Provincial Compliance Activities

Final Report

Corporate Audit and Evaluation Branch
April 2011

Table of Contents

• Executive summary
• Introduction
• Focus of the audit
• Findings, recommendations and action plans
• 1.0 Program management
• 2.0 Monitoring and reporting
• Conclusion

Executive summary

Background: The Canada Revenue Agency (CRA) administers tax, credit and benefit programs on behalf of the provinces and territories (provinces) to provide better service to taxpayers and governments (Quebec administers its personal income tax system and Quebec and Alberta administer their corporate income tax systems). The responsibility for provincial compliance activities is shared by several branches within CRA.

Statements concerning the levels of service that Canada should provide to the provinces are contained in Tax Collection Agreement (TCA), negotiated between Finance Canada federally, and the respective provincial Ministry of Finance, while any enhanced services requested by provinces and related financial compensation are detailed in supplementary agreements, which are developed and managed by the Strategy and Integration Branch (SIB). Legislative Policy and Regulatory Affairs Branch (LPRAB) provides guidance and support to stakeholder areas within CRA during the implementation of the provincial programs under the various agreements in place.

The Provincial Compliance Division (PCD), part of the Small and Medium Enterprises Directorate of the Compliance Programs Branch (CPB), is responsible for ensuring a framework is in place to provide the best possible service to the provinces with respect to provincial compliance activities. Provincial programs for which PCD is responsible include:

• The Provincial Income Allocation (PIA) Audit Program, where income tax auditors review provincial income allocation of individual and corporate taxpayers that report income in more than one province (multi-jurisdiction). Individuals and corporations who report income activity in only one province (single jurisdiction) are risk assessed during the planning phase of the income tax audits.
• The strategic direction of the T1 Residency Review, where tax returns, meeting certain criteria, are reviewed to ensure provincial tax is paid to the proper jurisdiction.
• Film Tax Advisory Services, which has both a federal and provincial component, provides information to Canadian programming and film production companies, as well as ensuring regulatory compliance for the tax credits claimed.

The Office Audit Section of the Small and Medium Enterprises Directorate (SMED) is functionally responsible for T1 Residency Review.

CRA ensures the integrity of provincial programs through various validation programs which take place before and after tax returns are assessed. CPB is responsible for audit validation of returns selected for review, and pre-assessment validations are performed by the Assessment and Benefit Services Branch (ABSB) or the provinces themselves.

Objective: The objective of this audit was to assess that program management, monitoring, and reporting controls are in place and working as intended for CPB's Provincial Income Allocation, T1 Residency Review and Film Tax Advisory Services.

The audit was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing.

Conclusion: The controls currently in place for the PIA Audit Program and the Film Tax Advisory Services support their program management, monitoring and reporting activities. For these two programs, comprehensive monitoring is performed and accurate, timely and relevant information is provided to all stakeholders. However, some controls should be enhanced to improve their delivery along with addressing deficiencies of the T1 Residency Review.

The TCA states that Canada will provide a “reasonable degree of diligence and service level for issues related to province of residence and inter-provincial income allocation”. The CRA's efforts with respect to this commitment are included in the PIA Audit Program and T1 Residency Review Program. The TCA itself provides no guidelines for the term ‘reasonable degree of diligence and service level' that would aid these two areas in establishing appropriate goals and objectives. CPB should develop guidelines and indicators to measure internally whether the Agency meets the requirements of the TCA.

Although there are no guidelines with respect to reasonable degree of diligence and service level, the PIA Audit Program has established specific goals and objectives and informs provinces of major changes to current policies and procedures. Contrary to the PIA Audit Program, T1 Residency Review has no documented goals and objectives. It also has inconsistent priorities and no policy guidelines. CPB should strengthen the program framework consistent with the Agency's obligation under the TCA.

PCD has trained senior auditors as Provincial Income Allocation (PIA) Specialists in every region to strengthen PIA audit program controls. However, PIA Specialists do not ensure that mandatory PIA audit plans for single jurisdiction files (SJ) are completed. Only 68% of the tax auditors complete PIA audit plans. Also, PIA Specialists are not reviewing the SJ audit plans for quality.

Film Tax Advisory Services Section has well established goals and objectives that are applied to both the federal and provincial component of the program. The section has implemented strong controls that aid in ensuring documented policies and procedures are followed.

Action Plan: CPB agrees with the recommendations and the action plans with related timelines are included in this report.

