CRA crackdown on 'carousel fraud' can hurt innocent businesses: lawyer

The fraud involving GST/HST has become more frequent and better organized in recent years

CRA crackdown on 'carousel fraud' can hurt innocent businesses: lawyer
Jeffrey Radnoff

Canada Revenue Agency has intensified scrutiny on so-called “Carousel” tax-fraud schemes in recent years, and tax litigator Jeffrey Radnoff says the CRA’s “overzealousness” can be “devastating” for legitimate businesses unwittingly caught up in the ploy.

Carousel or missing-trader schemes profit from GST/HST deductions issued on fake transactions. A group of businesses set up a phony supply chain, pretending to sell non-existent goods or repeatedly reselling goods to each other. One party in the supply chain – the missing trader – pretends to charge tax on the sham transactions with fake documentation and then disappears without paying the remittance to the CRA. Sometimes the missing trader uses stolen identification to register its company. The last company in the supply chain will claim to export the goods offshore and all the companies, aside from the missing trader, will claim refunds on the falsified tax paid to the missing trader.

“Sometimes, legitimate companies become unknowingly involved in such schemes and used as a node in the process, unaware of their involvement,” says Radnoff, senior partner at Radnoff Haward LLP, in Toronto

Carousel fraud has become more frequent and better organized in Canada lately, but countries with value-added tax rules, such as many in Eastern Europe, lose 100s of millions every year to it, he says. The industries in Canada which tend to be involved include scrap and refined precious metals, and intangible goods such as software and media, he says.

“The CRA’s overzealousness can have severe consequences for legitimate businesses unwittingly involved in a carousel scheme supply chain,” says Radnoff. “For example, the CRA might refuse to issue a GST/HST refund until an audit is completed of the genuine business. This could mean that millions of dollars of cash flow are held up for over a year.”

Some taxpayers held up in audits have taken their issue to the courts but have been unsuccessful in forcing the CRA to issue refunds prior to completion of the audit, he says. “Sadly, it could have devastating consequences for a small business unwittingly caught up in the scheme.”

The CRA is “very interested” in carousel/missing-trader schemes because the schemes involve “a lot of volume at a low margin” and the amount of money the government loses is potentially large, David Piccolo, a tax litigator and partner at TaxChambers LLP. “Per file, it could be a couple million dollars of HST.”

At the centre of carousel schemes are the invoices of accommodation, which businesses file to get back the money they paid in GST or HST. Invoices of accommodation are the common element in other forms of fraud, as well, says Piccolo.

Businesses will pay the net amount of GST/HST to the government, he says. If they collected more GST/HST than they paid out, they owe the government the difference. If they paid more out than what they collected, they qualify for input tax credits to cover the balance.

As for GST/HST fraud schemes not involving carousels but involving invoices of accommodation, the CRA has also been targeting temporary employment agencies, according to an article in Canadian Accountant written by tax lawyer David J. Rotfleisch. In that industry, “innocent businesses have been caught in the crossfire,” said Rotfleisch.

In these temp agency schemes, says Piccolo, a business will contract the agency for a number of employees, the temp agency will deliver them, and as far as the business is concerned, they paid for the employees and the employees showed up. Even though the temp agency sent all the employees from their own payroll, it then claims that it subcontracted for a portion of them. The temp agency’s subcontractor becomes the missing-trader and does not remit the GST/HST. The temp agency claims the GST/HST fraudulently, but the business at the beginning of the chain does so honestly.

In that situation, the CRA may then claim that the fraud encompasses the whole relationship, and the employees allegedly from the temp agency were, in fact, employed by the business itself, says Piccolo.

“I've seen that sort of situation where you have the end user who doesn't know what's happening below in the chain. All they know is that they the people showed up, or the goods showed up, but they don't know, necessarily, the specifics of it.”

For taxpayers caught up in them, the most difficult aspect of defending against these schemes is that the CRA has an information advantage, says Piccolo. They have the details from their audits on the other parties in the alleged scheme, but the taxpayer cannot access that because there is confidentiality between the CRA and each individual taxpayer, he says.

“You're always at an informational disadvantage…There's a good reason for why each taxpayers file is confidential… I don't want my tax information not to be confidential. I'm sure you would want the same. But I think that's a practical difficulty.”

Quebec saw a large number of cases dealing with invoice-of-accommodation fraud in the early 2010s, says Piccolo. He predicts that trend is moving west.

“They're sort of importing that knowledge into Ontario… I suspect there's going to be a whole bunch of cases coming out of the Ontario courts – the Tax Court, but in respect of the Ontario context – in the next three-to-five years.”

A spokesperson from CRA media relations told Canadian Lawyer that combatting tax evasion, fraud and other financial crimes is important to protect Canada's tax base, which supports the quality of life Canadians enjoy.

"Tax schemes are a threat to the tax base and as such are taken seriously by the [CRA]," says the spokesperson. "When a scheme is identified, the CRA conducts a review to validate the transactions and reported activity of individuals and businesses that may be participating in the scheme. If taxpayers are dissatisfied with CRA's response to their situation, there are recourse options available to them."


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