Tag: Tax shelter

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.

Putting the charitable back into giving

For years CRA has pursued tax schemes it sees as abusing the charitable tax credit rules.  Two 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

International Charity Association Network (ICAN) was audited in 2007 with respect to its 2006 operating year.  CRA auditors were particularly interested in whether ICAN  may have been receiving property for which tax receipts were issued in amounts far in excess of the value of the property, sometimes called ‘buy low, donate high’ arrangements.

ICAN failed to provide adequate documentation for $464M of charitable receipts it issued in 2006.  According to CRA, this is almost five times the total charitable receipts issued by the United Way of Greater Toronto in the same year.  While the United Way had over 200 staff, ICAN managed its activity level with only 16 employees.

On August 9, 2008, CRA revoked the charitable status of ICAN.

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

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 operated as a charity offering forgivable loans to finance the education of students at an affiliated college. CRA became concerned that some donations to the program were not valid charitable donations because the donors’ contributions were made solely to finance the education of their own children.  The donation structure enabled donation credits for the parents and tuition credits for their student children – an early education in double-dipping, one might say.

In 2003, a CRA auditor orally requested documentation from Redeemer, included a donor’s list.  While the information request was in support of the audit of Redeemer itself, CRA proceeded to contact certain donors to advise them that their donation deductions would be disallowed, and all were reassessed accordingly.

In 2004, a similar CRA request was made with respect to later tax years but Redeemer refused on the basis that CRA must first obtain a Federal Court order.  Income Tax Act section 231.2(2) specifically precludes a request for “information or any document relating to one or more unnamed persons unless the Minister first obtains the authorization of a judge.”

In 2005, Redeemer applied for judicial review of the original request, looking to have the donor list returned and the donor audits effectively rescinded.  

Eventually the case made its way to the Supreme Court of Canada (SCC), which issued its judgment on July 31, 2008, holding that CRA could obtain a donor list and use it to perform donor audits:

Redeemer had to maintain donor records as part of its normal course of operations.

The provision of such information to CRA on an audit is a legitimate and necessary part of verifying the bona fides of charitable activities.

It would be unworkable if judicial authorization was required whenever an audit of a charity entails a possibility that its donors might be investigated and reassessed.

A donor can reasonably expect that a donation will be examined if the registered charity is audited and that a claimed tax credit will be non-compliant if the charitable program is not valid. 

Three of the seven Supreme Court judges dissented, expressing the concern that the audit powers over the charity could and were being used improperly.  Specifically, CRA had indicated as early as the year 2000 that it intended to reassess the Foundation’s donors.  By its verbal request to the charity in 2003, CRA was able to circumvent the taxpayer protection rule and judicial scrutiny in s.231.2(2) to identify and reassess those donors.

A chilling effect on donations?

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 generally.  

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 defense 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.  

For more information on CRA’s informational outreach efforts to donors and charities, see www.cra.gc.ca/donors.