TaxMatters@EY - July 2014
Auditor General’s latest report focuses on aggressive tax planning
Maureen De Lisser and Yves Plante, Toronto
The 2014 Spring Report of the Auditor General of Canada included the results of a performance audit of the Canada Revenue Agency’s (CRA’s) Aggressive Tax Planning (ATP) program. The audit focused on how the CRA manages the ATP program and how the Department of Finance responds to requests for legislative changes to address the ATP issues that the CRA identified.
Aggressive tax planning
The Auditor General and the CRA acknowledge taxpayers, including individuals, corporations and trusts, use tax planning to organize their affairs to reduce or eliminate the amount of tax owing. Moreover, the courts have long held that taxpayers have the right to do so. That said, the Income Tax Act includes many statutory anti-avoidance rules and a general anti-avoidance rule to prohibit or limit specific types of transactions.
The CRA defines ATP arrangements as those that often have some legal basis in a very technical sense but that go beyond what Parliament intended when the law was passed. In general, ATP arrangements are entered into for the primary purpose of avoiding or reducing the payment of the otherwise required taxes, thereby pushing the limits of acceptable tax planning. In certain cases, ATP arrangements may cross the line into tax evasion, which involves a deliberate contravention of the law. For example, those participating in tax evasion may under-report taxable receipts or claim expenses that are non-deductible or overstated.
Detection and correction of ATP
The Auditor General reviewed the CRA’s tools and processes to detect and correct ATP. These tools and processes include:
- Risk-based audits, including large business audits and the Related Party Initiative, which manages the compliance of individuals and family groups with a net worth greater than $50 million
- Referrals from auditors and the CRA’s Income Tax Rulings Directorate
- Voluntary disclosures from taxpayers
- Informant leads
- Legislatively mandated reportable tax avoidance transactions
- Publicly available information, including on the internet and from various tax forums
The Auditor General’s report indicated that the CRA is aware of numerous types of ATP arrangements. To audit the CRA’s efforts, the Auditor General focused its examination on only four types of ATP arrangements. The selected examples are:
- Registered retirement saving plan strips, which are designed to provide benefits to individuals who withdrew funds tax free from RRSPs that are normally locked in and then received income tax receipts for amounts that are three or more times the actual RRSP contribution
- Stock dividend value shifts, where a taxpayer who has realized a capital gain creates an artificial capital loss to offset the capital gain
- Loss transfer structures referred to as “tech wrecks,” whereby the tax losses realized by one corporation are used to reduce the income tax of another corporation that it does not control, known as an unaffiliated corporation
- Offshore insurance, whereby a Canadian insurance business reinsures or swaps its Canadian insurance portfolio with a foreign portfolio using a foreign affiliate.
Conclusion and recommendations
In its report, the Auditor General concluded that the CRA’s ATP program has tools and processes to detect, correct and deter non-compliance and made recommendations to improve certain administrative aspects of the program, including the need to complete the evaluation of the effectiveness of the National Risk Assessment Model, improve ATP performance measures and improve the monitoring of ATP staff training.
In terms of the Department of Finance’s response to requests for legislative changes to address the ATP issues the CRA identified, the Auditor General was not provided with all requested documentation from the department for Cabinet confidence reasons. As a result, the Auditor General could not conclude whether the department has followed its processes to provide timely analysis of ATP legislative issues.
The Auditor General nevertheless noted in the report that the department has addressed most of the CRA’s priority requests from the 2011 to 2013 audit period in recent budgets or by the courts. For example, the four selected ATP examples had been (or will be) resolved as follows:
- Registered retirement saving plan strips: new anti-avoidance measures announced in the 2011 federal budget stopped the use of these plans
- Stock dividend value shifts: the courts ruled to deny the tax benefits
- Loss transfer structures referred to as “tech wrecks”: new anti-avoidance rules announced in the 2013 federal budget stopped the use of these plans
- Offshore insurance: proposed changes in the 2014 federal budget amend the existing anti-avoidance rule to clarify that it applies to this type of plan
Minister of National Revenue’s response
In a subsequent press release, Revenue Minister Kerry-Lynne Findlay stated she was pleased to note the Auditor General of Canada confirmed that the CRA’s ATP program had the tools to detect, correct and deter non-compliance. The minister indicated that the CRA has accepted and is acting on all of the audit recommendations to improve the administrative aspects of the ATP program.
The minister also noted that the government has introduced several measures to preserve the integrity of the tax system, including:
- The Offshore Tax Informant Program, which was launched on 15 January 2014, through which the CRA may pay rewards to individuals who provide the CRA with concrete details of major international tax non-compliance that lead to the assessment and collection of additional federal taxes owing
- The mandatory reporting of international electronic funds transfers over $10,000
- Revising the Foreign Income Verification Statement (Form T1135) to require more detailed information, including the names of specific foreign institutions and countries where offshore assets are located and the amount of foreign income earned on those assets
- Ensuring that the offshore regulated bank provisions are not inappropriately used to circumvent the foreign accrual property income rules through foreign affiliates that are not part of a Canadian financial institution group