Tax advisors face tough new rules

If you use a professional tax advisor to help prepare your return, you should know that he or she is now under government scrutiny as never before. The result may be a more conservative approach to tax advice in some cases.

The Canadian tax system is based on the principle of self-assessment-which means that taxpayers are themselves responsible for filing their income tax returns accurately, honestly and on time. A significant change occurred in June 2000, with the enactment of civil penalties for third parties who counsel others to file their returns based on false or misleading information.

According to Canada Customs and Revenue Agency’s (CCRA’s) Information Circular (IC) 01-1, the objective of the third party civil penalties is to “deter third parties from making false statements or omissions to income tax or GST/HST matters. The penalties are directed at ensuring tax compliance and deterring inappropriate behaviour.”

Focus on false statements
The IC outlines principles of application of the new rules, recognizing that CCRA benefits from a co-operative relationship with professional advisors, who have a responsibility to act in the bt interests of their clients, including the right to minimize tax liabilities within the scope of the law.  Therefore, these penalties will be applied fairly, consistently and only when justified.

The legislation is intended to focus on those tax return preparers and advisors who counsel or assist others in the making of false statements, or who knowingly include errors in the reporting of income and expenses. 

It is not intended to impede professionals in their day to day business operations or penalize individuals for honest errors. Nor is it intended to create additional verification work for the professional.

As well, individual employees will not be held responsible, under the third-party penalties, while directly engaging in the business of a professional firm.  This policy will also apply to those employees of groups that have consolidated their tax or accounting in one of the members of their organization, but not to individuals that are more than 10 per cent shareholders of the company or corporation. 

Applies after June 29, 2000
The Penalty provisions apply to false statements made after June 29, 2000. CCRA is not bound by a specific time limit in which to assess the penalties. 

There is little expectation on the part of CCRA that many professionals will be faced with a third-party penalty assessment, as it is felt that substantially all professionals act responsibly.  To provide guidance in the application of the new rules, the following principles have been established: 

The Legislation is:

    1. Intended to apply to tax shelter and tax shelter-like arrangements that contain false statements, often without the knowledge of the client and may be defective because of overvaluations of property, excessive or inflated costs, or lack of actual or intended business activity.

    2. Intended to apply to those advisors, tax return preparers and promoters who make (or participate in making) false statements knowingly or in circumstances amount to “culpable conduct”.  According to CCRA this behavior goes beyond the bounds of the law resulting in an under-reporting of tax payable or overstating of refunds or rebates claimed. 

What is ‘culpable conduct’?
Culpable conduct singled out under this provision will include conduct, whether an act or failure to act, that:

  • Is tantamount to intentional conduct
  • Shows an indifference as to whether the Act is complied with or
  • Shows a willful, reckless or wanton disregard for the law.
Financial planners who act as “tax advisors” or “tax preparers” can also be implicated by virtue of their participation in culpable conduct.  Participation includes activities that:
  • Cause a subordinate to act or omit information
  • To know of, and not make a reasonable attempt to prevent, the participation by a subordinate in an act or an omission of information. 

A subordinate for these purposes includes:

  • Any other person over whose activities the particular person has direction, supervision or control, be this an employee of the particular person or of another person.

Protection provisions
However, subsection 163.2(15) will offer special protection to employees of persons engaging in such conduct.  It is therefore important for all persons in a tax practice to know how far they can go in offering communications about tax law and how to communicate effectively in ensuring there is no omission of information. 

In addition, “planning activities” include the following:

  • Organizing, creating or assisting in the organization or creation of an arrangement, entity, plan or scheme and
  • Participation, directly or indirectly in the selling of an interest in or the promotion of an arrangement, entity, plan, property or scheme.
  • Anything done by the person in determining the value of a property or service.

Honest mistakes

  • The law also applies to those who are willfully blind to obvious “errors” when preparing, filing or assisting a taxpayer filing a tax return.

