Tax Avoidance - A Persisitent Problem
Vern Krishna for The Lawyers Weekly
May 28, 2010
Tax laws confuse many Canadians.
Budget 2010 announced another assault to combat tax avoidance. The government's existing general anti-avoidance provision has a fair to miserable record of success, the new proposals will give the tax authorities an additional weapon to fight the war against tax planners.
The new proposals will require taxpayers to self identify and report their aggressive tax positions to the Canada Revenue Agency
The history of tax avoidance is long, colourful and bloody. Taxpayers can be forgiven, however, for wanting to reduce their taxes. Although we may tolerate the other person's taxes going up, we generally resist any increases in our own bill.
Of course, there are many ways to save tax, but some are closer to the edge than others. The first known incident of avoidance appears about 4,000 years ago in Mesopotamia. A king, embroiled in a war, needed money for his army. He levied a small tax on individuals who crossed a bridge across a local river to go and farm on the other side. The citizens resented the new levy and began swimming across the river to avoid the tax - an act of lawful tax mitigation. Not to be outdone by clever tax lawyers, however, the King enacted the first anti-avoidance rule in history by decreeing that it was a capital crime to swim across the river. The punishment was severe. It put an end to the tax avoidance scheme.
Fast forward to the 21st century and we find little change in taxpayer attitudes. War and taxation are twins. Sir Robert Borden introduced the federal income tax on business profits in Canada in 1916 and a tax on personal income in 1917 - both temporary measures to finance the First World War.
American history is similar. Although the U.S. introduced taxation earlier - 1913 in the Sixteenth Amendment
- than Canada, the tax was miniscule and was essentially a "class tax." Real taxes came in 1942 following the Japanese attack on Pearl Harbour. In a creative marketing campaign, the U.S. Government ran Disney Animated Shorts featuring Donald Duck praising the importance of "taxes to beat the Axis!" The class tax became a "mass tax."
The universal response to taxation is the continual search for methods of keeping money out of the government's hands. There are really only three ways to minimize tax: Evade, Avoid, Mitigate.
Tax evasion is the reduction of tax through illegal means - usually misrepresentations, concealment and dishonest reporting with criminal intent. Evasion has severe penal and monetary sanctions, as Canadians and Americans who had undisclosed accounts with Union Bank of Switzerland are discovering to their dismay.
Tax avoidance is minimization within the technical legal rules. The difference between evasion and avoidance can be the thickness of a prison wall.
Tax minimization has always been legal. Its scope, however, changes with judicial and societal attitudes. To paraphrase Lord Tomlin in the Duke of Westminster, "Every taxpayer is entitled to arrange his or her affairs to minimize tax." The Westminster principle is the high watermark of judicial tolerance towards tax planning.
Similarly, Justice Learned Hand rejected any theory of public duty to pay more than the law requires: "There is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands; taxes are enforced exactions not voluntary contributions. To demand more in the name of morals is mere cant."
However, social welfare legislation and wars bring heavy demands for revenues.
Tax law is dynamic and can respond. In 1984, the federal government lost a landmark avoidance case (Stubart) as a consequence of some procedural legal bungling and the Department of Finance rewrote the rule book by introducing the General Anti-Avoidance Rule
(GAAR). The new rule moved the goal posts on legal tax planning.
The essence of GAAR is that the government can s rike down "abusive" tax avoidance, even if otherwise in accordance with the law, if a transaction fundamentally undermines and misuses or abuses the policy of the Income Tax Act. The only saving grace is that, unlike normal tax assessments, the burden is on the Minister to establish that the taxpayer's transactions misuse or abuse the statute.
The rule creates considerable uncertainty. Of course, that is what it is intended to do - a yellow flag for tax planners that they may not want to go too close to the edge of the precipice, lest they fall off. What is "too close" to the edge? That is for the lawyer to assess. As Justice Brandeis said: "If you are walking along a precipice, no human being can tell you how near you can go to that precipice without falling over, because you may stumble on a loose stone, you may slip, and go over; but anybody can tell you where you can walk perfectly safely within convenient distance of that precipice."
When enacted, the new rules will require taxpayers to self-identify otherwise legal transactions with a red flag, which, in effect, would say, with characteristic Canadian politeness: "Please audit me." Once again, the government moves the goal posts on taxpayers.
is tax counsel, mediator and arbitrator at Borden Ladner Gervais LLP
and executive director of the CGA Tax Research Centre
at the University of Ottawa.
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