The Truth About Cheating on Taxes – Bottom Line It Costs Us All

Cheating on taxes does not have the social stigma attached to it that drunk driving now does. It should. Taxes are the main way governments raise revenue for infrastructure, defense, and social services.

The underground economy is estimated at $41 billion. This means a loss of taxes of between $10-$20 billion annually that has to be met by the tax paying public. Statistics Canada has estimated that almost $444 billion of unreported income was earned in Canada from 1992-2008, excluding illegal activities.

Have you ever paid cash to avoid paying GST? Saving a bit of tax on a pair of shoes or a tennis racket may seem innocent enough. But you know that your vendor is not collecting GST and is not reporting income on the sale. Welcome to the underground economy!

Kevin Lee, CEO of Canadian Home Builders’ Association said “The underground economy in home renovations exposes homeowners to significant risk they often don’t understand and that can threaten their financial security. Furthermore, legitimate businesses suffer when they are forced to compete with those who cut corners, and don’t pay their fair share of taxes.” No tax, no receipt, no warranty for a pair of shoes or a tennis racket is one thing. If you pay for a house renovation with no receipt, or a reduced receipt for a part cash job, your risk is much greater if there is any problem with the work.

The underground economy is sophisticated. Electronic Suppression of Sales software (zapper software) is used to hide sales to evade the payment of GST and income tax. Zapper software selectively deletes or modifies, without a record of the deletion or modification, sales transactions from the records of point-of-sale systems (electronic cash registers) and businesses’ accounting systems.

CRA estimates zapper use could account for $3.25 billion in unreported sales annually. Fighting zapper use is a priority for CRA and a major initiative in their underground economy strategy. In 2012-2013, CRA audited 10,822 underground economy files, with a total dollar value of taxes assessed of $305 million.

Tax cheating is also as simple as not reporting income. A 2012 CRA audit of income earned by 145 wait staff at 4 establishments in St. Catharines, Ont., revealed $1.7-million in unreported tips. Wait staff earn up to double their wages in tips, but report at most 10% of it (and in some cases none). Statistics Canada estimated $36 billion in income went undeclared in the underground economy (not including illegal activities) in 2008. Of that, $1.3 billion was from tips.

I had a client who ran a small furniture store and did not report all of his income. He had a separate bank account, albeit at a different bank, where he deposited all of unreported sales. CRA found the bank account and assessed him for the unreported income. We were able to avoid prosecution for tax evasion, but he had to pay full penalties.

Failure to remit trust funds, either payroll source deductions or GST collected, is another common tax cheat. Payroll audits are fairly common, and CRA reviews more than 250,000 GST/HST and 480,000 payroll account files a year and they identify over $1.8 billion in non-compliance. Actual non-compliance is probably much higher.

The simple failure to file an annual income tax return is another prevalent tax cheat, although for many Canadians it arises due to family or business problems rather than a deliberate attempt to evade taxes. Every year, CRA identifies 600,000+ non-filers and finds $2.7 billion in non-compliance.

The ever popular offshore bank account, while still in use to evade taxes, is becoming obsolete. Bank secrecy in traditional tax obscuring jurisdictions, including the grandfather of them all, Switzerland, is very much a thing of the past. There have been leaks to tax authorities from some offshore banks. The Panama Papers tax leak in early 2016 was unprecedented in the scope of offshore information revealed. Canada has implemented the Offshore Tax Information Program (OTIP) that gives whistle blowers up to 15 per cent of taxes collected by CRA. Canada will be joining the OECD tax transparency agreement by 2018.

The CRA voluntary disclosure program allows non-filers and tax evaders to come forward to CRA before CRA approaches them and not be prosecuted or penalized. The participation in the program is increasing annually. For the year ended March 31, 2015, CRA processed over 10,000 voluntary disclosures, almost doubled from the previous year. The amount of previously unreported income more than doubled to $780 million.

