Federation of Law Societies of Canada v Canada: Constitutional Challenge to Certain Amendments to the Income Tax Act

By Parveen Karsan & Zahra Tahsili

In response to recent changes in mandatory disclosure rules under the Income Tax Act (R.S.C., 1985, c. 1 (5th Supp.)) (“ITA“) (the “New MDR Legislation”), on September 11, 2023, Federation of Law Societies of Canada (the “Federation”) filed an application in the Supreme Court of British Columbia challenging the constitutionality of the application of these amendments to legal professionals. Taking the initial step, the Federation seeks interlocutory injunctive relief from the Supreme Court of British Columbia, ultimately aiming for a declaration exempting legal professionals from the newly introduced disclosure regulations in the ITA.

The Federation of Law Societies of Canada initiated legal action on September 11, 2023, filing an application in the Supreme Court of British Columbia to constitutionally challenge the application of the recent amendments to the mandatory disclosure rules under the Income Tax Act, known as the New MDR Legislation, to legal professionals.

The legal dispute questions the expansion of mandatory disclosure obligations, the introduction of a new category of notifiable transactions, and the removal of a provision relieving parties from disclosure obligations when fulfilled by another party. The Federation contends that these changes force legal counsel to disclose confidential and potentially privileged client information, thereby undermining the duty of loyalty owed to clients. Non-compliance may lead to fines of up to $100,000 and imprisonment. The Federation argues this is an “unconstitutional attempt to turn legal professionals into agents of the state”. For more information on new mandatory disclosure rules, please read our article “Memo Re: Mandatory Disclosure Rules Around Reportable and Notifiable Transactions“.

An interim injunction, granted on September 14, 2023, provides legal professionals with a temporary exemption from the application of the New MDR Legislation until the earlier of the BC Supreme Court’s decision on the injunction application or November 20, 2023, with an extension to December 1, 2023.¹

New MDR Legislation

The New MDR Legislation impacts reportable transactions by modifying ITA Section 237.3 and introducing mandatory disclosure requirements for notifiable transactions under Section 237.4.

A transaction is deemed reportable if it’s reasonably considered that one of its main purposes is to obtain a tax benefit, meeting specific hallmarks such as a contingent fee arrangement, confidential protection, or contractual protection. Disclosure is not mandatory if the information is subject to solicitor-client privilege (Section 237.3(17)), and no penalty is incurred if a person exercises reasonable care to prevent a filing failure (Section 237.3(11)).

Despite the pre-existence of mandatory disclosure rules for reportable transactions, the New MDR Legislation, introduced in 2023, significantly altered their definition and disclosure rules. This change lowers the reporting threshold and increases accountability for legal professionals. Importantly, it eliminates relief for a party, like a legal professional, when another party, such as the client, fulfills the disclosure obligation.

Notifiable Transactions, a new category, align with transactions designated by the Minister. Section 237.4 defines “substantially similar” broadly, favouring disclosure interpretation. Like reportable transactions, disclosure for notifiable transactions is not required if the information is reasonably believed to be subject to solicitor-client privilege (Section 237.4(18)). Additionally, only advisors who know or reasonably expect to know of a notifiable transaction must file an information return (Section 237.4(7)).

Previous Similar Litigation

In its argument, the Federation referenced two prior cases: Law Society of British Columbia (“LSBC”) v. Canada (Attorney General), 2015 SCC 7 [PCA SCC Decision] and Canada (Attorney General) v. Chambre des notaires du Quebec, 2016 SCC 20 [Chambre des notaires].

The PCA SCC Decision originated from provisions in what is now the Proceeds of Crime (Money Laundering) and Terrorist Financing Act, S.C. 2000, c. 17, formerly known as the Proceeds of Crime (Money Laundering) Act or “PCA“. These provisions mandated lawyers to report financial transactions reasonably suspected of money laundering to the federal government. The Federation and the LSBC challenged the constitutionality of the provisions, securing interlocutory injunctive relief. Despite subsequent amendments and the repealing of reporting provisions, new requirements were enacted in 2008. Once again, the Federation and the LSBC challenged the legislation’s constitutionality. In 2011, the Supreme Court of Canada ruled that the amendments violated both Sections 7 and 8 of the Charter, emphasizing that a lawyer’s duty of commitment to their client’s cause is a constitutionally protected principle of fundamental justice and legislation that compromises this duty in favour of the state is unconstitutional.

