Sleep-Easy tax savings

Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.—Judge Learned Hand

Years ago, when our children were young, we took them on a vacation in France. One morning we drove our rented Peugeot to a nearby village in Brittany, where we bought some freshly baked bread at the local boulangerie. As we drove home, the smell of the bread, which was still hot from the oven, filled the car with a delicious aroma. The kids in the back seat were unusually quiet, but we didn’t think much of it. When we got back to the farmhouse, my wife retrieved the bread bag and found herself staring in amazement at a forlorn heel. The rest had been devoured by the kids during the drive. The smell had driven them into a feeding frenzy!

The moral of the story is that it doesn’t matter how much bread you have when you leave the bakery. What counts is how much remains when you get home.

The same is true of your money. Too many people focus on total return, when all that really matters is how much you have to spend once the taxman has eaten his share. As Judge Learned Hand, one of America’s greatest jurists, stated in the above quote, there is nothing unpatriotic about arranging your financial life in a way that will keep your taxes at an absolute minimum.

However, there is a certain irony in Judge Hand’s comment in that it formed part of a ruling against a taxpayer named Evelyn Gregory who in 1928 had used a complex corporate reorganization to reduce her personal income for tax purposes by $10,000. The judge’s landmark ruling against Mrs. Gregory was later upheld by the U.S. Supreme Court, which said in its own ruling that the entire manoeuvre, while legal on the face of it, was “a contrivance” and a “devious form of conveyance masquerading as a corporate reorganization.”

So perhaps to Judge Hand’s comment we should add, “As long you don’t push the envelope too far.” That’s the real message you need to remember if you want to keep the tax people from haunting your dreams. Unfortunately, human nature being what it is, smart promoters are constantly coming up with new schemes for beating the Canada Revenue Agency (CRA). In most cases, the people who get sucked into these deals end up in a pile of trouble.

For example, I constantly receive inquiries from people wanting to know more about so-called charitable organizations that promise big tax receipts for small donations. In some cases, the appeal is made even more enticing by a suggestion that the donated money will be used to reduce famine or combat disease in developing countries—save tax dollars while saving the world!

Based on the anecdotal evidence of the emails I get, numerous organizations are actively soliciting donations from Canadians by appealing to this combination of philanthropy and greed. One example that came to my attention involves donating to an organization that purchases pharmaceutical drugs to be sent to distressed regions of Africa. Through a series of complex financial manoeuvres, the donor ends up with a charitable receipt that significantly exceeds the amount actually contributed.

There are many variations on this idea, involving everything from comic books to art. But the underlying premise is always the same: give a little, deduct a lot.

The Canada Revenue Agency (CRA) has issued several warnings about these charitable tax shelters, but they apparently continue to flourish and draw people in. All I can say is that if you’re tempted, think twice. Thousands of taxpayers have been reassessed for deductions based on receipts from these “charities” and more cases are ongoing as I write.

Some taxpayers have gone to court to fight the CRA’s reassessments, and in at least one case they won what appeared to be a victory. In 1999, the Tax Court of Canada ruled in favour of three investors who filed a claim on behalf of 1,850 people who had donated to an art charity run by CVI Art Management. The scheme involved using donated money to purchase limited-edition prints. These prints were then appraised at higher prices and donated to charitable organizations, which in turn issued receipts based on the appraised values. One of the plaintiffs spent $8,667 for prints that were later donated to a university. He received a tax receipt for $29,400.

When the Tax Court of Canada upheld the plaintiffs’ right to claim the deduction, it appeared to throw open the doors to donate low/claim high charities, and they began springing up across the country. However, in 2005, the Federal Court of Appeal overturned the ruling, saying that the entire transaction lacked credibility (shades of the Gregory case so long ago). Subsequently, in April 2006, the Supreme Court of Canada refused the plaintiffs’ request to appeal, without comment. So the ruling of the Federal Court of Appeal stands.

Despite the Court of Appeal ruling, many of these charity tax shelters continue to claim that their receipts are valid and will be accepted by the CRA. The tax department has repeatedly warned people that this is not the case, stating on its website that amendments to the Income Tax Act limit donations made after 2003 to a maximum of the donor’s out-of-pocket costs.

Nonetheless, variations of these schemes continue to pop up. In an article in the June 2007 issue of Investment Executive, a publication directed at financial advisors, writer David Baines tells of interviewing one Vancouver promoter who claimed to have distributed $700 million worth of pharmaceuticals through a chartable organization in the previous five years. Assuming tax receipts were issued for those amounts, that adds up to a potentially huge revenue loss for Ottawa and the Government of British Columbia. No wonder both the Department of Finance and the CRA have been focusing increased attention on this area of charitable giving.

Sleep-Easy Investing: Your Stress-Free Guide to Financial Success, is published by Viking Canada. To purchase a copy at 37% off the suggested retail price, go here.