Promoters of tax shelters usually try to provide assurance to potential investors by obtaining advance income tax rulings from the government. But investors should never rely on an AITR as absolute insurance against a tax audit.

The Canada Revenue Agency’s scale has been tipping firmly in favour of compliance. The latest shift is evident in its treatment of the last of the infamous film tax shelters, which were effectively shut down by Ottawa at the beginning of 2002.

The CRA’s actions should strike fear in the hearts of investors, argue the promoters, saying the agency has gone too far. But has it? The situation bears a closer look.

The CRA is reviewing many of the 2001 deals to which it gave AITRs. Reportedly, the CRA says it’s not undoing its rulings; it’s simply auditing the expenses reported by the film tax shelter promoters.

To understand whether the CRA is acting reasonably or not, let’s start with the basics.
An AITR is a written statement by the CRA’s income tax rulings directorate setting out how the CRA will interpret and apply specific provisions of tax law to a specific transaction or transactions that a taxpayer wishes to undertake. The taxpayer could be an individual or a group, such as a group of tax shelter investors.

Establishing the potential tax impact on a tax shelter is key for promoters. If they don’t provide what they promised — a big tax break — they risk getting sued by investors.

The taxpayer pays for an AITR. It’s $100 plus GST for the first 10 hours, and $155 plus GST for each subsequent hour spent by the directorate on the AITR application.

AITR requests must contain copies of all relevant documents, including the taxpayer’s name, address and social insurance number. The rulings are released to the public — principally through electronic tax database services — without the personal identifiers.

More important, the requests must include a complete description of the facts and each proposed transaction.

The 2001 deals are alleged by the promoters to be covered by binding CRA rulings. However, says Patrick Boyle, a tax lawyer and partner with Fraser Milner Casgrain LLP in Toronto: “Rulings are always subject to an audit of the accuracy and completeness of the facts and/or an audit of the numbers, characterization of expenses, whether the parties and prices are at arm’s length, etc.”

Mike Templeton, tax lawyer and partner with Toronto-based McMillan Binch LLP, agrees with Boyle. If expenses are not reasonable, he says, the CRA “always have that ‘out’ from a ruling.”

The CRA information circular IC 70-6R5, makes its position plain. It’s available on the agency’s Web site (www.cra-arc.gc.ca/E/pub/tp/ic70-6r5/ic70-6r5-e.html).

Section 6 of the circular states:
“Transactions on which an [AITR] was issued are subject to review by the CRA tax services offices during the course of a subsequent audit. The review determines whether or not the material facts presented in the [AITR] were accurately stated and the transaction was carried out [as stated] in the request.”

The question that remains with the 2001 film tax shelters is whether the expenses filed by the promoters were reasonable.

The CRA must think it has a legitimate reason to launch such a high-profile attack, says Templeton. Because the stakes are high, he adds, the lawyers who prepare the AITR applications for tax shelters are usually “very careful, so nothing will be open to attack.”

However, he echoes Boyle’s comments, saying it’s difficult for the lawyers to ensure all the expenses provided by a client/shelter promoter are reasonable.

“How do you ‘due diligence’ that? Get them certified by an accountant? It’s pretty hard to get comfort on those types of items,” Templeton says.

As Investment Executive went to press, the specifics under scrutiny in the 2001shelters are not known. Did one or more promoters push the envelope with expenses? Is the CRA audit division being overzealous? Short of a Tax Court challenge, the answers to such questions are unlikely to be made public, and the CRA won’t disclose details of any negotiated deals.

Meanwhile, the credibility of the AITR system is taking a beating as an unfortunate byproduct of the highly publicized actions regarding the shelters.

“While the CRA’s most recent actions do not
appear to be inconsistent with the basis upon which rulings are issued,” says Boyle, “these types of challenges do undermine the overall credibility of the rulings process.”