Agency assumes taxpayer is trying to pull a fast one, an attitude that comes through in assessments

By Stewart Lewis | Mid-October 2005

The canada revenue
Agency has a new attitude. And it’s not a kinder, gentler one, say senior tax lawyers.

The CRA is beefing up policing efforts, they say, and the number of disputes with taxpayers is rising. Long gone are the days when the CRA referred to taxpayers as “clients.” Today, the agency assumes the taxpayer is doing something wrong.

This sense of increased aggressiveness is evident even at the basic assessment level. The CRA is issuing assessments that are borderline to outright incorrect, tax practitioners allege. When challenged, the CRA’s response — “If you don’t like it, take us to court” — seems to taunt taxpayers.

Many taxpayers can’t afford to fight back. There’s a lot at stake — legal costs, opportunity cost as taxpayers’ attention is diverted from their businesses to fight the CRA, and the inevitable emotional cost of going through the audit process and/or litigation. And the CRA knows that, say senior tax lawyers.

Lawyers attribute the CRA’s increased vigilance to its suspicions that tax practitioners and taxpayers are cheating.

Low- to middle-income taxpayers, for example, are being forced to fight for claims for tax credits involving medical expenses, disabilities and their children. High-income earners are suspected of hiding money in offshore trusts and illegal tax shelters.

Practitioners are suspect largely because of the spillover from recent events in the U.S. At the end of August, KPMG LLP admitted to engaging in fraud that generated US$11 billion in phony tax losses, which cost the U.S. treasury about US$2.5 billion in evaded taxes.

The fraud involved designing, marketing and implementing illegal tax shelters. Nine
senior firm members and former partners were indicted on criminal charges.

Canadian tax advisors believe this debacle has raised the level of CRA’s wariness of tax practitioners on this side of the border. Combine this belief with the fact Canadian clients are asking their tax-planning professionals whether those professionals are engaging in similar illegal activities, and we have an entire professional sector that feels as if it is under more than its fair share of suspicion.

Even before the KPMG news broke, Ottawa announced in the February 2005 federal budget that it planned to pump an extra $30 million annually into fighting what it calls “aggressive international tax planning.”

Then, in August, the CRA announced the establishment of 11 “centres of expertise” to be set up in regional tax offices across the country to “counter tax avoidance and evasion,” citing this as an ongoing concern that “could erode the Canadian tax base.” Ottawa plans to hire extra auditors for this purpose and develop “communication initiatives” to inform tax planners and taxpayers alike about potentially offensive international tax schemes.

The increased tension between the CRA and taxpayers has resulted in more work for tax litigators, says Ed Kroft, a tax partner in the Vancouver office of national law firm McCarthy Tétrault LLP, but it’s not good news for affected clients.

Canada has joined with other countries to crack down on aggressive tax planning using offshore trust and tax havens. The general rule of thumb about offshore arrangements, Kroft says, is that if it seems too good to be true, it probably is.

Many tax shelters involve extensive leveraging schemes, in which the taxpayer puts in a small amount relative to the tax receipt he or she receives. In situations in which a client invests a small amount expecting to be able to deduct millions in losses, says Kroft, the client should expect to be audited.

In fact, the probability of an audit has become so real that many tax shelter promoters have litigation funds built into the cost of their tax shelter schemes.

Ottawa attempted to shut down tax shelters through tax amendments proposed in December 2003.

“But if Ottawa can’t put a stop to tax shelters by amending the [Income Tax] Act, they will put a stop to them by enforcement,” says Robert Kepes, a tax lawyer with Morris & Morris LLP in Toronto.

The CRA has used this double-pronged approach in the past with tax shelters involving filmmaking, software deals and art, says Kepes. Ottawa tries to stop the supply with tax amendments but if the deals pop up, then enforcement is stepped up. “Everyone will get reassessed,” he says.

That’s a worst-case scenario for a taxpayer.