Archived - Follow-Up Audit of the Office of the Auditor General Income Tax Legislation Audit

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Prepared by Internal Audit and Evaluation for:
Department of Finance
Audit and Evaluation Committee

January 4, 2012

Table of Contents

Executive Summary
Background
Audit Objective and Scope
Approach, Assurance and Auditing Standards Employed
Conclusions
Findings by Audit Criteria

Appendices

Appendix A – List of Finance Employees Interviewed
Appendix B – Key Reference Documents Consulted
Appendix C – Members of the Audit Team
Appendix D – Overview of the Technical Amendments Process

Executive Summary 

The Department of Finance is responsible for formulating tax policy at the federal level and for developing the legislation and regulations needed to implement federal tax measures.  On an ongoing basis, the Department develops legislative amendments to address technical issues in the Income Tax Act, in order to more clearly convey the intent of the legislation or to make it easier for taxpayers to comply with it. Usually, technical amendments do not involve any reconsideration of tax policy.  Decisions regarding the release of draft legislative proposals for consultation and the tabling of technical bills in Parliament are made by the Minister of Finance.

In November 2009, the Office of the Auditor General (OAG) released a performance audit that focused on the Department’s activities to identify and develop legislative amendments to correct technical deficiencies in the Income Tax Act.

The OAG audit recommended that the Department:

  • use an integrated and consistent process for recording, tracking, and prioritizing all technical issues for possible legislative amendment (OAG recommendation 3.27);
  • develop and implement a plan to address the backlog of approximately 400 technical amendments (OAG recommendation 3.40); and
  • develop regularly and release draft technical amendments, including those that arise from comfort letters, so that taxpayers and tax practitioners know what changes will be made and can provide input to the Department (OAG recommendation 3.40).

The objective of the follow-up audit was to assess the extent to which the recommendations and management action plan for the November 2009 OAG Audit of Tax Legislation have been implemented. It is worth noting that the decision of whether to release any particular package of draft income tax legislation is that of the Minister, thus not part of the scope of the audit.

The follow-up audit concluded that overall, the implementation status for recommendations 3.27 and 3.40 concerning the OAG November 2009 Chapter 3 – Income Tax Legislation audit is that recommendation 3.27 has been fully implemented and recommendation 3.40 has been substantially implemented.  This conclusion validates the Department’s self-assessment communicated to the OAG in April 2011 concerning the implementation status for both recommendations.

Since no issues were identified during this follow-up audit, no recommendations are provided, and no management action plan is required.

Background 

The follow-up audit of the Office of the Auditor General (OAG) Audit of Tax Legislation was approved as part of the Department of Finance’s three-year risk-based audit plan, tabled at the departmental Audit and Evaluation Committee meeting on March 1, 2011.

The Department is responsible, through the Tax Policy Branch (TPB), for developing and evaluating federal tax policy. It also advises the Minister of Finance on the need for technical changes and policy changes to the Income Tax Legislation to ensure that Canada’s tax system functions effectively. In that context, the Branch is responsible for developing technical amendments to the existing Income Tax Legislation in order to correct anomalies that arise after original tax measures are passed, and for making recommendations to the Minister of Finance with respect to those proposed technical amendments (for details on the technical amendments process, refer to Appendix D).

In Fall 2009, the OAG released a performance audit that focused on the Department’s activities to identify and develop legislative amendments to correct technical deficiencies in the Income Tax Act.

The OAG audit recommended that the Department:

  • use an integrated and consistent process for recording, tracking, and prioritizing all technical issues for possible legislative amendment (OAG November 2009, Chapter 3, recommendation 3.27);
  • develop and implement a plan to address the backlog of approximately 400 technical amendments (OAG November 2009, Chapter 3, recommendation 3.40); and
  • develop regularly and release draft technical amendments, including those that arise from comfort letters*, so that taxpayers and tax practitioners know what changes will be made and can provide input to the Department (OAG November 2009, Chapter 3, recommendation 3.40).

