Whether it is with house flippers in the overheated real estate market, international tax evasion, GST/HST or the federal government’s new tax reforms, tax lawyers say the Canada Revenue Agency is sharpening its fangs with new capabilities and growing more aggressive in the hunt for tax revenue.
According to Vitaly Timokhov, a partner at TaxChambers LLP in Toronto, whose practice focuses on cross-border and corporate taxation, the mix of increased auditing and tax reforms from the federal Liberal government has shifted his tax practice to one dominated by litigation and audit defence from one in which most of his business came from tax planning. Typically, tax planning is more profitable, but right now, more is to be made from tax litigation, he says.
In the auditor general’s 2018 fall report, it states that the 2016 and 2017 budgets gave the CRA nearly $1 billion in extra resources, which “provided the tools and capacity to leverage new global collaboration and data sharing to combat tax cheating,” says Dany Morin, a spokesman for the CRA.
Tax avoidance is legal and the Inland Revenue Commissioners v. Duke of Westminster decision in 1936 set the basis for tax planning, providing that a person is entitled to arrange their affairs to pay the least amount of tax legally owed, says Marie-France Dompierre, a tax litigator and partner at Lavery de Billy LLP in Montreal. But the tax authorities can still use s. 245 of the Income Tax Act — the general anti-avoidance rule — to invalidate tax savings if the benefit came from a series of transactions done with no commercial purpose other than avoiding tax.
Dompierre says that, in Quebec, there’s a new penalty of 100 per cent of what the lawyer billed if the arrangement is deemed “aggressive tax planning.”
“Which is very subjective. It’s not quite clear what it is,” she says.
Also adding to the fight against tax avoidance is the Guindon v. Canada decision from 2015, says Dompierre, which has led to more penalties being levied against tax preparers for devising tax-avoidance plans.
In June 2017, Canada signed on to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, a convention in which Canada joins 87 other nations to counter tax evasion and avoidance. Globally, $100 billion to $240 billion is lost every year through tax avoidance, Grace Perez Navarro, deputy director at the centre for tax policy and administration at the OECD, told Canadian Lawyer.
Armed with funding from the 2017 and 2018 budgets, Morin says, the CRA has developed better tools to combat international tax avoidance, including access to all international electronic funds transfers of more than $10,000 leaving the country, “automatic exchange of offshore banking information and disclosures from multinational corporations,” more international collaboration, an informant program, tightened enforcement of promoters of abusive or illegal tax schemes and the general anti-avoidance rule.
The Panama Papers put international tax evasion on the minds of citizens and policy-makers around the world — following the leak of 11.5 million documents from the Panamanian law firm Mossack Fonseca, which was facilitating tax-evasion schemes. The CRA reviewed the Panama Papers and found 2,670 individuals linked to Canada with money in 3,330 offshore entities. As of the time of the 2017 annual report, the CRA was auditing 1,100 taxpayers connected to offshore accounts.
“The government of the day likes to think that there’s a big, big pot of cash and [it’s] sitting out there in the international tax-avoidance arena,” says Kim Moody, CEO of Moody’s Gartner Tax Law LLP.
“I just don’t think that it’s as big as they think it is. It might be big for certain jurisdictions, but not for Canadians,” says Moody, whose firm, a mixture of accountants and lawyers, represents private clients including individuals, partnerships and trusts.
On the domestic front, the housing markets in Toronto and Vancouver are notoriously inaccessible and inflated. Partly as a response to the difficulty among prospective house buyers who aren’t multi-millionaires, the CRA has sharpened its focus on the real estate industry. From 2015 to 2018, the CRA audited or reviewed 38,610 real estate files in the greater Toronto and Vancouver areas and has served more than $70.9 million in penalties for Canadian real estate transactions during the same period.
For those buying and selling their home, any profit made on the transaction is protected from tax by the principal residence exemption. Those who flip houses for business purposes are expected to pay tax on their gains. House flippers have been running into the CRA when they incorrectly claim the principle residence exemption or report their profit on a property sale as a capital gain.
“So, the CRA has definitely smartened up a little bit about it . . . which again, frankly, as a taxpayer, I appreciate and welcome because I’ve seen abuse as well,” says Timokhov.
Part of the reason for the aggressiveness in real estate transactions is that the real estate market and the economy, in general, are on the upswing, whereas in a recession there is less opportunity for profit, says Jeff Radnoff, senior partner at Radnoff Law Offices in Toronto.
The heightened assertiveness of the tax man is leading taxpayers to be more proactive, getting lawyers involved earlier in the process, says Dompierre. The CRA and, in Quebec, Revenu Québec, are demanding more and more information from taxpayers, sometimes seemingly on a “fishing expedition,” and Dompierre says she encourages her clients to ask for help at that stage, as it is easier to control the message and mitigate the process.