Tax cheating costs all of us. For every tax dollar that someone doesn’t remit, another Canadian has to take up the slack to make up the shortfall.
David J Rotfleisch, CPA, JD is the founding tax lawyer of Rotfleisch & Samulovitch, P.C. a Toronto-based boutique tax law firm. With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax litigation. www.Taxpage.com and david@taxpage.com

The Truth About Cheating on Taxes – Bottom Line It Costs Us All

Employee Stock Options Tax Planning– Vancouver Tax Lawyer Commentary

Employee Stock Options- Introduction

The income tax planning for the structure of a stock option plan requires the income tax law and corporate law expertise that our experienced Vancouver tax lawyers bring to all client tax issues. In a stock option plan, the employee is given or earns the right to acquire shares of the corporation, usually at some fixed period of time in the future. Sometimes the employee acquires certain shares at the inception of the stock option plan with rights to acquire additional shares in the future. The vesting of the stock option rights may be deferred for some period of time and will usually only vest if the individual is still employed by the corporation.

Employee Stock Option Agreement- Requirements

There has to be a written stock option agreement which specifies how the employee earns rights to additional shares, the price to be paid for those shares and requirements for vesting. For privately held corporations continued employment with the corporation is generally a prerequisite for exercising the stock option and for keeping the shares. In the event of a departure from employment, even if the employee is fired, the shares are usually reacquired by the corporation on some basis since a closely held corporation does not want shareholders who may have adverse interests. Our top Vancouver tax lawyers are experienced in tax planning for the structuring and drafting of stock option agreements.

If the shares of the corporation are publicly traded then the employee will generally be permitted to keep the shares even after employment is terminated. However, he or she will generally be unable to exercise stock options to acquire any additional shares after leaving employment with the corporation.

Stock option plans are one of the proverbial “golden handcuffs” since the employee’s rights are limited or terminated in the event of termination of employment, so proper income tax planning and business planning is essential in structuring the terms and conditions of the plan.

Most stock option plans are limited to management but some stock option plans are made available to all employees of the organization. In that case there will usually be a different stock option plan for management and for non-management employees.

Another tax planning advantage to stock option plans from a corporate point of view is that there is no cash outflow to the corporation. On the contrary, if the employees are required to buy the optioned shares at fair market value, the corporation actually receives funds. Payments are only required by the corporation if dividends are declared.

Employee Stock Option Plans- Taxation

The issuance of stock options has Canadian income tax implications that vary depending on whether the corporation is private or public and also depend on how long the shares are held after exercise of the stock option and our Vancouver tax lawyers have the experience to properly advise you.

When stock options are given without a tax reorganization, and a benefit is conferred on the employee, the Tax Act has special provisions that are applicable.

Stock option benefits are taxable as employment income because they are, in effect, an alternative to cash compensation.

The common law rule that stock option benefits arose in the year in which the stock option was granted created considerable uncertainty in determining the value of benefits derived from unexercised stock options. The Canadian Income Tax Act resolves the uncertainty by specifying both the method of valuation and the time for inclusion of the benefit in taxable income.

An individual is taxable on the value of stock option benefits derived by virtue of employment. The benefit is determined by reference to the shares actually acquired pursuant to the stock option plan.

The first question is: Was the benefit conferred by virtue of the employment relationship? Issuance of stock for other considerations (for example, as a gift or in return for guaranteeing a loan) does not give rise to a benefit from employment. The tax definition of “employment” includes employees, and Officers are included in the tax definition of “employees”. Case law supports the idea that a director is an officer of a corporation; therefore, directors are bound by these provisions in almost all circumstances. An exception to this rule occurs when the benefit received by the director was not conferred by virtue of the employment relationship.

The triggering event for the recognition of stock option benefits is the acquisition of shares at a price less than their value at the time the shares are acquired. The time of acquisition is determined by reference to principles of contractual and corporate law.

Except in special cases (discussed below), the value of a stock option benefit can be determined only at or after the time the stock option is exercised, that is, when the shares are acquired. The value of the benefit is the difference between the cost of the option to the employee, any amount paid for the shares, and the value of the shares at the time they are acquired from the plan. Shares are considered to be acquired when the option is exercised.

“Value” means “fair market value”. In the case of publicly traded securities, stock market prices will usually be considered indicative of fair market value. Since listed stock prices inherently reflect the value of minority shareholdings, there is no need to further discount their value for minority interest.

The value of shares of a private corporation, which will be the case with owner-manager entrepreneurs and closely held businesses, is more difficult to determine. Shares of private corporations are generally valued by reference to estimated future earnings and the adjusted net value of assets. The pro rata value of the corporation is then adjusted to reflect a discount for minority interests, lack of market, etc.

When it comes to income tax planning for stock option plans there are two special income taxation rules. One applies to options issued by Canadian-controlled private corporations (“CCPC”) and the other to acquisitions of prescribed equity shares. These rules are incentive provisions intended to stimulate equity participation in Canadian corporations.

Shares acquired from a CCPCs stock option plan in an arm’s length transaction receive preferential treatment if they are held for at least two years. This is so whether the shares are issued by the employer corporation or by another Canadian-controlled private corporation with which the employer does not deal at arm’s length.

An employee may defer income tax recognition of any benefit derived from stock options issued by a Canadian-controlled private corporation until disposition of the shares. CCPC employees are also able to deduct 50% of any stock option benefits received from CCPC’s under s. 110(1)(d.1) of the income tax act on the condition that they have not disposed of or exchanged shares for two years after the acquisition date. Upon disposition of the shares, the employee is taxable on the benefit amount less the deduction and the taxable portion of any capital gains realized on disposition.

The employee benefits by deferring any income tax liability which would otherwise arise upon acquisition of the shares through an “ordinary” stock option plan and by converting what would normally be fully taxable employment source income into income that is, in effect, taxable at a lower rate. The portion of the benefit that is taxable to the employee is not a capital gain but income from employment, taxed at the same rate as a capital gain.

An employee who disposes of shares in a Canadian-controlled private corporation within two years from the date of acquisition is taxable in the year of disposition on the full value of any benefit derived from their acquisition.

There is also a special rule for stock option plans under which an individual acquires prescribed equity shares in an employer’s corporation or in a corporation with which the employer does not deal at arm’s length. Under these special rules, It is also possible to receive a 50% deduction. The benefit, however, is taxable on a current basis.

The following conditions must be satisfied in order for a stock option plan to qualify for this special tax treatment:

  • The shares must be prescribed at the time of their sale or issuance
  • The employee must purchase the shares for not less than their fair market value at the time the agreement was made; and
  • The employee must have been at arm’s length with the employer and the issuing corporation at the time the agreement was made.
    Employee Stock Option Plans- Vancouver Tax Lawyer Assistance

An employee stock option plan can be an important part of a corporation’s compensation package and has benefits to both employer and employee. Tax planning, structuring and drafting such an employee stock option plan requires advice from one of our experienced Vancouver tax lawyers. If you require tax help or advice with your employee stock option plan contact our Vancouver tax lawyer firm.

Employee Stock Options Tax Planning– Vancouver Tax Lawyer Commentary

Canadian Income Tax – Net Worth Audit and Tax Assessments – Toronto Tax Lawyer Analysis

A normal income tax audit can be an intimidating and costly process for a taxpayer. Taxpayers who carry on a business, particularly one that deals in cash, may be surprised to know that the Canada Revenue Agency (“CRA”) has a number of methods that it can employ to reassess taxpayers, not all of which rely upon the examination of a business’ prepared books and records.

In cases where the CRA believe that the taxpayer’s normal books and records do not reflect an accurate picture of income earned, Canada’s Tax Act provides that the CRA may assess a taxpayer based on indirect methods using information obtained from third-parties or the taxpayer. These tax audit techniques are therefore referred to as indirect verification methods.

One of the most common, powerful and from a taxpayer point of view troublesome methods employed by the CRA to assess the income of a taxpayer is the net worth audit. It proceeds from the premise that a taxpayer has unreported income that the auditor may not be capable of identifying through direct means. The purpose of this article is to explain how a net worth audit proceeds and why any Canadian taxpayer who is faced with this burdensome form of tax audit would be best served by retaining one of our experienced Toronto Tax Lawyers as early as possible in the process.

Net Worth Audit Explained by Toronto Tax Lawyer

The net-worth tax audit is used as a tool for the CRA to identify an increase in a taxpayer’s wealth over the audit period, often three taxation years or reporting periods. The CRA tax auditor starts by examining the taxpayer’s assets and liabilities at the beginning of the chosen audit period, and then compares them to the assets and liabilities at the end of the period. In addition, the auditor will take into account expenditures during the audit period. Doing so allows the auditor to arrive at the closing net-worth of the taxpayer. Any increase over the audit period is income to the taxpayer, and to the extent that the originally reported income in the tax return is lower, the CRA makes the assumption that the difference is unreported income. The formula can be expressed as follows:

Opening Net Worth + Reported Income – Expenditures = Closing Net Worth

Any amount in excess will be treated as income by the CRA.

The net-worth tax audit method relies upon the simple assumption that when a taxpayer accumulates wealth in a taxation year, there are two options; to either spend or invest the income.

The CRA auditor will examine in depth the taxpayer’s expenditures during the selected audit period. Any expenditures can by virtue of the CRA’s powers to make assumptions may be imputed into a taxpayer’s income. In addition, it is common for the auditor’s net-worth methodology to include adjustments to expenditures on the basis of normal standards of spending according to Statistics Canada. However this type of adjustment to business expenses can be easily refuted using supporting evidence. Similarly CRA will use actual expenditures, such as from credit cards, rather than Stats Can data, where records are available.

The draconian power of the CRA to conduct a tax audit in this way is created by subsection 152(7) of the Income Tax Act which states that CRA is not bound by any of the information provided by a taxpayer – such as through the filing of a tax return or the production of books and records – and may assess based on the information it can obtain from both the taxpayer and any third-party sources. Alongside this is the power granted to CRA that allows the auditor to make reasonable assumptions that are supportable by the evidence available. So taxpayers have had victory at the Tax Court through their Toronto tax lawyers by showing that the assumptions made by the CRA auditor were not founded in any real evidence beyond industry averages. .

Net-Worth Audit Methodology

A net-worth audit can be considered the nuclear-bomb in the CRA’s powerful tax audit arsenal. In general these types of audits are normally conducted in one of two situations:

  1. The taxpayer has inadequate books and records to support their filed returns; or
  2. The initial stages of the tax audit reveal serious discrepancies with the spending habits of the taxpayer and reported income.

It is also important to note that the net-worth audit is just one of several methodologies that the CRA uses when it suspects unreported income. For example the “application of funds” method examines only expenditures. Another technique, the bank deposit analysis method, examines deposits into a taxpayer’s bank account and, to the extent that the amounts are not sufficiently explained, the auditor will characterize them as unreported income.

Though the CRA does have the power to apply these types of audit methodologies this power is subject to review and scrutiny by the Tax Court of Canada. Indeed, in many cases the CRA has had its net-worth, application of funds and deposits techniques scrutinized and overturned by the Tax Court. This is just one of the many reasons why proper legal representation by one of our top Toronto tax lawyers is crucial from the beginning of the audit.

How the Net-Worth Audit Proceeds

Once the auditor has determined that there may be unreported income, and confirmed that the presented books and records may not be adequate the auditor will normally proceed by making third-party demands to financial institutions, credit card companies and suppliers for any information about the spending habits of the taxpayer.

In addition, the CRA will conduct searches of land titles, examine mortgages and the Personal Property Security databases to identify assets and the amount of equity a taxpayer has in them.

CRA will normally, in a personal context, examine the books and records of the audited taxpayer’s family members and impute all of their spending into income as well.

When all of this information is assembled, the tax auditor then begins the painstaking task of transcribing a taxpayer’s personal financial records into a cohesive financial statement based on the formula above.

In essence, the auditor is tasked with determining and comparing asset values at the beginning and end of the period and imputing the difference into a taxpayer’s income. In addition, any expenditures during the audit period that the auditor identifies as personal in nature will form part of the unreported income to come up with a tax liability that can be shockingly high to say the least. Given the overall amount of information that is compiled mistakes are common and proper representation by our Toronto tax lawyers will aid in the reduction of a large income tax assessment.

How to Fight a Net-Worth Assessment with Toronto Tax Lawyer Tax Help

Unfortunately for those who take action too late, the most basic rule of Canadian Income Tax Law applies just as strongly in the net-worth context. That is, once a taxpayer has been assessed using the net worth audit, the onus is on the taxpayer to dispute the amounts on a timely basis and then lead evidence to prove that the CRA’s tax audit was mistaken.

There are essentially only two ways for a taxpayer to rebut the collective assumptions in a net worth audit context. First, a taxpayer may challenge the suitability of the net worth method as not being accurate given the taxpayer’s circumstances. This type of challenge is normally not successful given the CRA’s internal policies and only ever at the Tax Court level.

The second and generally more successful way a taxpayer may challenge the net worth assessment is more onerous and time consuming: a taxpayer will have to analyze and challenge every specific aspect and calculation of the net worth assessment on a line by line and item by item basis. In addition, a thorough analysis to refute a net-worth assessment will include a detailed review of the taxpayer’s assets at the beginning of the audit period as well as an analysis of the taxpayer’s interim and closing liabilities. In order to effectively challenge the net worth audit or tax assessment a taxpayer requires the help of one of our top Toronto Tax Lawyers

Our professional Canadian tax lawyers have successfully opposed net worth assessments by questioning every assumption, item and interpretation made by the auditor and attacking all deficiencies.

Canadian Tax Lawyer Net Worth Audit Tax Help

If you are being subjected to a net-worth audit, give our experienced Canadian Tax Litigation Lawyers a call. Our team of Toronto Tax Attorneys can ensure your rights are protected by dealing directly with the tax auditor on your behalf and challenging their schedules on an item by item basis. Our Canadian Tax Law firm can give you the representation you need to ensure you are not put out of business or forced into bankruptcy when the CRA pulls the net worth assessment weapon out of its arsenal.

Canadian Income Tax – Net Worth Audit and Tax Assessments – Toronto Tax Lawyer Analysis

Requirement to File Income Tax Returns

File Income Tax Returns

Unfiled Tax Returns

The general obligation to file income tax returns is set out in section 150 of the Income Tax Act.

Corporation Income Tax Filings

All corporations resident in Canada have to file T2 income tax returns within 6 months of their year end.  There is no requirement that corporations have a calendar year end. Corporations that are not resident that are carrying on business in Canada or realize a capital gain during the year or dispose of taxable Canadian property also have an obligation to file a Canadian corporate tax return.

Trust and Estate Tax Returns

Trusts and estates have a calendar year end and are required to file T3 income tax returns within 90 days of the year end.

Individual Tax Returns

As a general rule individuals are required to file T1 tax returns by April 30 of each year, however there are exceptions. Individuals with self employment income have until June 15 to file their tax returns. If an individual had no taxable income during the year, there is no obligation to file a tax return unless the individual had a capital gain during the year of disposed of capital property, or unless CRA issues a demand to file a tax return under subsection 150(2).

Offences for Failure to File

Failure To File Offence

Failure to file a return is an offence under subsection 238(1) and is punishable by a fine of between $1,000 and $25,000 plus a possible jail sentence of up to 12 months.  These penalties are applicable for every failure to file and each unfiled year is a separate offence, so failure to file 3 years of returns would be subject to a minimum penalty of $3,000.

Tax Evasion Offence

If CRA can prove that the failure to file the income tax returns was a deliberate attempt to evade the payment of income taxes, they can and do bring tax evasion charges under paragraph 239(1)(d).  The penalties on conviction for income tax evasion are much more severe, with fines of between 50% to 200% of the tax evaded plus possible jail time of up to 2 years.  CRA may also elect to proceed by indictment under subsection 239(2) in which case the penalties increase to between 100% to 200% of the taxes evaded plus possible imprisonment of up to 5 years.

