Tag: Tax shelter

Are charitable donation schemes finally history?

During a recent seminar on aggressive tax planning, a panelist outlined the onerous compliance burden of the proposed avoidance transactions rules.  He asked rhetorically what the government might be targeting with such an apparently wide casting of the net.

A neighbouring attendee whispered that maybe it would catch the charitable donation schemes.  An interesting thought, though CRA has long tracked donor-taxpayers, promoters and charities without the need of this further monitoring mechanism, and has successfully reassessed, prosecuted and de-registered, respectively.  

Even so, incredibly I had a conversation earlier in the summer with an advisor who had again been solicited for what appeared to be yet another such scheme.  

History of donations schemes

Though they’ve been around since the 1990s, I should be clear that I’m talking about the ‘buy-low, donate-high’ arrangements promoting tax benefits in excess of taxpayer outlays.  Early ones peddled artwork, computers and comic books, and later they reached for the heartstrings with things like textbooks, prescription drugs and medical supplies.  

CRA (when it was CCRA) directly warned of these schemes over a decade ago in December 1999.  By December 2003, new legislation was introduced limiting the value of a charitable tax receipt to the donor’s cost where property is donated within three years of acquisition or is acquired through a gifting arrangement.

CRA getting more active

Subsequently there has been a renewed CRA effort to address concerns about the charitable sector.  Some of this has been through more carrot than stick, such as the Charities Partnership and Outreach Program.  As well, the Budget 2010 relaxation of the disbursement quota rested in part upon the government’s expressed confidence in CRA’s ongoing monitoring capabilities.

Still, the stick remains.  Specifically, charities related fraud is one of the three tines of CRA’s Project Trident, the other two being tax preparer fraud and identity theft.  

Perhaps the watershed event evidencing CRA’s progress was in August 2008, with the de-registration of ICAN, The International Charity Association Network.  Here was a purported charity that dwarfed even the largest of known charities, propagated by such schemes.  It was the 200th registration revocation “for cause” since 1992, as published in the Charities Directorate listing on the CRA website.  While only a limited number would be related to this specific activity, it is interesting to note that there have been 78 more revocations for cause in the 2 years since, including some having similar allegations.

Recent court activity 

As to this seeming turn in the tide against charities related fraud, two cases reported in June 2010 are worth noting.  In an administrative review, the federal court upheld the revocation of EFILE privileges for a tax preparer who submitted doctored charitable receipts.  And in a private law suit, an accountant was found liable to his donor-taxpayer client for having received secret commissions in a buy-low, donate-high scheme.  

And that advisor who was solicited by the promoter just recently?  He just laughed it off.  Too bad it’s not so easy for us to see the backs of all these promoters, once and for all. 

Putting the charitable back into giving

For years, the Canada Revenue Agency (CRA) has pursued tax schemes it sees as abusing the charitable tax credit rules. Recent high-profile cases seem to indicate that the agency may be gaining some traction in its efforts. 

While this is heartening from the perspective of protecting the integrity of legitimate charitable fundraising, these developments may also foreshadow a dark cloud of privacy issues for potential charitable donors generally.

ICAN

On August 9, 2008, CRA revoked the charitable status of International Charity Association Network (ICAN), which had failed to provide adequate documentation for $464M of charitable receipts it issued in 2006.  In its press release announcing the revocation, CRA stated that it is “reviewing all tax shelter-related donation arrangements, and it plans to audit every participating charity, promoter and investor.”  

Interestingly, this press release followed closely on the heels of a win by CRA at the Supreme Court of Canada a week earlier in the Redeemer case.

Redeemer Foundation

Redeemer Foundation accepted donations from parents whose children then received forgivable loans to attend at an affiliated college.  During a 2003 audit of the charity, CRA requested and obtained a donor list, which it used to identify, audit and reassess donor-parents (denying the charitable deductions).  Redeemer resisted further CRA requests, but on July 31, 2008, the Supreme Court of Canada confirmed CRA’s audit power to compel disclosure and to use such information to conduct further audits.  

Clearly, those participating in and facilitating questionable donation structures have been put on notice by CRA.  

Legitimate charities and donors need not fear

Bearing in mind that both these cases involved aggressive donation schemes, one is nevertheless left to wonder what effect the combination of these two cases might have on potential charitable donors in general.  

In the face of an active CRA with a bolstered audit tool, potential donors may be inclined to keep the chequebook in pocket for fear that they may be exposed to unwanted scrutiny, remote though that possibility may be. Hopefully not, for charity’s sake.

Perhaps the best defence for both donors and charities is to be aware of the types of questionable schemes that may be targeted by CRA, and steer clear of them.  

