Recent Developments
The Content of the web site is not legal advice. Do not use or otherwise rely upon any of the Content without first seeking legal advice. A solicitor-client relationship only begins when I am formally retained by a client in writing.
Welcome to Recent Developments
Here I will be posting about recent developments in Canadian tax law. I will post periodically so please check this section often.
- David M. Piccolo
Tax Evasion Charges Stayed
A New Brunswick man’s charge for failing to file a tax return was recently stayed by the Canada Revenue Agency. According to the Public Prosecutor on the file, the charge was stayed for economic reasons – the taxpayer earned little taxable income in the year and had already been found guilty of failing to file tax returns in previous years.
Although I was quoted in the above article, I think it is important to emphasize that I don’t believe that this taxpayer’s case is a precedent to be used by others who do not want to file income tax returns; the taxpayer in this situation had already been prosecuted for failing to file tax returns in previous years and had served jail time for those charges. I suspect that in this case CRA felt it would be a better use of its resources to pursue another taxpayer for the first time instead of continuing to go after this particular individual.
Residence Tiebreakers
On August 11, 2010, the National Post posted an article about some of the US tax issues Conrad Black currently faces. The article provides an overview of how an individual may be taxed in foreign jurisdictions. The article discusses the different bases that countries use in their income tax system and the possibility that an individual or corporation could be taxed on its worldwide income in two different countries.
If an individual or corporation is a taxpayer in both countries, that taxpayer may seek relief from an available tax treaty. All tax treaties will have some form of tiebreaker so that the taxpayer will be taxed on its worldwide income in only one country. The tiebreaker rules for individuals are different from the corporate tiebreaker rules and they may vary treaty to treaty.
One commonly used tax treaty is the Canada-US Tax Treaty. According to Article IV(2) of the Canada-US Tax Treaty, the tiebreaker rules for individuals are as follows:
• The jurisdiction where the individual has a permanent home available to them;
• The jurisdiction where the individual’s personal and economic relations are closer (centre of vital interests);
• The jurisdiction where the individual’s habitual abode is located;
• The jurisdiction in which the individual is a citizen;
The tie-breaker rules apply in sequence, so if the first rule doesn’t settle the issue, one moves to the next rule. If the above rules do not break the tie, the competent authorities in each country (in this case, the Canada Revenue Agency and the IRS) will come to a mutual agreement on the individual’s residency.
Revoked Charities (Updated)
The following is a list of the various charitable organizations that have had their charitable registrations revoked or annulled by CRA since the start of 2009:
• January 12, 2009 – Little League Baseball Canada
• January 12, 2009 – The Millennium Charitable Foundation
• February 9, 2009 – Phoenix Community Works Foundation
• February 17, 2009 – Dominion Christian Centre of Canada
• April 27, 2009 – Universal Aide Society
• May 11, 2009 – The Children’s Emergency Foundation
• June 8, 2009 – Living Waters Ministry Trust
• June 8, 2009 – Healing and Assistance Not Dependence Canada
• July 27, 2009 – The Mission Against Poverty Shelter
• August 10, 2009 – Jesus El Buen Pastor Spanish Pentecostal Church of Toronto
• August 10, 2009 – Funds for Canada Foundation
• September 8, 2009 – New Hope Ministries Institute
• September 14, 2009 – Alberta Distribution Relief Agency Aid Society International
• April 19, 2010 - Liberty Wellness Initiative
• April 19, 2010 - Destiny Health & Wellness Foundation
• May 10, 2010 – The Orion Foundation
• May 10, 2010 – Henvey Inlet First Nation Community Support Organization
• June 7, 2010 – Canadian Lacrosse Association
• July 17, 2010 – Tamil (Sri Lanka) Refugee-Aid Society of Ottawa
Donors to these organizations should have received correspondence from CRA if they claimed a charitable donations credit for any of their donations.
CRA to Relax VDP Rules
On July 15, 2010, the Globe and Mail published an article regarding a possible relaxing of CRA’s Voluntary Disclosure Program (VDP) guidelines. Currently, in order to qualify for a voluntary disclosure, a taxpayer must give CRA a complete picture of all of the outstanding tax issues that the taxpayer has in any year. However, the Income Tax Act restricts the number of years in which relief is available, under the VDP, to the 10 most recent years. If a tax issue arose in a year prior to the past 10 years, the taxpayer may have been subject to full interest and penalties in those years. This may have caused some taxpayers to not utilize the VDP for fear that they would create a large liability for themselves.
The change CRA is making is purely administrative; it appears that there will be no amendment to the Income Tax Act. Also, it is unclear when that change will be effective, as there is no official announcement from CRA as of yet. As such, it appears that CRA’s primary focus is to bring taxpayers back into the system, so that they can collect future taxes from them. Further, it also appears that CRA believes it is more cost-effective to ensure tax compliance by making it easier for taxpayers to voluntarily disclose errors than to devote more resources to audits and investigations.
Taxpayer Information Within CRA
On June 20, 2010, the Toronto Star reported that the Canada Revenue Agency (CRA) had performed internal investigations on its employees regarding improper access to taxpayer information. The report noted that certain employees had accessed taxpayer information for personal use – for example, one case involved an employee who checked financial information of creditors of her spouse.
Subsection 241(4) of the Income Tax Act outlines when taxpayer information may be disclosed. The subsection provides a number of situations where taxpayer information held by CRA can only be disclosed, including to properly calculate amounts under the Income Tax Act and to administer the Canada Pension Plan and Employment Insurance system.
