Other than “approved” shelters such as RRSPs, TFSAs and flow-through shares, there are few if any tax shelters that still work to reduce your tax bill.
Taxpayers should be aware of some of the dangers of investing in a scheme designed to reduce income tax, quite aside from whether the scheme technically “works”:
- If the scheme is a “tax shelter” as defined in the Income Tax Act, the promoter is required to obtain a tax shelter ID number from the CRA, provide you with that number, and to report your name and Social Insurance Number to the CRA as an investor in the shelter. This ensures that the CRA will audit your investment, and if it doesn’t like the effects, your tax benefits will be denied. (Note that the ID number does not mean that the CRA will allow the deductions claimed!)
A “tax shelter” is defined, very generally, as any scheme where the promoter represents that the savings you can obtain for tax purposes will exceed the amount you invest in the scheme.
- If the promoter fails to register the shelter, or if you do not file a Form T5004 “Claim For Tax Shelter Loss or Deduction” with your return showing what shelter(s) you are using and how much you are claiming, then your losses or credits will be denied even if they would otherwise qualify.
Note also that if the right forms are not filed to alert the CRA that you are claiming tax shelter benefits, the CRA has no deadline to reassess you to deny the benefits. The usual 3-year deadline is extended to 3 years after the promoter files the necessary forms identifying you as an investor in the shelter. So the CRA might decide 10 years later to reassess you to deny the deductions you claimed, and assess you a massive amount of interest on top of that.
- If the scheme is not a “tax shelter” as defined, but has two of the three “hallmarks” of a tax avoidance plan, then again it must be reported to the CRA on a special form (RC312 “Reportable Transaction Information Return”). Again, if it is not reported, the tax benefits can be disallowed and the CRA may have unlimited time to reassess you. The “hallmarks” are:
- contingent fees for the promoter (usually a percentage of the tax you save);
- “confidential protection”, meaning you are not permitted to disclose the details of the scheme to others; and
- “contractual protection”, such as insurance or a promise to defend the scheme if you are reassessed by the CRA to deny its benefits.
- Charity donation shelters get special attention. These involve a mechanism whereby you get a tax receipt from a charity for much more than the cash you actually put into the arrangement. Even if the promoter assures you that the scheme works and has been vetted by a law firm, note the following:
- The CRA does not accept any charity donation shelters as valid, other than simple donations of flow-through shares (for which special rules provide that a capital gain needs to be reported). In taxpayers’ appeals to the Courts, the CRA invariably wins these disputes, with the judges agreeing that the donation shelter did not “work”.
- If you do not report the shelter as a tax shelter on your return, then as per above your donation credit will be denied, and there is no limit to when the CRA can reassess you.
- Assuming you report the shelter, the CRA will refuse to issue your initial Notice of Assessment until it has audited the shelter, at which point it will deny the donation credit.
- Even if you appeal the CRA’s assessment denying you the donation credit, you must still pay half of the amount in dispute while the appeal is underway.
- Quite aside from all the special tax shelter rules, the CRA can and does use the general anti-avoidance rule to deny you any deduction or credit that is part of an “avoidance transaction” and is considered to constitute a misuse or abuse of the words of the Income Tax Act, Income Tax Regulations or any tax treaty.