Everyone wants to save money on their taxes, and it’s good to be aware of potential deductions and credits throughout the fiscal year. However, planning your finances to deliberately take advantage of tax loopholes or avoid paying taxes by exploiting tax laws can land you in hot water. The Canada Revenue Agency (CRA) defines aggressive tax planning as arrangements made “for the primary purpose of avoiding the payment of the required taxes.” While aggressive tax planning is not a criminal offense as of 2018, the practice can result in penalties and losses if the CRA challenges your interpretation of the Income Tax Act.
Tax avoidance means avoiding paying taxes using legal means, such as through loopholes, which are novel, but admissible, interpretations of existing laws. Tax avoidance is technically legal, unlike tax evasion, which means lying on your return to avoid paying taxes. Aggressive tax planning is a method of tax avoidance and occurs within the law but goes against the intent and spirit of the law.
There are a variety of legitimate ways to avoid paying taxes, and all of them require detailed records and full disclosure when filing taxes. In its effort to crack down on aggressive tax planning and tax avoidance, the CRA has made a number of amendments over the years to the literature and laws surrounding possible tax avoidance techniques. A 2011 amendment to the Income Tax Act requires reportable tax avoidance transactions to be noted on Form RC312. The CRA reviews these transactions on a case-by-case basis, and may deny claims if a transaction is deemed to contradict the intent of the Income Tax Act. Transactions such as investments in tax shelters or havens are of particular interest to the CRA.
International Tax Havens
A tax haven is basically a country where income tax rates are much lower than they are in Canada. Companies and wealthy individuals take advantage of tax havens by setting up offshore accounts or trusts in these havens. Income accrued by these foreign accounts is not taxable by the Canadian government. Like other methods of tax avoidance, tax havens can be legitimate but must be fully disclosed on your income taxes using the T1135 Foreign Income Verification Statement. Failure to report foreign properties can result in significant penalties.
Gifting Tax Shelters
Tax shelters are generally defined as an arrangement for a donation or a purchase of property in which the tax benefits resulting from the donation or acquisition are greater than the initial cost. Tax shelters can be legal because they don’t technically involve any evasive techniques or dishonesty; however, the CRA tends to frown upon them. In many cases, when a tax shelter is identified, the CRA takes steps to amend the laws that allow that shelter to exist.
If your client invests with a tax shelter that’s challenged by the CRA, it could stand to lose any potential deductions or face penalties. The use of so-called mass-marketed tax shelters, in particular, can be seen as aggressive tax planning. Mass-marketed tax shelters allow businesses to make a purchase in return for a charitable donation receipt of several times the amount actually paid. One example of this type of tax shelter is a scheme where companies purchased art for a low price, and then had the art valued using potentially illegitimate techniques before donating it to charity. The companies received a donation receipt for the amount of the art’s value, which was several times greater than what was paid.
The CRA requires all legal tax shelters to be registered with a tax shelter identification number to keep track of the operations and their participants. If you opt to donate to a fully registered tax shelter, the CRA still has the right to deny tax benefits if it deems them to go against the Income Tax Act. As of 2018, all mass-marketed tax shelters audited by the CRA have been found to contravene the Income Tax Act, and resulting credit claims have been denied.
If your potential clients are using tax shelters, or are interested in using them, advise your clients of the potential risks, and find up-to-date information on any advance rulings by the CRA that might affect that tax shelter. As an accountant, you should also be aware of potential third-party penalties.
The CRA can impose large tax penalties on taxpayers who either knowingly participated in aggressive tax planning practices or submitted a false claim, or did so through reckless or negligent accounting practices. Third-party penalties impose these tax fines on third parties such as accountants or tax advisers who advised a business to participate in aggressive tax planning practices.
When advising corporate clients, be sure you fully understand the intent of the Income Tax Act and avoid recommending actions that might go against that intent. If your client is challenged or audited by the CRA, you could be liable for the full amount of taxes the company avoided paying using those methods.
Tax planning, as long as it follows the spirit of the Canadian Income Tax Act, is a prudent practice for businesses and accountants. However, manipulating the laws to avoid paying taxes is aggressive tax planning and can cost you and your clients. Understand the difference and encourage your clients to use honest, legitimate tax planning practices.