The article states that CRA only informs victims of the breach of privacy where they judge the breach to be more than minor. However, the article is unclear as to how quickly they are informed and how much information they are given about the breach.
TFSA’s
On Tuesday June 15, 2010, the Globe & Mail published an article regarding the large number of over-contributions to Tax-Free Savings Accounts (TFSA’s). The article states that a large number of these over-contributions are mistakes based on a misunderstanding of the rules regarding contributions and withdrawals. For example, it may have been unclear to individuals that they could only contribute $5,000 in 2009, regardless of the any subsequent withdrawals that same year.
The article does a good job in explaining the remedies individuals can take to reduce or eliminate any penalties associated with an over-contribution. I suggest this article to anyone who has mistakenly over-contributed to their TFSA.
UBS Settlement Nearing Approval
On June 3, 2010, the upper house of the Swiss Parliament approved a deal between the Swiss bank UBS and the US government that would disclose the names of American clients to the IRS. The lower house of the Swiss Parliament has yet to approve the deal. If the lower house does approve the deal, the names of over 4,000 American clients will be disclosed to the IRS, which will likely lead to either audits or prosecution for tax evasion.
The parliamentary approval is limited to the particular deal made between UBS and the US government. This will surely lead other foreign governments to try to negotiate with various Swiss banks to get client names. However, the chances of a successful agreement are likely much low for a number of reasons. First, getting another parliamentary approval may be more difficult if the political landscape in Switzerland changes. Second, the other countries may not have the leverage that the US government can generate. Third, other Swiss banks will likely not have the financial difficulties that UBS had when the agreement was created. Finally, the client names may not lead to the significant returns that the US government are expecting.
Tax Hits for Ex-Spouses
The May 19, 2010 edition of the National Post contained an article regarding possible tax liabilities that ex-spouses face due to their break-up. The article discusses subsection 160(1) of the Income Tax Act which creates a tax liability to a recipient of property when the property is received from a non-arm’s length taxpayer; the amount of the liability is limited to the value of the property transferred. The article raises the scenario where an individual could become liable for their ex-spouse’s tax liability upon the transfer of property that occurs due to a separation. However, there is an exception to this rule.
Subsection 160(4) of the Income Tax Act states that where the transfer of property is pursuant to either an order or judgment from a court or a separation agreement, and at the time of the transfer, the parties were separated and living apart due to a breakdown of their marriage or common-law partnership, the recipient ceases to be jointly and severally liable for the transferor’s tax liability. This exception is in-line with other exceptions to other provisions (such as spousal attribution) upon the breakdown of a marriage or common-law partnership.
Therefore, based on this provision, individuals who are undergoing a breakdown of a marriage or common-law partnership should structure any property transfer to ensure that it meets the criteria in subsection 160(4). If they do, they can avoid one of the scenarios raised in this article.
More VDP Stats
On May 5, 2010, CRA released statistics on the number of voluntary disclosures they’ve received for the past few years. The following is a summary of their figures (all are approximate):
• 2005-06 Fiscal Year – 7,300
• 2006-07 Fiscal Year – 8,240
• 2007-08 Fiscal Year – 8,400
• 2008-09 Fiscal Year – 11,400
CRA’s news release does not indicate the cause for the dramatic increase from the 2007-08 fiscal year to the 2008-09 fiscal year, but I can speculate on a couple of reasons. The poor economy could have caused the increase for two reasons. First, individuals may have had to tap into their savings due to the downturn, and if a portion of the savings was off-shore, a voluntary disclosure may be used as part of the repatriation process. Second, individuals may have strategically filed voluntary disclosures as part of a bankruptcy in an attempt to avoid the new bankruptcy provisions that apply to individuals with large tax debts (where their tax debts would otherwise exceed $200,000).
Another possible cause for the spike in voluntary disclosures is the increased visibility of the program due to the highly publicized case regarding Swiss bank UBS and the IRS.
Receipts Crucial for Claiming Expenses
On April 19, 2010, Justice Sheridan of the Tax Court of Canada released her decision in Naguit. The issue before the Court was the deductibility of certain amounts claimed (travel, advertising, and rent) on the taxpayer’s income tax returns for the 2004 through 2006 taxation years. I represented the taxpayer in this case and the appeals were allowed for the 2004 and 2006 taxation years.
There were two issues before the Court regarding the deductibility of the travel expense – 1) whether the amounts claimed were actually incurred; and 2) if they were incurred, were they incurred for business purposes. The taxpayer’s only receipt in support of her travel was a credit card statement for the flight and hotel. It was the taxpayer’s testimony that the balance of the travel expenses were paid in cash. Justice Sheridan ruled that the amounts paid in cash were not deductible. Had receipts been available to support the expenses paid in cash, Justice Sheridan may have allowed them as she found that there was a business purpose to the travel.
Two More Charities Revoked
On April 19, 2010, CRA revoked the charitable registration of two Toronto-based organizations – Destiny Health and Wellness Foundation and Liberty Wellness Foundation. According to CRA’s news releases, the charitable registrations were revoked for two reasons. First, it is CRA’s position that the organizations were operated to promote tax shelter arrangements, as it appears that the organizations exchanged units in a tax shelter for charitable receipts well in excess of the value those units. Second, it is also CRA’s position that the organizations operated for the personal benefit of the promoters as CRA claims that the personal financial and business arrangements of the promoters of the organizations were not sufficiently separate from the financial and business arrangement of the organizations. The April 20, 2010 edition of the Toronto Star has more information on the promoters of these organizations.
