Ottawa is becoming increasingly vigilant about making sure Canadians are paying their full share of taxes, as two recent Canada Revenue Agency announcements suggest.

In November 2009, the CRA launched a special project to audit domestic “inter vivos” trusts, also known as “living” trusts, with the goal of determining whether they have been set up properly and managed according to all the relevant trust and income tax laws. For now, the CRA project will be run out of a number of the agency’s regional offices in southern Ontario, but many in the tax practitioner community anticipate the initiative expanding to other parts of the country.

Then, in a separate development, the CRA began a letter-writing campaign in January, which saw the tax authority mail out some 37,000 letters to individuals in an effort to “educate taxpayers as well as promote compliance with the Income Tax Act.” The CRA asked the selected taxpayers to self-review their 2008 and 2007 claims for “rental income and expenses, employment expenses and business or commission income expenses.”

These two developments are part of a larger pattern of the CRA becoming much more active in applying tax laws and assessing penalties, tax practitioners say. Whether it’s a taxpayer’s failure to report foreign income or failure to file a tax information slip with his or her return, tax practitioners add, the CRA appears, in general, to be taking a less lenient approach.

“There’s definitely been an increase in the aggressiveness and scope of audits [undertaken by the CRA],” says Jason Safar, a partner in the tax services practice of PricewaterhouseCoopers LLP in Mississauga, Ont.

Not only is the CRA increasingly active in launching audits, but the agency seems to be doing more to publicize its actions, both in the interest of being transparent and to act as a deterrent to those taxpayers who choose to remain non-compliant with their tax obligations.

Says Murray Pituley, director of tax and estate planning for Winnipeg-based Investors Group Inc. in Regina: “The CRA is doing its job, what needs to be done. But it’s clear it has started to play hardball more.”

For its part, the CRA says that its review actions are being taken as part of its overall commitment to promoting awareness and compliance with income tax laws in the interest of maintaining the integrity of the Canadian tax system.

In the CRA’s review of inter vivos trusts, which are created during the lifetime of the settlor and offer an array of favourable tax and estate planning opportunities, the agency is examining certain aspects of the trust, or actions taken related to the management of the trust, tax practitioners report.

For example, the CRA may look to see if a promissory note has been issued to the beneficiaries. Under certain circumstances, the promissory note may not be enforceable, which could result in unfavourable tax consequences for the trust, the beneficiary or both.

The CRA may examine whether an amount has been withdrawn by the trustees for personal use. If so, the CRA could challenge the deduction taken in relation to the amounts withdrawn or assess a taxable benefit to the trustees.

The CRA may look to see if the trust is in compliance with the 21-year rule, which dictates that trusts must pay taxes on accrued capital gains every 21 years.

Finally, the CRA may check to see if all the proper accounting records related to the trust have been kept, trustee minutes taken and that the original settlement property, often a gold coin or some other asset, can be produced.

“It’s very important that taxpayers pay attention to the way trusts are set up, to make sure they review them with their tax advisors regularly,” says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce’s private wealth-management division in Toronto.

Failure by a trust to be in compliance with all the necessary trust and income tax rules might result in tax liabilities, penalties and interest.

In a worst-case scenario, this situation may even result in the CRA determining the trust “never existed to begin with,” says Tannis Dawson, senior specialist, tax and estate planning, with Investors Group in Winnipeg. In such a scenario, all the benefit and growth would accrue to the original shareholder.