Tax collectors and the Bank of Nova Scotia are locking horns in federal court over access to the names of investors - including "six prominent Canadian business families" - behind a $1.1-billion offshore investment fund.
For about three years, the Canada Revenue Agency (CRA) has been engaged in a high-stakes to-and-fro with the bank. Tax collectors are trying to pierce the layers of a British Virgin Islands investment fund, while the bank insists it can't force its own foreign subsidiaries to name names.
The battle escalated last autumn when, in a sworn affidavit, a CRA auditor alleged that the bank was effectively defying a 2008 judicial order. "The Bank of Nova Scotia has not provided to the CRA the information and documents it was required to pursuant to the order of this court," Pierre C. Leduc, one of the CRA officers overseeing the probe, said in the sworn statement, which was filed in federal court in October.
The bank disputes the contention that it has not fully complied, court filings show, and it is opposing the CRA's latest application. The bank has not been accused of any criminal wrongdoing.
None of the investors have been accused in the court filings of any wrongdoing, and CRA has merely said it is seeking to "verify" their "compliance."
The spat is another sign of the tax agency's ramped-up efforts to target the use of offshore investments by wealthy Canadians, tax lawyers and experts say.
During the past year, CRA auditors have zeroed in on Canadians suspected of disguising their holdings in the principality of Liechtenstein.
Just last week, Revenue Minister Jean-Pierre Blackburn threatened again to sue Swiss bank UBS AG unless it hands over the names of its Canadian clients.
The CRA's row with Scotiabank also offers an inside look into how difficult it can be for tax officials to unmask taxpayers who are less inclined to be identified, even when the bank handling their funds is headquartered in Canada.
Scotiabank declined to make a bank official available for an interview with The Globe and Mail, and said it could not respond to a detailed list of questions because the matter is currently before the court.
Many of the identities of the Canadians behind the Caribbean-based investment fund, which is known as St. Lawrence Trading Inc., are still a mystery to federal auditors. Internal fund documents circulated to investors show that, as of 2001, "six prominent Canadian business families" owned as much as $900-million (U.S.) of the fund, which held investments in hedge funds and mutual funds around the world. CRA auditors say they have unearthed the names of 120 of the estimated 180 Canadians behind St. Lawrence Trading, and are still in pursuit of the unidentified investors.
Caitlin Workman, a spokeswoman for the CRA, said auditors have completed reassessments of 49 investors and the agency believes those people failed to report a total of $70-million in income. However, the CRA was unable to say how many investors are disputing those reassessments. One source close to the dispute said a number of investors have responded to the department with notices of objections about the amount the agency says it is owed.
"Somebody in [the CRA]has a bee in their bonnet and thinks they're going to bring a fortune into the treasury and somebody's going to make a name for themselves," the source said.
The roots of the agency's fight with Scotiabank can be traced back to 2002, when the bank entered into a convoluted agreement with St. Lawrence Trading.
At that time, the then-Liberal federal government had proposed changes to the Income Tax Act that would have resulted in "adverse Canadian tax consequences" for the fund's investors, according to an internal fund memorandum that auditors have filed in court. In the end, the rules were not enacted into law, but the prospect of changes sparked a flurry of behind-the-scenes manoeuvrings.
According to the internal fund literature, the investors and their advisers devised what they thought was a solution to ensure that their investments maintained their "exclusion from Canadian tax" - the Canadian investors agreed to sell half of St. Lawrence Trading to Scotiabank in return for a note. The note is set to mature in 2016, at which point the bank would likely sell St. Lawrence Trading on the market and hand the proceeds back to the Canadian investors. An internal fund memorandum shows that investors expected to pay Scotiabank an annual "seven figure" fee in return for the bank temporarily taking the investments off their hands.
The CRA's efforts to lift the veil on the investors via Scotiabank, however, have been met by repeated obstacles. The first barrier, court records show, was that the sale of St. Lawrence Trading to the Bank of Nova Scotia was made through subsidiaries of the bank in the Bahamas and Ireland.
When the CRA obtained its first federal court order in 2008 for the list of investors, a Dublin lawyer for the bank's Irish subsidiary declared that the subsidiary could not hand any information because of Irish law. Scotiabank Ireland had "a duty of secrecy with regard to the information," the lawyer, William Johnston, said in a Sept. 11, 2008, letter.
Undeterred, the auditors tried other channels. Given the vast fortunes involved in this transaction, the bank was required to perform anti-money-laundering checks on the investors, so the tax collectors asked for that material and the names of any outside firms involved in the checks.
The bank responded that, yes, Scotiabank Ireland performed such checks, and it enlisted the services of a firm in Bermuda, another country outside the jurisdiction of the court.
Auditors persisted, arguing that because the bank's Canadian parent guaranteed the note provided to investors, there must be information somewhere in Canada about these people.
Chris Purkis, the bank's managing director of equity derivatives, responded in an affidavit that, unless Scotiabank Ireland defaulted on the note, Canadian bankers "would not, and did not, know who the shareholders were."
However, as part of its most recent application, CRA has brandished internal Scotiabank e-mails that show at least one Canadian bank official was part of an e-mail exchange with a Montreal businessman with an interest in St. Lawrence Trading.