Reducing Participation in the Underground Economy - Canada Revenue Agency 2014–2015 to 2017–2018

November 2014

Message from the Minister

I am pleased to present our updated Underground Economy strategy. The underground economy creates an unfair advantage for those who engage in it. It undermines the competitiveness of honest businesses, especially small businesses, who abide by the law.

Most Canadians are hard-working citizens who voluntarily follow Canada’s tax laws. The Organisation for Economic Co-operation and Development (OECD) ranks Canada’s underground economy among the lowest of OECD countries. We’re proud of that ranking – and of the strong identification, audit, and enforcement programs that help us achieve it.

Since 2006, the percentage of the GDP for the underground economy has dropped to 2.3%. Nevertheless, any amount is unacceptable.  In fact, the very existence of the underground economy flies in the face of core Canadian values of fairness, honesty, and integrity.

If left unchallenged, the underground economy will erode the integrity of Canada's tax system.

The business environment is ever-changing, and the CRA must stay nimble. We must refine our compliance actions and we must evolve our strategies.

We have developed this three-year strategic framework  proposing new measures to encourage greater levels of tax compliance—particularly in sectors of the economy where cash transactions are common, and there is real risk of participation in the underground economy.

Our goal is to put greater emphasis on reducing the social acceptability of, and participation in, the underground economy. But we can’t achieve that alone.

On November 17, 2014, it was my pleasure to chair the inaugural meeting of my Underground Economy Advisory Committee. I will meet and correspond with this Committee regularly, as it is comprised of the groups and individuals best qualified to advise us on the current trends, help us identify emerging risks, deepen our understanding of taxpayer compliance behaviour, and contribute to the development of innovative compliance tools.

In addition, they have the networks and communications channels to broadly consult, inform and educate high-risk members.

Looking ahead, we will continue to work with key stakeholders, such as the provinces and territories and my Ministerial Advisory Committee members, to ensure that the CRA has a modern, responsive and fulsome strategy for addressing and reducing UE activity in Canada.

By ensuring an increasing majority of people are playing by the rules, our Government is deepening Canada’s tax base while lowering taxes for all.

The Honourable Kerry-Lynne D. Findlay, P.C., Q.C., M.P.
Minister of National Revenue

Executive summary

Combatting the Underground Economy is one of the top compliance priorities for the Canada Revenue Agency (CRA). Through implementation of this strategy, we will reduce the social acceptability of, and participation in, the underground economy (UE). This will protect the fairness and integrity of the tax and benefit system, the revenue base overall, and ensure a level playing field for all business and taxpayers.

Although it is difficult to estimate the size of the UE, in 2011, Statistics Canada estimated the upper bound for total UE activity in Canada was 2.3% of GDP.Footnote 1 While Canada’s tax compliance rates are among the best in the world, the UE will continue to be a priority for the CRA.

We consider the UE to include both unreported and under-reported sales or income, which may involve:

Taking a comprehensive perspective, we will focus on the following three strategic themes to reduce participation in the UE, over this and the next three years:

We recognize that the UE is an issue of significant concern for our provincial and territorial partners. We commit to continue to work closely with the provinces and territories and engage with other key stakeholders, through avenues such as the newly formed Minister’s UE Advisory Committee, to ensure we achieve our goals of reducing the social acceptability of, and participation in, the UE.

Making sure that taxpayers correctly report their tax obligations is central to the fairness and integrity of our tax system. By implementing this strategy, the CRA will reduce participation in the UE and ensure that honest Canadians are not put at a disadvantage by those who choose not to comply with their obligations.

“The underground economy in home renovations exposes homeowners to significant risk they often don’t understand and that can threaten their financial security. Furthermore, legitimate businesses suffer when they are forced to compete with those who cut corners, and don’t pay their fair share of taxes. We are pleased to be working with the Canada Revenue Agency to combat the very real harm and risks posed by the underground economy.”

