Tax Avoidance: Will It Trigger An Audit?
Canadians are on the home stretch for the 2009 tax season and a most but not all taxpayers will seek clarity of the tax laws (Income Tax Act/ITA). Most Canadian taxpayers understand the difference between tax avoidance and tax evasion. Tax avoidance in simple terms is the practice of avoiding paying too much tax which is legal. Tax evasion is not paying your taxes through illegal means which will get you 10 years in jail. However, even though tax avoidance is legal the 2010 Canadian Federal budget announced another step towards the Canada Revenue Agency’s challenge on tax avoidance. The latest proposal will require taxpayers to voluntarily self-identify and describe their aggressive tax arrangement to the CRA. In other words the taxpayer reporting their tax position may help the CRA target the individuals for audits.
There are numerous strategies to save tax and some are very simple in terms of donation tax credits and then there are others deemed by the CRA to be on the edge of the ITA. Tax avoidance began almost 4000 years ago in Mesopotamia. The King of Mesopotamia while budgeting for his army decided to levy a user’s fee (tax) for individuals crossing the bridge to farm on the other side of the river. The citizens took exception to the new tax and began swimming across the river to avoid paying the tax which was a legal form of tax avoidance. The King decided to outsmart the tax lawyers and passed the first anti-avoidance act in history by ruling that it was a capital crime to swim across the river and punishment will be severe. Hence, the new anti avoidance law eliminated the tax avoidance.
Today we will find very little difference between 4000 years ago and present day, Canadians still share the same attitude towards taxation. The Canadian taxation system evolved from war. Sir Robert Borden established the federal income tax on business profits in Canada in 1916 and a tax on personal income in 1917. These taxes were supposed to be only temporary measures to help with the cost of the First World War. However, the system of taxation still exists today and the ITA expands yearly with new laws, provisions and precedence established in the tax courts. The original ITA manual was under 20 pages; today the ITA is approximately 4000 pages and growing.
As mentioned before there are three ways of minimizing taxes, tax avoidance, minimization and evasion. Once again tax avoidance is tax minimization within the ITA legal rules. Tax evasion is the minimization through illegal means for example not reporting income, misrepresentation, illegitimate receipts, etc. The difference between evasion and avoidance is jail time.
Tax minimization has been and always will be legal. The scope does change as the laws change and also with taxpayer’s attitudes. To paraphrase Lord Tomlin in the Duke of Westminster “Every taxpayer is entitled to arrange his affairs to minimize tax.” Also Justice Learned Hand stated “there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands. Taxes are enforced exactions not voluntary contributions, to demand more in the name of morals is mere cant.”
There is a heavy demand for tax revenue in Canada because of wars in the Middle East and social welfare legislation. Because of this the tax law is advanced and very responsive. For example, in 1984 the federal government lost a landmark case, Stubart, and because of this the Department of Finance amended the ITA and introduced the General Anti Avoidance Rule (GAAR).
GAAR is a rule that allows the government to strike down abusive tax avoidance even though it is follow the Income Tax Act. However, the burden of proof, unlike most tax assessments and reassessments, is on the Minister to establish the abusive actions of the taxpayer. This rule was introduced to create uncertainty in the taxpayers mind so that they will think twice about going close to the edge of the ITA. However, it is to be determined how close to the edge is close. This is for the lawyers to determine and as far as most will agree, if it is within the ITA rule books the edge has no boundaries and it is very hard to determine “the edge” if you are following the law.
The 2010 federal budget’s new rules when enacted will require taxpayers to self identify otherwise legal transactions with a red flag, which, if effect, would say with Canadian politeness “please audit me”. Once again the rules are changed favouring the Canadian government and putting more pressure on the Canadian taxpayer to pay more taxes than necessary.
By Bruce D. Allen, BBA BEc
