HOW CRA IDENTIFIES ISSUES THAT CONCERN THEM (AND THEN YOU)

You have a better probability of finding Sasquatch than a taxpayer eager to pay more tax (unless you're in Warren Buffett's locale). We hunt for effective tax strategies but our savings reduce what the government collects. Win/lose or lose/win.

Canada Revenue Agency (CRA) interprets the tax laws to identify potential under-payers. If you make the list, they’ll let you know. You can appeal their decisions and ultimately the courts decide who is right. CRA has a huge advantage since few are willing or able to go to court.

INSIDERS

How does CRA operate? Two insiders shared their insights at a CALU technical session last week:

• Susan Gulliver worked at CRA for 36 years — her last 23 in Aggressive Tax Planning. She spent 15 years on the GAAR (General Anti-Avoidance Rule) Committee. She's now a Senior Tax Advisor at PricewaterhouseCoopers.
• Dan Rivet has been at CRA for 17 years. He's on the GAAR Committee. He is the Manager of the GAAR, Inter-Provincial Tax Avoidance and Technical Support Section. How do you fit that on a business card without abbreviations?

I spoke to both briefly. In 2009, I met Donald Bowman, the former Chief Justice of the Tax Court of Canada. I need an autograph book!

Identifying Issues

How does CRA identify the issues which concern them? There are five key ways:

1. requests for rulings
2. conducting regular compliance audits and finding practices of widespread concern
3. attending conferences and seminars
4. reading published articles
5. participating internationally; e.g., in the OECD and the Joint International Tax Shelter Information Centre (JITSIC)

These sources are certainly reasonable. Let’s explore further.

Ruling Requests

If you ask for a ruling, you might change your mind and withdraw your request if you sense the decision might be unfavourable. While ignorance can be better than knowing for certain, CRA does not forget. Withdrawn requests go to the GAAR Committee for review. Lesson: If you'd rather not know, don't ask.

Ruling requests could be misused. Apple and Samsung are busy suing each other and already have 21 lawsuits pending around the world. Let’s turn to tax strategies. Suppose your company is a laggard losing sales to competitors or a leader staving off competition. Maybe you could get request a ruling anonymously (e.g., through a lawyer?) and withdraw your request to trigger a GAAR review. That’s nasty but might work, if structured properly.

Public Sources

CRA has been accused of not understanding industry practices, violating the 5th habit of the highly effective: seek first to understand and then to be understood.

Professionals require continuing education credits to maintain their designations (100 hours every two years for actuaries). Why not attend industry conferences and seminars? CRA staff are doing that and reading articles. While this may look like snooping, the purpose is to learn.

There are also internal courses. Some advanced courses are taught by outside instructors who don't have biases or conflicts of interest. That’s ideal. If you rely on financial advice from commissioned salespeople, be wary (e.g., read the wealthy reveal how their advisors fail them).

Outcome

We might not like what CRA does but now we have a better understanding of the inner workings. Before using a strategy that looks “too good to be true”, ask yourself how CRA may react (and these 13 questions). Happy tax planning!

Links

• How effective are tax auditors?
• Surviving an audit: two lies and three tips
• Warren Buffett’s very strange tax argument (Forbes, Aug 2011)
• Secret 7: The best tax-sheltering in Canada
• The four steps in wealth management
• Three steps to keeping financially solvent
• Mope, gloat or move: How tax compares by province
• How you comply with the taxman makes all the difference: The Related Party Initiative (Globe and Mail, May 2011)
• The tautology of Canada's GAAR: A tax haven for uncertainty
• Sharon Gulliver (PWC website)
• image courtesy of Kamil Dratwa (Poland)

Podcast 141 (5:23)

direct download | Internet Archive page | iTunes

PS Has your opinion of CRA changed over the years?

THE RBC CANADIAN OPEN AND UNINTENDED CONSEQUENCES

Actions have unintended side effects.