Kevin Lee, CEO, Canadian Home Builders’ Association

Table of Contents

Strategy overview

Underground Economy Strategy Overview
CRA Vision The Canada Revenue Agency is the model for trusted tax and benefit administration, providing unparalleled service and value to its clients, and offering its employees outstanding career opportunities.
CRA Values Professionalism - Integrity - Co-operation - Respect
CRA Mission To administer tax, benefits, and related programs, and to ensure compliance for governments across Canada, thereby contributing to the ongoing economic and social well-being of Canadians.
Goal We will reduce the social acceptability of, and participation in, the underground economy in order to protect the fairness and integrity of the tax and benefit system and the revenue base overall, and to ensure a level playing field for all businesses and taxpayers.
Objective Reduce participation in the underground economy.
Strategy Taking a comprehensive perspective, we will focus on three broad approaches to reduce participation in the underground economy, over this and the next three years. We will: further refine our understanding of the underground economy; seek to reduce the social acceptability of participation in the underground economy; and deploy a range of initiatives to encourage compliance and reduce participation in the underground economy.
Initiatives We will develop and put in place a number of concrete initiatives in support of the three elements of the strategy.
Monitoring and Implementation We will develop a suite of measures that will allow us to gauge progress and evaluate the cumulative impact of the efforts under this strategy. We have created a robust governance structure to ensure this strategy is effectively implemented.

Introduction

The Canada Revenue Agency (CRA) is committed to contributing to the well-being of Canadians and supporting economic prosperity by delivering an efficient world-class tax and benefit administration that is responsive, effective, and trusted. The trust that Canadians place in the integrity of our tax and benefits administration is the bedrock that supports our self-assessment system. This trust is built and preserved by ensuring that everyone pays their share, and it is demonstrated by Canadians in their willingness to voluntarily meet the obligations that the system places on everyone.

By any measure, Canada's tax system enjoys both a high level of integrity and compliance rates that are among the best in the world. However, as in other countries around the world, there are a small number of individuals and businesses who try to avoid paying their share by operating wholly, or partially, within the so-called underground economy.

The underground economy includes economic activity that is unreported for tax purposes. We consider the underground economy to include both unreported and under-reported sales or income, which may involve: failure to file or register; failure to report a business activity; failure to report part of a business activity or income; or failure to report employment income.

Participants in the underground economy deliberately transact activities (either receiving payment or paying for services and products) outside of the formal economy—essentially operating off the books, which results in not only reduced tax revenues for all levels of government, but also diminishes the protections that help ensure the health, safety, consumer confidence, and social benefits that Canadians enjoy and expect. Indeed, the underground economy hurts everyone: it has negative impacts on businesses, consumers, and the Canadian tax base as a whole, and it undermines the competitiveness of businesses that follow the law.

It is difficult to calculate the precise scale of the underground economy. The clandestine nature of underground economy activities makes accurate measurement difficult, and the challenges associated with quantifying and comparing the size of the underground economy are widely recognized. Still, the Organisation for Economic Co-operation and Development (OECD) endorses methods used by national statistical agencies that correct for potential underestimation of production resulting from unobserved activities—that is, the non-observed economy (NOE)—in the national accounts. These adjustments to gross domestic product (GDP) figures are generally considered a proxy for the underground economy.

In early 2014, Statistics Canada released updated estimates of the maximum size of the underground economy in Canada; in 2011, the estimated upper bound for total underground activity in Canada was estimated at $41 billion, which is equivalent to 2.3% of GDP.Footnote 2 In 2009, Statistics Canada's estimate of the upper bound was also 2.3% of GDP, suggesting that underground economy activity has been relatively stable over the past five years after dropping from 2.9% of GDP in 1992.Footnote 3

While the amount of tax revenue that would have accrued to governments stemming from this activity is smaller, it is still significant enough to warrant treatment as a priority compliance area for the CRA. This is true not only from the perspective of lost revenue and other harmful consequences for citizens and businesses, but because, left unchallenged, the underground economy can have a corrosive effect on the integrity of Canada's tax system, the competitiveness of businesses, and the federal government's ability to fund its programs and balance its budget.

The policy and legislative framework that encourages participation in the formal economy and establishes consequences for those who try to avoid their obligations is under the purview of the Minister of Finance. The Government of Canada has made important changes to its policy and legislative framework in recent years to fight this type of non-compliance. Changes include putting in place new administrative monetary penalties and criminal offences to combat the use of Electronic Suppression of Sales software (Box 1), and streamlining the process for the CRA to obtain information concerning unnamed persons from third parties, such as banks.