For taxpayers who contributed to these organizations, the next step will likely be a reassessment from CRA disallowing their charitable deductions. It is very likely that some of these taxpayers have already been contacted by CRA notifying them of the proposed results of their audit. It is also very likely that both the taxpayers and the organizations will appeal CRA’s decision.
Time for Flat Tax?
In the April 14, 2010 edition of the National Post, an op-ed piece was published in support of enacting a flat tax. Although the piece appears to be written for a US audience, its argument is applicable to Canada. The author begins by calling for a “simple and fair flat tax”. He then proceeds to generally outline how the income tax would be calculated for individuals and businesses. However, while the author believes that such a system would simplify the income tax system, I argue that that is not the case.
The author suggests that individuals would be taxed as follows: take their labour income, subtract an allowance based on family size, and tax the difference. The author suggests that businesses would be taxed by subtracting wage costs, input costs, and investments costs from revenue and taxing the remaining amount. What the author does not do is explain how to calculate “labour income”, “wage costs”, “input costs”, and “investment costs” and this is the flaw in his argument.
A great deal of the Income Tax Act and its regulations (the Act) explains how to calculate these terms. These provisions are not simplified by moving from a graduated tax rate to a flat tax rate. Further, the Act also contains provisions regarding items such as RRSPs, pensions, the Canada Child Tax Benefit that make it more complicated. However, these provisions are not made any simpler through the implementation of a flat tax.
While a flat tax may simplify the tax rate to be applied to a taxpayer’s income, it doesn’t address the complicated question of what is that taxpayer’s income in the year.
eBay Businesses
On April 10, 2010, the National Post printed an article regarding the tax implications regarding sales on eBay. The article examines the income tax implications that may occur if an individual is a very active seller on eBay. The main consequence highlighted by the article is that the eBay selling may be considered a business, and any profit from such sales would be included in income for the year. However, there are other important issues overlooked by this article.
The first issue regarding eBay sales is determining the cost of the goods sold. Although the taxpayer may be able to determine their revenue through sources such as PayPal, it may be difficult for that same taxpayer to determine the cost of purchasing their inventory. This is especially important if the sales are taxable as an adventure or concern in the nature of trade as inventory for an adventure or concern in the nature of trade must be valued at cost for income tax purposes.
Second, there may be GST implications if the selling is considered a business. Once the individual is no longer considered a small supplier (as defined in the Excise Tax Act), they will have to collect GST on sales to Canadian residents, file GST returns and remit the collected GST. Further, claims for input tax credits may be unavailable due to time restrictions found in the Excise Tax Act.
Pension Income Splitting
The benefit of pension income splitting for Canadian seniors has often been described as simply moving pension income from a higher tax bracket to a lower tax bracket. However, this is an oversimplification, as there are many more benefits to pension income splitting then access to a lower tax bracket.
One additional benefit is increased access to personal tax credits. Pension income splitting may be used to increase the amount of certain credits, such as the age credit, pension income credit, and the medical expense credit. For example, if a husband has pension income and his wife doesn’t, regardless of their tax brackets, the couple can benefit from pension income splitting by transferring $2,000 to the wife so that she can claim the pension income credit. Pension income splitting may also be used to increase the usefulness of other credits, such as the charitable donation credit, and the dividend tax credit. For example, where spouse A’s only income is $18,000 in dividends, spouse A will not fully utilize their dividend tax credits. However, the dividend tax credits may be used to shelter income transferred from spouse B.
A second benefit is increased access to means-tested programs. Old Age Security (OAS) is a means-tested program, which means that when an individual reaches a certain level of income, the individual must repay all or part of the OAS they receive. Pension income splitting can be used to reduce an individual’s income to reduce or eliminate the impact of the means-test.
It should be noted that there are many reasonable scenarios in which transferring pension income from the spouse in the lower tax bracket to the spouse in the higher tax bracket minimizes the couples overall tax liability. For more detailed information, please click here.
Another Tax Preparer Convicted
On March 23, 2010, Ms. Shantelle Mohan was sentenced to 42 months in prison after pleading guilty to one count of fraud over $5,000. Ms. Mohan prepared tax returns for her clients in which she claimed fraudulent losses related to teak tree farms located in Costa Rica. Her clients received refunds due to these losses and agreed to invest a portion of these funds to Ms. Mohan. Although Ms. Mohan is going to prison, her clients will also have their own issues with CRA.
Since the losses claimed on their returns are fraudulent, CRA will correctly deny those losses on the returns. As such, the refund that they received will have to be repaid to CRA. Further, CRA will charge interest on the outstanding amount and may also levy a penalty on the taxpayer. It is certainly possible that the interest and penalties will equal or exceed the size of the refund.
To avoid falling victim to a unscrupulous tax preparer, taxpayers should take note of the following:
• Be wary of tax preparers whose fees are based on the size of any refund, as these preparers may artificially increase a refund to increase their income.
• Be wary of tax preparers who e-file tax returns but do not provide a copy of the tax return they submitted. If this occurs, contact CRA to request a copy of your tax return.
• Be wary of tax preparers who state that they will use your funds to donate to charities. If you are suspicious of whether a charity exists, you can search here to find out.
• Finally, if something sounds too good to be true, it probably is!
Voluntary Disclosures Program Sees Huge Increase in 2009
According to an article in the March 18, 2010 Globe and Mail, the Voluntary Disclosure Program has been an unexpected source of revenue for the Canadian Government. In the 2009 fiscal year, nearly $600 million in taxes were reported through the Voluntary Disclosure Program. According to a lawyer quoted in the article, the increase can partially be attributed to scare tactics employed by CRA.
