Sometimes taxpayers skirt the rules by under-reporting income, and the consequences can be substantial. Worse, they do not dissipate over time.
Let’s say, for instance, that Chris inherited a property in Italy several years ago, and sold it soon after taking possession. Rather than bring the money back to Canada, he left the money sitting in an investment account outside the country. Now, he’d like to repatriate the funds into Canada. Chris has never declared the income earned on the investment when filing his annual Canadian tax return.
In another situation, Cameron is operating a home renovation business through an incorporated entity, and occasionally takes on projects for a cash payment. The cash isn’t reported as business income. Instead, Cameron spends the money personally, which understates the company’s overall reported income.
In addition to owing taxes, both Chris and Cameron face the potential for interest, penalties, and even prosecution.
For assets held outside of Canada, the level of global co-operation is evolving rapidly, leading to greater transparency and a much higher risk of detection. New inter-country agreements require financial institutions to report information to local tax authorities, which is subsequently shared with tax authorities in other countries.
Domestically, CRA can analyze data to detect trends and patterns that indicate tax evasion. Some new programs even encourage people to snitch on other taxpayers. For instance, the new Offshore Tax Informant Program provides a substantial monetary reward when information leads to convictions related to offshore assets.
CRA has an administrative program, Voluntary Disclosure, which encourages people like Chris and Cameron to come clean and declare a delinquent indiscretion from the past. This also applies to companies, employers, partnerships and trusts. A valid disclosure eliminates the risk of penalty or prosecution, and can result in cancelled or reduced interest.
The process begins with the taxpayer making a complete and accurate disclosure of the situation that involves the potential for a tax liability or penalty. The issue must relate to a period older than one year where there is a past-due amount. The disclosure can be on a named or unnamed basis. The latter allows the taxpayer to gauge the CRA’s perception of the situation before providing a full disclosure. With an anonymous disclosure, the taxpayer must provide the first three characters of his postal code, along with his age and gender if the taxpayer is a person.
Either way, the situation can’t be the subject of an open investigation by CRA or another authority.
Taxpayers are wary, however, because they have no way of knowing if an enforcement action has been initiated prior to making the application, which would invalidate the disclosure. If CRA feels the required conditions have not been met, the application is likely to be declined, and there is the prospect of an assessment including interest, penalties and, possibly, prosecution. CRA has the right to initiate investigations with the information that was provided.
If CRA accepts the disclosure, but the taxpayer disagrees with the resulting assessment or re-assessment, the regular dispute process kicks in. This begins with filing a Notice of Objection within the required time frame.
If CRA rejects the disclosure application, there is no formal right of objection. However, a taxpayer may request reconsideration on the grounds that discretion was not provided in a fair and reasonable manner. This is done through a written request to the director at the applicable tax centre. CRA personnel, who are not involved in the initial application, will review the file.
Upon receipt of a negative decision after CRA’s administrative review, a taxpayer may apply to the Federal Court for a judicial review, once again on the grounds that discretion was not fair and reasonable for the circumstances. If the Federal Court finds errors in the process, it will refer the case back to CRA for reconsideration. The last level of appeal is via the Federal Court of Appeal.
The potential relief for interest owing is limited to a 10-year window. When a voluntary disclosure is finalized, the taxpayer is required to pay all income tax and interest owing.
While the process appears routine, help clients to proceed with care, especially since a taxpayer is typically permitted only one disclosure in her lifetime. Still, it can be a valuable opportunity for taxpayers to avoid the full wrath of the law.
More than 15,000 disclosure cases were completed last year, an increase of about 140% from 2003. While the number of voluntary disclosures continues to increase, the average income tax per case is trending downward, suggesting people who owe smaller amounts are taking advantage
of the disclosure system. If your client wants to disclose, she can submit to:
The Voluntary Disclosures Program
Shawinigan-Sud Tax Centre, 4695 12e Avenue
Shawinigan, QC G9P 5H9
(If she’s a B.C. resident, she’d send it to the Surrey Tax Centre, 9755 King George Boulevard, Surrey, BC V3T 5E1.)
James Kraft, CPA, CA, MTax, TEP, CFP, is vice-president, head of Business Success Planning at BMO Financial Group. Deborah Kraft, MTax, TEP, CFP is director of the Master of Taxation Program at the University of Waterloo.