Box 1. Electronic Suppression of Sales Software

Electronic Suppression of Sales (ESS) software (commonly known as zapper software) has been used by some businesses to hide their sales to evade the payment of sales and income tax. ESS software selectively deletes or modifies, without a record of the deletion or modification, sales transactions from the records of point-of-sale systems (for example, electronic cash registers) and businesses' accounting systems.

Boston University law professor Richard Ainsworth estimates that some 5% of all restaurant industry's sales in the United States are zapped from financial records. According to the Canadian Restaurant and Food Services Association, Canada's restaurant industry generates $65 billion in annual sales. If similar trends prevail in Canada, zapper use could account for $3.25 billion in unreported sales. As a result, fighting zapper use is a priority for us and a major initiative in our underground economy strategy.

To fight this type of evasion, Economic Action Plan 2013 put in place new administrative monetary penalties and new criminal offences under the Excise Tax Act for GST/HST and under the Income Tax Act. These measures specifically target those who use and possess this software and came into effect in 2014.

Although the balance of this document speaks to the administrative elements of an underground economy strategy, the CRA and the Department of Finance Canada have a close and collaborative working relationship. We regularly provide the Department with program and statistical information along with our assessment of challenges posed by the underground economy. This information is taken into consideration by the Department in developing tax policy and legislation.

Given the clandestine nature of underground activity, fighting the underground economy presents a significant challenge for all tax administrations around the world. A recent OECD study provides an international perspective on relative adjustments for the non observed economy (NOE) across countries and suggests Canada has one of the smaller NOE adjustments in comparative perspective (see Exhibit 1, below). By contrast, a number of European Union (EU) economies have adjustments in the mid-range (5–8% of GDP), while Italy, Mexico, and Eastern European countries have considerably higher adjustments (9–16% of GDP).Footnote 4

“Restaurants Canada wants customers to feel confident that the taxes they pay on hospitality services are being properly remitted to the government. Tax evasion not only results in unfair competition for law-abiding restaurant owners, it deprives us all through reduced government spending on critical services. This is why Restaurants Canada actively engages with the CRA to combat the underground economy. The UE is bad for business and bad for the communities where it is active.”

Joyce Reynolds, Restaurants Canada

Exhibit 1: Adjustments for the Non-Observed Economy (NOE) in Comparative Perspective

NOE adjustments as a percentage of GDP in the UNECE 2005 survey and the OECD 2012 survey
Norway Canada Netherlands United Kingdom Sweden Belgium Israel France Austria Czech Republic Slovenia Hungary Poland Slovak Republic Mexico Italy
OECD survey 2012 1.0 2.2 2.3 2.3 3.0 4.6 6.6 6.7 7.5 8.1 10.2 10.9 12.7 15.6 15.9 17.5
UNECE survey 2005 2.4   1.0 1.3 4.0     7.3 9.3   11.9 15.7   12.1 16.7

Source: OECD (2014), The Non-Observed Economy in the System of National Accounts, The Statistics Brief N. 18. http://www.oecd.org/std/na/Statistics%20Brief%2018.pdf.

We work with international partners to share best practices and identify emerging risks in addressing the underground economy, and we have contributed internationally in responding to these challenges. As one example, the CRA led an international task group that produced a report titled Reducing Opportunities for Tax Non-Compliance in the Underground Economy, which was released in January 2012 by the OECD.Footnote 5 We have been working on implementing recommendations stemming from these reports.

This report explored the approaches and experiences of OECD member countries in addressing non-compliance associated with participation in the UE. The report identified a number of important themes that have been adopted by OECD member countries in addressing UE non-compliance, including the coordination of efforts in a “whole of body” manner, implementing enhanced risk assessment processes, developing multi-faceted risk treatments to address non-compliance and leveraging improved compliance through key intermediaries. These themes form the foundation of the CRA’s revised strategy in combatting the UE.

The CRA is in the business of protecting Canada's revenue base. We maintain the integrity and sustainability of our self-assessment tax system by ensuring that individuals and corporations file and register when required and pay the amounts they owe. The effective identification, deterrence, and correction of payment, filing, and registration non-compliance—including that stemming from the underground economy—is critical to maintaining Canadians' trust and confidence in our tax system.

Our efforts to fight the underground economy are aimed at ensuring a fair tax system and a level playing field for all businesses and taxpayers. We are particularly concerned about sectors of the economy where cash transactions are common and the temptation to participate in the underground economy is high.