We're not talking about a butterfly across the ocean causing a storm just after you wash you car. The causality is hard to show and the effects are minor.  Instead, think of beavers. They use renewable resources to build nice homes with swimming pools. They're happy but they flood land above their dams and send less water downstream.

Golf

The RBC Canadian Open is making golf fans happy and stimulating the Toronto economy. What's the effect on the residential neighbourhood surrounding St. George's Golf and Country Club?

We live inside the No Parking blue zone but not in the smaller Local Traffic Only zone. A portion of Islington Avenue, a major road, is closed from July 12-30. The detours are putting more traffic on other streets like The Kingsway, Kipling and Eglington.

We're still getting city services like garbage collection. Traffic isn't bad enough to require the police to direct it. Drivers aren't honking their horns in frustration. Life is fairly normal.


Here are three externalities

• cars park just outside the No Parking zone
• the MetLife blimp in the skies is more intrusive than the satellite view in Google Maps but they're probably not recording activities in our yard (aside: my first fulltime job was with MetLife)
• some neighbours are renting parking on their driveways and lawns for $20 to (gulp) $50, depending on the day and location. The official parking is at the distant Woodbine Racetrack with yellow school buses as shuttles. No air conditioning.

Overall, the event looks well-organized. Planning started three years ago. The disruptions are limited because of school holidays and summer vacations. Other neighbours may feel differently depending on where they live. Some businesses may have extra customers. 

Win/Lose

Other activities may have greater externalities. Let's look at some.
Down the street, a neighbour feeds racoons. This makes her happy but they damage and defecate on nearby lawns. Logic doesn't work well with animal lovers who ignore these consequences

Our Costco started selling gasoline last month: premium fuel is about the price that other gas stations charge for regular. The regular gas stations are probably losing business.

Drivers with radar detectors zip faster with impunity. This encourages other drivers to speed too … but they're more likely to get caught.
Some people engage in dangerous sports and endanger the lives of the rescue crews.

Addictions like drinking, smoking and gambling may give participants satisfaction (at least in the beginning) but there are huge consequences for families and society overall. Car accidents. Second-hand smoke. Bankruptcy and crime.

The tax-free underground economy helps participants but honest taxpayers make up the lost revenue. We benefit when tax auditors catch the culprits but about 50% the audits found no unreported income.

There's also the Planet of the Apes series. Depending on movie, apes are slaves to humans or vice versa. That's win/lose too.

Inducements

Businesses take steps to induce behaviour. McDonalds is selling any size of soft drink for $1. That's cheaper than water. However, those buying the largest sizes and conditioning their bodies to consume them are inflicting harm on themselves.

Governments take steps to induce taxpayers to act in ways that benefit society. Some incentives create tax savings for a few, which shifts the tax burden to the masses. To limit these side effect, governments take steps to limit the size of the benefits. That helps maintain tax revenue. Here are common tax saving tools.

• RRSPs: caps on deposits  and tax on withdrawals
• TFSA (Tax-Free Savings Account): limits on deposits but tax-free withdrawals
• investment loans: limits on interest deductibility based on the investments made

Unblocking The Restrictions

Hybrid technology improves fuel economy, but can boost performance instead. It's unlikely that Porsche and BMW are striving to beat the fuel efficiency of the Prius.

On the financial side, the wealthy say they most want tax advice and income tax strategy (67%). They expect frequent, proactive advice and aggressive recommendations. The right advisor can propose creative strategies and --- more important --- implement them effectively.

For instance, life insurance has unique tax advantages. Deposits are capped by the Maximum Tax Actuarial Reserve (MTAR) but you can deposit more by simply buying more insurance. Withdrawals are taxable but the savings can be accessed via tax-free loans. Tax deductions arise when the loan proceeds are invested. In some cases, a portion of the premium can be made tax deductible too.

There are probably other tools with effective tax strategies too.

When there are side effects, why not join the winners? You can. Even if you live near a golf course.