The OAG conducts an annual monitoring exercise to follow up on the implementation status of past OAG recommendations.  In April 2011, department officials reported progress for each of the recommendations as follows:

  • 3.27 – Full Implementation.  A new database using Microsoft Access has been up and running since December 2010, an instruction manual has been written, and training sessions have been provided to all database users.
  • 3.40 – Substantial Implementation. In order to address the current backlog of necessary technical amendments, the existing inventory of amendments has been reviewed and grouped under various topics.
  • 3.40 – Substantial Implementation. The Department has developed a process under which smaller packages of technical amendments are provided on a regular and more timely basis to the Minister of Finance for consideration for release.

Comfort letters are provided by the Department to taxpayers and their advisors. They indicate that a recommendation to the Minister of Finance will be made that a non-policy legislative change be made in the Income Tax Act; usually these changes are made to provide relief to the taxpayer when the tax result is clearly not the one intended by the law.

Audit Objective and Scope 

Objective

The objective of the follow-up audit was to assess the extent to which the recommendations and management action plan for the November 2009 Office of the Auditor General (OAG) Audit of Tax Legislation have been implemented.

Scope

The audit scope focused on TPB’s activities concerning the identification, development, and release processes related to technical amendments to the Income Tax Legislation from November 2009 to October 2011. These included:

  • TPB’s electronic (Black Book) database.
  • Technical amendments backlog.
  • Outstanding and new database entries.
  • Department’s implementation of two OAG recommendations.

The scope did not include:

  • Minister’s decisions related to the release or tabling of legislative tax changes, including the timing thereof. The focus was only on the identification and development of draft technical amendments and the processes for preparing draft technical amendments for release;
  • Bill approval process at Parliament, for making technical amendments to the Income Tax Act; and
  • The development and implementation of amendments intended to introduce new tax policy or change existing tax policy.

Approach, Assurance Statement and Auditing Standards Employed

The follow-up audit was conducted in accordance with Treasury Board policy, directives, and standards on internal audit, and the procedures used meet the professional standards of the Institute of Internal Auditors.   These standards require that the follow-up audit be planned and performed in such a way as to obtain reasonable assurance that the audit objective is achieved.  During the follow-up audit, appropriate procedures were followed and sufficient evidence was obtained to support the accuracy of findings and the overall audit opinion presented in this report.  The findings are based on a comparison of the conditions, as they existed at the time of the follow-up audit, against the audit criteria identified within this report, which were accepted by management.  The opinion is applicable only to the entity examined, and are supported by relevant and sufficient evidence to ensure its integrity.

Audit procedures included, but were not limited to, interviews, observations, review of supporting documentation, and analytical testing.  The audit criteria used to develop the required audit tests were based on (1) relevant elements of the Office of the Comptroller General’s Audit Criteria related to the Management Accountability Framework, (2) key controls highlighted by the Tax Policy Branch’s Black Book Database Instructions Manual, (3) relevant assertions concerning the reliability assessment of computer-processed data/ financial audit manual from the United States Government Accountability Office, and (4) good management practices.

In total four individuals were interviewed, all from the Department’s Tax Policy Branch (list of interviewees is provided in Appendix A).  The audit team also conducted a review and analysis of applicable authorities, as well as other documents from various relevant sources (list of key documents consulted is provided in Appendix B).

The audit approach allowed for the audit results to be communicated in such a manner as to enable management to review and provide feedback on the findings and conclusions before they were finalized.

Conclusions 

The follow-up audit concluded that overall, the implementation status for recommendations 3.27 and 3.40 concerning the OAG November 2009 Chapter 3 – Income Tax Legislation audit is that recommendation 3.27 has been fully implemented and recommendation 3.40 has been substantially implemented.  In particular, the follow-up audit concluded that:

  • Key database recording, tracking and prioritizing controls for the integrated and consistent processing of technical issues were found to be effective;
  • The technical amendments backlog as reported by the OAG in the November 2009, Chapter 3 – Income Tax Legislation audit, is found to be significantly and progressively eliminated; and
  • The development by the Department of smaller packages of technical amendments for consideration by the Minister of Finance for regular release has improved since the completion of the November 2009, Chapter 3 – Income Tax Legislation audit.