We take the abuse of Canada's tax laws very seriously; accordingly, we dedicate significant effort to the identification and pursuit of those who willfully participate in the underground economy. We use a range of different activities to deal with the underground economy, including compliance research, outreach, education, communications, and targeted compliance actions that include audit and enforcement programs; we use every means at our disposal—including significant consequences such as penalties and criminal prosecution—against those who hide all or part of their sales or income, or otherwise avoid meeting their obligations.

Goals and objectives

The CRA is committed to administering Canadian tax laws in a fair and equitable manner for both the federal government and the provincial and territorial governments whose taxes the CRA administers. Identifying and addressing the underground economy continues to be a high priority for the CRA as part of our efforts to ensure fairness in the tax system and a level playing field for all.

Our goal is to reduce the social acceptability of, and participation in, the underground economy in order to protect the fairness and integrity of the tax and benefit system and the revenue base overall, and to ensure a level playing field for all businesses and taxpayers. Our ultimate objective is to reduce participation in the underground economy.

We have designed this strategy to be consistent with other key Agency objectives. In particular, the activities outlined under this strategy are consistent with the Government of Canada's commitments under the Red Tape Reduction Action Plan. This includes seeking to simplify taxpayers' overall dealings with us, using risk-based approaches to focus on the most egregious cases, and using innovative techniques to improve administrative effectiveness and reduce the tax compliance burden for taxpayers.

Strategy and initiatives

We will focus on three broad approaches to reduce participation in the underground economy over this and the next three years. These approaches are intended to increase the effectiveness of our interventions to reduce participation in the underground economy. To this end, we will:

Further refine our understanding of the underground economy

The CRA has a good understanding of the underground economy in Canada. Much information has been acquired through internal and external research (such as the Statistics Canada study noted above), our audit and verification activities, and our attitudinal surveys of Canadians. However, our capacity to detect and identify underground economy activity must stay up to date, relevant, and effectively targeted. In this regard, further refining our understanding of the underground economy will improve our capacity to take effective action to deter and counter underground activity.

Highlights of recent activities to improve understanding of the underground economy include:

Looking ahead, we will further refine our understanding of the underground economy, including by:

Input from Minister’s UE Advisory Committee

  • The CRA should expand their definition of the UE to include transactions involving counterfeit or pirated goods.
  • There is a need to focus on the behavioural factors that motivate otherwise compliant people to participate in the UE.
  • There is a need to recognize that the incidence and nature of the UE differs across sectors.

Seek to reduce the social acceptability of participation in the underground economy

The underground economy is of special concern to tax administrators because it erodes the tax base and undermines the trust that Canadians place in the fairness and equity of our tax system. However, among some segments of the population, participation in the underground economy is socially acceptable; we want to change that perception. Littering and driving without a seatbelt were, in the past, tolerated or perceived by some to be acceptable, but—due to longstanding efforts to change social views—are no longer perceived to be acceptable and are now far less prevalent. Similarly, we will seek to reduce the social acceptability of participation in the underground economy so that, over time, overall participation in the underground economy is reduced. We recognize that sustained efforts over a number of years will be needed to have an impact.

Highlights of our activities to reduce the social acceptability of participation in the underground economy include:

Looking ahead, we will seek to reduce the social acceptability of participation in the underground economy by increasing our efforts to educate and inform businesses and individuals about the risks and consequences of participating in the underground economy. This will include:

Input from Minister’s UE Advisory Committee

  • It is important to communicate the consequences of participating in the UE in non tax terms. For example, the CRA’s partnership with the Canadian Home Builders’ Association on the “Get it in Writing!” campaign focused on consumer protection and safety as reasons to not participate in the UE.

Deploy a range of initiatives to encourage compliance and reduce participation in the underground economy

The CRA has a variety of highly effective tools to detect those who have not reported all or some of their sales or income, including: leads from taxpayers; information-sharing agreements; spot visits by auditors; information obtained from third-party reporting systems; specialized computer software; and leads from other audit files. We work with the provinces and territories and with federal government agencies and departments to better identify those participating in the underground economy, and we use a mix of outreach, education, communication, and compliance actions to fight the underground economy.

However, new and innovative initiatives and activities have the potential to encourage compliance with the tax rules right from the start, and thus to discourage and reduce participation in the underground economy overall.

Highlights of our recent activities to reduce participation in the underground economy include:

Box 2. Underground Economy Specialized Teams

The goal of our small and medium enterprise audit strategy is to identify cases of reporting non-compliance and to take the appropriate corrective action. We do this by reducing our interventions for low-risk groups of taxpayers and by focusing our audit resources on taxpayers who are at risk of non-compliance.

In addition, we have started using specialized teams to do comprehensive audits on taxpayers operating in high-risk sectors. This approach increases the effectiveness of our audits and reduces the burden on compliant taxpayers. Although we are focusing audit resources on high-risk files, we still keep appropriate audit coverage levels for low-risk groups of taxpayers.

Our efforts to reduce participation in the underground economy are also supported by a number of initiatives to encourage and support compliance more broadly, such as:

Box 3. The Industry Campaign Approach

The Industry Campaign Approach (ICA) is a new initiative launched by the CRA to encourage voluntary tax compliance within various industry sectors. Through the ICA, we are working with industry associations in sectors to provide businesses with sector-specific tax information that help them to comply with their tax obligations. It also provides the CRA with valuable insights and help build a better appreciation within the CRA of the challenges and realities that businesses face.

SMEs represent the largest proportion of businesses in Canada. Through the ICA, we are adopting an innovative approach that helps these businesses understand how to meet their tax obligations and improve their tax compliance up front, as a complement to traditional compliance activities. The ICA is intended to encourage businesses to self-correct and take steps to prevent common mistakes, and may even help them avoid more intrusive compliance measures by the CRA in the future.

Looking ahead, we will deploy a range of actions and initiatives to encourage compliance and reduce participation in the underground economy. This will include both our traditional activities and new innovative techniques, as follows:

Input from Minister’s UE Advisory Committee

  • The CRA should expand its application of behavioural economics.
  • The CRA should focus on obtaining existing business to business information and other useable data to improve its ability to identify serious non-compliance.
  • When designing any new measures that address the UE, the CRA must be careful to target the highest risk, while minimizing the burden on those who are compliant.

Working with provinces and territories

The underground economy is a serious problem not only for the federal government, but also for the provincial and territorial governments whose taxes the CRA administers (individual income tax for all provinces and territories except Quebec, corporate income tax for all provinces and territories except Quebec and Alberta, and the harmonized sales tax in the four Atlantic provinces and Ontario).

We recognize that the underground economy is an issue of significant concern for our provincial and territorial partners, and we are working closely with the provinces and territories to ensure their priorities in this area are recognized.

As one example, we co-chair the Federal-Provincial-Territorial Underground Economy Working Group, a partnership between federal, provincial, and territorial governments with a mandate to reduce participation in the underground economy through research, information sharing, communication, education, and audit activities.

In addition, we continue to engage provincial and territorial governments to find better ways to reduce the impact of the underground economy, and we have established specialized regional audit teams to target underground economy risks that may be unique to specific regions.

As in the past, we will engage provinces and territories on this issue on an ongoing basis. The CRA hosted a UE roundtable meeting with the province of New Brunswick, and we look forward to similar meetings with other provincial and territorial partners. We remain open to our partners' ideas and suggestions in support of our shared objective to reduce participation in the underground economy.

About the Minister's UE Advisory Committee (Advisory Committee)

The mandate of the Advisory Committee is to advise on the current underground economy trends, help identify emerging risks, deepen government’s understanding of taxpayer compliance behaviour, and contribute to the development of innovative compliance tools.

In addition, the Advisory Committee has the networks and communications channels to broadly consult, inform and educate high-risk members.

The Advisory Committee will be consultative in nature, and its composition includes expertise in: industry knowledge, scientific behavioural analysis, and government rules and regulations.

The focus of the Advisory Committee, chaired by the Minister of National Revenue, will be to provide advice, input and feedback on UE strategies and activities.

Membership  

Chair, Minister of National Revenue

Hon. Kerry-Lynne D. Findlay

Canadian Home Builders’ Association

Kevin Lee

Chartered Professional Accountants Canada

Gabe Hayos

Restaurants Canada

Joyce Reynolds

Canadian Federation of Independent Business

Corinne Pohlman

Merit Canada

Terrance Oakey

Canadian Payroll Association

Patrick Culhane

Retail Council of Canada

David Wilkes

Canadian Chamber of Commerce

Émilie Potvin

Associate Professor of Marketing, Rotman School of Management, University of Toronto

Nina Mažar

The Advisory Committee will meet formally twice per year, with ongoing dialogue occurring on a regular basis as the government seeks feedback on particular aspects of the strategy and the initiatives conducted in support of the strategy.

The formation and continued productive working relationship of the Minister's Advisory Committee will reinforce the fairness and integrity of Canada’s tax system.

Implementation and measurement

As part of the implementation of this strategy, we will look beyond our own experiences and practices and will vigorously seek out best practices, innovative activities, and creative initiatives from other tax administrations around the world, as well as from provincial and territorial partners. Given the evolving nature of the challenges in this area, the effort to acquire global learnings and best practices will be ongoing.

As well, our analysis of both existing and new streams of information will continue to be strengthened, which will enhance our business intelligence and will generate dividends in terms of both efficiency and effectiveness. These approaches to reducing participation in the underground economy will be considered on an ongoing basis.

It is expected that these efforts will bring dividends over a number of years. In the interim, we will continue with both traditional and novel approaches to detect and address the underground economy, with the approaches to be adapted as the strategy takes effect.

To measure the impact of our efforts to reduce the underground economy, we will develop a suite of measures that will, over the long term, allow us to gauge our progress and evaluate the cumulative impact on compliance of the efforts under this strategy. These measures will also provide transparent accountability to taxpayers.

In addition to our traditional activity and output-based measures, over time we will seek to incorporate outcome-based measures, to evaluate the impact of our interventions.

Our progress in this area will be measured using the following framework.

Exhibit 2. Underground Economy Strategy Framework

Chart description

The graphic provides a visual representation of the strategy framework.

The graphic then shows how each of the three strategy elements relate to initiatives outlined in the strategy.

These elements and related initiatives are together shown to lead to a number of expected outcomes, as follows:

Finally, the graphic shows that these outcomes will be measured, and that the CRA will develop a measurement framework that will allow us to gauge progress and evaluate the cumulative impact on compliance of the efforts under this strategy.

Governance

A robust governance structure is in place to build on our efforts to date and ensure the effective implementation and regular renewal of this strategy as set out in Exhibit 3 below.

Exhibit 3. Underground Economy Governance Structure

Chart description

The graphic describes the CRA's underground economy governance structure. The structure is both a reporting and a leadership structure (that is, the arrows between the boxes run both up and down). At the top of the structure is the Minister of the CRA. Beside the Minister is the Minister’s UE Advisory Committee which provides advice and input to the Minister on issues related to the UE. Beneath the Minister is the Commissioner of Revenue. Beneath the Commissioner are the Agency Management Committee (AMC), which will undertake an annual review of the strategy, and the Programs and Operations Committee, which will provide ongoing implementation oversight. Immediately below is the Director General Underground Economy Steering Committee, which is shown to report to both the AMC and to the Programs and Operations Committee. Beneath the Steering Committee is the Underground Economy Director Working Group; beneath the Director Working Group are four working groups, as follows: the Compliance Approaches Working Group, the Communications Working Group, the Research Working Group, and the Measurement and Reporting Working Group.

To ensure the effective operationalization of the strategy, we have created the cross-Agency, Director-General-level Underground Economy Steering Committee. The Steering Committee has developed an internal underground economy framework that will implement this strategy; clarify expectations, accountabilities, and the measurement of results; and define roles and responsibilities within the Agency. The Steering Committee is supported in its work on an ongoing basis by a cross-Agency, Director-level committee, which in turn is supported by four working groups.

Ongoing oversight for the implementation and deployment of the strategy will be provided by the CRA Programs and Operations Committee, which is chaired by the Commissioner and includes Assistant Commissioners and Deputy Assistant Commissioners from the regions and Headquarters branches.

The Agency Management Committee, which is chaired by the Commissioner and includes all Assistant Commissioners, will review this strategy each year to ensure the strategy remains current, effective, and relevant.

The Commissioner reports directly to, and receives direction from, the Minister of National Revenue on the CRA efforts to address the underground economy. The Minister receives regular input and support from the Minister’s UE Advisory Committee, which includes industry experts, on the status of the underground economy and feedback on the CRA's strategic approach.

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