TAX CONTROVERSY January 2020 - MNP LLP
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TAX CONTROVERSY
TAX
CONTROVERSY
January 2020
In this latest issue, we will update you on this quarter’s ongoing CRA audit activity, share an article on CRA’s audit of
trusts and tell a story about recent CRA scams We will also review some U.S. Internal Revenue Service (IRS) audit
initiatives across the border that will impact U.S. citizens or green card holders.
Trends in Audit Activity
The CRA continues to keep us busy across the country. At the Canadian Tax Foundation’s Ontario Tax Conference in
October, the CRA noted in 2018 it made audit assessments totalling $1.185 billion from audits of small- and medium-
sized enterprises. We understand the CRA assessed an average of $137,000 per small business audit and $336,000 per
medium-sized business audit.1
Below is a list of current CRA audit activity seen across MNP. This quarter, most of the audit activity appears to be
standard desk audits.
Audit Type Description
Transfer Pricing Audits A transfer pricing penalty will apply if “reasonable efforts” are not made to
determine arm’s-length transfer prices / allocations and the CRA’s adjustment to
transfer pricing for a taxpayer in a tax year exceeds the lesser of 10 percent of the
taxpayer’s gross revenue for the year and $5,000,000. There are important
documentary requirements and deadlines which must be met to evidence these
“reasonable efforts.”
Related party/Cross-border Review of cross-border transactions and related party balances.
Transactions
The CRA has indicated it is also sharing information with foreign governments. For
example, in September the CRA sent 900,000 financial records to the IRS in respect of
the 2018 taxation year. Under the information-sharing agreement, the IRS is
supposed to send the CRA similar information about U.S. bank accounts held by
Canadians.
1
B. Hodge, G. Robert, S. Sicard and M. Tonkovich, “CRA Audit Updates / Best Practices” (presentation delivered at the 2019 Canadian Tax
Foundation Ontario Tax Conference & Live Webcast, Toronto, 29 October 2019).TAX CONTROVERSY
Audit Type Description
Shareholder Loans Review of large shareholder loan balances, particularly where there is comparatively
low income reported by the shareholder on their personal tax return.
Net Worth Audits Numerous audits across Canada.
Payroll Audits Various reviews (examination, amongst other things, of Canada Pension Plan and
Employment Insurance remittances, worker classification, taxable benefits, etc.).
Related Property Rental Reviews occurring to determine whether income is classified as income from
Income property or business.
Vehicle Expenses Audit of vehicle expenses for both individuals and corporations. For corporations,
CRA requests:
• A detailed list of all transactions included in vehicle expenses
• Copies of invoices for the 10-largest amounts plus all general ledger items from
the third month of each year under review
• List of all vehicles for which amounts are claimed and details of owner as well as
vehicle logs
Part III Assessments – Review of capital dividend account (CDA) elections to determine if CDA calculations
Capital Dividends are accurate and if Part III tax can be applied on excessive capital dividend elections.
Empty Homes Tax (B.C.) Review of property status declarations in the City of Vancouver to determine if
subject to the tax.
Election Forms Closer review of election forms such as S.85 and CDA elections.
GST / HST Audits • Refund integrity desk audits seen in Saskatchewan and Ontario
• Ongoing HST / GST audits nationally
Post-Assessment Reviews • Employment Expenses
(Personal Tax Returns) o Vehicle
o Subsistence and mileage for employees (pipeline companies)
o Requesting employers complete a job requirement questionnaire
• Childcare, moving expenses, medical, donations, carrying charges, spousal
support
• RRSP over-contributions
• Foreign tax credit claims
If you have any questions or concerns with requests for information or proposed reassessments by the CRA, please
contact your MNP Advisor.TAX CONTROVERSY
The CRA’s Audit Crackdown on Family Trusts
Jeanne Cheng, MNP LLP
This article was previously published in Tax for the Owner-Manager, Volume 19, Number 4, October 2019 and has been
reproduced with permission.