Although the article doesn`t cite how much of that $600 million was actually remitted to CRA, the value for CRA of not having to chase taxpayers and take enforcement actions should not be overlooked. The cost savings that CRA receives with every voluntary disclosure is unknown, but it is not insignificant given that CRA receives thousands of voluntary disclosure applications each year. Therefore, the Voluntary Disclosure Program impact on the Canadian Government`s bottom line each year is more than the previously unreported tax.
Content of Tax Appeals
In an interesting article on March 13, 2010, Jamie Golombek wrote about a recent decision in the Tax Court of Canada. The issue before the Tax Court of Canada was whether Fidelity Investments Canada ULC had filed a proper notice of objection. According to Mr. Golombek’s article, upon receiving a notice of objection for 2006 for a particular mutual fund, Fidelity sent a letter to CRA asking for 2 adjustments to the notice of assessment. The Tax Court of Canada found that a notice of objection had not been filed by Fidelity.
The actual content of a valid notice of objection can contain as little as “I object to the notice of (re)assessment for the 20XX taxation year.” If the letter is sent to a tax services office, it should meet the requirements found in section 165 of the Income Tax Act. Further, if such a letter were attached to CRA’s T400a Notice of Objection form, there should be no issue as to whether a notice of objection was filed. While such a letter would be the bare minimum to start the objection process, supplementary information would be required to resolve the objection.
Given the basic nature of such a letter, it is mind-boggling that none of the accountants and lawyers employed or retained by Fidelity were able to locate and resolve the deficiency.
Quick Thoughts on 2010 Budget
On March 4, 2010, Finance Minister Jim Flaherty released the 2010 Budget. Unlike previous years, this year’s budget did not contain major changes like the introduction of the Tax Free Savings Account or the Working Income Tax Benefit, or a reduction in the GST. Instead, this budget contained minor tweaks to the Income Tax Act.
According to projections by the Ministry of Finance, the tweak that will have the biggest impact on the budget relates to employee stock options. Currently, employees who receive stock options from their employer can participate in the plan without ever actually owning shares in their employer; in particular, the employer can “cash out” their employee’s stock options. The tax implications for such a transaction are as follows: the employee is effectively taxes stock options at a capital gains rate by virtue of the stock option deduction, while the employer receives a deduction for the amount paid to the employee.
The budget proposes to limit the deductibility of such payments by the employer by forcing the employee to elect whether they want to receive the stock option deduction when their employer “cashes out” their stock options. If the employee elects to receive the deduction – which will generally be the case – the employer will not be able to deduct the payment of the cash-out.
For more information on the various tax measures in the budget, click here.
Deadlines to Appeal Tax Matters
The appeal process for income tax and GST matters begin with a notice of objection. A notice of objection filed by a taxpayer states that the taxpayer disagrees with the contents of a notice of assessment or notice of reassessment issued by CRA. However, both the Income Tax Act and the Excise Tax Act (which contains the GST) share strict deadlines as to when a notice of objection can be filed.
A notice of objection can be filed, as of right, within 90 days of the date listed on the notice of objection. If a taxpayer fails to file a notice of objection within that 90 day period, a taxpayer may apply to CRA for an extension of time to file a notice of objection. The taxpayer has one year after the 90 day period has expired to apply for the extension of time. Accordingly, taxpayers have 15 months from the date listed on the notice of assessment or reassessment to file a notice of objection. After the 15 month window has elapsed, the taxpayer has no further ability to appeal.
Mafia Leader Pleads Guilty to Tax Evasion
On February 11, 2010, Nicolo Rizzuto pleaded guilty to an unreported number of charges of tax evasion. Mr. Rizzuto is reportedly the head of a Montreal Mafia family. The charges of tax evasion stem from income earned in Swiss bank accounts.
According to the report, Swiss bank accounts were opened by people who acted as fronts for Mr. Rizzuto. The accounts would be in their name, but the funds and any income earned in the account were owned by Mr. Rizzuto.
As a result of the guilty plea, Mr. Rizzuto was fined $209,000.
Buying Bank Secrecy
According to the German Finance Minister, Germany is prepared to purchase stolen data containing information in relation to Swiss bank accounts. Other European countries, including the Netherlands and Austria, also appear to have interest in this information. The Swiss government is refusing to co-operate with its European counterparts in any investigation that may arise because of this information.
Given the bank secrecy laws in Switzerland and the trillions of dollars in Swiss bank accounts, any information that governments can acquire may be extremely lucrative from their perspective. However, the fact that this information may be generated through criminal means should be worrisome. Though the tax authorities in each country are attempting to catch possible tax evaders, the use of illegal tactics to acquire this information should not be condoned. We don’t accept the “it takes a criminal to catch a criminal” philosophy in the criminal justice system, so we shouldn’t accept it in this context. The ends don’t justify the means.
One possible solution is for Germany, Canada, the US, and other interested governments to purchase bank secrecy from Switzerland. Essentially, these governments would pay Switzerland to repeal their bank secrecy laws. The repeal would allow these governments access to banking records without purchasing information from criminals and individuals with money in Swiss bank accounts can either file voluntary disclosures or take their chances in another jurisdiction with bank secrecy laws.
Ottawa to Combat Losses on Income Trusts
According to a report in the January 27, 2010 National Post, income trusts have been merging with corporations that have tax losses as a means of reducing their taxable income. The Income Tax Act contains provisions restricting the availability of losses upon the acquisition of control of a corporation, but they may not be applicable. In response, the Canada Revenue Agency (CRA) may consider using the general anti-avoidance rule (GAAR) to deny the use of the losses.
