When the New York Times ran a story detailing how Donald Trump allegedly deployed questionable tactics to avoid paying taxes for nearly 20 years beginning in the early 1990s—swapping equity for debt as a means to avoid seeking forgiveness on millions of dollars in loans, all of which would have been taxed as income, thereby offsetting the losses he used to offset taxes otherwise payable—critics immediately erupted at what they felt must surely have been illegal maneuvers.
Only they weren’t, at least not at the time. What’s important to note is that even Trump’s accountants and lawyers counselled against such an aggressive tax approach, saying that the moves would most certainly fail to withstand scrutiny should he be audited. (The President-Elect is, as it happens, under audit from the Internal Revenue Service.) The account is nevertheless a high-profile reminder of the risks of aggressive tax planning. But at least in Canada, aggressive tax planning like Trump’s may fail to deliver bottom-line savings—and can, in fact, create a great deal of unnecessary risk and costs in the form of penalties and interest.
Aggressive plans such as these are often pitched by tax law or accounting firms that market ‘proprietary’ methods to circumvent the tax man. Earlier this year, for example, I learned of one Canadian firm that was pitching a proprietary plan to save a wealthy individual millions of dollars. I advised the individual that the plan was overly aggressive and could easily be attacked under certain provisions of the Income Tax Act. He took my advice and steered clear.
It was a good thing, because just a few months later the CRA challenged an almost identical tax plan in court and won.
MORE CHALLENGES: What You Need to Prepare for the CRA’s Enforcement Blitz »
The difficult reality is that we’re seeing more of these supposedly tax-friendly solutions emerge, each one offering greater benefits than the other. They can be tempting for Canadian entrepreneurs whose businesses are grappling with weak growth and whose investment portfolios are growing at an even slower pace. Who wouldn’t want to save on their tax bill?
To be clear, there’s a distinct delineation between tax avoidance—minimizing a personal or corporate tax liability with effective tax planning—and tax evasion, which involves using dubious means to skip out on all or most of a tax bill. Even in the former instance, there is a limit to the degree of tax-planning creativity on which a business owner or corporation can rely without raising the ire of CRA.
Take the recent case of Golini vs. The Queen. In it, the defendant Paul Golini used a series of complex transactions involving holding companies, offshore annuity purchases, overseas investments and loans to create a $6 million shareholder loan balance—essentially allowing him to access millions of dollars of proceeds from his corporation on a tax-free basis over several years beginning in 2008. The CRA challenged his strategy and the case ultimately ended up in court.
The CRA reassessed Mr. Golini’s taxes owing at $5.4 million, a sum that a judge upheld in the recent court decision. The ruling could still be appealed and that amount potentially reduced, but the case underscores the idea that highly complex tax manipulation can easily run afoul of Canadian tax law.
Now, most entrepreneurs won’t be attempting a strategy as convoluted as the one deployed in the Golini case, but all it takes is the advice of an aggressive tax lawyer or accountant to spur an audit that could result in back-tax payments, interest and severe penalties.
Aggressive tax planning also raises a concept that few Canadian business owners understand, but should. It’s called the General Anti-Avoidance Rule (or GAAR), which is essentially a test sometimes used to determine whether a taxpayer is trying to avoid paying his or her fair share by abusing the rules of the Income Tax Act.
MORE AVOIDANCE: Why Some Companies Pay No Tax »
To fall within the scope of GAAR, your plan would have to satisfy the following three criteria: was there a tax savings to the party in question (defined as a “reduction, avoidance or deferral of tax or other amount payable or an increase in a refund of tax or other amount”); did an individual or corporation’s tax strategy entail avoidance; and if there was avoidance, was it used in an abusive way, such as tapping one provision of the Income Tax Act to circumvent another.
So even though you may not be caught by the standard provisions of the Income Tax Act, if your planning is perceived to be abusive, you could run afoul of the GAAR principle and face court action.
The best advice I can give is that if you think you’re being pitched a tax strategy that seems even mildly aggressive, take a step back. Notwithstanding that your accounting and tax law knowledge may be limited, what does it look like to you? If it seems too good to be true, that may very well be the case.
When in doubt, approach another legal or accounting firm for a second opinion. Most reputable and experienced accountants will be able to confirm whether a suggested strategy is questionable, or even illegal.
While it may be tempting to act aggressively to slash your tax bill, just remember that a perceived saving today could turn out to be a significant cost tomorrow.
Armando Iannuzzi is a tax partner at Kestenberg Rabinowicz Partners LLP, a Markham, Ont.-based firm that provides strategic tax, accounting and finance services to entrepreneurs.