The Canada Revenue Agency promises to crack the compliance whip even harder in 2007, the agency’s deputy commissioner and chief operating officer, Bill Baker, told attendees at the annual Canadian Tax Foundation conference in Toronto on Nov. 28.

As well, the conference heard that the Department of Finance hopes to clarify issues surrounding the children’s fitness tax credit and changes to the dividend tax credit, both of which were announced in the 2006 federal budget.

The CRA aims to tackle “aggressive tax planning,” said Baker, which includes schemes that promise tax-free withdrawals from RRSPs, as well as offshore tax planning, an area in which the agency is finding many instances of non-compliance.

Square in the CRA’s sights is a strategy known as “RRSP-stripping.” These schemes are offered by tax-shelter promoters that promise clients they can make tax-free withdrawals from their RRSPs. The RRSP owner withdraws his or her savings to be used as security for a loan — minus the promoter’s commission — to buy shares in a private company or an interest in mortgages at inflated rates of return. The promoter then promises that funds to pay off the loan, plus a profit, will come from the investment return.

The usual result is that the promoter absconds with the RRSP monies, and the client get nailed with a tax bill for making the RRSP withdrawal. To add insult to injury, the CRA will include the loan amount in the client’s taxable income for the year.

“The taxpayer’s RRSP is stripped of cash and replaced with allegedly worthless shares,” explains Ed Kroft, a tax litigator with McCarthy T»trault LLP in Vancouver.

The CRA is so intent on cracking down on this practice that it is willing to use the general anti-avoidance rule to stop it, says Kroft. GAAR cases against these RRSP-stripping schemes are “the most frequent,” he adds.

GAAR is a broadly worded rule that enables the CRA to nail any “misuse or abuse” of the federal Income Tax Act. GAAR is often reserved for complex, corporate tax avoidance. The CRA can often find more specific ways, based on tax legislation, to go after tax avoidance. But the CRA is hauling out its biggest gun against smaller investor-taxpayers.

If an RRSP is used to buy shares that are not “qualified investments” under the RRSP rules, then the value of the shares will be added to the client’s income, notes Kroft. (For more on the definition of qualified investments, see CRA interpretation bulletin IT-320R3 at www.cra-arc.gc.ca/E/pub/tp/it320r3/README.html.)

In addition to RRSP-stripping, offshore tax planning will also come under fire, according to Baker: “Increasingly, some tax practitioners are treating tax legislation as ‘guidelines.’ We’re finding too much non-compliance. We don’t have to turn over too many stones to find it.”

The CRA’s compliance efforts are getting full backing from Ottawa, added Baker, who noted that the CRA is “building sophisticated databases. We’re spending hundreds of millions on technology.”

Baker also said the agency has 50 “special projects” underway. In the past, these projects have included examining the income and expenses of certain professions — such as pharmacists, waiters and building contractors — and going after those that fall outside the norm.

Meanwhile, on the legislation front, the federal Department of Finance, which is responsible for drafting the tax legislation the CRA enforces, “is working to get a few things checked off,” says Brian Ernewein, general director, tax policy branch, at Finance.

Among the outstanding measures for which Finance hopes to provide more guidance at the beginning of 2007 are the children’s fitness tax credit and the dividend tax credit.

The children’s fitness tax credit promises $500 for enrolment of a child under 16 in an eligible activity program. A panel of experts has been working on the detailed rules for this credit and is setting out the activities that would qualify and the documentation required.

Business and tax experts have raised a number of concerns about the proposed changes to the dividend tax rules. Only “eligible dividends” qualify for the improved tax credit. For example, a Canadian-controlled private corporation may pay eligible dividends to the extent that its taxable income is not already benefiting from the lower, small-business tax rate — excluding investment income.

The responsibility of determining whether a dividend is eligible is on the payer corporation, which is required to designate in writing that a dividend is an eligible dividend.

@page_break@This could present a giant administrative headache for investment firms. However, says Ernewein, it would be unreasonable to request notices of eligible dividends for each individual investor. “That’s the extreme. It’s not our intent,” he suggests.

A more general notice to investors in quarterly or annual reports, or on the issuer’s Web site, will suffice, says Wayne Adams, director general of income tax rulings at the CRA.

Finance is also dealing with a flood of questions that have arisen about the new income trust legislation announced on Oct. 31, says Ernewein. These include: what about the effect of mergers and reorganizations; what about re-acquisitions; new debt; options?

“Guidance on all these issues, and coming out with legislation, are top priorities,” says Ernewein.

Among Finance’s “to do” list, he concedes, is new legislation on interest deductibility. Draft legislation was first announced in October 2003, and Finance is hoping to get something out “soon,” says Ernewein.

Finance is also struggling with the potential impact of allowing income-splitting for seniors — a recently announced benefit to soften the blow of taxing income trust distributions.

As for the litigation realm, one of the other trends increasingly found in the tax world, says Kroft, is “procedural wrangling” in the Tax Court of Canada. The judges are not used to it, but litigators “have a duty to their clients.” And it’s a fact of life in most litigation, he adds.

Some of the types of procedural disputes becoming more common, says Kroft, include production of documents during pretrial discoveries, fact determinations, establishing the onus of proof, pretrial discovery of experts and the binding nature of settlements.

Of course, these disputes will cost clients money. However, financial advisors can lessen the amount of procedural wrestling, says Kroft.

“Advisors should be aware that a tax dispute starts right at the moment the auditor arrives,” says Kroft. “It can be more acrimonious when the parties don’t communicate. What is done early in the process will have an impact on what litigators do later.”

Perhaps, in part, to ward off disputes, the CRA wants to work with tax advisors by getting more of them involved in the agency’s “executive interchange.” This may mean working for the agency for a year.

Said Baker: “We need people who can be can provide insight into the issues we face.” IE