TaxMatters@EY - November 2012
Tax shelters – a cautionary tale
Bob Neale, Toronto
In the March 2012 edition of TaxMatters@EY, we wrote about an Ontario Superior Court of Justice decision that offered a succinct description of the efficacy of charitable donation tax shelters: “If it looks too good to be true: the pitfalls of charitable donation tax shelters.”
Recently, the Canada Revenue Agency (CRA) updated its Tax Alert: Tax Shelter website to include the following comments:
- What is a tax shelter? Tax shelters are defined in the Income Tax Act. In very general terms, a tax shelter includes either a gifting arrangement or the acquisition of property, where it is represented to the purchaser or donor that the tax benefits and deductions arising from the arrangement or acquisition will equal or exceed the net costs of entering into the arrangement or the property. Also, a gifting arrangement where the donor incurs a limited recourse debt related to the gift will be a tax shelter. Generally, a limited recourse debt is one where the borrower is not at risk for the repayment.
- Mass-marketed tax shelters. Mass-marketed gifting tax shelter arrangements are made for the primary purpose of avoiding the payment of the required taxes rather than raising funds for charities. Mass-marketed gifting tax shelters include schemes where taxpayers receive a charitable donation receipt with a higher value than what they paid. This can typically be four or five times their out-of-pocket cost.
The CRA audits every mass-marketed tax shelter arrangement, and no arrangement has been found to comply with the Income Tax Act.
- Cautionary steps for participating in tax shelter arrangements. Anyone considering entering into a tax shelter arrangement should obtain independent professional advice from a tax advisor before signing any documents. In addition, they should:
- Know who they are dealing with, and request the prospectus or offering memorandum and any other documents available in respect of the investment and carefully read them.
- Pay particular attention to any statements or professional opinions in the documents that explain the income tax consequences of the investment. Often, these opinions will tell the investor about the problems that can be expected and suggest that the investor obtain independent legal advice.
- Not rely on verbal assurances from the promoter or others — get them in writing.
- Ask the promoter for a copy of any advance income tax ruling provided by the CRA in respect of the investment. Read the ruling given and any exceptions in it.
Individual taxpayers should be aware that the CRA could normally reassess returns up to three years after the date of assessment. The fact that tax shelter benefits were accepted on initial assessment should not be interpreted as acceptance of the claim by the CRA. It may take more than one year to complete a tax shelter audit.
Not all tax-advantaged investments meet the Income Tax Act definition of a tax shelter. However, it is common for other limitations to the tax benefits they provide to be included in the income tax system.
Your Ernst & Young advisor can help you assess the merits of such investments, as well as their impact on your existing income tax situation.
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