This conclusion validates the Department’s self-assessment communicated to the OAG in April 2011 concerning the implementation status for both recommendations.

Findings by Audit Criteria 

The following pages present the assessment of risk exposure identified in the follow-up audit. Risk exposure for each audit criterion is categorized as follows: 

High exposure
Medium exposure
Low exposure

A high, medium or low ranking corresponds to the potential risk exposure auditors believe may have an impact on the achievement of Department objectives.

The assessment summarizes the audit observations based on the factual evidence gathered and analyzed during the follow-up audit.

Findings by Audit Criteria
Criteria Risk Exposure Assessment
1.0 Integrated and Consistent Process for Recording, Tracking, and Prioritizing all Technical Issues for Possible Legislative Amendment
The Tax Policy Branch has an effective management process in place to comprehensively record, track, and prioritize legislative changes. Low

Key database recording, tracking and prioritizing controls for the integrated and consistent processing of technical issues were found to be effective. 

The Office of the Auditor General audit recommended that the Department use an integrated and consistent process for recording, tracking, and prioritizing all technical issues for possible legislative amendment.

From the results of the various tests conducted on database entries, we found that all key controls were effective. For example, we have tested the database entries for:

  • Completeness – Entries that should be recorded are included in the database.
  • Occurrence/ validity – Entries are valid.
  • Accuracy – Entries reflect the source documents’ information.
  • Timeliness – Progress for processing of entries is identified.
  • Classification – Processing prioritization of entries is indicated.
Therefore, for:
  • Recording we found no missing active or duplicate entries. We also found there were no empty fields, data inaccuracy or report summaries issues.
  • Tracking we observed that each database entry was tracked and progress over the processing of all technical issues is regularly monitored.
  • Prioritizing we found that database entries were classified and prioritized in a consistent manner by the Tax Legislation Division.
2.0 Address the Backlog of Necessary Technical Amendments
The Tax Policy Branch developed and implemented a plan to address the backlog of technical amendments. Low

The technical amendments backlog as reported by the Office of the Auditor General’s (OAG) November 2009, Chapter 3 – Income Tax Legislation audit is found to be significantly and progressively eliminated.

The OAG audit recommended that the Department draft and implement a plan to address the backlog of approximately 400 technical amendments. In order to address this issue the Department grouped and progressively developed for release the backlog of technical amendments.

Packages of technical amendments are first released for public comment by the Department with the approval of the Minister of Finance and then tabled by the Minister (or designate) in Parliament in the form of technical bills. Although no income tax technical bill has been passed by Parliament since the reporting of the OAG audit in November 2009, the audit found that more than 80% of the technical amendments backlog, as reported by the OAG in the November 2009, Chapter 3 – Income Tax Legislation audit, have been released for public comment. The Department expects to progressively eliminate the remainder of the backlog through the continued development of smaller packages of technical amendments for consideration by the Minister of Finance for release on a timelier basis.

3.0 Regularly Release Draft Technical Amendments
The Tax Policy Branch develops and provides for approval technical amendments on a regular and timely basis. Low

The development by the Department of smaller packages of technical amendments for consideration by the Minister of Finance for regular release has improved since the completion of the November 2009, Chapter 3 – Income Tax Legislation audit.

The Office of the Auditor General audit recommended that the Department regularly develop and release draft technical amendments. The Auditor General’s Report noted that “If proposed technical changes are not tabled regularly, the volume of amendments becomes difficult for taxpayers, tax practitioners, and parliamentarians to absorb when they are grouped into a large package.”

In response to this recommendation, the Department agreed to consider making future potential improvements regarding the development of technical amendments for consideration by the Minister of Finance for release.  For instance, to seek the approval of the Minister for more frequent releases and not wait for one technical bill to obtain royal assent before any new draft proposals are proposed to the Minister for release. 

The audit found that the Department:

  • Improved the frequency of its development of technical amendments for release by developing smaller packages of technical amendment for consideration by the Minister for release on a more timely basis;
  • Generally decreased the size (where circumstances were appropriate) of proposed technical amendments packages recommended to the Minister for release; and
  • Developed for release new technical amendments before the approval of any prior technical bill by Parliament.  

Appendix A 

List of Department of Finance Canada Personnel Interviewed

  • Director, Personal Income Tax, Personal Income Tax Division (Tax Policy Branch)
  • Director, Tax Legislation, Tax Legislation Division (Tax Policy Branch)
  • Senior Legislative Chief, Tax Legislation Division (Tax Policy Branch)
  • Tax Policy Officer, Tax Legislation Division (Tax Policy Branch)

Appendix B 

List of Key Documents Consulted

Legislation

  • Financial Administration Act
  • Income Tax Act

Other Documents

  • Fall 2000 Report of the Auditor General of Canada: Chapter 13 - Assessment of Financial Management Capabilities in Departments, October 2000
  • United States Government Accountability Office, Financial Audit Manual, July 2008
  • United States Government Accountability Office, Assessing the Reliability of Computer-Processed Data, July 2009
  • Fall 2009 Report of the Auditor General of Canada: Chapter 3 – Income Tax Legislation, Nov. 2009
  • Evidence of the March 23, 2010 Meeting of the Standing Committee on Public Accounts concerning the Chapter 3, “Income Tax Legislation,” in the 2009 Fall Report of the Auditor General of Canada, March 2010
  • Chapter 3, “Income Tax Legislation,”  of the Fall 2009 Report of the Auditor General of Canada – Twelfth Report of the Standing Committee on Public Accounts, April 2010
  • Government Response to the Twelfth Report of the Standing Committee on Public Accounts: Chapter 3: “Income Tax Legislation,” of the Fall 2009 Report of the Auditor General of Canada, August 2010
  • 2011 Office of the Auditor General Monitoring of Recommendations exercise, April 2011

Documents Specific to Finance Canada

  • 2010 Department of Finance, Tax Policy Risk Register, Nov. 2010
  • 2009-10 Department of Finance, Departmental Performance Report
  • 2010-11 Department of Finance, Report on Plans and Priorities
  • 2010-11 Department of Finance, Integrated Business Plan, June 2010
  • 2011-12 Department of Finance, Tax Policy Risk Analysis, April 2011
  • 2011-12 Department of Finance, Tax Policy Branch, Tax Policy Priorities, May 2011
  • Department of Finance, Tax Policy Branch, Black Book Database Instruction and Database Administrator Manuals
  • Department of Finance, Tax Policy Branch, Black Book Database Statistics
  • Department of Finance, Tax Policy Branch, Reconciliation of technical amendments backlog/ outstanding deficiencies between the OAG Nov. 2009 – Chap. 3 - Report and the Black Book Database Entries, August 2011

Appendix C 

Audit Team

This follow-up audit was conducted by:

  • Chantale Dumornay, BAA, Auditor, Internal Audit and Evaluation
  • Jean-Luc Tétreault, CA-CIA, CGA, CMA, Audit Manager, Internal Audit and Evaluation
  • Christian Kratchanov, MBA, CIA, Adm.A, CMC, Chief Audit and Evaluation Executive, Internal Audit and Evaluation

Appendix D 

Overview of the Technical Amendments Process

Department staff regularly receives proposals to address technical issues with the Income Tax Legislation from:

  •  Within the Department
  •  Canada Revenue Agency
  •  Taxpayers

If technical amendments are warranted

Department staff provides advice, analysis and briefings on the proposed legislative changes to:

  • Department of Finance Senior Officials
  • Deputy Minister of Finance
  • Minister of Finance

If the Minister of Finance approves the release of the proposed legislative changes

  • Department staff issue press releases with the technical legislative proposals for comment
  • Department staff prepares technical amendments bills for consideration by Parliament based on the released legislative proposals