Introduction

The Canada Revenue Agency (CRA) administers tax, credit and benefit programs on behalf of the provinces and territories to provide better service to taxpayers and governments (Quebec administers its personal income tax system and Quebec and Alberta administer their corporate income tax systems). In 2009-2010, CRA processed on behalf of the provinces and territories gross individual tax of $59.7 billion and corporate tax of $6.7 billion.

The Tax Collection Agreement (TCA), negotiated between Finance Canada federally, and the respective provincial Ministry of Finance, establishes a basic framework for the CRA to provide certain levels of service to the provinces. A Basic Service Offering (BSO) document, developed by the Strategy and Integration Branch (SIB), confirms services the CRA provides to the provinces under the TCA without cost recovery. Provinces may request enhanced administrative services for provincial programs, such as more robust validation of taxpayers' claims. These enhanced services and related financial compensation would be covered by an additional, related administrative agreement. SIB is accountable for developing and managing the additional agreements. Legislative Policy and Regulatory Affairs Branch (LPRAB) provides guidance and support to stakeholder areas within CRA during the implementation of the provincial programs under various agreements.

The Provincial Compliance Division (PCD) forms part of the Small and Medium Enterprises Directorate (SMED) of the Compliance Programs Branch (CPB). This division is responsible for ensuring a framework is in place to provide the best possible service to the provinces with respect to provincial compliance, including developing policies, managing issues, and providing functional direction to the field. PCD is also an active member of several joint CRA-provincial/territorial committees and assists other branches of CRA with their responsibilities from the time a new provincial tax measure is considered.

Provincial programs for which PCD is responsible include:

• The Provincial Income Allocation (PIA) Audit Program, where income tax auditors review the provincial income allocation of individual and corporate taxpayers that report income in more than one province (multi-jurisdiction). Individuals and corporations who report income activity in only one province (single jurisdiction) are risk assessed during the planning phase of the income tax audits.
• The strategic direction of the T1 Residency Review, where tax returns, meeting certain criteria, are reviewed to ensure provincial tax is paid to the proper jurisdiction.
• Film Tax Advisory Services, which has both a federal and provincial component, provides information to Canadian programming and film production companies and reviews regulatory compliance for the tax credits claimed.

The Office Audit Section of the SMED is functionally accountable for T1 Residency Review.

The integrity of provincial programs administered by CRA is protected and compliance is enforced through various validation programs, which are listed in the BSO. These processes may occur at pre- and/or post-assessment stages of the treatment of a tax return. CPB is responsible for audit validation of returns selected for review either before or after the original assessment. Other pre-assessment validations are performed by the Assessment and Benefit Services Branch (ABSB) or the provinces themselves.

There have been no previous audits of provincial compliance activities.

Focus of the audit

The objective of this audit was to assess that program management, monitoring, and reporting controls are in place and working as intended. The audit focused on CPB's PIA Program, T1 Residency Review and Film Tax Advisory Services.

Several provincial compliance activities were scoped out of the audit during the planning stage, including pre-assessment validations of information on income tax returns which are the responsibility of ABSB, and CRA's administrative framework to manage relations with the provinces, which is the responsibility of SIB. Separate internal audits in these areas may be considered in the future.

Examination work was conducted from October 2009 to July 2010. This entailed the review of documents as well as interviews with staff and management in CPB, SIB and LPRAB at Headquarters (HQ). Additional documents were reviewed and interviews were conducted with:

• Stakeholders in the provincial governments of British Columbia and Manitoba;
• Account Executives and Intergovernmental Relations Advisors in CRA Regional Offices in the Pacific, Prairie and Atlantic Regions;
• Management and staff in the Audit Divisions of selected Tax Services Offices (TSO) in the Pacific, Prairie, Ontario and Atlantic Regions; and
• Management and staff in the Individual Returns and Compliance Divisions and Appeals Divisions in Tax Centres (TCs) located in the Prairie and Atlantic regions.

The audit was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing.

Findings, recommendations and action plans

1.0 Program management

1.1 Agreements

The Film Tax Advisory Services is a small program in PCD that has not been subject to an internal audit in the past. There is a federal and provincial component to this program. In the TCA, any provincial film tax credit that has a parallel federal credit tax is covered under a BSO at no additional charge to the province. Any film tax credit that is not similar to a federal tax credit may require a Service Level Agreement (SLA), between CRA and the province, which defines the services to be provided to the province on a cost-recovery basis. A standard template of the SLA has been developed and SLAs are being negotiated between CRA and provinces. The provincial component of the Film Tax Advisory Services follows the established goals and objectives of the federal program.

