Tag: Tax evasion

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  The taxpayer only pays tax when funds are withdrawn, whether voluntarily or by operation of law.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.

Keeping those tax deals confidential? Be wary

There was no mention of it in the Federal Budget Speech, but there is a very important proposal in the Budget Plan itself that could have serious implications for wealth advisors, particularly those involved in sophisticated tax planning.

It has to do with requiring the reporting of certain tax avoidance transactions that fall outside existing tax shelter registration requirements.

The trend toward information reporting

The Canadian government is following a path that a number of jurisdictions have taken of late — to require disclosure of certain transactions that may warrant greater scrutiny by tax authorities. This includes many major economies and some of our closest trading partners, including the U.S., U.K., Ireland, New Zealand and Australia.

Closer to home, in January last year provincial authorities in Quebec circulated a working paper titled “Aggressive Tax Planning” for public consultation. Following those discussions, Revenu Quebec announced in October that it would be intensifying its efforts in this area, including requiring the mandatory disclosure of confidential or conditional remuneration transactions. Penalties for non-compliance can be as much as $100,000, with no time limit for the agency to review undisclosed transactions.

The proposal

There are existing substantive rules in the Income Tax Act intended to counter aggressive tax planning, including information reporting to help identify certain transactions and participants. 

Further, there are rules that may be applied to deny tax benefits, including the General Anti-Avoidance Rule (GAAR).

Still, we operate within a self-assessment system that relies on taxpayer disclosure to support the integrity of the system. The government sees these foregoing substantive rules as being more effectively applied if CRA is able to identify aggressive tax planning in a timelier manner. 

The proposal uses the term “hallmark” to describe the characteristics of an avoidance transaction that will be deemed a reportable transaction. Transactions would have to be reported if they bear at least two of the following three hallmarks:

  1. A promoter or tax advisor in respect of the transaction is entitled to fees that are to any extent:
    1. attributable to the amount of the tax benefit from the transaction;
    2. contingent upon the obtaining of a tax benefit from the transaction; or
    3. attributable to the number of taxpayers who participate in the transaction or who have been given access to advice from the promoter or advisor regarding the tax consequences from the transaction.
  2. A promoter or tax advisor in respect of the transaction requires “confidential protection” about the transaction.
  3. The taxpayer or the person who entered into the transaction for the benefit of the taxpayer obtains “contractual protection” in respect of the transaction (other than as a result of a fee described in the first hallmark).

According to the proposal, the presence of these hallmarks doesn’t necessarily imply there is abuse, but rather indicates there is a higher risk of abuse which merits a closer look by the CRA. 

It’s important to understand this is strictly a reporting exercise. Disclosure would have no bearing on whether the tax benefit is allowed, nor would it be considered an admission that the GAAR applies to the transaction.

Scope and timeframe of implementation

The focus is on whether the transaction itself may be reportable by the taxpayer, not whether other individuals must report or be registered in some manner. 

Nonetheless, professionals of all stripes will want to be aware whether they are touched by a given transaction — even if only tangentially. They may not be required to take action, but it’s prudent to be aware. 

The proposal language is a bit vague and references “promoter or tax advisor,” without any further details of how widely that net may be cast — at least not in the Budget Plan document. It will be interesting to see how this definition is fleshed out once all parties concerned have weighed in during the public consultation process.

As to timeline to implementation, the quick speed of the Quebec experience should be instructive. The Budget Plan purports the proposal (as modified through consultations) is intended to apply to transactions after 2010, and series of transactions completed after 2010. 

CRA’s best tool?

On a personal note, I’m reminded of a conversation in an earlier business life a dozen or so years back. 

During lunch at a wealth-planning conference I was running, a senior official in the International Tax Directorate was asked about recent legislative changes. He commented that it was certainly nice to have new tools, but that their best tool remained . . . divorce. 

Apparently, at least at that time, acrimonious marriage breakdown was a catalyst to not-so-anonymous tips to their hotline. 

And you thought disclosure was just an issue between you and the CRA.