The canada revenue
Agency has a new attitude. And it’s not a kinder, gentler one, say senior tax lawyers.
The CRA is beefing up policing efforts, they say, and the number of disputes with taxpayers is rising. Long gone are the days when the CRA referred to taxpayers as “clients.” Today, the agency assumes the taxpayer is doing something wrong.
This sense of increased aggressiveness is evident even at the basic assessment level. The CRA is issuing assessments that are borderline to outright incorrect, tax practitioners allege. When challenged, the CRA’s response — “If you don’t like it, take us to court” — seems to taunt taxpayers.
Many taxpayers can’t afford to fight back. There’s a lot at stake — legal costs, opportunity cost as taxpayers’ attention is diverted from their businesses to fight the CRA, and the inevitable emotional cost of going through the audit process and/or litigation. And the CRA knows that, say senior tax lawyers.
Lawyers attribute the CRA’s increased vigilance to its suspicions that tax practitioners and taxpayers are cheating.
Low- to middle-income taxpayers, for example, are being forced to fight for claims for tax credits involving medical expenses, disabilities and their children. High-income earners are suspected of hiding money in offshore trusts and illegal tax shelters.
Practitioners are suspect largely because of the spillover from recent events in the U.S. At the end of August, KPMG LLP admitted to engaging in fraud that generated US$11 billion in phony tax losses, which cost the U.S. treasury about US$2.5 billion in evaded taxes.
The fraud involved designing, marketing and implementing illegal tax shelters. Nine
senior firm members and former partners were indicted on criminal charges.
Canadian tax advisors believe this debacle has raised the level of CRA’s wariness of tax practitioners on this side of the border. Combine this belief with the fact Canadian clients are asking their tax-planning professionals whether those professionals are engaging in similar illegal activities, and we have an entire professional sector that feels as if it is under more than its fair share of suspicion.
Even before the KPMG news broke, Ottawa announced in the February 2005 federal budget that it planned to pump an extra $30 million annually into fighting what it calls “aggressive international tax planning.”
Then, in August, the CRA announced the establishment of 11 “centres of expertise” to be set up in regional tax offices across the country to “counter tax avoidance and evasion,” citing this as an ongoing concern that “could erode the Canadian tax base.” Ottawa plans to hire extra auditors for this purpose and develop “communication initiatives” to inform tax planners and taxpayers alike about potentially offensive international tax schemes.
The increased tension between the CRA and taxpayers has resulted in more work for tax litigators, says Ed Kroft, a tax partner in the Vancouver office of national law firm McCarthy Tétrault LLP, but it’s not good news for affected clients.
Canada has joined with other countries to crack down on aggressive tax planning using offshore trust and tax havens. The general rule of thumb about offshore arrangements, Kroft says, is that if it seems too good to be true, it probably is.
Many tax shelters involve extensive leveraging schemes, in which the taxpayer puts in a small amount relative to the tax receipt he or she receives. In situations in which a client invests a small amount expecting to be able to deduct millions in losses, says Kroft, the client should expect to be audited.
In fact, the probability of an audit has become so real that many tax shelter promoters have litigation funds built into the cost of their tax shelter schemes.
Ottawa attempted to shut down tax shelters through tax amendments proposed in December 2003.
“But if Ottawa can’t put a stop to tax shelters by amending the [Income Tax] Act, they will put a stop to them by enforcement,” says Robert Kepes, a tax lawyer with Morris & Morris LLP in Toronto.
The CRA has used this double-pronged approach in the past with tax shelters involving filmmaking, software deals and art, says Kepes. Ottawa tries to stop the supply with tax amendments but if the deals pop up, then enforcement is stepped up. “Everyone will get reassessed,” he says.
That’s a worst-case scenario for a taxpayer.
@page_break@Before a dispute with the CRA gets that far, your client should be able to back up his or “story,” says Kroft: “Most disputes with the tax department are about the facts, not about law.”
That’s why it’s important for clients — both individuals and business people — to keep accurate records that will back up claims for expenses, deductions and credits, says Kepes.
They should also be prepared to go the distance with the CRA if they plan to put up a fight. “Tax disputes are not short,” says Kroft. “Who’s to say when the CRA will yield?”
Unlike a civil dispute involving two private parties trying to preserve their resources and move on, says Kroft, the CRA is motivated by principle.
That means a tax dispute could be settled at the assessment or audit stages. Otherwise, the first third-party arbiter that will be in a position to listen to your client’s side of the story will be a Tax Court of Canada judge.
To help clients stay away from the Tax Court’s door, Deloitte & Touche LLP has devised a hit list of items that get the CRA’s attention. The list is based on the firm’s experience in filing personal tax returns across the country, says Heather Evans, tax lawyer and partner in Deloitte’s Toronto office.
Here are some of the most common sticking points:
> Verification of capital gains and losses. The CRA often asks for details about capital gains and losses, says Evans. It’s important for clients to keep track of the cost bases of their various investments. For example, income trusts often provide return of capital, which will erode the cost base over time and affect the amount of any eventual capital gain.
> Allowable business investment losses. Losses in small-business corporations are always questioned by the CRA. The rules governing ABIL are very complicated, says Evans.
Therefore, all supporting material should be made available to the CRA when the losses are claimed.
> Carrying charges. This is a perennial issue, says Evans. Expenses incurred to earn investment income, such as interest and management fees, are generally deductible, but the CRA will look for supporting documentation. Clients should be careful not to claim any personal expenses as part of their investment expenses. The CRA is stepping up its investigations into funds borrowed for investing, she says.
> Province of residence. Interprovincial tax planning is coming under increasing scrutiny, whether it’s at the individual, corporate or trust level, says Evans. This is an issue for Ottawa and the provinces. The latter are trying to protect their turf, and Ottawa is trying to undo any aggressive planning that will deplete the federal coffers.
> Large charitable donations. Cash donations in excess of $25,000 are consistently reviewed, says Evans. So are large donations of property. In July, Ottawa brought in significant changes to the Income Tax Act’s anti-avoidance rule, directed at weeding out abusive charitable donation schemes.
> Mining and oil and gas investments. CRA requests for confirmation of flow-through amounts are common, says Evans. The specialized tax rules governing resource investing can lead to incorrect reporting when the taxpayer isn’t familiar with them. If clients have this type of investment, advisors may need to work with a tax practitioner who is familiar with these rules.
> Foreign tax credits. Many clients will have foreign-source income from employment or
investments. Generally, tax treaties with other countries will enable clients to claim foreign tax credits against Canadian taxes, offsetting taxes paid in the foreign jurisdiction. But the CRA is keen to protect its turf and has become more willing to question eligibility for these taxes.
> Tuition/education expenses. This isn’t an uncommon claim, but the CRA regularly asks for proof, so clients should make sure their children obtain the proper tax receipts from their respective schools.
> Child-care expenses. The CRA often requests verification for these claims. The problem is that many claims may not qualify for the child-care deduction. (For more, see the story on page B12.)
> Employment expenses. Most employees don’t qualify for expense claims. Most attempts to make employee expense claims will be met with questions from the CRA, says Evans. IE
Stewart Lewis is a senior reporter with Investment Executive. He is the editor of the annual tax-planning special report.
The new, harsher face of the CRA
Agency assumes taxpayer is trying to pull a fast one, an attitude that comes through in assessments
- By: Stewart Lewis
- November 1, 2005 November 1, 2005
- 15:23