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Whether or not the CRA is successful in this case, this current focus on offshore investment funds warrants a review of the Canadian tax reporting requirements and penalties for non-compliance.

For Canadian income tax purposes, Canadian residents must report their world income on their tax returns.

Moreover, there are a number of Canadian tax rules and reporting requirements that are aimed at offshore investments to ensure Canada collects its fair share of tax in relation to funds invested outside the country. These include the foreign investment entity rules that may require an annual income inclusion even when there is no income distribution from the foreign investment, trust rules that deem certain foreign trusts to be resident and therefore taxable in Canada, and the annual foreign investment reporting requirement for individuals who own foreign investment property with an aggregate cost in excess of $100,000.

So when funds are invested offshore — including funds deposited in those secret numbered Swiss accounts — there are generally reporting requirements for Canadian residents.

What if you don’t report? The penalties for non-compliance can be very significant:

• If an individual knowingly fails to file a form T1135 (reporting foreign investment assets), the penalty starts at $500 per month for 24 months ($1,000 per month if a demand has been served) and, after 24 months, there is an additional 5% of the cost amount of the foreign property.
• If an individual knowingly fails to report foreign income in a return, the penalty can be 50% of the unpaid tax.
• In the case of tax evasion, additional criminal fines may apply, ranging from 50% to 200% of the tax evaded (or attempted to evade) and may even include a prison term of up to two years.
• Advisors who participate in taxpayers' misrepresentations may also be subject to fines and penalties.

And, of course, the taxpayer is still liable for any tax due in relation to the omission or misstatement, plus interest accruing from the time the tax liability arose, compounded daily.

For those individuals who think they may have escaped these penalties because the underreporting happened before the normal three-year reassessment period, beware. In the case of fraud or misrepresentation, the CRA may reassess at any time.

So what can you do if you now realize that you haven’t complied, or even if you knowingly failed to report required foreign information? There is relief available under the CRA voluntary disclosure program (VDP). If you "fess up" before the taxman comes knocking, you may be spared the penalties and possible prosecution that could otherwise arise.

Under the VDP, the disclosure must be made as a written submission to the taxpayer's local tax services office. It must be completed within 90 days of the initial disclosure. If accepted, fines and penalties and future prosecution will be eliminated. However, tax and interest must still be paid, although in some cases the interest may be reduced.

To be valid, the disclosure must be truly voluntary — that is, initiated by the taxpayer. It cannot be a response to an audit, investigation or enforcement action that is already underway.

UBS account holders should be warned: if UBS releases account detail to the CRA, access to the VDP will no longer be available.

Until recently, the Canada Revenue Agency's (CRA’s) administrative position was that a scholarship provided by an employer to an employee's dependant was taxable in the hands of the employee unless certain strict criteria were met. The CRA considered such scholarships to be a benefit enjoyed by the employee as a result of his or her office or employment and, consequently, a taxable benefit to the employee.

A series of court cases, however, has led to an alternative interpretation. The CRA now accepts that an employer-provided scholarship or bursary in respect of post-secondary education to the dependant of an employee is a benefit to the dependant in the form of a scholarship or bursary, and not a taxable benefit to the employee.

The following are the recent court cases dealing with this issue:

• Okonski v the Queen, 2008 DTC 2992 (TCC)
• DiMaria v the Queen, 2008 DTC 3027 (TCC) and
• The Queen v Bartley et al, 2009 DTC 5019 (FCA).

The findings in all three cases were similar:

• The employee did not have legal rights to the scholarship funds received by the family member;
• There is no legal requirement for parents or guardians to finance the post-secondary education of their dependants;
• The payment of a scholarship to a family member does not enrich the employee; and
• The only person to be economically enriched is the family member, and he or she should be reported as having received the benefit in the form of a scholarship.

As a result of this change in policy, the scholarship or bursary is taxable to the dependant. However, effective in 2006, a scholarship or bursary to a student enrolled in a post-secondary program for which the student is entitled to claim the education credit is fully exempt from tax. Consequently, in many cases, the scholarship or bursary will not attract any tax.

Employers encouraged to amend their 2007 and 2008 T4 slips

Employers who included a taxable benefit in their employees’ income in 2007 or 2008 as a result of providing financial assistance in the form of scholarships or bursaries to dependants of employees are encouraged to amend these T4 slips, and to issue T4A slips in the amount of the fair market value of the scholarships or bursaries to the employee's' dependants.

