Our system of taxation in Canada is such that residents of Canada are taxable on their worldwide income and the Income Tax Act governs what comprises that income and what expenses may be claimed. Our system is one of self reporting, where taxpayers are responsible for completing and filing accurate returns on a timely basis. Although many people feel that when they receive a notice of assessment from the Canada Revenue Agency (CRA) their returns have been "approved" by the government, this is not necessarily the case. In fact, the notice of assessment simply acknowledges that the CRA has received a return and has assessed it as filed for the time being. The CRA generally does not review tax returns in detail upon original assessment. It has the right under the Income Tax Act to review the return at a later date, within certain timelines.
It appears that the CRA is undertaking new specific initiatives to review some taxpayers' income tax returns and related structures. Those taxpayers have received letters from the CRA indicating that they should review their personal tax returns to ensure that they have been filed properly. It appears that the CRA is targeting taxpayers with rental or business income and those claiming motor vehicle or business use of home expenses. These particular letters do not indicate that the tax returns are being audited by the CRA. They simply advise the taxpayers that they should ensure that things have been reported properly, with T1-ADJ forms attached for taxpayers to notify the CRA of any errors.
The letters also make reference to the Voluntary Disclosure Program (VDP), offered by the CRA to encourage taxpayers to report errors and/or omissions in previous filings. If the conditions under the VDP are met, the CRA will not assess penalties. One of the conditions for such a disclosure is that the CRA must not already have contacted the taxpayer in respect of any of the tax years involved in the disclosure. Whether these random letters sent out now by the CRA will disqualify a subsequent filing under the VDP is not clear.
This initiative appears to be an attempt by the CRA to target a large group of taxpayers with relatively little effort and resources. If taxpayers receiving these letters are confident that their returns have been filed accurately, no action is required. If, however, a taxpayer is concerned about a previous tax filing, regardless of whether he or she has received such a letter or not, that taxpayer should discuss these issues with a Collins Barrow professional advisor.
Another initiative that the CRA is undertaking is the review of trusts. Often, family trusts are used in tax planning strategies to minimize income tax while retaining control over assets. When we structure such trusts for clients, we review in detail the client's situation to ensure that such a structure can be tax effective. If so, we then work with the client's lawyer to ensure that the trust is properly constituted and set up in accordance with the Income Tax Act. In particular, the trust must establish that there is certainty of intention, certainty of subject matter and certainty of object. Beyond those primary requirements, proper accounting records must be maintained and proper legal documents are required as evidence of decisions made annually by the trustees. Trustees also must ensure that income tax returns are filed each year and that the rules in the Income Tax Act have been complied with.
Generally, one does not want a trust that has been set up during one's lifetime to have income taxed in the trust, as all of that income would be taxed at the highest marginal tax rate. Consequently, any such income must be paid out of the trust to a beneficiary during the year or must be payable to a specific beneficiary. The CRA has strict interpretations as to what is considered payable, and legal documents must be in place prior to the end of the year to meet these requirements. Income earned by trusts that are created by will is subject to the same marginal income tax rates as apply to individuals. As a result, it is generally preferable for such income to be taxed in the trust rather than in the beneficiary's hands. Again, several rules must be met to allow this to happen. These are just a few of the concerns that must be considered when administering trusts; there are many more issues to be addressed.
It appears that the CRA intends to review such structures and likely will be looking to ensure that the initial structuring of the trust was sound and that the requirements under the Income Tax Act are followed. It is important for trustees to ensure they understand what is required and that all of their books and records for any trust structures are complete and ready for the CRA to review.
Contact your Collins Barrow advisor to find out more about these CRA initiatives.
Karen Sands, CA, is a Tax Partner in the Kingston and Brockville, Ontario offices of Collins Barrow.
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