When it comes to taxpayers getting into trouble with the Canada Revenue Agency (CRA), it’s usually because they fail to dot their Is and cross their Ts – or they simply get greedy and ignore details.

“The rules are there for a reason,” says Jamie Golombek, managing director, tax and estate planning, with Canadian Imperial Bank of Commerce‘s wealth advisory services division in Toronto. “If you don’t follow them, the CRA can get you.”

In some cases, following the CRA’s rules can be very technical, as Nathan Zailo recently found out. Zailo v. The Queen sends a message to students studying outside the country who want to access tuition credits: their program of study must be a degree program that qualifies under Canada’s Income Tax Act (ITA).

Golombek notes that tuition credits often capture the CRA’s attention because the dollar values are high – and the CRA wants to ensure it’s giving the tax credit where it’s due. “Otherwise,” he says, “it’s costing us all money.”

Zailo enrolled full-time in the audio engineering program at the Musicians Institute College of Contemporary Music in Los Angeles. He claimed a $9,160 tuition credit covering his fees and equipment, which the CRA rejected because Zailo was not in a course “leading to a degree” as required under Sec. 118.5(1)(b) of the ITA. The institute offers bachelor’s degree programs, but the program that Zailo was enrolled in grants a “certificate” – not a degree. (He could have obtained an associate of arts degree through a different program, which could be used to seek a bachelor’s degree.)

Zailo appealed the CRA’s reassessment, but the Tax Court of Canada’s (TCC) Justice E.P. Rossiter sided with the CRA: “Parliament obviously distinguished between universities and colleges or other post-secondary educational institutions. The distinguishing factor is that universities offer bachelor’s degrees and higher while the others do not. If associate degrees are accepted in the definition of ‘degree,’ then universities and other post-secondary institutions are no longer distinguishable and the legislative scheme becomes incoherent.”

It’s not only details that can trip up taxpayers. Sometimes, they simply want to game the system – and get caught. Take the growing number of charitable donation inflated-receipt cases hitting the courts. One of the latest was R. v. Berg in the Federal Court of Appeal (FCA) earlier this year. Allen Berg participated in a charitable tax-donation program for which he received inflated receipts. This program involved the sale and purchase of time-shares in St. Vincent and the Grenadines in the Caribbean.

In 2002, Berg purchased 68 time-share units for $242,000. He paid the promoters a fee of $508,000 and received a promissory note saying he still owed $2.18 million. Berg then transferred the units to Cheder Chabad, a registered charity, which issued Berg a receipt for $2.42 million, 10 times the fair market value and equal to the amount he paid and the promissory note.

The following year, Berg made a similar transaction: buying time-shares for $134,000 and $366,130 in fees, and receiving a promissory note for $1.6 million and a charitable receipt for $1.78 million.

Berg expected a net cash return of $684,000 for the transactions. The tax credits were allowed on the initial assessment.

Later, the CRA disallowed the entire amounts and Berg sought a reassessment. The TCC held that Berg was entitled to claim a charitable “tax credit to the extent that he was actually impoverished by his purchase and subsequent transfer of the time-share units,” which was the amounts he paid for the units – $242,000 and $134,000.

The Canadian government appealed – and the FCA held that Berg “was motivated by greed” and did not have the “requisite donative intent”: “Mr. Berg did not intend to impoverish himself by transferring the timeshare units to Cheder Chabad. On the contrary, he intended to enrich himself by making use of falsely inflated charitable gift receipts to profit from inflated tax credit claims. He consummated the deal solely with that objective.”

Ash Gupta, tax lawyer with Gowling Lafleur Henderson LLP in Toronto, says the Berg case is an example of “aggressive behaviour” in which the courts and tax authorities have said, “Not only are we going to hit you hard, but we’re going to hit you very hard.”

But greed isn’t always the bane of a taxpayer’s existence. Sometimes, taxpayers get caught up in bogus schemes and look to the tax regime to help to correct a wrong – although that strategy isn’t always successful.

Take Prochuk v. The Queen, in which Allan Prochuk used $250,000 of his RRSP money to invest in a foreign-exchange currency fund. However, the fund was a scam and Prochuk recovered only $63,750. He claimed the balance, $186,250, as a business loss, which he could use against income, using the argument that he was in the business of trading.

The CRA rejected that claim. Prochuk appealed, arguing that he had run a stock-trading business within his RRSP since 2000 and that his livelihood depended on the profits. He had grown his RRSP to $1.34 million in 2004 from $886,000 in 1999. In 2007, he made 512 trades within his RRSP.

The foreign-currency fund was supposed to offer a 17.5% annual return on investment and Prochuk’s intention was to make a profit. The feds argued that Prochuk’s loss was a capital loss and the investment was intended to yield income, and also argued that trading in an RRSP does not amount to carrying on a business and that Prochuk’s tax returns did not indicate any level of trading that would constitute trading as a business.

TCC Justice Johanne D’Auray’s decision: “Mr. Prochuk is sadly another victim of a scheme sold to taxpayers with the promise of a high return on investment.”

Golombek calls the Prochuk case a “very unusual situation. You don’t see a lot of people doing day trading in their RRSP. It was the right decision.”IE

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