In order for GAAR to apply, three elements must exist:
1. The taxpayer must receive a tax benefit from a transaction or part of a series of transactions;
2. The transaction or series of transactions must constitute an “avoidance transaction”;
3. The tax benefit constitutes abusive tax avoidance. In other words the receipt of the tax benefit would be inconsistent with the object, spirit or purpose of the provisions relied upon by the taxpayer.
A superficial analysis of these transactions would show that these taxpayers receive a tax benefit as they would be receiving the loss carry-forwards that will reduce their taxable income. There may be a question, however, whether the transaction or series of transaction constitutes an “avoidance transaction”. Without knowing the specific facts of the conversions, it is impossible to say how these would be characterized. However, if these were found to be avoidance transactions, the tax benefit could constitute abusive tax avoidance.
The Supreme Court of Canada dealt with the issue of loss trading in the Mathew. Though the facts of the case were different than these cases, the Supreme Court of Canada recognized a general policy within the Income Tax Act that prevented the transfer of losses between taxpayers, subject to specific exemptions. However, a strong argument could be made that the availability of the losses to these trusts should be interpreted to mean that these transactions fall within one of these specific exemptions.
Given the amount at stake for both CRA and the trusts, it is likely that this issue will be brought before the Tax Court of Canada and the Federal Court of Appeal before all is said and done.
CRA Seeking Names from Bank of Nova Scotia
Further to its quest to find taxpayers with offshore accounts, CRA has filed an application in the Federal Court seeking names of investors to a British Virgin Islands Corporation that was partially purchased by the Bank of Nova Scotia in 2002. The investors in this corporation are suspected to include members of “six prominent Canadian business families”.
Given the current economic state and budget deficit, CRA has ramped up its efforts to track down assets held by Canadian taxpayers in offshore accounts. It seems CRA has chosen is to seek information from the five major banks as part of these efforts. Last December, CRA began investigating the involvement of employees of RBC Dominion Securities in setting up an offshore entity to hold assets.
Given the nature of the information requested, this is a story that will be worth following.
Class Action Certified
Taxpayers who donated to the Banyan Tree Foundation Gift Program between 2003 and 2007 have had their class action certified; in Ontario, for a class action lawsuit to proceed, the class must be certified by the Ontario Superior Court of Justice. The taxpayers are suing Banyan Tree Foundation Gift Program, three associated corporations, and its lawyers who provided a legal opinion that was used in its marketing.
The Banyan Tree Foundation Gift Program was one of a number of organizations that issued charitable receipts for amounts in excess of the contributions made by taxpayers. Initially, these organizations are registered as charities and are marketed as such. However, after an audit by CRA, their charitable registration is revoked and the organizations instead register as a tax shelter.
While the specific facts in this case are unique, there are other organizations that were once registered charities that are now registered as tax shelters. The taxpayers who donated to these organizations are now finding that CRA is denying their charitable deductions. If the taxpayers lose at the Tax Court of Canada or Federal Court of Appeal, it is likely that similar class action lawsuits, against the organization, its promoters, and their lawyers, will be filed.
British Tax Protest is Risky Business
British singer Billy Bragg has threatened to stop paying his taxes unless the British government places limits on the amount of bonuses that top executives can receive from banks which were bailed out during the recession. The singer has threatened to not submit his January instalment payment unless his demands are met by January 31, 2010. The singer has suggested that other taxpayers to follow suit. However, Canadian taxpayers should be careful to join such a protest as it could lead to serious negative consequences.
First, the Income Tax Act is full of civil penalties for things such as failing to file an income tax return and failing to pay instalments. These penalties can be up to 17% of the tax owing for failing to file a return or 50% of the unpaid instalment. Further, if an individual files an income tax return he knows or ought to know is incorrect could face a penalty of up to 50% of the tax owing.
Second, the Income Tax Act also contains offenses which could lead to fines or jail time. An offense for failing to file a return could lead to a fine of up to $1,000 or up to 1 year in jail. An offense for tax evasion could lead to a fine of up 200% of the taxes owing or up to 2 years in jail. These penalties are per charge, so a failure in multiple years could lead to multiple penalties.
Governments take any threat to their authority to tax very seriously. Mr. Bragg, or anyone else who plans to participate in this protest, should consider finding a lawyer if they plan on following through on this threat, because they’ll need one.
CRA Releases Stats
On January 11, 2010, the Canada Revenue Agency (CRA) released statistics regarding their activities to catch taxpayers who haven’t filed income tax returns or those who under-reported their income (the press release is no longer available on the CRA website).
In the 2008-2009 tax year, CRA performed more than 1,100 net worth audits through its special enforcement division. These audits were performed by the special enforcement division because it was suspected that the taxpayer was earning income from an illegal source. Further, CRA’s audits in the same period identified almost $8 billion in non-compliance from Canadian businesses. CRA also provided statistics as to its accomplishments in using the criminal justice system to combat non-compliance.
It should be noted that the figures that CRA quotes from its audits are a preliminary figure as the figures are counted before any appeals have been made or finalized. It would be interesting for CRA to review these figures in 5-10 years to see how these totals have held up after the appeals have been concluded.
CRA May Sue UBS
According to a report in the January 7, 2009 edition of the Toronto Star, Canada is in the process of negotiating with Swiss Bank UBS regarding information about accounts held by Canadian taxpayers. According to the Minister of National Revenue Jean-Pierre Blackburn, Canada is prepared to sue UBS to acquire the information if the negotiations fail.
In the summer of 2009, the US government successfully received a court order which forced UBS to disclose information regarding US account-holders. As a result of the court order, the IRS has collected many millions of dollars of tax revenue from income earned through Swiss bank accounts. The success of the IRS has clearly emboldened the Canadian Revenue Agency in its efforts to combat tax evasion.
