The Regularization of Undeclared Assets May Soon be Changing SO DO IT NOW OR FACE CONSEQUENCES!

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Confess your tax sins!

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Absolution now!

INTRODUCTION

The Canadian Voluntary Disclosures Program (the “VDP”) is aimed at providing Canadian taxpayers with a second chance to correct their tax affairs. Administered by the Canada Revenue Agency (the “CRA”), the VDP encourages taxpayers to come forward to correct inaccurate or incomplete tax information, or to disclose information regarding income not previously reported. Taxpayers who make a valid disclosure currently only have to pay the taxes due on the unreported income, plus the interest, and are not assessed penalty nor prosecuted.  Moreover, limited interest relief is available, depending on the circumstances.[1] This may be soon changing though. June of this year the CRA produced a draft information circular for discussion outlining dramatic changes to the VDP which are anticipated to come into effect on 1 January 2018.  These changes will narrow the eligibility of those who may apply to the VDP as well as imposing additional conditions and requirements on any applicants who apply after the new year.

While authority for the VDP is currently granted by an express provision of the Income Tax Act (the “Act”),[2] relief is generally granted at the discretion of the CRA. While a taxpayer may apply for judicial review of the CRA’s decision in VDP matters, the practical reality is that the Federal Court is reticent to overturn the CRA’s decision in these matters and therefore the CRA is effectively the final decision maker in the overwhelming number of VDP applications. The CRA has published documents, including an information circular, that provides information that may assist taxpayers in determining whether relief under the VDP may be granted in their particular set of circumstances.[3] They have also produced a draft information circular showing what the programme would look like and how it would function if the proposed changes were implemented.

OVERVIEW OF THE CURRENT VDP

A disclosure must satisfy both the statutory requirements and the four conditions for validity for the CRA to approve it and to waive all applicable penalties. There are also a number of situation where a taxpayer may be excluded from the VDP based on policy considerations.  Each of these will be reviewed in turn.

Statutory Requirements

In order to be eligible for relief under the VDP, the following statutory requirements must be satisfied:

  1. the applicant must be a “taxpayer”, which includes individuals, corporations, trusts and, for the purposes of the VDP, partnerships, regardless of whether the taxpayer is liable or not for tax;[4] and
  2. the application for relief must be made within 10 calendar years from the end of the year in respect of which the taxpayer is seeking relief (e.g., if an application for relief under the VDP was made on March 1, 2017, relief is only available in respect of the 2007 and subsequent taxation years).[5]

Four Conditions

Furthermore, in order for the CRA to consider a voluntary disclosure made under the VDP to be valid, it must satisfy each of the following four conditions:[6]

  1. the disclosure is made voluntarily;
  2. the disclosure is complete;
  3. the disclosure involves the application or the potential application of a penalty; and
  4. the disclosure includes information that is: (i) at least one year past due, or (ii) less than one year past due and is in respect of a previously filed return that contains information that is at least one year past due.

Matters Excluded from the VDP

There are limited circumstances under which the CRA will not consider granting relief under the VDP, regardless of whether the disclosure meets the four conditions for validity outlined above. These circumstances include disclosures in respect of: [7]

  1. income tax returns where no taxes are owing or a refund is expected
  2. provisions under the Tax Act that permit taxpayers to elect specific tax treatment
  3. advance pricing arrangements
  4. rollover provisions, which allow a taxpayer to defer income that would otherwise arise on the transfer of property to a taxable Canadian corporation (e.g., section 85 of the Tax Act)
  5. returns that must be filed in the year of bankruptcy, and (vi) post-assessment requests for penalty or interest relief.

Named vs. No-Names Disclosures

A taxpayer has the choice of making a “named” disclosure or a “no-names” disclosure.  In a named disclosure, the identity of the taxpayer is revealed to the CRA in the initial submission requesting relief under the VDP. The taxpayer then has 90 days from the effective date of disclosure (the date that the CRA receives the initial disclosure) to provide a full and complete disclosure.[8] In a no-names disclosure, the taxpayer has 90 days from the effective date of disclosure to disclose their identity and provide a full and complete disclosure. A no-names disclosure is advantageous because it allows a taxpayer to discuss its situation with a VDP officer and gain a better understanding of the CRA’s position on the potential viability of relief under the VDP – and  the implications if the taxpayer’s disclosure is rejected – without the taxpayer having to reveal his or her identity.

However, the CRA considers that discussions on a no-names basis with a VDP officer are non-binding.[9] Therefore, a taxpayer must eventually identify him or herself in order to receive a final determination from the CRA as to whether the disclosure is a valid voluntary disclosure and entitled to the benefits under the VDP.