Links

• Bonding with nongolfers (includes comedy)
• How effective are tax auditors?
• Ways you want your advisors to improve
• The original and overlooked Tax-Free Savings Account (TFSA)
• Secret 7: The best tax sheltering in Canada
• The four steps in wealth management

Podcast Episode 76 (6:09)

direct download | Internet Archive page

PS Today looks like a great day for golf

HOW EFFECTIVE ARE TAX AUDITORS?

No one wants to get audited. Not even the tax auditors. But they get audited too.

The Auditor General, Sheila Fraser, looked at how the Canada Revenue Agency (CRA) audits Small and Medium Enterprises (SMEs). Despite 5,600 staff focusing on these businesses, earlier problems remain. As taxpayers, we want compliance with the rules to ease our tax burdens, which vary considerably by province, especially for entrepreneurs.

We're talking about big dollars. The CRA estimates there aren't many tax cheaters but those abusers cost us plenty. About $12.7 billion in unpaid tax according to their 2006-07 Annual Report. Of that, about $2.5 billion relates to SMEs.

Overall, the Canada Revenue Agency (the Agency) has made unsatisfactory progress in addressing the recommendations we selected from our previous reports for follow-up.

--- Auditor General, March 2009 Status Report

Sheila found the "taxman" fares poorly in

• taxing the underground cash economy (targeted by 1,000 CRA staff): "about half of its underground economy audits over the past five years did not detect unreported income"
• auditing too many low-risk files

Auditing The Wrong Files

The CRA "has difficulty demonstrating that it is selecting and auditing small and medium enterprises of high risk or priority."

--- Auditor General, March 2009 Status Report

The CRA uses computerized risk assessment to classify tax returns by the potential tax recovery into four categories from low to high. That makes sense.

However, the CRA focuses on low-risk files where they expect a $0 tax recovery. This is like targeting drivers going 0-10 above the speed limit but ignoring drivers zooming past at 50+.

In the last two fiscal years, the CRA audited 87,000 SMEs. Of these, 13% were tagged as high-risk and brought in 41% of the total tax recoveries. However, 56% of the audits were on zero or low-risk files and brought in 39% of the total tax recoveries.

"Available auditors may lack the experience necessary to do complex high-risk files and therefore audit lower-risk files."

--- Auditor General, March 2009 Status Report

What's going on? Among other explanations, CRA says their auditors are better suited to doing low risk audits. Also, audits do turn up problems even where tax recoveries are low. This is like a "broken windows" approach: tackle minor crimes like speeding and littering to prevent bigger crimes.

The CRA does not know why high-risk files bypass audits because the human screeners who make the ultimate decisions aren't required to document their reasons. Screeners favour their own judgement over computerized risk assessments. Human judgement leads to inconsistencies.

The Right Staff
During the Tax Roundtable in the 2008 CALU conference, a CRA official reported difficulties filling two senior vacancies in the Ontario audit unit. Why? The pay scale starts at $40,973 and caps out at $110,779. The private sector pays better. Also, tax auditors would rank among the least prestigious professions. Want proof?

At a party, announce that you're an actuary and people will leave you for fear of boredom. Say you're a tax auditor and watch them bolt even faster and go further away.

Cheaters

The study found that most people know little about the implications of tax cheating, and concluded that more communication would encourage better compliance.

--- 2007 public opinion research by the CRA

Honest taxpayers suffer. Cheaters prosper and encourage others to follow. Until they're caught. Let's see what happens.

Links

• Auditing Small and Medium Enterprises by Canada Revenue Agency (Auditor General, March 2009 | 40 page PDF)
• 2009 Auditor General's Reports Released (KPMG)
• Biography of Auditor General Sheila Fraser (about.com)
• Mope, Gloat or Move: How tax compares by province
• Surviving an audit: two lies and three tips
• photo courtesy of Adam Ciesielski (Capetown, South Africa)

Podcast Episode 37 (5:45)

direct download | Internet Archive page

Three Steps To Keeping Financially Solvent

It is hard for us without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.

