The history of tax shelters is rife with abuse and misuse. Even the government seems finally to realize this.
Year-end is the heaviest promotion period for tax shelters, including a current favorite, TV and film production service tax shelters. Promoters claim their schemes deliver great tax advantages, and investors believe they've found the deal of a lifetime.
It's no secret, however, that the federal government has never really liked tax shelters of this type. The Canada Revenue Agency (CRA) has always tried to limit revenue leaks caused by the robust marketing of these schemes.
This rear-guard action was justified not only by the government's desire to save money but also on the grounds of protecting the public. Shelters may comply with the word of the Income Tax Act but skirt its meaning by generating investor returns limited to the taxes saved.
Some tax shelters have been so aggressive in presenting themselves as CRA-approved that they virtually invited a CRA crackdown.
Among the most questionable shelters were those set up to fund research and development of computer software, or buy inexpensive works of art which were then flipped at higher appraised values as a fundraiser for charities.
CRA effectively shut these down when it discovered that, while investors were deferring a great deal of tax to fund these schemes, very little software was being produced and little money was being raised for charity. Shelter promoters, on the other hand, were getting very rich.
According to CRA, a tax shelter is any property for which, within 4 years of its purchase, the promoter says an investor can claim deductions or receive benefits which equal or exceed the amount invested.
CRA warns potential investors to be suspicious of any tax shelter promotion in which their expected return in the first few years would come mainly from projected tax refunds.
CRA has consistently alerted investors that shelters which do not meet certain standards would be rejected after the fact. The investor is then liable for back taxes, along with interest and possible penalties, on claimed losses.
Criteria used to alert would-be investors of CRA's probable rejection of tax-shelter status are:
- No real business activity being carried on
- No reasonable expectation of profit
- Assets overvalued, and expenses inflated or unreasonably high
- Losses for tax purposes exceed the amount of investment actually at risk
- Promoter's verbal assurances of income tax consequences differ from, or are not confirmed by, professional opinions contained in the investment documents
If CRA finds any of the above conditions exist, all or part of the losses claimed by investors may be disallowed.
While CRA may provide an advance tax ruling on portions of these transactions, as well as issue a tax shelter registration number, it does not rule on issues such as the existence of a business, reasonable expectation of profit, and fair market value of a property or service.
Furthermore, the mere claim of a tax shelter usually generates a CRA review of the shelter.
Now the government is signaling that one of the last remaining popular tax shelters is about to bite the dust. The TV and film production service tax shelter, that, in the past, attracted $2.7 billion in investment funds, may have completely disappeared. The only remaining shelter still standing is natural resource flow-through shares.
On CRA’s website, last modified on November 28, 2007, CRA recommends that anyone considering entering into a tax shelter arrangement should obtain independent professional advice from a tax advisor before signing any documents.
In addition, you should know who you are dealing with:
- Request and carefully read the prospectus or offering memorandum and any other documents available in respect of the investment.
- Pay particular attention to any statements or professional opinions in the documents that explain the income tax consequences of the investment. Often, these opinions will tell the investor about the problems that can be expected and suggest that the investor obtain independent legal advice.
- Don't rely on verbal assurances from the promoter or others - get them in writing.
- Ask the promoter for a copy of any advance income tax ruling provided by the CRA in respect of the investment. Read the ruling given and any exceptions in it.