In recent years, federal budgets have significantly increased funding to the CRA. Much of this funding has been and will
continue to be used to expand CRA audit activity. Specifically, the CRA has focused on certain industries and areas of
taxation, including small businesses, real estate sales activity, international tax reporting and planning and trusts.
Taxpayers often experience anxiety, fear and uncertainty during the audit process, which can extend well beyond a
year.
Those feelings are not unwarranted. The 2018 Fall Reports of the Auditor General of Canada found the CRA did not
consistently apply tax rules when it audited or reviewed taxpayers' files. The auditor general also found wide
inconsistencies in the deadlines taxpayers were given to respond to CRA requests, the length of time it took the CRA
to complete an audit and the documentation requirements imposed on taxpayers.
A particular area of focus for the CRA has been trusts; in fact, the CRA has a dedicated audit department for trusts. The
government's increasing focus on trusts is also evidenced by the announcement of new trust reporting rules (draft
legislation was released on July 27, 2018). The rules will require trust taxpayers (with some exceptions) to make
additional disclosures relating to the settlor, trustees, beneficiaries and others, applicable for taxation years ending
after 2021.
Often referred to as a family trust, a discretionary inter vivos trust can be set up to hold family assets, including shares
of private corporations. Family trusts can help planners accomplish various objectives, including estate planning, asset
protection and tax minimization. When the shares of a business are sold for a gain and the vendor is a discretionary
trust with multiple beneficiaries, a significant reduction or even elimination of taxes related to the sale can be achieved,
especially if the shares held by the trust are qualified small business corporation (QSBC) shares as defined in
subsection 110.6(1). The CRA has been concerned about abuses in this area and recent audits have targeted family
trusts that have reported sales of QSBC shares.
The CRA's audit process for a trust involves accumulating documentation and information about many details related
to:
• The trust's setup and administration, including its bank statements;
• Evidence regarding the subscription of shares by the trust;
• The payment of trust expenses; and
• Trustees' resolutions concerning the payment of income and capital gains to beneficiaries.
Although many tax practitioners and trust experts have a good understanding of the intricacies related to the setup
and administration of a trust, in practice, such details are not always addressed by trustees, especially those relating
to tasks that can be burdensome or costly — for example, setting up a bank account for the trust and preparing
annual resolutions.TAX CONTROVERSY Many of the trusts the CRA has selected for audit have reported a capital gain from the sale of shares of a QSBC. The tax rules that govern the capital gains exemption are complex and the beneficiaries and trustees of the trust may not always fully understand them. For a trust to claim a capital gain, shares of a corporation held by the trust must first qualify as QSBC shares. The CRA may request a full analysis be provided to confirm the shares meet the multiple conditions in subsection 110.6(1). The CRA may also ask for bank statements for the trust and the beneficiaries in order to confirm the proceeds of the share sale were received by the trust and subsequently distributed to the relevant beneficiaries. The calculation of a trust's taxable income involves the inclusion of the taxable capital gain from the sale as income to the trust, and a corresponding deduction pursuant to subsection 104(6) of amounts that are paid or payable by the trust to its beneficiaries. Subsection 104(24) provides that an amount is not considered to be paid or payable unless it was paid in the year to the beneficiary or the beneficiary had a legal entitlement to receive the amount. If the CRA does not obtain satisfactory evidence one of those conditions was met, it can reassess the trust and deny the subsection 104(6) deduction, resulting in a significant tax liability (plus any applicable penalties and interest). Therefore, it is critical the trustees ensure proper documentation and other timely actions, such as the movement of cash between bank accounts of the relevant parties. Further pitfalls may arise if the beneficiaries include individuals under the age of 18. In a recent client matter, a trust had sold QSBC shares during a previous taxation year. The funds from the sale were distributed directly to only one beneficiary of the trust, even though the trust's tax return in the year of sale allocated taxable capital gains to several beneficiaries, all of whom reported the income on their personal tax returns and claimed their lifetime capital gains exemption in connection with the gain. Ultimately, the tax return of the beneficiary who actually received all of the funds was reassessed by the CRA to include all of the taxable income from the sale. Given the increasing scrutiny by the CRA, it is imperative all relevant parties — especially trustees — understand their roles and responsibilities and carry out all necessary legal and administrative steps, beginning when the trust is created. As noted earlier, the new reporting rules will apply to returns filed for tax years ending after December 30, 2021. As the effective date for the new reporting requirements approaches, it is apparent the CRA's crackdown on trusts will continue — and if insufficient attention is paid to planning, documentation and implementation, practitioners and trustees can be sure the CRA's auditors will uncover it.