More tax and estate info to come

Watch this space each month for the most current tax and estate planning information of use to you in your practice.  As well, I look forward to seeing you at our PD Network sessions this fall, where the tax and estate focus will be on the Tax-Free Savings Account (TFSA), and how you can use your client’s will to deliver value and build your practice.

Advisor liable to client in donation scheme

Tax-motivated donation schemes have been in the public eye for decades now.  

Such schemes have long been on the radar of the Canada Revenue Agency, since before it was CRA or even CCRA, back to when it was Revenue Canada.  In progressively more formal pronouncements and definitive tones, the agency has warned about the tax exposure risks of engaging in such enterprise.

In recent years, CRA has actively – and very effectively through the tracking convenience of assigned tax registration numbers – pursued and reassessed participants.  Purported tax benefits have been reversed, interest layered on, and penalties imposed. 

A degree removed from the taxpayer-agency battles, it was inevitable that we would begin seeing civil cases before the courts.  In particular, it is not at all surprising that affected investor-taxpayers would turn their attention toward those who assisted them in engaging in such programs.

The question remained whether and how liability might be determined.  Some answers are now starting to emerge.

Wrangling with CRA

Just reported June 30, 2010 is an Ontario case in which an advisor was sued by his former client when CRA unwound claimed tax benefits.

For almost two decades, Accountant MP was a close advisor to client EL’s small business operations, and secondarily to EL himself and his wife VL.  Mainly MP assisted with the business corporation’s financial and tax reporting, and also advised upon related personal tax matters, for example on decisions about dividend/salary mix.  From time to time MP brought tax-related strategies to EL/VL, such as limited partnership units.

At issue in the case were artwork donation transactions MP recommended to EL in 1998, and to both EL/VL in 1999.  A taxpayer could purchase prints in bulk for a little over $300 apiece, donate them to an American University at appraised values of 4-5 times the purchase price, and then submit the appraised value for calculating the charitable tax credit.  In total over the two years, the couple ‘invested’ $78,500, claiming tax credits well in excess of that outlay, based on the later appraised values.

In 2001, EL/VL were reassessed, and initially faced both interest and penalties.  When they consulted MP, he advised them not to pay the disputed amounts, and to await the outcome of a challenge the program sponsors intended to bring to court.

A test case did follow, spanning through to 2005 from the Tax Court to the Federal Court of Appeal and denial of leave to the Supreme Court of Canada.  In the end, the tax credit was limited to the cost of the artwork, with no penalties due, but interest applied on the underpaid tax that was outstanding over the intervening years.

Client sues Advisor

Following this tax litigation, EL/VL, now into their retirement, became suspicious that MP may have been paid secret commissions on the artwork. A suit was launched against MP alleging breach of fiduciary duty, or in the alternative negligence.

While characterization of a “fiduciary” is most familiar in trustee-beneficiary and principal-agent relationships, it is not unknown to be impressed upon other relationships where there is a strong degree of reliance upon another person.  In fact, in 1994 the Supreme Court of Canada found a tax accountant to be a fiduciary to a stockbroker.

In the present case, the judge had “no hesitation in concluding that, in relation to matters of tax planning, [MP] had undertaken to act solely on behalf of [EL/VL] and had relinquished his own self-interest in that regard, except for the normal fees he would charge for providing his advice.”

The judge’s factual determinations included:

Obtaining a secret commission, and worse that it was paid by the scheme’s promoters

Failure to point out the risks identified in the promoter’s own legal opinions, and worse still … failure to even disclose the existence of the legal opinions being in MP’s possession

Pressure tactics employed by MP, including tight time constraints and pre-completion of purchase orders by MP prior to arriving at meetings with EL   

Quantifying the damages

The direct cost of the endeavour was the $78,500 outlay less $38,703 taxes avoided, netting to $39,797.  In addition, EL/VL sought the $7,500 commission to MP, interest payable to CRA on the outstanding taxes, and interest on money borrowed to ultimately pay the bill – a total claim of $151,500. 

While the two interest charges were not accepted as appropriate heads for compensation, the judge otherwise dispensed with any notion that the claim should be reduced because EL/VL could have acted differently.  MP was held liable for the net taxes and also had to pay over the commission to EL/VL. 

Perhaps the egregious elements of this case make the outcome easy to understand, but the finding should ring loudly for all advisors touched by such schemes.  

It remains a fact-dependent determination whether advisors of other stripes and levels of interaction may be characterized as fiduciaries, and what quantum of liability may ensue.  That’s a lot of grey area yet to be explored.