This article was originally published in Investment Executive.
With revamped enforcement powers and the international exchange of information, the CRA is ramping up to pursue impugned tax-motivated investments
In the 1967 movie the Flim-Flam Man, an aging con artist mentors his young protegé to pursue the mentor's mission in life: to "educate" those susceptible to greed by swindling them. "Son, you'd be amazed at the hundreds of satisfied students I've matriculated over the last 50 years," he boasts.
Recent developments in Canada's tax policy and the shifting of public opinion following the release of the Panama Papers have given financial services professionals even more reason to warn clients not to fall prey to greed. In a poll taken shortly after that massive data leak, 81% of Canadians said the wealthy are not paying their fair share of taxes. At the same time, more than one-third said they would, if given the opportunity, consider legally avoiding taxes.
On June 30, the Ministry of National Revenue announced that the Canada Revenue Agency (CRA) is going to estimate the tax gap - the difference between taxes paid if all obligations are fully respected vs taxes actually paid. In response to a seemingly insatiable appetite to maximize the tax gap, tax scheme promoters have tempted prospective investors with opportunities that involve all sorts of convoluted structures and transactions.
We have seen all kinds of aggressive tax products, schemes and scams, including: tax losses claimed on securities transactions without economic losses; so-called "buy low, donate high" charitable donation tax credits involving everything from art to pharmaceuticals to condominium time-shares to wine; multi-tiered corporate structures creating tax deductions seemingly out of thin air; and foreign entities concealing investments offshore.
These schemes often use transactions and structures of mesmerizing complexity that no individual investor can truly understand. However, one thing remains constant: the promise of lofty after-tax returns with no apparent downside.
When your clients come to you for advice, remember to explain how these products are fraught with risks. Overly aggressive, tax-motivated investments almost always get challenged vigorously by the CRA, typically resulting in agonizing and protracted litigation with any ostensible tax advantages ultimately evaporating.
Over the next five years, the CRA will get $444.4 million to address tax evasion and aggressive tax avoidance, both at home and abroad, by hiring extra auditors and specialists, developing robust business intelligence infrastructure, increasing verification activities and improving the quality of investigating criminal tax evaders.
The CRA will even create a special program dedicated to stopping organizations that fabricate and promote tax schemes for the wealthy, resulting in an anticipated twelvefold increase in the number of tax schemes examined. The extra auditors will increase the number of examinations annually focused on high-risk taxpayers by 500%, to 3,000 from 600. The CRA estimates the return on investment from these initiatives will be $2.6 billion.
As fodder for all of this enforcement action, the CRA will rely not only on foreign leaks bringing in treasure troves of information. Canada is one of more than 100 jurisdictions committed to the new Common Reporting Standard, which will require participating countries to secure extensive information from domestic financial services institutions and automatically exchange it with other jurisdictions.
This means that the CRA will be handed detailed information about Canadians with offshore accounts, including the accountholder's identity, account balances, interest and dividends received, and asset sale proceeds. Countries renowned for generations as tax havens guaranteeing absolute banking secrecy will be required to routinely divulge information to tax authorities around the world, including the CRA. The CRA is poised to detect - and doggedly pursue - impugned tax-motivated investments more than ever before.
Therefore, wealth advisers must ensure that their clients understand both the inherent risks and the current realities of any "creative" tax plans. Prospective participants in these schemes would do well to resist sales pitches that sound too good to be true - because they almost always are.