The PIA Program and the T1 Residency Review are situated in a separate area in the TCA. The language in the TCA, explained below, does not provide CRA with any guidance on how CRA can comply with its requirements. However, the PIA Program has established specific goals and objectives and negotiates with the provinces most changes to the current policies. Contrary to the PIA Audit Program, T1 Residency has no documented goals and objectives.

T1 Residency Review

The TCA states that there should be a reasonable degree of diligence and service level for issues related to province of residence and provincial income allocation. However, the TCA does not provide guidelines for the term ‘reasonable degree of diligence' and ‘service level'. As a result, CPB has limited direction to establish goals and objectives and create indicators to measure its compliance to the TCA for these activities.

T1 Residency Review has not been given a similar level of diligence as PIA. Without the Agency determining guidelines and creating indicators to measure ‘reasonable degree of diligence' and ‘service level' it is difficult to determine whether the Agency is meeting its obligations under the TCA.

The T1 Residency Review has no policy guidelines and the priority of this workload has been decreasing as noted in the following:

• Between 2007-2010, priorities of programs, projects and workloads in the Office Audit Section have been adjusted annually in the planning guidelines[Footnote 1], [Footnote 2]. No explanation was provided of how risk assessment was applied to determine the priority of the T1 Residency Review.

• Total resources used for this workload across the country totalled 2.5 full-time equivalents in 2008-2009 and 2.0 in 2007-2008.

• Residency is determined based on where the taxpayer resides as of December 31 of that calendar year. There are no guidelines specifically on how to analyze information gathered to make a decision on residency, only on how to perform database and internet searches. Absence of these guidelines may result in inconsistent application of province of residency rules by auditors and reviewers.

Recommendations

CPB should develop guidelines or indicators to internally measure the Agency's compliance with the TCA concerning “reasonable degree of diligence and service level for issues related to province of residence and inter-provincial income allocation”.

CPB should strengthen the program framework of T1 Residency Review, consistent with the Agency's obligations under the TCA.

Action Plan

CPB will articulate more clearly the guidelines relating to T1 Residency to improve the consistency in how the program is delivered to the provinces. At the same time, CPB will review the indicators of this program to ensure they establish a reasonable degree of diligence in the administration of this program. Timeline October 2011.

CPB will strengthen the program framework and ensure it meets the minimum requirements of the guidelines. This will include carrying out an annual risk assessment review to establish monitoring thresholds that will be updated as required in the planning guidelines. In offices where risk is deemed to be higher than the previous year, the number of files to be reviewed will be increased.

The annual risk assessment review will ensure that the program is compliant with the TCA as it will benchmark the program against the objectives and indicators noted above. Timeline March 2012.

1.2 Operational Plans, Policies and Procedures

The Film Advisory Section of PCD has implemented strong controls that assist in ensuring documented policies and procedures are followed. These policies and procedures have been developed by identifying, analyzing and addressing the risks that could impede the achievement of the programs goals and objectives.

The PCD is functionally responsible for the PIA Audit Program. The audit divisions of the Tax Service Offices (TSOs) perform compulsory PIA audits on multi-jurisdictional income tax returns over $20 million in revenue ($1 million prior to April 1, 2010). Auditors also must risk assess all other income tax cases over $1 million in revenue using the PIA audit plan.

To aid in increasing the auditors' knowledge base and quality of audit files and strengthen program controls, PCD trained senior auditors as PIA Specialists in every region. This action enhanced CRA's mandate of ensuring the income of tax filers operating in multiple jurisdictions is properly allocated among the provinces in which they operate. The PIA Specialists have various tasks outlined in a duties and responsibilities document distributed in September 2008, including providing technical assistance to auditors, identifying high-risk issues, quality review of PIA audits, and liaising with other PIA Specialists, Headquarters and provincial and territorial counterparts.

Single Jurisdiction Files

Auditors are required to complete an audit plan for tax files that indicate a permanent establishment in a single jurisdiction (SJ) to determine whether another permanent establishment exists in another province. A review conducted by Internal Audit on a random sample of 300 audit files indicated that 32% did not complete mandatory SJ audit plans.

The PIA Specialists duties and responsibilities include the task of monitoring SJ audit plans through sample reviews. These reviews ensure auditors are complying with the requirement to prepare an audit plan for these files as well as evaluating the quality of the audit plan. PIA Specialists indicated during interviews that these sample reviews are not completed due to pressures from other duties such as providing technical support to auditors and performing quality reviews of higher risk multiple jurisdiction files. Some PIA Specialists were not aware of the requirement to complete these reviews.