The policy change applies only to scholarships for post-secondary education. It does not apply to scholarships, bursaries or tuition provided to employees’ family members who attend elementary or secondary schools. In such cases, the CRA considers the fair market value of the scholarship, bursary or tuition to be a taxable benefit to the employee.

This intensely challenging economic climate is reflected in our biennial transfer pricing research, which highlights the growing number of countries that devote attention to transfer pricing activities.

Our transfer pricing report examines the approaches and attitudes of tax authorities in 49 countries and territories. You can explore the full survey at ey.com/tpsurvey.

In the first case, Garron et al v the Queen (2009 TCC 450), two Barbadian trusts were denied the capital gains exemption provided in the Canada-Barbados Treaty (the Treaty) on the basis that they were not resident in Barbados because their “central management and control” was in Canada. (For further information on this case, see our Tax Alert 2009 Issue No. 27.)

In the Antle case, the Tax Court took a different approach, finding that the Barbados spousal trust was not valid, and that, in any event, the general anti-avoidance rule (GAAR) applied to the series of transactions undertaken by the taxpayers.

Facts

In 1998, Mr. Antle and Mr. Kapila incorporated PM Environmental Holdings Ltd. to acquire shares of a third company from Stratos Global Corporation.

In September 1999, Messrs. Antle and Kapila agreed to sell their shares in PM to MI Drilling Fluids Canada Inc. This sale was completed in December 1999 after the following series of transactions:

• The original offer from MI was cancelled and superseded by a new offer naming the wives of Messrs. Antle and Kapila as the sellers of the PM shares.
• A spousal trust was established, the sole beneficiary of which was Mr. Antle’s wife. The trustee was a Barbados lawyer.
• Mr. Antle gifted his PM shares to the trust, relying on the spousal rollover provisions of the Income Tax Act (ITA).
• The trust sold the PM shares to Mrs. Antle at their fair market value ($2.7 million) in exchange for a promissory note in favour of the trust.
• The trust was wound up and the promissory note was distributed to Mrs. Antle.
• Mrs. Antle sold the PM shares to MI for $2.7 million.

The purpose of the series of transactions was to transfer the PM shares to a Barbados spousal trust tax free and sell them back to the Canadian spouse to create a "bump" in their cost, relying on the capital gains exemption under the Treaty. The expected result was no tax, because there was no capital gain on the sale of the shares from Mrs. Antle to MI. Had Mr. Antle sold the PM shares directly to MI, there would have been a capital gain and a resulting tax liability.

Issues raised by reassessments

The Minister reassessed Mr. Antle and the trust, including the taxable capital gain from the sale of the PM shares in Mr. Antle’s income or, in the alternative, in the trust's income, on the basis that the trust was a Canadian resident.

There were a number of issues raised by the reassessments. However, the Tax Court judge, Justice Campbell J. Miller, determined that the case hinged on two main issues:

• Was there a valid trust?
• Did the GAAR apply to the series of transactions?

He also commented on whether the creation of the trust was a sham, and on the residence of the trust.

The decision

Justice Miller determined that the trust was not valid — that is, it never came into existence — and that in the alternative, the GAAR applied to the series of transactions.

His findings are summarized below.

Trust not valid

To establish a valid trust, there must be "three certainties": the certainty of intention, the certainty of subject matter and the certainty of objects. In addition, there must be a transfer of property to the trust.

With these requirements in mind, the judge reviewed the circumstances surrounding the creation of the trust and the purported transfer of shares to it.

First, there was no certainty of intention, as Mr. Antle did not truly intend to settle the PM shares in the trust. Justice Miller based his conclusion on the backdating of documents, fuzzy intentions, a lack of transfer documents, a lack of discretion on the part of the trustee, and the delivery of signed documents distributing capital from the trust prior to its purported settlement.

Second, there was a lack of certainty of subject matter. If Mr. Antle transferred anything to the trustee, it was not his full interest in the PM shares, there was an element of his ownership in PM that did not pass to the trust (Mr. Antle retained some interest in the shares so that he could sue Stratos for $1.4 million of additional consideration deducted from the value of the PM shares).

Third, title of the PM shares was never transferred from Mr. Antle to the trust.

Without certainty of intention and certainty of subject matter, and no actual transfer of shares, the trust was not valid. By ignoring the trust, Mr. Antle either sold the shares to his wife, resulting in a gain taxable in his hands, or he rolled the shares to his wife and the gain was attributed back to him. In either case, Mr. Antle realized a capital gain, and the appeal was dismissed.

