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

By Stewart Lewis | Mid-October 2005

Before a dispute with the CRA gets that far, your client should be able to back up his or “story,” says Kroft: “Most disputes with the tax department are about the facts, not about law.”

That’s why it’s important for clients — both individuals and business people — to keep accurate records that will back up claims for expenses, deductions and credits, says Kepes.

They should also be prepared to go the distance with the CRA if they plan to put up a fight. “Tax disputes are not short,” says Kroft. “Who’s to say when the CRA will yield?”

Unlike a civil dispute involving two private parties trying to preserve their resources and move on, says Kroft, the CRA is motivated by principle.

That means a tax dispute could be settled at the assessment or audit stages. Otherwise, the first third-party arbiter that will be in a position to listen to your client’s side of the story will be a Tax Court of Canada judge.

To help clients stay away from the Tax Court’s door, Deloitte & Touche LLP has devised a hit list of items that get the CRA’s attention. The list is based on the firm’s experience in filing personal tax returns across the country, says Heather Evans, tax lawyer and partner in Deloitte’s Toronto office.

Here are some of the most common sticking points:

> Verification of capital gains and losses. The CRA often asks for details about capital gains and losses, says Evans. It’s important for clients to keep track of the cost bases of their various investments. For example, income trusts often provide return of capital, which will erode the cost base over time and affect the amount of any eventual capital gain.

> Allowable business investment losses. Losses in small-business corporations are always questioned by the CRA. The rules governing ABIL are very complicated, says Evans.
Therefore, all supporting material should be made available to the CRA when the losses are claimed.

> Carrying charges. This is a perennial issue, says Evans. Expenses incurred to earn investment income, such as interest and management fees, are generally deductible, but the CRA will look for supporting documentation. Clients should be careful not to claim any personal expenses as part of their investment expenses. The CRA is stepping up its investigations into funds borrowed for investing, she says.

> Province of residence. Interprovincial tax planning is coming under increasing scrutiny, whether it’s at the individual, corporate or trust level, says Evans. This is an issue for Ottawa and the provinces. The latter are trying to protect their turf, and Ottawa is trying to undo any aggressive planning that will deplete the federal coffers.

> Large charitable donations. Cash donations in excess of $25,000 are consistently reviewed, says Evans. So are large donations of property. In July, Ottawa brought in significant changes to the Income Tax Act’s anti-avoidance rule, directed at weeding out abusive charitable donation schemes.

> Mining and oil and gas investments. CRA requests for confirmation of flow-through amounts are common, says Evans. The specialized tax rules governing resource investing can lead to incorrect reporting when the taxpayer isn’t familiar with them. If clients have this type of investment, advisors may need to work with a tax practitioner who is familiar with these rules.

> Foreign tax credits. Many clients will have foreign-source income from employment or
investments. Generally, tax treaties with other countries will enable clients to claim foreign tax credits against Canadian taxes, offsetting taxes paid in the foreign jurisdiction. But the CRA is keen to protect its turf and has become more willing to question eligibility for these taxes.

> Tuition/education expenses. This isn’t an uncommon claim, but the CRA regularly asks for proof, so clients should make sure their children obtain the proper tax receipts from their respective schools.

> Child-care expenses. The CRA often requests verification for these claims. The problem is that many claims may not qualify for the child-care deduction. (For more, see the story on page B12.)

> Employment expenses. Most employees don’t qualify for expense claims. Most attempts to make employee expense claims will be met with questions from the CRA, says Evans. IE

Stewart Lewis is a senior reporter with Investment Executive. He is the editor of the annual tax-planning special report.