Tag: Tax shelter

CRA compelled to assess tax return claiming credit in alleged gifting tax shelter

At issue

A person who owes tax may be pleased if the Canada Revenue Agency (CRA) delays assessing a tax return.  On the other hand, such delay can obviously be costly to someone who is anticipating a significant refund. 

This is the tactic employed by the CRA in recent years in the ongoing cat and mouse game over gifting tax shelters.  But it will need to be revisited in light of a Federal Court ruling last month.

Section 152(1) of the Income Tax Act (ITA)

The ITA specifically empowers and obliges the Minister National Revenue (MNR), through the CRA, to assess tax returns:

152. (1) The Minister shall, with all due dispatch, examine a taxpayer’s return … and determine … (a) the amount of refund … ; or (b) the amount of tax
[emphasis added – See McNally below]

CRA on “Tax Shelters”

The CRA maintains a page on its website warning of the dangers of investing in tax shelters.  In addition to outlining the nature of tax shelters and potential implications for taxpayers participating in them, there is a brief history of CRA’s efforts to curtail them and an inventory of Tax Alerts from as far back as 1998.  

Not mentioned on the page is the audit policy the agency began applying around 2010.  Where a taxpayer claims a credit through an organization that is (or is to be) audited as a potential gifting tax shelter, the return will not be assessed until after the audit is completed.  Audits of this nature may take a year or more to complete.

McNally v. MNR, 2015 FC 767

Mr. McNally filed his 2012 tax return on time in April, 2013, in it claiming a donation to EquiGenesis.  In June 2013 he received a letter from the CRA advising him that his return would not be assessed until an audit of EquiGenesis could be completed, which “can take up to two years to complete.”  He was given the option to withdraw the claim (for the time being), in which case CRA would assess the return without further delay. 

 Mr. McNally instead initiated the present application seeking an order of mandamus requiring the Minister to assess his return.

EquiGenesis had been audited and had charitable tax credits denied in 2003, 2004 and 2009, but allowed in 2005 and 2006.  The 2010, 2011 and 2012 programs are currently under audit.

Interestingly, Mr. McNally conceded that the “outcome of his assessment is a forgone conclusion [that] his credit will be disallowed.”  Still, he sought the current order so that he could proceed with his appeal rights under the ITA.

With regard to the audit policy, the MNR stated that the “purposes in implementing this change were to deter participation in such tax shelters.” 

With such a clear statement of the policy purpose, the judge concluded that “it is plain and obvious that Mr. McNally’s rights have been trampled upon for extraneous purposes.”  While there may be circumstances when an assessment may legitimately need to await an audit of a third party, the stated purpose of discouraging gifting tax shelters leads to the conclusion here “that the audit is an excuse for delay, not a reason for delay.”

On the central issue of the MNR’s statutory duty to assess a return “with all due dispatch”, the judge sided with Mr. McNally.  His return was to be examined and a Notice of Assessment issued within 30 days of the judgment.

Practice points

  1. Though McNally may be appealed, participants in gifting tax shelters may try to use this ruling to press CRA to assess presently-delayed returns. 
  2. Bear in mind that this is a procedural issue, having no impact on the legitimacy of a given gifting tax shelter, nor on the ultimate validity of any claimed credits.
  3. Along a related line of litigation, in McNally it was mentioned that the 2009 EquiGenesis program is before the Tax Court in October this year.

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”.

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.