TAX CONTROVERSY
CRA Scams – New and Improved
Fraudsters are becoming ever more sophisticated in creating opportunities and tactics to scam unsuspecting
individuals out of funds. Taxpayers need to be vigilant when they receive any sort of communication from someone
claiming to be from the CRA – whether that be in the form of an email, text or telephone call. Typically, these
scammers will insist a person provide personal information to receive a payment, for example a credit card or bank
account number or a passport number. They also pose as collections agents, misleading taxpayers into paying false
debts.
Taxpayers should never respond to any threatening or coercive language designed to scare them into paying fictitious
debts to the CRA (jail or deportation, for example). They should not enter any personal information into websites to
which they are directed. These are simply designed to obtain taxpayers’ private information.
The CRA may contact taxpayers by phone, mail or by email. They do not use text messages, Facebook Messenger or
WhatsApp. Taxpayers are warned to not click on any links in any email they receive. This is a technique known as
phishing and is used to steal personal information when the link is clicked. Taxpayer’s are also advised to consider
email security (for example, when transmitting sensitive data or setting passwords). Personal email accounts can also
be hacked to gather sensitive personal information which can be used by fraudsters.
Recently, a scammer used the name of a real CRA agent and called an MNP client. They cited MNP’s name and told
the client they were going to be audited. Luckily MNP was able to verify the call was a scam and halted any further
activity. In another situation, the fraudster somehow knew the taxpayer used MNP for their tax reporting, name-
dropped MNP and advised the client that they should pay $6,000. The scammer also noted to the client the MNP
Advisor (named) was aware and approved the payment. Unfortunately, the client fell for the scam and paid the
money.
It is important for taxpayers to be aware of the status of their tax filings and any amounts owing or refundable; by
doing so, they can often immediately detect the validity of a communication. A best practice is for a taxpayer to take
down the CRA agent’s contact details and agent code and call their MNP advisor with the information to follow up
with the CRA. If the communication is received by email, this can be forwarded to MNP to follow up. Additionally, the
taxpayer can (and should) ask for any telephone request be made in writing and sent by mail or fax.
CRA will never:
• Ask for information about taxpayer’s passports, health cards or driver’s licenses.
• Demand immediate payment via non-cash means, i.e. bitcoin, Interac e-transfer, prepaid credit cards, gift
cards, etc.
• Leave voicemails that are threatening or contain personal or financial information.
• Send emails requiring links to be clicked or information be filled out.
• Set up a meeting with taxpayers in a public place to take payment.
If you suspect a CRA scam:
1. Confirm the legitimacy of the CRA caller: ask for their name, agent code, phone number and office location. Call
the CRA to confirm the information (1-800-959-8281 for individuals, and 1-800-959-5525 for businesses).
2. Ask for the CRA request for information in writing (fax or send to address on file or send to MNP Address).
3. Trust your instincts.
The CRA has detailed information on its website about fraud and scam prevention:
CRA: Slam the Scam and What to Expect When the CRA Contacts You.TAX CONTROVERSY
U.S. Tax Corner: The IRS’s Pursuit of Offshore Income – Targeted Audit Campaigns and $10,000 Penalties
Katri Ulmonen, MNP LLP
Determined. Focused. Unrelenting. These are common traits shared by visionaries, leaders and world class athletes.