Employee v Independent Contractor
One common issue facing businesses of all sizes is how they should organize their human resources – should they be employees or independent contractors. From a tax perspective, businesses prefer independent contractors over employees as they are not required to withhold income tax or pay the employer’s portion of Canada Pension Plan and Employment Insurance, provincial payroll taxes, or Worker’s compensation premiums. However, the determination of whether an individual is considered an employee or an independent contractor is fact-based.
The leading case on this issue is 671122 Ontario Ltd. v. Sagaz Industries. In the case, the Supreme Court of Canada summarized a non-exhaustive list of factors used in the determination:
1. The level of control exercised by the “employer” over the individual. A high level of control generally indicates an employer-employee relationship.
2. Whether the worker provide their own tools. If they do, this may indicate an independent contractor relationship.
3. Whether the worker hires their own staff. If they do, this may indicate an independent contractor relationship.
4. The worker’s degree of responsibility for investment and management. A low degree of responsibility generally indicates an employee-employer relationship.
5. Whether the worker has an opportunity for profit/loss. If they do, this may indicate an independent contractor relationship.
One thing to notice is that the existence of an independent contractor agreement is not determinative. Instead, the actual facts of the relationship and the interaction between the “employer” and the individual determine the classification of the relationship. Therefore, businesses that are looking to have independent contractors instead of employees need to make sure that the relationship actually resembles an independent contractor relationship.
UBS Off-Shore Accounts on 60 Minutes
On January 3, 2009, 60 Minutes did a piece on the whistleblower who tipped off the IRS to the off-shore bank accounts held by Swiss Bank UBS. The information led to a court order against UBS forcing it to reveal details regarding accounts held by US taxpayers. The IRS subsequently created a temporary voluntary disclosure program to allow account-holders to disclose their income without prosecution.
That court order has been seen as an early step in preventing taxpayers from Western nations, including Canada, from using off-shore bank accounts in jurisdictions known for their bank secrecy laws.
Clips and more can be found here.
Canadian Brokerage Firm Linked to Off-Shore Accounts
According to a report in the December 14, 2009 The Globe and Mail, the Canada Revenue Agency (CRA) is investigating the involvement of staff from RBC Dominion Securities in implementing a plan to help Canadian clients avoid income tax by moving assets from Canada into Liechtenstein, a noted tax haven.
According to the report, the staff created a Liechtenstein Foundation, which held the Canadian client’s assets. Since the Foundation owned the assets, the Canadian clients sought to avoid including any income or capital gains on their income tax returns.
It appears that CRA’s investigation was instigated by information provided by Heinrich Kieber. In 2008, Mr. Kieber sold confidential information to the German government regarding accounts with Liechtenstein Bank LGT. This information has been used by tax authorities from around the world as they seek to reduce revenue losses from tax evasion.
Given the experience of account holders with Swiss Bank UBS over the summer, it is likely that this story is the first of many more to come.
Family Business Expenses Denied
On November 30, 2009, the Tax Court of Canada released its judgment in Massicotte. The case involved the taxpayer and her brother who jointly owned rental property in Toronto. In the 2004 and 2005 taxation years, the taxpayer claimed a deduction for salary paid to her two sons; the taxpayer paid each son $7,500 per year, with the majority of it paid into RESPs for their benefit. The taxpayer paid the amounts to her sons for odd-jobs around the rental property – garbage removal, snow removal, yard work, etc. The Tax Court allowed only $500 of the $7,500 to be deducted in the taxation years for each son. Justice Boyle of the Tax Court made his decision on the following basis.
First, the amount paid to the sons was unreasonable, given the age of the sons, the hourly wage paid to the sons, and the amount of time that was required to earn the amounts in question. The Income Tax Act only allows deductions that are reasonable, with the unreasonable portion considered non-deductible (although the full amount may be considered income for the recipient). The balance of the amount was considered to be a personal expense, which is not deductible.
Second, the taxpayer`s evidence at trial was less than satisfactory. The only documentary evidence that was provided were year-end receipts from the sons acknowledging that they received the full $7,500 in the year. However, the taxpayer was unable to produce any other evidence establishing the actual jobs performed, and the dates and time worked by the sons.
These are two common pitfalls that family businesses face when the Canada Revenue Agency (CRA) questions the deductibility of salary paid to relatives (or any non-arm`s length party). Had the taxpayer kept better records at the time, she likely would have been more successful at the Tax Court. One simple method would have been for the taxpayer to have kept a log of the time worked, given that the boys were paid on a hourly wage.
HST Transitional Rules
On December 9, 2009, the Ontario Legislature passed its controversial bill implementing the HST in Ontario. Starting July 1, 2010, a 13% HST will be applied to sales of most goods and services. However, consumers looking to avoid paying the HST need to review the transitional rules for personal property and services. The following are a few highlights.
According to the transitional rules, if a consumer were to pay for personal property after May 1, 2010 for goods to be delivered after July 1, 2010, the consumer will be subject to the HST. Further, if a consumer prepays for a service after May 1, 2010 in which 10% or more of the service is performed on or after July 1, 2010, the consumer will be liable for HST on the portion of the service performed on or after July 1, 2010.
Another interesting note in the transitional rules relates to exchanges. Any exchanges, for purchases made prior to July 2010 which was subject to PST, made between July 1, 2010 and October 31, 2010 will be subject to the following rule: if the exchanged good is more expensive than the returned good, HST will apply on the difference; if the exchanged good is less expansive, HST will not apply. However, if the good was not subject to PST, and the exchange occurs after July 1, 2010, HST will be applied on the full amount of the replacement good.
