Taxpayers and financial advisors who try to come up with innovative ways to beat the taxman are facing a tougher task ahead. Governments around the world are cracking down on “aggressive tax planning” as they strive to secure every dollar they can after spending furiously to pull their economies out of the downturn.

In that vein, the Canadian government pledged in its 2010 budget to ramp up its fight against tax-avoidance schemes that push the envelope. Following similar efforts taken last year in the U.S., Britain and Quebec, the feds unveiled plans for a new reporting regime for certain types of tax-planning transactions.

The idea is to require the participants in aggressive tax-planning schemes to report the existence of these transactions to the Canada Revenue Agency. The primary objective is to alert the CRA of certain potentially abusive transactions that are not currently subject to specific reporting requirements under the federal Income Tax Act.

The feds stress that the CRA must be able to review claims by taxpayers, including tax benefits claimed under aggressive tax-planning arrangements, in order to “preserve the fairness and the integrity of Canada’s self-assessment system.” This protection of the tax system must be balanced against taxpayers’ right to minimize their tax bills.

The proposed regime sets out the sorts of transactions that must be reported, who has to report them, the content of those reports and the consequences for non-compliance. The initial design for the regime was published for a 60-day comment period in May. At the end of August, after assimilating those comments, the government released legislation to implement the proposed regime (as part of a larger package of proposed legislative changes) for a further 30-day comment period. As Investment Executive went to press in early October, that comment period had just concluded and legislation had not yet been brought before Parliament.

In the meantime, advisors and clients alike should be aware that the proposed regime is expected to come into effect in the year ahead. As currently drafted, the rules would apply to transactions that are entered into after 2010 and to deals initiated before the end of this year but not completed until 2011.

In defining the types of transactions that will have to be reported, the federal government is following an approach taken in other jurisdictions — namely, if a deal involves at least two of three “hallmarks” of a tax-avoidance transaction, it falls under the reporting regime. Those hallmarks include: contingency fees being paid to an advisor or promoter as part of the deal; any requirement that the details of the deal remain confidential; and the existence of any guarantee that the transaction will deliver a tax benefit to the taxpayer.

The feds say these features “commonly exist in the context of tax-avoidance transactions” and their presence “often indicates a greater likelihood that the underlying transactions … could be challenged under the existing provisions of the tax law.”

However, the feds also insist that reporting the transaction doesn’t necessarily constitute an admission that the transaction should be considered offside by the tax authorities. This insistence is not likely to comfort taxpayers and tax advisors who are involved in deals that must now be flagged for the CRA.

A comment on the proposed regime by Toronto-based PricewaterhouseCoopers LLP indicates that the proposed regime “may create significant issues” for taxpayers and advisors in certain cases. In particular, the comment points to the logistics of ensuring that transactions are properly reported, noting that “advisors and their clients will need to work closely to reach a consensus on whether reporting is required.”

Moreover, the PwC comment points out that although the proposed regime indicates that reporting a transaction does not constitute an admission that it violates anti-avoidance rules, taxpayers may worry about how this sort of reporting impacts what the tax authorities decide to audit.

Indeed, the introduction of this proposed regime may serve as a deterrent to aggressive tax planning as much as it is a reporting mechanism. The prospect of reporting a proposed deal to the CRA may simply cause some taxpayers and advisors to abandon these sorts of transactions altogether rather than risk inviting additional scrutiny by the CRA.@page_break@Given the development of this type of reporting regime in both Quebec and at the federal level, observes the comment from Toronto-based Deloitte & Touche LLP: “Taxpayers who have historically engaged in aggressive transactions and played the tax audit lottery may have to change their strategy.”

The comment by Ernst & Young LLP, also of Toronto, indicates that while the proposed new federal regime is not as broad as the one introduced in Quebec — or as expansive as steps recently taken in the U.S. — the Canadian proposal would still “represent one of the most significant federal legislative tools for tackling tax avoidance since the introduction of the general anti-avoidance rule [GAAR] in 1988…. The proposed reporting requirement would represent a significant new tool in the CRA’s information-gathering arsenal and, if enacted, would likely result in an increase in audit activity.”

The proposed regime applies only to deals that fall within the definition of an “avoidance transaction” under the Income Tax Act’s GAAR and to deals that are part of a series of transactions that includes an “avoidance transaction.” A genuine, routine business transaction that bears some of the hallmarks of an abusive deal doesn’t necessarily have to be reported.

The proposed regime imposes this reporting obligation on both the taxpayer who is the intended beneficiary of the transaction and any tax advisors and promoters who are involved with the transaction. If the required disclosure is not made, not only would a tax reassessment be a possibility, but a late-filing penalty could be levied on anyone failing to satisfy their reporting obligations.

The prospect of penalties is also one of the rationales for introducing this proposed regime. Under the GAAR, taxpayers don’t face penalties on abusive transactions; they just have to pay the taxes that were avoided — with interest. According to a parliamentary paper on the issue published earlier this year: “This is where the Government of Canada differs from some other tax authorities, which add penalties to the tax and interest payable, and it is a reason why some believe that the Canadian government could be better equipped to combat [aggressive tax planning].”

However, the fact that the proposed regime is designed to impose a reporting obligation on taxpayers, advisors and promoters has also raised some concern in the legal and accounting communities that this new requirement could clash with their existing legal and ethical obligations to clients.

The joint committee on taxation of the Canadian Bar Association and the Ca-nadian Institute of Chartered Ac-count-ants makes a couple of basic points in its submission: some of the provisions may cast the net too wide and this may pose problems for advisors’ other professional obligations to their clients. The comment also warns that the final rules should be drafted to ensure they do not capture transactions that fall outside the spirit of the rules: “Several of the proposed concepts could be too broad and could cause significant problems.”

Moreover, imposing reporting obligations and penalties directly on advisors risks undermining the relationship between advisors and clients, the joint committee’s comment warns: “Unless the application of these rules is narrowed to ensure it does not extend to ‘routine’ tax advice provided in the normal course by advisors in their clients’ best interests, serious ethical and professional concerns will arise.”

In particular, the joint committee’s comment suggests that complying with a reporting obligation will put advisors in direct conflict with their profession’s rules. “Disclosing information about a client to the CRA would normally be a breach of confidentiality rules for most professionals,” the comment says, adding that lawyers, in particular, are subject to rules of client/solicitor privilege.

In addition, these professionals face a fiduciary duty that requires them to act in the best interests of their clients. That tax advisors could face penalties for their roles in a certain transaction, the joint committee’s comment says, could push them to put their own interests ahead of those of their clients: “Even if the professional does not actually put his or her interests first, in practice, the possibility that he or she could do so still creates a potential conflict of interest or a lack of independence. Such a dynamic threatens to seriously erode the normal features of a professional/client relationship.”

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