Chambre des notaires emerged from ITA provisions allowing tax authorities to require any person to provide information or documents for any purpose related to the administration of the ITA. The Chambre des notaires du Quebec sought a declaration that these provisions were unconstitutional when applied to notaries. The Barreau du Quebec joined for the declaration to extend to lawyers. The Quebec Superior Court and Court of Appeal ruled in favour of the Chambre and the Barreau. The Supreme Court of Canada dismissed the Attorney General’s appeal, affirming that ITA provisions requiring notaries and lawyers to report confidential client information to the Canada Revenue Agency (“CRA”) violated Section 8 of the Charter.

BC Supreme Court Decision on New MDR Legislation

In the case at bar, the Federation contends that the legislation harms public confidence in the legal profession’s duty of loyalty to clients. The new reporting requirements, it argues, lead to the disclosure of confidential client information and may potentially jeopardize privileged information, damage solicitor-client relationships, and create irreconcilable conflicts of interest between lawyers and their clients.

The Government counters that legal professionals are protected, citing exemptions for information reasonably considered privileged and asserting that clients share reporting obligations. They argue that legal professionals won’t be penalized if they exercise due skill to prevent reporting failures.

The BC Supreme Court, in its decision, emphasizes a lawyer’s duty to keep client information confidential, noting that the reporting provisions demand disclosure of information subject to broad confidentiality duty as required in Form RC312. It highlights the need for legal judgment in completing the reporting Form, raising concerns about the potential disclosure of privileged information despite exemptions.

The legislation, according to the Court, introduces conflicts of interest. Legal professionals may lean toward disclosure due to potential penalties, and disagreements over whether information is privileged may arise. This dynamic could lead lawyers to recommend alternative structures to avoid reporting or sanctions, potentially conflicting with the client’s best interest.

In para. 55, the Court articulates the primary grounds for issuing the interim injunction. The Court 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. In Chambre des notaires, at para. 37, the Supreme Court of Canada called the professional secrecy of legal advisers an interest “which is a principle of fundamental justice and a legal principle of supreme importance”. In the PCA SCC Decision, at para. 96, the Supreme Court of Canada 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”.

Conclusion

The constitutional challenge, filed in the Supreme Court of British Columbia, is not merely a legal battle but a defence of the fundamental principles that underpin the Canadian justice system.

The Federation’s argument revolves around the perceived infringement on legal privilege, an essential cornerstone of the lawyer-client relationship. The amendments, introduced in the New MDR Legislation, widen the mandatory disclosure obligations, creating a potential clash between legal duties and state-imposed reporting requirements. The legal community now faces the ethical dilemma of choosing between compliance with the new regulations and safeguarding the duty of loyalty owed to clients, creating an irreconcilable conflict of interest. The court’s emphasis on the need for legal judgment in completing the reporting forms underscores the complexity of the issue at hand.

Drawing on past cases, particularly the PCA SCC Decision and Chambre des Notaires, the Federation establishes a precedent that a lawyer’s duty of commitment to their client’s cause is a constitutionally protected principle of fundamental justice. This principle, once again, stands at the forefront of the Federation’s argument, asserting that the New MDR Legislation threatens to compromise this duty in favour of state interests.

The interim injunction granted by the BC Supreme Court, reflects the judiciary’s recognition of the potential harm posed by the amendments. The court acknowledges the delicate balance between the public’s interest in an independent bar and the government’s pursuit of tax transparency. The potential damage to public confidence in an independent legal profession is deemed a matter of high public importance, echoing sentiments from previous legal challenges.

As legal professionals navigate this challenging terrain, the outcome of this constitutional challenge will undoubtedly set a precedent for the delicate balance between governmental initiatives and the preservation of legal privilege. The Federation’s pursuit of a declaration exempting legal professionals from the newly introduced disclosure regulations is not just a fight for the legal community but a crucial defence of the principles that ensure the integrity of the administration of justice in Canada.

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[1] Federation of Law Societies of Canada v. Canada (Attorney General), 2023 BCSC 2068. Available at: https://flsc.ca/wp-content/uploads/2023/11/Justice-Warren-re-Federation-of-Law-Societies-of-Canada-v.-Canada-Attorney-General-11-24.pdf

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