servants. Justice Larochelle noted that when B.T. Céramiques’ accountant asked CRA officials whether the audit had turned into a criminal investigation, the tax authority denied it. Even the CRA’s so-called Information, a legal document that spells out the grounds for requesting a search warrant, did not paint a true picture of the origin and circumstances surrounding the investigation, noted Justice Larochelle in Agence du Revenu du Québec et Sa Majesté La Reine c. B.T. Céramiques et Francesco Bruno et Gisella Palmerino et Alfredo Magalhaes et Rodolfo Palmerino (540-61-061227-135).
“CRA’s conduct is highly reprehensible,” said Justice Larochelle. The Income Tax Act grants the fiscal authority with “wide discretionary powers in terms of its application and execution. The corollary is the obligation to use it judiciously, in a transparent way and with respect to the Constitution. This case demonstrates that the investigation conducted under the guise of an audit lasted a year. Despite the red flags that were raised and the availability of resources, the case was not re-directed towards an investigation that respected the rules,” added Justice Larochelle.
According to Martin Delisle, a Montreal tax litigator with De Grandpré Chait LLP, the ruling is a “serious notice or reminder” to both federal and provincial tax authorities that they must be transparent and conduct “legally” their audits and investigations. “It’s also a serious reminder that tax authorities cannot conduct investigations under the cover of a regular audit,” said Delisle.
Justice Larochelle also held that the evidence obtained by Revenue Quebec during the course of its own probe against the same company and individuals was inadmissible because it originally emanated from the CRA investigation. That finding seems to suggest that the “fruit of the poisonous tree” doctrine, an American doctrine first described in 1920, too applies in Canadian tax law even though Revenue Quebec argued that this doctrine does not apply either in Canada or in Quebec, said Mostovac. The doctrine holds that if the source (or the tree) of the evidence is tainted, then anything gained (or the “fruit”) from it is tainted as well, noted Mostovac.
“We showed that the tree and the roots were poisoned from day one and that Revenue Quebec was not entitled to the evidence even though they asserted they had acted in good faith and that they should be entitled to use this evidence even though Revenue Canada could not use the information,” said Mostovac.
The ruling also underscores the impractical nature of the seven-prong test elaborated by the SCC in Jarvis to help determine when an inquiry’s purpose is to investigate penal liability, notes Paul Ryan, a Montreal tax lawyer with Ravinsky Ryan Lemoine LLP. Taxpayers often cannot figure out when an audit becomes an investigation, in large part because the Jarvis test is objective and not subjective. “It’s never easy to distinguish at what point in time a civil audit turns into an investigation,” said Ryan. “The Jarvis test in practical terms is not very clear, particularly since when they launch a criminal probe they still want to tax you. So which one is predominant? There are more and more lawsuits being launched over this issue.”
Since the B.T. Céramiques investigation lead to other probes, it is widely expected that defence lawyers will have a field day with the Larochelle ruling. B.T. Céramiques was accused of inflating the expenses of other construction companies, including those owned by construction magnate Tony Accurso, through false billing in order to help them reduce their reported revenues. The B.T. Céramiques inquiry also lead to Project Coche, an RCMP investigation that yielded charges against eight CRA auditors based in Montreal. One of the auditors was convicted earlier this summer on charges of breach of trust and extortion while three others are currently at the preliminary inquiry stage.
“If I am the lawyer of a CRA official, and I am convinced that the warrant obtained against my client has as its source the B.T. Céramiques investigation, then I am going to use it to say that this whole thing is poisoned,” remarked Mostovac.
But that may not be as easy to do as it seems, suggested Ryan. It was widely assumed following the Jarvis ruling that a constitutional breach would lead to a stay on charges. But the SCC’s ruling in R. v. Grant,  2 SCR 353 created a new test for determining whether evidence obtained by a Charter breach should be excluded. “The Grant ruling has considerably narrowed the remedies that exist when there is a breach,” noted Ryan. “A court must assess and balance the effect of admitting the evidence taking into account the seriousness of the Charter infringing state breach against society’s interest in the adjudication of the case against its merits.”