February 14, 2014

The following topic is what I intended to write about this week.  I was certainly not expecting to have to write anything about the budget because it was supposed to be boring.  It certainly was not for me… see my previous note.

W5 Punitive Penalties Story

On Sunday the 9th of February, the CTV news show W5 reported on a case of over 1804 people who were effectively defrauded.  A charlatan, using the business name Financial Arbitragers, effectively told people “you pay me $5k to prepare your taxes, I will get you a full refund of all the income tax you would pay this year.”  Sounds too good to be true?  Of course it is.  The “ingenious plan” was that they would report “business losses” on their tax returns to offset their employment income.  But there was no business, just a crazy guy with a lot of crazy “legal person” theories preparing tax returns for outrageous fees.  But the fraudster made $4.5 million in fees in 2009 alone off of this BS, so he is clearly not stupid…

But people bought it, and now the Canada Revenue Agency (CRA) has applied what are called “gross negligence” penalties against the taxpayers for the years at issue.  Gross negligence penalties start at 50% of the tax owed.  Plus tax and interest, compounding daily.  Ouch! Many of the taxpayers are now facing bankruptcy and are just not able to pay, because the money is spent …

The W5 story took the tack that these people were defrauded (which they were) and therefore victims not offenders who should be punished with gross negligence penalties.  There is a group of these poor people represented by Duane Milot (Milot bio) whom I know and who I know is a good tax lawyer.  He did a great job on the show of advocacy in favour of his clients.  It was great PR for him, and I give him double, no, triple! kudos for having fought his corner well, appearing very sympathetic, and for tossing the “Hail Mary” pass of appealing over the courts and the CRA’s heads to the public.  Given my recent experiences with the press, I think I should ask Duane for lessons on media relations. (and yes I am envious…).

But the reality is that his clients have absolutely no hope of winning.  The problem is that in Canadian tax law, if you have been willfully blind, you are guilty of gross negligence.  The more that the people on the show swore that they just followed their advisors blindly, and did what they were told by their trusted advisors, the more they were burying themselves.

As W5 pointed out, there has been recent case law exactly on point, and the taxpayers have always lost in the Tax Court of Canada (TCC).  In a nutshell, the refunds were too big, and the reasons given to the taxpayers by the fraudsters as to why this would work were too dumb, and the taxpayers’ general behavior too obviously oblivious for the TCC to stomach.  It does not help that when caught, the fraudsters told their victims put in notices of objection that mimicked a lot of the “free man on the land” arguments (e.g. that there is a legal person and a natural person and the natural person does not have to pay tax, or some such nonsense).  FYI, the TCC has certainly heard enough of that crap, and has officially lost its bottle with anyone spouting it.  I can appreciate that the taxpayers in question objected to the reassessment by doing whatever their advisors told them to do…. but the judge lumped them in with a bunch of complete nutjobs, and just threw the book at them.

This does not seem very fair, but as Yoda would have said, in Canadian tax “owe or not owe one does, there is no “fair””.  The law is fairly clear that short of proving that one was mentally incapacitated it is very difficult to prove that there was not some form of willful blindness when sufficient warning signs were there.  As the CRA continually repeats, “if it seems too good to be true, it probably is.“

However, I can understand why the taxpayers believed that they could rely on their “expert tax advisor”.  In recent years there have been a number of these very aggressive schemes come through the system.  In many cases they seem to spread like wildfire, particularly when fraudsters can get their hooks into a religious group.  One of the taxpayers in the W5 story was a pastor of a Filipino church, and a large number of the clients seemed to be of Filipino origin.  I am not saying that any particular group is susceptible to this type of thing, rather that the fraudsters like to get in with religions leaders and elders, because it makes the scheme seem all the more credible.  Having a religions leader “vouch” for the scheme by participating in it just seems to add an extra patina of legitimacy that makes it easier for people in the congregation to fall prey to fraud.

For example, I had a guy phone me up the other day asking for tax advice because he had bought an investment from a senior member of his “congregation” that was certain to go to the moon.  When I asked him why he was certain it would be golden (when it seemed to me to be a fairly obvious scam), he said “the guy who sold it to me is a blah blah blah blah like me.  And we are like family and would never lie to another…” (I presume there is no religious group actually called “blah blah blah blah”, and if there is, no offense intended!).  I think he will lose his money, and he did not want to pay for any proper advice, so, well, screw him.

Also the Federal Court of Appeal  (FCA) just ruled in the Berg case that I blawged about last year. (see link) That case was a scheme based on using “non-recourse debt” to inflate charitable donation tax receipts.  I would be very surprised, given the nature of the charity, if Mr. Berg had not heard about it at his place of worship… At the TCC, the scheme was held to be non-compliant, to say the least.  However, the TCC went against some prior precedent, finding that rather than deny him the entirety of his charitable deduction, it would only deny the non-recourse debt portion.  In effect. Mr. Berg was allowed tax credit for the $300k+ that he actually paid to the charity, but not for the $3m in deductions claimed.  The FCA overturned the TCC and ruled, as it should have, that Mr. Berg gets nothing.  In the FCA’s view, the amount he paid was not a gift and there was no charitable intent, but rather the cash was consideration for the inflated charitable receipt or just the cost of doing “business”.

The upshot of these cases and my anecdotal comments is that just because a wonderful tax-saving scheme is being discussed by leaders/members of a religious organization, that does not make it any more legitimate.  Indeed, if you hear someone talking tax in a house of worship, you should probably run away, or get a proper second opinion from someone outside the faith.  Preferably someone like me who only believes what I can see in the Income Tax Act, at least when it comes to tax.

The second take away is that the CRA is applying gross negligence penalties in a more comprehensive fashion, and winning when they are challenged.