Tag: Penalties

Receipt fraud by tax preparers

CRA wins and warns on gifting tax shelters

The adage “if it’s too good to be true …” does not appear to be a sufficient warning for some taxpayers to resist participating in fraudulent donation tax schemes.

Indeed, it seems to have become a regular part of the Canada Revenue Agency’s communications efforts to warn against tax schemes masquerading as legitimate charitable operations.  Unfortunately, the message does not appear to be getting to everyone, or at least it is not being heeded as much as may be hoped.

This past November, rulings were handed down denying nine appeals of reassessments originating out of the same tax preparation firm.  But that’s just the tip of the iceberg.

Mehfuz Trust and the Raza brothers

According to the judgments, Mashud Miah’s son survived a premature birth in Vancouver, motivating the father to establish a charity in the child’s name in 2000-2001.  In its early years, the Mehfuz Trust may have properly served its purpose of funding a children’s medical clinic in Mr. Miah’s homeland Bangladesh.  By 2009, tax controversy led to the closure of both charity and clinic.

Mr. Miah served as chairman of the trust, which was established with the assistance of a Fareed Raza, a tax preparer.  Mr. Miah’s other occupation was in janitorial services, including cleaning for Mr. Raza’s office.

Anatomy of a tax investigation

At a CRA internal training session in 2008, an investigator from the Vancouver enforcement office learned how her Toronto colleagues had been uncovering false charitable receipt schemes perpetrated by some tax preparers.

Upon returning to her home office, the investigator began looking into significant donations going to the Mehfuz Trust through the tax preparation offices run by Fareed and Saheem Raza.  Not only were the donations out of character with past giving patterns, many taxpayers appeared to be donating a very significant portion of their net income.

A criminal investigation of the tax preparation office led to the seizure of files and records.  The evidence showed that the actual amounts donated were as little as 10% or less than the amount claimed by the taxpayer.  As well, the form used for the inflated receipts differed from the official receipts issued by the Mehfuz Trust.

It was Mr. Miah who had reported the Raza brothers to the CRA in the spring of 2008, having come across the impugned receipts in the hands of Saheem Raza.  Even so, the judge was critical of Mr. Miah who had signed the charity’s annual returns each year, which clearly showed the inflated receipt amounts well in excess of the known actual donations.

The seizure of the office records gave the CRA a roadmap of which taxpayers to audit and eventually reassess as far back as 2003, well beyond the normal reassessment period (being generally three years from original assessment).

Of course these court rulings were only with respect to those taxpayers who appealed their reassessments.  The Vancouver CRA investigator estimated that the total forged receipts through this operation amounted to approximately $12,000,000, resulting in initial lost tax revenue of about $4,700,000.

Latest warnings from CRA

Unrelated but roughly coinciding in time with the release of these judgments, in late November the CRA posted yet another Alert on its website about gifting tax sheltering schemes.

The posting is a reminder that taxpayers who claim credits based on such tax shelters will have their assessments (and potential refunds) withheld until the corresponding tax shelter has been audited.  And if a claimed amount is in dispute, 50% of the assessed tax must be paid pending resolution of the dispute.

That said, the cases above were not registered tax shelters, but simply the sale of fraudulent charitable receipts.  Perhaps “buyer beware” should be added to “too good to be true”.

CRA pursues RRSP strip – Is taxpayer innocent or complicit?

Just a couple of years into his retirement in 2001, Edward Baker ran into an old business client.  The chance meeting led him to attend a tax seminar for Canadians being held in Cancun, out of which he struck up correspondence with one of the presenters, a Mr. Claridge.  Eventually Mr. Baker allocated $100,000 to an investment for his RRSP.

Almost a decade and a half later, a judge of the Tax Court of Canada expressed his own views on this chance encounter, the investment, and its implications for the RRSP.

Limits to RRSP transactions

RRSPs allow us to save for retirement by placing before-tax dollars in a tax-sheltered environment.  The taxpayer only pays tax when funds are withdrawn, whether voluntarily or by operation of law.  It is the “operation of law” part that was relevant in this case.

Where RRSP losses result from adverse market experience, that is one thing.  It is another matter though, where such losses arise out of suspect transactions, generally regardless of the awareness or intention of the RRSP annuitant.

And as pointed out by the judge, to the extent that there are any losses in an RRSP, all taxpayers share in the losses through forgone tax revenue.  To safeguard RRSPs from abuse, where a RRSP trust purchases property for more than it is worth or sells property for less than it is worth, there will be an income inclusion pursuant to ITA section 146(9).

The investment opportunity

Mr. Claridge offered Mr. Baker the opportunity to invest in Kelso Securities, a small public company in the transportation manufacturing field.  It appeared to be on the cusp of a breakthrough in rail brake technology.  Mr. Baker claims that he spoke with the CEO about the business, and with its lawyer who stated that its shares were RRSP-qualified.

Mr. Baker opened a new self-direct RRSP account, into which he transferred $100,000 from an existing RRSP.  With these funds, 5,000 preferred shares (eventually convertible to common shares) were purchased at $20 each.  Mr. Baker gave Mr. Claridge full discretion to negotiate the price, agreeing in advance to a $20,000 commission irrespective of the price.

It is not clear whether Mr. Claridge ever received his commission directly.  Subsequent to the purchase, he failed to reply to Mr. Baker’s phone or email contact.

