Provinces crack down on aggressive tax planning

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On the surface, inter-provincial tax planning appears pretty simple—clients should assume they’ll pay tax on any income or disposed assets based on the rates of the province they live in. But wealth management strategies tend to be more complex than that, especially if there are ways to avoid over-paying taxes.

Some may see strategic tax planning as “gaming the system,” and there are situations where this phrase applies. Provincial tax offices are taking notice, and leading a movement to address any “aggressive tax planning” measures that could erode provincial tax coffers.

“We’ve moved into an entirely new era,” says Doug Carroll, vice president of tax and estate planning at Invesco Trimark. “The change in demeanor towards aggressive tax planning—to use the current phrasing—certainly seems to have come to a point… there is actually a broader policy issue that may be involved in making sure the tax system is not avoided by those who simply have the wherewithal to plan around it.”

Closing loopholes Quebec is at the forefront of this movement. Not long ago, it was a destination province for aggressive tax planners intent on taking advantage of a now-closed loophole that allowed beneficiaries to avoid paying provincial tax altogether.

Today, policy makers in the province are actively seeking ways to penalize and recoup taxes lost through “avoidance transactions” that comply “with the letter of the law while abusing its spirit,” according to a provincial white paper on the topic, Measures to intensify the fight against aggressive tax planning schemes, issued in October 2009.

The paper outlines the responsibilities of a newly-created administration unit, mandated to coordinate action against aggressive tax planning. Among its duties: risk analysis, determining at-risk populations, developing intervention strategies and proposing legislative amendments to combat aggressive tax strategies more effectively.

The province’s tax department makes its views on “active” or “aggressive” tax planning clear in its discussion of risk and reward: “The risk/reward ratio is favourable to the taxpayer who participates in an ATP (aggressive tax planning) scheme because of the almost total lack of negative financial consequences.”

To shift that risk/reward balance, the province is extending limits on investigation—from three and four years to six and seven years—and implementing disclosure rules and new avoidance penalties that could see fines equal to 25% of any tax planning benefit amounts.

Those promoting aggressive tax planning measures also face penalties: fines worth 12.5% of the amount they receive in compensation. This, the government says, “represents half of the penalty rates applicable to the taxpayer and promoter for tax evasion.”

The Alberta Trust Other provinces are following Quebec’s lead. In its latest provincial budget, Alberta’s Finance Minister stated that, “Alberta Finance and Enterprise is working diligently with other provincial and federal jurisdictions to identify and pursue tax avoidance schemes.”

The Alberta trust is likely at the centre of this. Using this strategy, tax planners take advantage of lower income tax rates in the province by putting assets into a “hands-off” Alberta trust, where trustees resident in the province make all decisions on how the trust is managed. (This strategy only makes sense for top earners—those in lower and middle income tax brackets are actually better off being taxed in British Columbia and Ontario.)

Although the Alberta trust strategy has come under scrutiny—trustees have received lengthy questionnaires in the past year to examine their arrangements—this is still a valid strategy for the time being. But, experts note that the arrangements need to be made very carefully.

“You have to at least have a proper trustee in Alberta who is resident in Alberta and really carrying on the management of your trust. They’re controlling the decisions,” says Karen Slezak, tax group partner at Soberman LLP.

So, simply moving to Alberta on the 31st of December is not enough to claim provincial residency. A current driver’s license, provincial health insurance, an actual residence, family ties, and even recreational memberships can all be taken into consideration.

One court decision, Garron Family Trust v. The Queen, could be used to clamp down on Alberta trusts (and all other offshore trusts) in the future. In that case, the court decided that a Barbados trust could in fact be taxed in Canada because decisions related to the trust and ongoing management weren’t handled by the Barbados resident trustee, but by the Garron family in Canada. The case is currently under appeal,

Outside of Alberta and Quebec, inter vivos trusts, which typically hold assets in trust for the benefit of adult children, are also under the microscope in Ontario, where a special project to audit the domestic trusts will examine whether or not the trusts comply with reporting requirements, the 21-year rule and whether parents paying into the trust have withdrawn money for their own use. It is expected that this initiative will spread to other tax offices.

(04/06/10)

This Advisor.ca Special Report is sponsored by: