On May 5, 2021, the Canada Revenue Agency (the « CRA ») circulated a warning for Canadian taxpayers, reminding them to exercise caution when participating in gifting arrangement schemes. The timing of this communication could mean that the tax authorities have seen a rise in the number of tax shelters being promoted to Canadian taxpayers. It could also simply serve as a general reminder of their existence.
Nonetheless, it is useful to briefly review the nature of the tax shelter regime, the characteristics of a tax shelter, and the consequences arising once one gets involved in such arrangement.
Tax shelters regime
Charitable giving has always been encouraged and tax planners have developed a number of structures to create tax minimization investments for taxpayers. Parliament has passed legislation that regulates some of these structures, which are referred to in the Income Tax Act (Canada) (the “ITA”) as tax shelters.
The tax shelter regime is administrative in nature. Its purpose is to create a registry of all tax shelters and compile the information related to each tax shelter, including a list of the taxpayers who have participated in, and the promoters who have promoted them. The registry provides the CRA with relevant information so that it can audit each tax shelter—including all promoters and participants. The CRA audits all tax shelters and, if it determines that a tax shelter violates the ITA and that the taxpayers are not entitled to some or all of the tax benefits, the CRA can identify all taxpayers easily.
A secondary purpose of the tax shelter regime is to protect taxpayers. The legislation imposes significant disclosure requirements on promoters. It should also be noted that the identification number for tax shelters is for administrative purposes only and does confirm the entitlement of a taxpayer to claim any tax benefits associated with the tax shelter. This way, the Minister seeks to ensure that promoters do not allege that the tax shelter identification number suggests that the CRA has approved the tax shelter. Moreover, the promoter penalties are severe and are intended to deter promoters from breaching the restrictions against selling tax shelters. Unfortunately, despite such penalties and the potential risks associated with tax shelters, they are still quite common.
Characteristics of a tax shelter
To determine if a certain gifting scheme is a tax shelter, three concepts must be looked: (1) the gifting arrangement; (2) the promoter; and (3) the tax shelter.
A gifting arrangement has two principal components:
- there must be an arrangement in which a taxpayer will make a gift to a qualified donee (generally registered charities); and
- statements or representations are made or proposed to be made in connection with the arrangement.
An arrangement indicates a sequence of events which sets out the type of gift the taxpayer will make, typically cash or property, and the identity of the qualified donee.
The object of the statements or representations is essentially the communication of that sequence of events to the taxpayer. The person making such representations could be anyone who qualifies as a promoter and a wide range of individuals will qualify as a promoter. A tax advisor could qualify as such.
The conclusion that an arrangement falls within the gifting arrangement definition does not, in and of itself, result in tax consequences, filing obligations, or restrictions. These arise only if the gifting arrangement is a tax shelter.
The tax shelter definition is long and complex. It includes several vague elements that the courts have interpreted and clarified, and several other elements that the courts have yet to interpret and clarify.
Broadly speaking, and most commonly, a tax shelter exists when there is a gifting arrangement whose statements or representations indicate that if the taxpayer were to enter into such arrangement, the taxpayer would receive a tax benefit equal to, or in excess of, the amount of the taxpayer’s donation. This can be referred to as “profitable gifting.”
Taxpayers should be careful with any arrangements or schemes that are marketed as “profitable gifting.” Depending on the nature of the arrangement, the tax benefit could be reduced to the actual value of the donation in a situation where, for instance, an inflated tax receipt was provided. The tax benefit could also be reduced to zero if CRA finds that there was no “true gift” as part of the arrangement. Moreover, the tax benefit could be refused outright if the promoter of the tax shelter is liable for certain penalties. Finally, participating in a tax shelter is likely to result in an audit.
Taxpayers should exercise great caution and consult a tax advisor to avoid the adverse tax consequences resulting from being involved in a tax shelter.