--- Joseph Cassano of AIG on their credit default swap business (Aug 2007)

Well, a house of cards was never built for shock
You could blow it down in any kind of weather.
--- Dire Straits, Solid Rock

Julie Dickson addressed a sold-out audience at the Actuaries' Club of Toronto this week. She's the Superintendent of Canada's most important regulator, the Office of the Superintendent of Financial Institutions (OSFI). Her remarks were informative, interesting and have relevance for you. OSFI oversees the federally-regulated banks, trust companies, insurance companies and pension plans.

Julie was accompanied by my first actuarial boss, Stuart Wason, now a Senior Director at OSFI. We haven't met in years. During my summer job at Crown Life, I learned plenty from Stuart and Henry Essert. They inspired me to pursue my actuarial career. I'm in their debt and haven't thanked them enough.

Offend the tax department and you can appeal all the way to the Supreme Court. Offend OSFI and your company risks swift intervention. Don't expect much sympathy either.

Actuaries would be well served to sit up and take notice of the speed at which risk management expectations are changing.

--- Julie Dickson

OSFI's mandate is solvency: ensuring that financial institutions have enough capital to weather financial storms. How? By predicting the unthinkable, setting high standards, and intervening early. This process works wells in protecting the public and the politicians. Here only one financial services company cuts dividends (but they cut them in half).

You can protect your own financial solvency as you follow the four steps in wealth management. Let's look at three ways

1. predict the unthinkable
2. follow high standards
3. forget bailouts

Predict The Unthinkable

Your challenge as actuaries is to learn from the past but like your motto says, you need to "see beyond risk".

--- Julie Dickson

We underestimate risk, especially during periods of stability. Also, we fear the wrong risks. So we don't prepare for storms and get shocked when the tide reminds us that our castle was made of sand.

We can't predict and prepare for every disaster but we still benefit from planning.

We can look at different "what if" scenarios, especially the bad ones we like to ignore.

1. Suppose a car accident confines you to a wheelchair for life. What happens to your savings, your ability to work and your future earnings?
2. Suppose you're forced to retire five years early due to a layoff or ill health. What happens to your retirement income?
3. Suppose you live an extra 10 years or earn lower returns after tax and inflation. Would your money last?

You can examine your current and projected financial situation more regularly with your financial advisor. Ideally one who know how to stress-test your plans. Maybe you're following simple "rules of thumb". Changing conditions can make them obsolete. In Dumb Money, Daniel Gross identifies four simple but incorrect assumptions that leading to the financial crisis in the US.

Yes, we can over-prepare but we're more likely to do too little.

Follow High Standards

Life is going to be more challenging for "experts", and a premium will be placed on how well you can explain such things as actuarial reserves and capital.

--- Julie Dickson

Raise the bar on your risk management. Picking better quality investments does dampen the returns (the perennial risk vs reward quandary) but the chances of potential problems drops too. Diversification helps diminish risk too.

Canada trusts actuaries to apply principles, which requires judgement. The US prefers rules, which makes compliance easier to monitor. Since rules don't change quickly, companies can follow the letter of the law without following the spirit.

Forget Bailouts

You can take on extra risk if you've got someone to bail you out. Maybe you've got a kind rich aunt. The financial sector turns to us taxpayers. Without market discipline, companies can take undue risks with impunity. That's where we rely on the regulators.

We face four key financial risks: outliving your savings, dying too soon, getting sick and getting disabled. What are you doing about them now while you can? You are your own regulator (unless you have a spouse).

Links

• The dangers of visiting OSFI's website
• Text of Superintendent Julie Dickson's speech (PDF | Sept 23, 2009)
• OSFI website
• Only one Canadian financial services company cuts dividends (Reuters, Sep 24, 2009)
• Fearing the Wrong Risks (with examples)
• Finance Minister Jim Flaherty on the Economy and Financial Literacy
• Keeping Promises: Do you care about Corporate Governance scores?
• Our four key financial risks
• The four steps in wealth management
• photo courtesy of Simon Bond

Podcast (6:10)

direct link | Internet Archive page