  • This includes the application of the law to estate freezes, rollovers, reorganizations, amalgamations and owner/manager remuneration. 

Such provisions will not fall offside as long as they do not contain false statements made knowingly or with culpable conduct.   

  • The law will not penalize those who have made honest mistakes, oversights and errors in judgement. 

The IC states that evidence concerning conduct will be gathered to determine when the error with made in good faith or in bad, or with a willful, reckless or wanton disregard for the law.

Case law references
Case law will be referred to in determining whether uncertainty exists. The penalty provisions will not be applied to honest differences of opinion on traditional sources of disagreement such as the following, unless a position is taken that is clearly contrary to established industry practice, CCRA’s public position or in case law:

  • Capital expenditures vs. repairs
  • Capital gains vs. income
  • Personal vs. business expense determination
  • Taxable status of goods or services for GST/HST purposes

Not intended to create work
The IC states that the law is not intended to create work additional audit or verification for accountants and lawyers conducting affairs in accordance with professional standards. Further, advisors and tax return preparers are entitled to rely in good faith on information provided by a client or someone acting on the client’s behalf, if the information is not obviously incorrect, misleading or contradictory to other information.  

But this reliance in good faith will not apply to a person who is also selling or promoting tax shelters or tax shelter-like activities, which are defined as “excluded activities.” 

Penalties will not apply to advisors and planners who conduct themselves with honest and responsibility.

Nor is the law intended to apply to activities that are administratively acceptable to CCRA.  Examples of this might include:

  • A bonus paid to the principal shareholder-manager or other key employees to reduce income to fall under the small business deduction limit.

Two types of penalties
According to the IC, there are two types of penalties that planners and tax preparers/advisors could be subject to if their activities fall offside:

    1. The Planner Penalty: which will apply to a person who makes, furnishes, participates in the making of or causes another person to make or furnish a statement that the person knows, or would reasonably be expected to know, is a false statement that could be used for a purpose of the Income Tax Act. 

What is interesting about this penalty is that the person who could use the false statement does not need to be identified.  Therefore, it will apply to tax shelter promoters who hold seminars or presentations to provide information about a tax shelter as well as appraisers and valuators.  

    2. The Tax-related Services Penalty: which will apply to a person who makes or participates in, assents to, or acquiesces in the making of a statement to, by or on behalf of another person with the knowledge that this is a false statement that could be used by or on behalf of another for the purposes of the Income Tax Act.

This would include a tax preparer who prepares a return for a specific taxpayer, and a tax advisor providing tax advice.  Interesting here is the fact that the planner and tax preparer penalties could both apply to the same false statement. 

Assessment factors
Some of the factors that will be considered by CCRA when determining if the penalties should be assessed are:

  • The false statement compromises the integrity of system of taxation by eroding the tax base.
  • Whether the false statement is widespread and/or abusive.
  • Whether the amount of taxes avoided by the taxpayer(s) is significant.
  • Evidence that the advisor or tax return preparer or valuator has made false statements in the past.
  • The advisor’s knowledge of the taxpayers business, financial, and/or personal circumstances.
  • Experience of the advisor or tax return preparer.

However, the burden of proof will rest with CCRA to prove that the third-party provisions apply.  In general the benefit of the doubt must rest with the tax preparer, advisor or valuator.

The third party civil penalties do not seek to impose a higher standard than each individual professions’ code of conduct and ethics.  A disclaimer on the tax return absolving the tax return preparer of responsibility for information received does not waive the application of the penalties.  However, where a person exercises due diligence, third party penalties cannot be applied.

Evelyn Jacks is contributing editor of CARPNews FiftyPlus and President of The Jacks Institute, Canada’s leading trainer of tax professionals.
Methods of exercising due diligence including interview techniques is the subject of The Jacks Institute’s Professional Development course entitled “Documentation and Interview Techniques”.

For more information, or a Free Brochure on educational opportunities from The Jacks Institute:  1-800-30-JACKS. To order her latest bestseller, Jacks on Tax Savings: