Taxes: The big squeeze

But these moves will also generate more tax revenue at a time when government finances are still tight, tax practitioners say, without the feds having to pay the political price for raising taxes or cutting spending. And closing loopholes plays well on Main Street because it seemingly takes away tax breaks from the wealthy.

“Most of the public would be generally supportive,” says Rick Robertson, associate professor with the Richard Ivey School of Business at the University of Western Ontario in London, Ont. “Most of us don’t have access to the tax breaks [eliminated by the recent budget]. [The feds] want to be able to say, ‘We balanced the budget; we didn’t do it on the backs of working Canadians and the middle class, and we maintained social programs’.”

In August, federal Finance Minister Jim Flaherty reiterated his government’s promise to eliminate the deficit “without doubt” in two years’ time, which would coincide roughly with the next federal election season.

Ottawa also needs to balance the books in order to keep promises it made in its 2011 election campaign, which included allowing up to $50,000 in income-splitting for parents and boosting annual contribution limits on tax-free savings accounts to $10,000 from the current $5,500.

With these goals in mind, this year’s federal budget took aim at dozens of tax issues affecting both corporations and individuals, with the focus on efforts to reduce offshore tax evasion. The Department of Finance Canada also tightened reporting rules, introduced a reward program for whistleblowers and broadened the CRA’s power to reassess tax returns and collect taxes and penalties.

Finance Canada has always kept an eye out for aggressive tax planning, attempting to eliminate artificial arrangements the department didn’t like in an ongoing cat and mouse game with taxpayers. But since the financial crisis of 2008, Ottawa, like governments around the world, has become particularly vigilant, closing down structures that Finance Canada had tolerated or found acceptable until now.

For example, Ottawa announced in this year’s budget that it would make changes to the Income Tax Act that would effectively shut down tax-advantaged income or capital-yield investment funds. These funds, which have been around for roughly a decade, offer investors the possibility of higher returns by using a derivatives-based strategy to convert ordinary income into capital gains, which are taxed at half the rate of income. The announcement came as an unpleasant surprise to firms that sell these products, which have had to scramble to restructure or close their funds to comply with the new rules. (See story on page B6.)

The budget also said that the feds would be consulting with the public on the tax treatment of testamentary trusts, including simple estates, and proposing that they be taxed at the top rate. Finance Canada says it was concerned that some taxpayers are using multiple testamentary trusts to achieve income-splitting that is regarded as being potentially abusive of the tax system. However, tax practitioners are urging the government to reconsider, pointing out that the proposed rules would be to the disadvantage of vulnerable beneficiaries. (See story on page B3.)

In fact, Finance Canada, in its desire to “protect the tax base,” risks overreaching its authority by modifying the way it enforces tax law and treats taxpayers, in being influenced not just by a concern over fairness but also its own fiscal realities.

“All of a sudden,” says Walid Hejazi, an associate professor of international business at the Rotman School of Management at the University of Toronto, “because the government needs more money, the CRA comes along and says, ‘We’re going to be more aggressive.’ But the bottom line is: if you’re breaking the law, whether or not we’re in a time of surplus or deficit, the government should go after you.”

In recent years, the CRA also has done battle more often in the courts, often invoking the general anti-avoidance rule (GAAR) to try to shut down strategies the CRA feels is breaking the spirit, if not the letter of the law. (See story on page B10.) However, that strategy has had only mixed results, forcing Finance Canada to withdraw some of its challenges or propose legislative changes instead.

For example, for years, Ottawa had signalled its concern with certain leveraged insurance arrangements, challenging them as being potentially abusive under GAAR. Having had little luck in the courts, the 2013 budget introduced changes to the tax law that essentially ended the controversial arrangements in one fell swoop. (See story on page B4.)

But if there’s one area in which the feds have become especially focused, it’s combating offshore tax evasion by either acting on its own or in concert with foreign governments. Ottawa has been particularly sensitive to proposals made by the G20 nations, which collectively have made this topic an international policy priority. In August, Ottawa released a consultation paper on possible approaches to prevent so-called “treaty shopping,” the practice of enterprises taking advantage of treaties that Canada has signed with foreign jurisdictions to gain access to preferential tax treatment afforded by that treaty that those enterprises otherwise would not have been able to access. (See story on page B13.)

Ottawa continues to sign tax-related information-exchange agreements with other countries, boosting the CRA’s ability to acquire information about accounts held by Canadians offshore. Ottawa is in the late stages of negotiating an intergovernmental agreement with the U.S. that would see Canadian banks report on accounts held by U.S. citizens to the U.S. Internal Revenue Service via the CRA. (See story on B14.)

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