2009 a Record Year for Voluntary Disclosures
According to the Minister of National Revenue Jean-Pierre Blackburn, 2009 has been a banner year for the Voluntary Disclosure Program (VDP). As of December 3, 2009, almost 7,000 voluntary disclosure applications have been filed in 2009. The voluntary disclosures filed in 2009 have disclosed more than $1.6 Billion in income-producing assets, which is about a 50% increase from 2008 figures.
One interesting note is that of the approximately 7,000 applications, only 90 involved assets held in bank accounts with Swiss Bank UBS. Earlier in the year, UBS had been ordered by the IRS to reveal the names of its US account-holders. This statistic is interesting because unlike in the US, where the temporary voluntary disclosure program was very popular with taxpayers with offshore assets (see below), in Canada it appears that the VDP is utilized by a wider spectrum of taxpayers.
Common-Law Partners and the Child Tax Benefit
On November 13, 2009, Justice Boyle of the Tax Court of Canada dismissed the appeal of Ms. Kimberley Anne Brunette. Ms. Brunette had filed an appeal with respect to the determination by the Canada Revenue Agency (CRA) that she was in a common-law relationship. The effect of CRA’s determination negatively affected her entitlement to the Child Tax Benefit, as well as the GST credit.
In his judgment, Justice Boyle reviewed the case law which defined the phrase “cohabiting in a conjugal relationship”. The case law established six categories of fact that must be examined to determine whether a taxpayer is “cohabiting in a conjugal relationship”. When applied to the facts of this case, he determined that Ms. Brunette was “cohabiting in a conjugal relationship”.
Offshore Tax Amnesty Program Gains Popularity
According to a top U.S. Tax Official, approximately 14,700 Americans participated in the special tax amnesty program run by the IRS as part of the U.S. government’s case against Swiss bank UBS. (See blog entry “The Voluntary Disclosure Program and Swiss Bank Accounts” below for more information) According to the same tax official, taxpayers who had offshore accounts, and unreported income, in jurisdictions other than Switzerland also made voluntary disclosures through this special tax amnesty program.
There was no update from Canadian tax officials regarding the number of voluntary disclosures, involving offshore accounts, filed since August, 2009. However, unlike the special U.S. tax amnesty program, Canada’s voluntary disclosure program is still available for taxpayers with undeclared offshore assets and income. Without the deadline to take advantage of the voluntary disclosure program, it is likely that the participation rate in Canada was lower than that in the U.S.
Tax Preparer Convicted of Fraud
On October 16, 2009, William “Billy” Ankomah was convicted of one charge of fraud over $5,000. He was sentenced to two years of house arrest and was fined $50,000. For a fee, Mr. Ankomah fraudulently overstated donations on his client’s income tax returns to decrease their tax liabilities. In total, Mr. Ankomah overstated over $300,000 in charitable deductions.
Mr. Ankomah’s scheme is a common example of tax preparer fraud, whereby the tax preparer receives an additional fee to decrease their client’s tax liability. This scheme, as well as other tax preparer fraud schemes, is very common. The Canada Revenue Agency (CRA) is actively investigating other cases of tax preparer fraud as part of its “Project Trident” program.
If you think you are the victim of such a scheme, you should review your income tax returns to see if the deductions claimed by your tax preparer match what you actually incurred. If there is a discrepancy and you have not been contacted by CRA, you can file a voluntary disclosure to eliminate or reduce penalties and interest.
Auditor General Finds Problems in Amending Tax Legislation
On November 3, 2009, the Auditor General of Canada released her Fall 2009 report. In this report, the Auditor General found that the Department of Finance and the Canada Revenue Agency (CRA) have contributed to the complexity of Canada’s tax regime by failing to make required amendments to tax legislation in a timely manner.
The Auditor General found that no technical amendments have been made to the Income Tax Act since 2001, despite a backlog of at least 400 amendments. The Auditor General also found that the Department of Finance and the CRA have little or no formal procedures related to identifying and responding to technical issues in tax legislation. The Auditor General found that the CRA is no longer meeting its timeliness standards in responding to requests for technical interpretations and advance tax rulings. Finally, the Auditor General found that the CRA has not updated some of its technical interpretations to reflect changes in tax law.
Supreme Court Affirms Crown as Ordinary Creditor
On October 30, 2009, the Supreme Court of Canada released its decision inQuebec (Revenue) v. Caisse Populaire Desjardins de Montmagny. The case involved a number of businesses which had gone bankrupt and had failed to remit GST and QST (Quebec Sales Tax) they had collected prior to going bankrupt. The Crown sought to collect the unremitted tax from the trustee-in-bankruptcy, who refused the request. The issue before the Supreme Court was whether collected but unremitted GST and QST is part of the bankrupt’s estate or whether it is property of the Crown.
The Supreme Court examined the legislative history of the Bankruptcy and Insolvency Act and found that it had been amended in 1992 to remove provisions which gave the Crown priority over other creditors. The Supreme Court then referred to the Excise Tax Act, which states that the deemed trust provisions within it cease to apply when the supplier becomes bankrupt. Finally, the Supreme Court examined the legal characteristics of the Crown’s rights and rejected its argument that collected but unremitted GST or QST is property of the Crown and affirmed the decision of the Quebec Court of Appeal.
Remission Orders
On October 28, 2009, a remission order for Adel Karadsheh was published in the Canada Gazette. The remission order relieved Mr. Karadsheh from a GST liability due to an incorrectly denied input tax credit that was created when he purchased a taxi cab.