An in-credible witness

The judge commented that even a brief internet search would have revealed that over 140,000 of the same class of shares had been issued by the company in the preceding two years at $1 a-piece.  One such issuance occurred after Mr. Baker’s purchase.

Meanwhile, the common shares (into which the preferred might eventually be converted) were trading at between $0.07 and $0.11 in the month following Mr. Baker’s purchase.

In addition, a CRA auditor testified that the seminar in question was offered by the Institute of Global Prosperity, an organization that promotes an aggressive anti-tax philosophy.  In fact, before paying the $8,000 to attend the Cancun seminar, an attendee would have already had to purchase a six audio disk set for $1,500, casting a doubt on Mr. Baker’s claim to be unaware of the subject matter and tenor of the seminar before arriving.

Inclusion conclusion

The defence contended that Mr. Baker had neither directed nor intended a transaction at less than fair market value. Though acknowledging a line of case reasoning that could support an innocent vicim of fraud, the judge declined this submission.

On the contrary, the judge criticizes Mr. Baker’s lack of due diligence in the affair, concluding that he must have been complicit in the scheme to acquire the Kelso shares at greater than fair market value.  He was particularly taken by the fact that Mr. Baker, having apparently lost his entire investment, had made no effort to pursue Mr. Claridge, nor either of the representatives of Kelso.

On the whole, the inference taken by the court was that there must have been a promise of some sort made to Mr. Baker that did not ultimately materialize, suspecting “that someone else made off with the funds.”

It was ruled that s.146(9) applies to the case, bringing into Mr. Baker’s 2001 income the difference between the consideration paid and fair market value, or $95,000.

Gross negligence penalties for wilful blindness in filing taxes

At issue

Our tax system depends to a large extent upon the diligence and honesty of taxpayers to self-assess and self-report all necessary information to determine appropriate taxes due.  Clearly there is a significant element of trust in our relationship with the Canada Revenue Agency (CRA).

Of course, errors and omissions can occur, most often (we would hope) attributable to innocent mistakes.  Other times, the taxpayer’s conduct may be considered negligent.  In either such case, the tax record will need to be corrected, interest would generally apply on overdue amounts, and some penalties may also be assessed.

In the most egregious situations, there could be a finding of gross negligence against a taxpayer.  Our Income Tax Act and courts are not tolerant of such blatant transgressors, and very harsh penalties are likely to follow.

Section 163(2) of the Income Tax Act (ITA)

A taxpayer who is found to have made a false statement or omission in a tax return that amounts to gross negligence, is liable to a penalty of the greater of $100 and 50% of the tax payable on the understated income.

Panini v Canada 2006 FCA 224

The concept of wilful blindness is well developed in criminal law.  Rather than inquire into a suspicion in order to find certainty, a defendant shuts his eyes to the fact.  Not wishing to know the truth, he prefers to remain ignorant.

Gross negligence may be established through proof of wilful blindness.

These concepts also apply in tax cases. Basically, “the law will impute knowledge to a taxpayer who, in circumstances that dictate or strongly suggest that an inquiry should be made … refuses or fails to commence such an inquiry.”

Torres v. The Queen, 2013 TCC 380

The judgment begins, “This is a sad and sorry tale of taxpayers … who were led down a garden path, with the carrot at the end of the garden being significant tax refunds. The tax refunds were the result of claiming fictitious business losses.”  CRA denied the losses and assessed penalties for gross negligence.

These seven appeals as to the gross negligence penalty assessments were heard together.  All of the taxpayers had used the services of “Fiscal Arbitrators” (FA) to prepare their tax returns.  As can be inferred from the judge’s comments, these cases are just the tip of the iceberg of FA clients whose loss claims have been denied by CRA, and who may similarly be facing gross negligence penalties.

The factual summaries are replete with actions and assertions from FA that push beyond the boundaries of common sense.  The core activity though is fairly straightforward: Representatives of FA prepared the taxpayers’ returns, all of which included false expense claims for non-existent businesses.  The taxpayers then filed the returns, leading to substantial tax refunds.  Not only were none of taxpayers actually in business in any manner; the expense claims were way out of proportion to their actual income, sometimes many multiples of it.

As to the taxpayers’ culpability, the judge summarized circumstances that would indicate a need for an inquiry prior to filing, what he termed “flashing red lights”, including:

  1. the magnitude of the advantage or omission;
  2. the blatantness of the false statement and how readily detectable it is;
  3. the lack of acknowledgment by the tax preparer who prepared the return in the return itself;
  4. unusual requests made by the tax preparer;
  5. the tax preparer being previously unknown to the taxpayer;
  6. incomprehensible explanations by the tax preparer;
  7. whether others engaged the tax preparer or warned against doing so, or the taxpayer himself or herself expresses concern about telling others.

In the end, the judge had little sympathy for these appellant taxpayers.  Gross negligence penalties were upheld.

Practice points

  1. In the conclusion of the Torres case, the judge repeats the old adage that if it’s too good to be true then it most likely is.
  2. The CRA warns on its website against tax scams of the nature perpetrated by Fiscal Arbitrators.
  3. Engaging a tax preparer does not absolve a taxpayer from being diligent in filing a tax return.  Even if unintentional errors occur, the properly due tax will have to be paid, generally accompanied by interest.  Where a taxpayer participates in or is wilfully blind to false or questionable claims, gross negligence penalties can add to the pain.