Application of the GAAR

Justice Miller followed the guidance provided by the Supreme Court of Canada as to the proper approach to the application of the GAAR, a distinct three-step process:

• There must be a tax benefit arising from a transaction or series of transactions;
• The transaction must be an avoidance transaction; it cannot have been reasonably undertaken or arranged primarily for a bona fide purpose other than to obtain the tax benefit; and
• The avoidance transaction giving rise to the tax benefit must be abusive; it cannot be reasonably concluded that a tax benefit would be consistent with the object, spirit or purpose of the provisions of the ITA relied upon by the taxpayer.

It is up to the taxpayer to refute the first two points and for the Minister to refute the third. The existence of a tax benefit was conceded by the parties.

Next, Justice Miller found there was an avoidance transaction, rejecting the taxpayer’s argument that the series of transactions was undertaken for estate planning purposes. There was no bona fide purpose of the trust other than to obtain the tax benefit.

Finally, the series of transactions was an abuse or misuse of the provisions of the ITA. Justice Miller concluded that the outcome of the series of transactions — a marital unit escaping a tax liability by using an offshore trust — was one that spousal rollovers, the attribution rules and the non-resident trust provisions specifically sought to prevent. He stated:

Conclusion

Justice Miller has a clear message for those engaging in tax avoidance strategies: it is crucial to properly implement the tax plan. He stated:

That being said, this particular series of transactions, even if properly implemented, would still have failed because of the GAAR.

Tax Alerts

 Application of the GST: changes for pension plans and financial institutions – 2009 Issue No. 25
On 23 September 2009, the Department of Finance released legislative proposals to amend the Excise Tax Act and draft regulations aimed at the financial services sector and pension plans. For the most part, these measures are a refinement of earlier proposed measures. 

 2009 global transfer pricing survey – Authorities respond to a changing world — 2009 Issue No. 26
The Canada Revenue Agency has indicated that it is seeking 100% audit coverage of large-case taxpayers, where intercompany cross-border transactions will be a primary focal point. It has also recently launched enforcement programs, such as the aggressive international tax-planning initiative, which includes review of certain transfer pricing transactions. 

 What determines where a trust resides? — 2009 Issue No. 27
The important Tax Court of Canada decision in Garron et al v the Queen addresses the issue of residence of a trust. The court held that the two trusts in question in this case were not resident in Barbados – even though the trustee of each trust was resident in Barbados – because their "central management and control" was in Canada. 

 Ontario and British Columbia announce HST transitional rules — 2009 Issue No. 28
The Ontario and BC governments have released their eagerly awaited transitional rules for those provinces’ implementation of the harmonized sales tax (HST) on 1 July 2010. The announcements give more clarity to the challenges businesses and organizations will need to address well in advance of the implementation date in order to comply with the new rules. 

 Quebec announces proposed legislation to fight aggressive tax planning — 2009 Issue No. 29
On 15 October 2009, the Quebec Ministry of Finance issued Information Bulletin 2009-5, setting out the application details for measures aimed at aggressive tax-planning schemes. The new measures add mandatory disclosure requirements and provide for significant penalties on taxpayers and promoters of tax avoidance.

All taxpayers who carry on business in Quebec and are subject to Quebec tax will be affected by the proposed measures. These measures could also be of interest to other Canadian taxpayers, as other Canadian tax administrations could potentially be tempted to follow Quebec’s lead.

Ernst & Young’s Guide to the Taxation of Employment Income, 2009 (2nd) Edition

Available in December 2009, this guide is designed to assist Canadian tax professionals in interpreting and applying the rules relating to the taxation of employment income. It includes a discussion of employee versus independent contractor, taxable benefits, stock options and allowable deductions. Purchase a copy today.

Editors: Mary-Lynn Desmeules, Jennifer Horner, Jim Kahane, and Dina Papadopoulos

Ernst & Young’s Guide to Capital Cost Allowance, 2009 (3rd) Edition

This informative guide discusses the capital cost allowance (CCA) and eligible capital expenditure (ECE) rules that determine the income tax treatment and classification of capital assets and outlays. It includes commentary, illustrative examples, descriptions of various CCA classes, and cross-references to legislation, case law, and administrative materials — as well as CCA lookup tables and relevant bulletins. Purchase a copy today.

Editors: Allan Bonvie, Lokesh Chaudhry, Maureen De Lisser, Joyce Hoeven, Paul Singleton.

Business immigration alerts and updates

For the latest information on Canadian and US business immigration issues from Egan LLP, a business law firm allied with Ernst & Young LLP in Canada, visit eganllp.com.