A remission order is an order made by the Federal government under the Financial Administration Act. The order reduces or cancels any tax (including any interest) or penalty that a taxpayer owes when either: the collection of tax or the enforcement of a penalty is unreasonable or unjust, or when it is in the public interest to reduce or cancel the tax or penalty. Applications must be recommended by the Canada Revenue Agency (CRA) in order for the Federal government to grant the remission order.
In order for CRA to recommend an application for a remission order, the taxpayer must seek all alternative options available to reduce the tax or penalty. Therefore, the taxpayer must have exhausted all available avenues including, where applicable, a notice of objection, a notice of appeal, or a taxpayer relief request prior to any application for a remission order. CRA then screens the application to determine whether the application fits within its criteria for relief. CRA has four categories in which it will consider recommending a remission order: extreme hardship, incorrect departmental action or advice, financial setback coupled with extenuating factors, or unintended results of the legislation.
Call for Reform of Voluntary Disclosure Program
In a column published in the October 27, 2009 edition of the National Post, Diane Francis called for reform of Canada’s Voluntary Disclosure Program (VDP). According to the column, it is estimated that Canadians own $100 billion in unreported off-shore assets and reform of the VDP would increase taxpayer compliance and the government’s tax revenues.
The column suggests that Canada create a temporary amnesty program similar to the program established by the IRS in response to unreported Swiss bank accounts held by American taxpayers. The column points out that the VDP is ineffective because it can produce unpredictable outcomes and does not offer any relief on the tax portion of any outstanding balance.
‘Natural Person’ Argument Rejected
On September 16, 2009, the Tax Court of Canada released its decision in Kion v. R. The case involved a husband and wife who operated a business as a partnership. From 1994 to 1999, they filed their income tax and GST returns without controversy. Beginning in the 2000 tax year, the couple started to file income tax and GST returns showing zero income because the couple started to follow the ‘natural person’ argument. The ‘natural person’ argument states that an individual is a natural person and is separate from the legal entity created by the Canada Revenue Agency (CRA), in the form of a social insurance or business number.
The Tax Court flatly rejected the ‘natural person’ argument as having any basis in law. Further, the Tax Court upheld the assessment of gross negligence penalties against the couple. The Tax Court found that the couple knew that they were filing incorrect income tax and GST returns using the ‘natural person’.
This decision is consistent with previous decisions from the Tax Court of Canada, Federal Court of Canada, Ontario Superior Court of Justice and B.C. Court of Appeal which have rejected it as well.
New Bankruptcy Rules and Tax Debts
On September 18, 2009, a series of amendments to the Bankruptcy and Insolvency Act (the Act) came into force. One of those amendments affects individuals with large tax debts to the Canada Revenue Agency. The amendments offer a different procedure for seeking a discharge than bankrupts without a large tax debt.
There are two conditions that must be satisfied for section 172.1 of the Act to apply. First, the individual owes more than $200,000, including interest and penalties, in income tax liability; any liability that resulted from an assessment for director’s liability is not counted for the purposes of the application of this section. Second, the tax debt represents at least 75% of their unsecured credit.
If section 172.1 applies, a first-time bankrupt can apply for a discharge after 9 months only if the taxpayer has not been required to pay surplus income to the estate. Otherwise, the bankrupt cannot apply for 21 months after filing for bankruptcy. For non-first-time bankrupts, they can only apply 24 months (if they have not been required to pay surplus income to the estate) or 36 months (in all other cases) after filing for bankruptcy.
Section 172.1 also gives bankruptcy judges the discretion to order a discharge on the condition that additional funds are paid to the Canada Revenue Agency (CRA). The Act states that in exercising their discretion, the judge must take into account the circumstances that caused the tax liability to arise, any attempts made by the taxpayer to pay CRA prior to filing for bankruptcy, and the individual’s future financial prospects.
The Voluntary Disclosure Program and Swiss Bank Accounts
On September 24, 2009, the Canada Revenue Agency (CRA) disclosed that 36 Canadian taxpayers have filed voluntary disclosures related to unreported income earned in Swiss bank accounts. These taxpayers had bank accounts with Swiss bank UBS, who in August, 2009, agreed to disclose the names of its wealthy American clients to the IRS. UBS has yet to come to an agreement with the CRA to disclose the names of any Canadian account-holders.
Given the lack of an agreement with the CRA, Canadian taxpayers who file a voluntary disclosure regarding any unreported income earned in a Swiss bank account should be able to qualify, given they meet all of the criteria for a voluntary disclosure. Until the CRA has received the list of account-holders from UBS, voluntary disclosures related to Swiss bank accounts should qualify as voluntary (subject to any unrelated actions by the CRA).
CRA and the Stripper – An example of the Net Worth Assessment
CRA uses a two-step process to create a net worth assessment. First, CRA looks at a taxpayer’s assets and liabilities at the beginning and end of the tax year, and determines the increase or decrease in the taxpayer’s net worth. Second, CRA determines the taxpayer’s expenditures for the tax year through an analysis that utilizes Statistics Canada data on the average expenditures of a comparatively-sized household and information provided by the taxpayer. CRA then determines that the taxpayer’s income for the tax year is equal to the increase in the taxpayer’s net worth plus the taxpayer’s expenditures for the year. The taxpayer is subsequently assessed or re-assessed for the outstanding amount of tax, interest, and possibly penalties for that tax year.
Like any notice of assessment, a taxpayer has a right to appeal the assessment or reassessment by filing a notice of objection.