“I think it is good because we, in tax litigation anyways, we get into the file a little bit late sometimes. And then it’s harder to help the taxpayer,” she says.
Some of the CRA’s new resources are being used to enforce GST/HST filing. In 2018, the CRA completed more than 70,000 GST/HST audits and examinations, which produced $3.5 billion. Timokhov says many of the issues coming out of the GST/HST stem from the fact that the complexity of the tax is underestimated and it “becomes a death trap for commercial lawyers.”
“Particularly in respect to GST transactions, they are taking a much harsher line,” says Vern Krishna, counsel at TaxChambers LLP in Ottawa and a professor at the University of Ottawa.
This leads to a lot more litigation, Krishna says, because of the nature of the process by which taxpayers are assessed on GST/HST. In an income tax matter, if the taxpayer files an objection to their assessment, 90 days must pass before they can file an appeal to the tax court. For a GST assessment, the wait is doubled — 180 days. This is coupled with another rule, by which the agency can begin collection procedures immediately, even before the matter comes before a court. In income tax matters, if an objection is filed, collection ceases until the dispute is settled.
“The rules in respect to GST are much harsher and the CRA is actively and aggressively pushing assessments on that side because they can have the leverage and the advantage over the taxpayers,” Krishna says.
Adding to this, he says there is an “inordinate delay” between the time a taxpayer objects to an assessment and the time that the CRA responds. Back in 2016, the auditor general report criticized the CRA for taking too long to deal with income tax objections and the backlog it created. It found that the average wait was 143 days for “low-complexity objections,” 431 days for “medium-complexity objections” and 896 days for “high-complexity objections.”
Krishna says that, in objecting to an assessment, it takes nine months to get a response from the CRA and an administrative resolution can take years, during which interest is accumulating on a daily, compound basis. To circumvent the delay, taxpayers must take the CRA to court.
“I personally have known of cases and been involved in cases that have taken 10 years to resolve,” Krishna says. “. . . And in some cases, if you delay long enough as they do, the interest will exceed the amount in dispute.”
Biram notes that if the CRA appeals officer “allows the objection in part or in full,” the taxpayer will be refunded.
“The consequences are very severe for taxpayers, especially middle-income taxpayers. It costs a lot of money to fight [the] CRA, and for middle-income taxpayers, it is enormously expensive and, in many cases, frankly, middle-income taxpayers just give up the fight,” Krishna says.
“It’s a different form of access to justice — or an absence thereof — that no one ever talks about,” he says.
A significant change in Timokhov’s practice has come from the tax changes regarding passive investment assets of small businesses, he says. Businesses with annual income between $450,000 and $600,000 — depending on the province — pay a nine-per-cent federal income tax. The Liberal reforms reduce that limit by $5 for every dollar of investment income above $50,000. So, small businesses with too much investment income remove themselves form the small business tax rate.
“The impact is very much is to discourage small business owners from the accumulation of investment assets,” says Timokhov.
“The government did not really offer any alternatives,” Timokhov says. “So, if you work hard, the only alternative that the government basically suggested is to take money out of the corporation, pay a 45- to 49-per-cent rate on dividends. If you pull out of a corporation and invest what you have, of course, you immediately face a 35-per-cent inefficiency on a cash basis.”
This is a challenge, he says, because the system that was changed had been established for almost 50 years, creating a cultural shockwave on businesses. Not for lack of trying, the tax bar and accounting industry have not figured out a way around the new provisions.
“There are no loopholes at this point,” he says.
There are three aspects to the Liberal tax changes that concern Moody. The tax changes concerning private corporations — including the income splitting and passive investment for small businesses, a new rule placing a capital gains tax on certain inter-corporation dividends and the changes to the small business deduction.
“Those three alone are so bloody complex that, in my view, most private corporations and their shareholders will struggle mightily to comply and, in many cases, I’ll suggest that they just won’t comply,” he says. “They’ll just throw up [their] hands or the advisors won’t even know that they’re not complying because it’s so complicated.”
He says the new rules on income splitting are “some of the most complex rules I’ve ever seen in my entire career.”
Morin says to help tax filers, the CRA offers a “free liaison officer service” to small-business owners and the self-employed, adding that the agency published a guide on its website on the new tax rules and has been engaged with professional stakeholders including CPA Canada to provide
further guidance and interpretation on the changes.
While complexity is fine for multinational corporations with immense legal teams, Moody says, this legislation applies to a broad audience, including many citizens without the resources to hire tax lawyers or tax accountants.
“That — to me — is just foundationally unfair,” Moody says.