Because auditors are not always completing the requisite audit plans on SJ files, there is a risk that income by province may not be reported properly. Tax filers who are operating in multiple jurisdictions may claim to be operating in a single jurisdiction when filing their tax returns. The lack of formal policies, procedures and work descriptions has caused confusion for the PIA Specialists as to who should be reviewing single jurisdiction audit plans.

Recommendation

PCD should strengthen the controls to ensure that PIA risk assessment for SJ files are completed by auditors, as per CRA PIA Communiqué AD-02-03R2, and quality reviewed by PIA Specialists.

Action Plan

Since April 1, 2010, the CPB has adopted a risk-based approach to auditing SJ files. Consequently, auditors are only required to prepare an audit plan for SJ files that are selected for audit based on identified PIA risk.

While SJ files have historically been considered as having a low PIA risk, CPB will continue to examine these files in the context of its TSO monitoring and Quality Assurance activities.

Tools

The Agency is required to forward all completed PIA audit files to the non-agreeing provinces for their review before finalization. The current process which is manual and time consuming, involves auditors printing and photocopying the audit working papers and mailing them to PCD. PCD is responsible for forwarding the working papers to the relevant province.

Recommendation

PCD should explore implementing a secure electronic process of compiling and forwarding completed PIA audit files to the provinces.

Action Plan

CPB agrees to assess the feasibility of making this process electronic by the end of March 31, 2012.

Training

PCD developed an extensive PIA audit training course in 2008. The training was conducted initially by PCD but has been taken over by the Audit Professional Services Directorate in CPB. We received documentation to support that the auditors are given the training and training efforts are monitored. PIA Specialists in all regions agree that it takes less time to perform a quality review on a file completed by a trained auditor which results in a better quality and more detailed audit report. PCD should continue to actively promote and track training to ensure all auditors who perform PIA audits attend the PIA course.

1.3 Issues and Initiatives

PCD used a transparent approach in the identification and documentation of intranet issues and risks with respect to the key activities and responsibilities of its Division. Sufficient evidence was provided to demonstrate that the Division was addressing these concerns.

2.0 Monitoring and reporting

2.1 Monitoring

Monitoring controls exist for both the Film Tax Advisory Services and the PIA Program. Program reviews in the TSOs have taken place and issues of concern, both federal and provincial, are reported on and addressed.

2.2 Reporting

Similar to other audit programs in CPB, Film Tax Advisory Services and PIA both utilize the Audit Information Management System to record, track and gather information on audits and reviews performed. Reports are provided on a regular basis to the provinces and TSOs on all the provincial activities under examination. Based on discussions with some provinces and the evaluation and testing of the reporting controls during the audit file reviews, the programs provide accurate, timely and relevant information to all stakeholders.

Conclusion

The controls currently in place for the PIA Audit Program and the Film Tax Advisory Services support their program management, monitoring and reporting activities. For these two programs, comprehensive monitoring is performed and accurate, timely and relevant information is provided to all stakeholders. However, some controls should be enhanced to improve their delivery along with addressing deficiencies of the T1 Residency Review.

The TCA states that Canada will provide a “reasonable degree of diligence and service level for issues related to province of residence and inter-provincial income allocation”. The CRA's efforts with respect to this commitment are included in the PIA Audit Program and T1 Residency Review program. The TCA contains no specific guidelines for the term ‘reasonable degree of diligence and service level' that would aid these two areas in establishing appropriate goals and objectives. The CRA should develop guidelines and indicators to measure internally whether the Agency meets the requirements of the TCA.

Although there are no guidelines with respect to reasonable degree of diligence and service level, the PIA Audit Program has established specific goals and objectives and informs provinces of major changes to current policies and procedures. Contrary to the PIA Audit Program, T1 Residency Review has no documented goals and objectives. It also has inconsistent priorities and no policy guidelines. CPB should strengthen the program framework consistent with the Agency's obligation under the TCA.

PCD has trained senior auditors as Provincial Income Allocation (PIA) Specialists in every region to strengthen PIA audit program controls. However, PIA Specialists do not ensure that mandatory PIA audit plans for single jurisdiction files (SJ) are completed. Only 68% of the tax auditors complete PIA audit plans. Also, PIA Specialists are not reviewing the SJ audit plans for quality.

Film Tax Advisory Services Section has well established goals and objectives that are applied to both the federal and provincial component of the program. The Film Advisory Services has implemented strong controls that aid in ensuring documented policies and procedures are followed.

Footnotes