But the IRS? Unfortunately for taxpayers and advisors alike, the answer is yes. In its own words, “The IRS remains
committed to our priority efforts to stop offshore tax evasion wherever it occurs.”
In 2017, the Government Accountability Office, which is akin to our Auditor General, released a report that criticized
the IRS’s inconsistent application of legislated international tax penalties to taxpayers. The IRS’ response was to begin
a series of international tax audit campaigns under the Large Business and International division.
When these audit campaigns were introduced back in January 2018, there was a mere baker’s dozen of audits. With
the announcement of the IRC 965 campaign (see below) in November, we now have more than 50 active campaigns,
many of which could impact unsuspecting and otherwise compliant clients. To make matters worse, the IRS has
discretion to use an assortment of techniques in its audit endeavors, including issuing $10,000 penalty notices in
advance of a detailed investigation (thus treating impacted taxpayers as “guilty until proven innocent”). Taxpayers
who are legitimately caught on audit may be subject to both civil and criminal charges in addition to an increased tax
liability. Some of these types of penalties may have a very high financial cap, far in excess of $10,000.
Below is a summary of current IRS audit campaigns that may impact individuals in Canada.
Should you be in receipt of any IRS notification, it is imperative to discuss this with your MNP Tax Advisor to determine
the appropriate course of action.
Audit Campaign Name Impacted Individuals IRS Audit Objective
Focus: U.S. Persons
Expatriation U.S. persons that expatriated after Delinquent U.S. filings
June 2018 Underpayment of U.S. taxes
Forms 3520 / A: Non- U.S. persons who have transactions Delinquent, late or inadequate U.S.
Compliance and / or own a Foreign Trust filings
Foreign Earned Income Taxpayers who claimed a foreign Taxpayers that do not qualify for the
Exclusion earned income exclusion on their foreign earned income exclusion
1040
High Income Non-Filers U.S. persons who have not filed U.S. U.S. persons who have not reported
tax returns their worldwide income to the IRS
Individual Foreign Tax Credit Taxpayers claiming FTCs Incorrect FTCs computed and claimed
(FTCs) (Phase 1 & 2) or taxpayers that do not qualify for FTC
IRC 965 U.S. persons who are shareholders of Underpayment of 2017 Transition Tax
Canadian Corporations related to Deferred Foreign Income in
the Canadian corporation
Offshore Voluntary Disclosure U.S. persons who initiated an OVDP Non-Compliant U.S. taxpayers
Program (OVDP) Declines- application but did not complete the
Withdrawals Campaigns voluntary disclosure
Post OVDP Compliance U.S. persons who disclosed under the Subsequent compliance and reporting
OVDP program post OVDP disclosureTAX CONTROVERSY
Audit Campaign Name Impacted Individuals IRS Audit Objective
Focus: Non-Resident Persons
Non-Resident Alien Schedule A Non-residents claiming deductions Non-residents who do not qualify for
and Other Deductions deductions claimed
NRA Tax Credits Non-residents claiming credits Non-residents who do not qualify for
credits claimed
Verification of Form 1042-S Non-residents claiming withholding Non-residents claiming unsubstantiated
Credit Claimed on Form 1040NR tax credits on their 1040NR withholding tax credits
HELPFUL TIPS FOR CLIENTS WHEN THE CRA CALLS
• Consult a tax advisor
• Be courteous
• Be cautious
• Stay organized
• Understand your rights
How MNP Can Help
Our Tax Controversy Specialists will work with you to prevent, manage and resolve tax disputes with the tax
authorities in a way that reduces your tax cost and minimizes disruption to your business. We then go one step
further to help you develop strategies and policies that work to protect your business in the case of future audits and
disputes.
For more information, contact your local MNP Business Advisor or visit MNP.caYou can also read
