The canada revenue Agency is stepping up its compliance and enforcement activities to make sure it collects every dollar it is owed. The “get tough” attitude began several tax seasons ago, and the agency shows no signs of slowing its relentless pursuit.

The CRA’s corporate business plan identifies three compliance priorities: pursuit of taxes currently lost to the underground economy; fighting GST and HST non-compliance; and targeting aggressive tax planning, which it defines as arrangements that “push the limits” of acceptable standards.

Heather Evans, a tax lawyer and partner with Deloitte & Touche LLP in Toronto, says that there are two primary reasons for the CRA’s ongoing zeal for compliance.

One is pressure from the Office of the Auditor General of Canada, which has directed the CRA to go after tax revenue more vigorously. (Visit its Web site at www.oag-bvg.gc.ca. ) The CRA is responding by selecting twice as many tax returns for review and verification as it did a decade ago.

The second is pressure from the CRA’s international tax treaty partners, including the Internal Revenue Service in the U.S. “There are a lot more co-ordinated activities these days between countries, especially regarding offshore tax planning,” says Evans.

The CRA is employing several key strategies, including investing in research and analysis; seeking third-party information on tax avoiders; using risk-assessment systems to detect non-compliance; issuing public “tax alerts” to make sure taxpayers are aware of potentially problematic tax-avoidance schemes; and focusing on early identification of such schemes.

The 2005 federal budget gave the CRA an extra $30 million annually to go after aggressive tax planning and compliance problems. About 80% of the funds have been used to beef up the CRA’s audit strength, says Jean-Jacques Lefebvre, director of the CRA’s aggressive tax planning division. The rest has been used to establish 11 “centres of expertise” in regional offices across the country to strengthen the CRA’s campaign against international tax avoidance and evasion.

The CRA’s Web site (www.cra-arc.gc.ca) defines tax “avoidance,” which is considered a step beyond aggressive tax planning, as tax planning that “reduces taxes in a way that is inconsistent with the overall spirit of the law.” Tax “evasion” is defined as “deliberately ignoring the law to reduce taxes,” such as when a taxpayer knowingly underreports income.

The CRA continues to keep a close eye on items such as claims for carrying charges, large charitable donations and support payments, Evans says. One way in which it does so is by “matching,” which involves cross-checking tax statements from employers and financial institutions with taxpayers’ individual returns to make sure that they match.

In recent years, Evans says, the CRA has taken a harder line with claims for self-employment expenses, which the tax authority believes has been an area of tax abuse.

“We have had a lot of clients who have been audited for home-office expenses, meals and entertainment, automobile expenses — legitimate business expenses — even in cases in which it is clear that the taxpayer could not have earned the income without incurring the expenses,” Evans says. “The CRA is just taking a much harder line in terms of forcing people to document scrupulously in order to prove their business expenses.”

Keeping good records is vital for all taxpayers, says Ed Kroft, a tax partner with Mc-Carthy Tétrault LLP in Vancouver: “If there is a challenge, records are scrutinized.”

An absence of documents backing up a tax return doesn’t necessarily mean it’s game over for a taxpayer, Kroft says, but it makes things more difficult.

“It puts more onus on the taxpayer to testify and to have his or her testimony taken as being true,” he says.

Third-party documentation can back up a taxpayer’s claims and also point to a pattern of credibility.

In keeping an eye out for questionable claims, the CRA tends to react to changing realities in the marketplace and trends in returns, Kroft says. If there’s a bull market in real estate, for example, the CRA will scrutinize returns from taxpayers who may be making sideline income by “flipping” real estate. If the sale of real estate is deemed to constitute a business instead of the sale of an investment, the CRA will tax the money at the higher business income rate instead of the capital gains rate.

“The CRA is reactive,” says Kroft. “But it reacts quickly as it scrutinizes returns.”

The CRA has outlined several types of transactions and items that it is watching closely:

> Large Charitable Donations. In recent years, tax avoidance schemes have been created involving complicated donation set-ups, in which the funds for donations are often borrowed.

“The funds would essentially go in a circle,” Evans says. “But at the end of the day, the taxpayer was cash-flow positive from having made the donation.”

Tax legislation has been introduced to stop the schemes, but the result has been more attention being paid to large donations. Evans says that the CRA is flagging for verification any donation of cash or in kind that is valued at more than $25,000.

> Capital Losses. In its battle against aggressive tax planning, the CRA is keeping an eye on claims made for capital losses, particularly if it appears that a loss was created by a transaction executed for the sole purpose of offsetting capital gains.

The CRA’s Lefebvre says that a new “tax alert” on the issue of capital losses will be out this fall.

> Carrying Charges. Interest and other expenses incurred to fund investments are tax-deductible. But the CRA is now much more active in asking for supporting documents.

> Non-Resident Trusts. Some wealthy taxpayers try to shield themselves from taxes by setting up foreign trusts and structures that take advantage of loopholes in international tax treaty arrangements.

The CRA is watching such transactions in order to make sure that the schemes do not contravene the tax avoidance rules. (See “Tax legislation left in limbo” on page B3.)

> Shareholder Loans. If a taxpayer takes a loan from a corporation he or she owns, the general principle is that taxes have to be paid on the funds, either in the form of dividends or salary.

“This is the regular subject of audits,” Evans says. “People sometimes do not appreciate that, legally and for tax purposes, the corporation is separate from them.”

> Tax Shelters. Although “buy low, donate high” tax shelters, such as the infamous “art flip” schemes, were shut down by the CRA at the end of 2003, the CRA continues to scrutinize vigilantly tax-shelter schemes sold by promoters.

Some appear to be bona fide, says Lefebvre, but others may not stand up to regulations against tax avoidance. When a scheme does not pass scrutiny, the CRA issues a tax alert, he says. IE