CRA Procedures

Requests and Demands to File Returns

CRA does not generally proceed to bring charges whenever it finds a taxpayer has failed to submit the required tax returns.  CRA’s policy is to encourage compliance with the Income Tax Act.  When they come across a taxpayer who has failed to file tax returns they normally send a request to file the missing returns.  If that request is not complied with then normally a Demand to file under subsection 150(2) is issued.  Only if the Demand is ignored will they proceed to prosecution, usually under 238(1).  When faced with clients being prosecuted with multiple years of unfiled returns our Canadian income tax litigation lawyers  are usually able to negotiate a plea bargain to plead guilty and pay the minimum penalty for just one year by bringing all years into compliance prior to the trial.

Requirement to File Income Tax Returns

Top 3 Canadian Income Tax Stories of 2015 as Determined by Canadian Income Tax Lawyer

Income Tax Collection| Top Tax Story

Looking back on every year there are numerous Canadian income tax developments and changes.  However in deciding on the top income tax stories for the year our Canadian income tax law firm looked for tax related developments that have the potential to affect a large number of Canadian taxpayers.  With this is mind, here are Canadian income tax lawyer picks for top tax stories for 2015.

Fraudsters Impersonating  CRA Collections Officers

The most important income tax story of the year is the Canada wide epidemic of phony phone calls from crooks claiming to be CRA collections officers.  You’ve heard of “phishing” scams where fraudsters try to get you to click on email links that then download malware or spyware on your computer.

But the latest wave of fraud has to do with old-fashioned phone calls made by crooks posing as Canada Revenue Agency (CRA) collections officers telling that you owe more taxes—something that strikes fear into the heart of every Canadian. And fear is the currency of fraudsters. These fraud artists call Canadian taxpayers and threaten imprisonment if immediate payments for back income taxes owing are not made. Payment arrangements using wire transfers, Western Union, prepaid credit cards or even immediate withdrawals from bank ATMs are then made. Thousands of Canadian taxpayers have been contacted, and hundreds of Canadians have been duped into making payments to these criminals in 2015.  Numerous warnings have been issued by CRA, local and provincial police forces and by the RCMP.

The CRA does not demand payment of income tax debts by wire transfer or by any means other than cheque or money order payable to CRA. A tax collections officers will initiate phone calls and may visit a taxpayer’s home or, in the case of corporations, the office however CRA does not jail Canadian taxpayers for unpaid income tax debts. If you have tax concerns and don’t want to contact CRA directly, you can always speak to one of our Canadian tax lawyers who can do so on your behalf.

Income Tax Changes by new Liberal Government

A vigorous debate about Canadian income taxes was a prominent feature of the 2015 Canadian election. The election of the Liberal government under new Prime Minister Justin Trudeau brought immediate tax changes that will affect the majority of Canadians. The 3 most notable income tax changes, that will affect the majority of taxpayers, are:

  • Reduction of taxes for the middle class
  • Increase of the tax rate from 29% to 33% on income over $200,000
  • Rollback of the tax free savings account (TFSA) limit from $10,000 in 2015 to $5,500 in 2016

Americans in Canada and the new FATCA rules

This change affects all US citizens in Canada, so it’s of widespread effect.  A new Canada- US cross-border tax agreement to exchange financial information is now in place, and a legal challenge to the agreement failed.  The U.S. Foreign Account Tax Compliance Act (FATCA) is designed to target tax non-compliance by U.S. taxpayers with foreign accounts, and this includes US citizens resident in Canada who may have no other connection with the US. FATCA requires U.S. persons including Canadian residents holding reportable accounts at foreign financial institutions, in other words Canadian banks, to report information on an information form attached to their annual tax US return. Failure to meet these reporting requirements  could result in fines of up to $50,000, and the CRA will enforce IRS penalties. The act also requires non-U.S. banks, that is to say Canadian banks, to provide information about U.S. citizens to the IRS.

Top 3 Canadian Income Tax Stories of 2015 as Determined by Canadian Income Tax Lawyer