Stages of a No-Names Disclosure

The first stage is to prepare an initial disclosure letter to the CRA setting out the facts and circumstances in a generic manner.  No identifying information is provided to the CRA. Taxpayers are only required to provide a general explanation (such as “I have $125,000 of unreported assets in a bank account in the British Virgin Islands”), as well as their age and the first three digits of their postal code so that the CRA can assign the file to the appropriate regional office. Once the CRA receives the initial disclosure (whether named or no-names) the tax payer is protected – as long as the disclosure is eventually accepted. If the CRA discovered you have unreported assets the day after they receive the disclosure, these are still protected under the VDP as long as the disclosure is not invalid for one of the policy reasons stated above.  According to the CRA website, they will then respond within 30 days to indicate if the submission is generally acceptable pending full disclosure, however it can take the CRA longer at certain times of year given their workload. At that time discussions may be had with the VDP officer on the file to determine if there is likely to be an issue going forward or not.

If there is no issue, the taxpayer will generally have 90 days from the initial disclosure, and at least 60 days from the CRA’s response, to make the full disclosure, including filing detailed financial reports illustrating the asset, any income earned (or lost), where it is, and other pertinent information. Up until the time of the full disclosure, the CRA is not aware of any of the taxpayers contact information and will not be able to identify the taxpayer or determine the location of any funds at issue. However if the CRA happens to discover the unreported income some other way the taxpayer is still protected by the VDP previously filed.

It is important to note that the above process describes the CRA’s current stated policy. However, the CRA is currently overwhelmed and is often unable to respond in a timely manner to VDP requests. The reality is that it may take several months until the tax payer receives even an acknowledgement that the CRA has received the disclosure.

This initial “thanks, we received it” letter informs the taxpayer’s counsel that once an officer is assigned to the case, the CRA will send a second so-called “90-day letter” and only at that point will the 90-day clock to complete the disclosure will start. Although the wait times for both letters are becoming shorter, the CRA voluntary disclosures office seems to have virtually shut down from the end of April until mid-September for the past several years and filing during this time can delay the process even further.

Payment of amounts owing

The CRA expects that a taxpayer will pay any amount of tax and interest owing at the time a voluntary disclosure is finalized. As a result we have found that is it better to send a cheque with the complete disclosure in order to show the CRA officer on the file that the taxpayer has a bona fides wish to resolve the matter. Once the disclosure is finalized though the taxpayer is required to pay the remainder of the tax owing (if any), any applicable interest that has accumulated (usually at the rate of half the regular interest charges the taxpayer would face if he or she were simply caught hiding the assets) as the CRA has calculated them. If the taxpayer refuses the assets and income will be deemed to be unreported, and the VDP programme no longer protects the taxpayer. The result is the tax owing, plus full interest, plus penalties, plus theoretical jail time, although this is exceedingly rare.

PROPOSED AMENDMENTS TO THE VDP

The amendments proposed in the draft information circular are quite drastic, and significantly narrow the scope of the VDP. The most notable change to the VDP will be the implementation of to streams of assessment under the “General Programme” and the “Limited Programme”. There are also increased conditions required by the CRA and an more types of exclusions based on policy conditions.

General Programme

Under the General Programme taxpayers who meet the two statutory requirements, the four CRA conditions, and who are not excluded by any policy conditions, and whose applications are accepted will not be charged any penalties and will not face any jail time resulting from the prosecution of the unreported income. The taxpayers under this programme may also be entitled to partial interest relief, as under the old programme, however this is by no means guaranteed.  The partial interest relief provision will also be limited in what years it applies to. Under the current VDP partial interest relief applied to the entire period under review (up to the passed ten years). Under the proposed amendments the partial interest relief may be granted in respect of assessments preceding the three most recent years, with the three most recent years being assessed full interest.

Limited Programme

The harsher of the two streams of assessment is the Limited Programme.  This programme will deal with any VDP applications which disclose “major non-compliance”, and will treat the non-compliant taxpayer less favourably than the General Programme.  Under this stream taxpayers who voluntarily disclose their tax situation will not be referred for criminal prosecution and will not face jail time, and will not be charged “gross negligence penalties” however all other penalties, interest charges will apply as if the CRA had discovered the non-compliance in another manner. This means that no interest at all will be waived. And the CRA plans to define “major non-compliance” broadly, including:

  1. “active efforts to avoid detection through the use of offshore vehicles or other means;
  2. large dollar amounts;
  3. multiple years of non-compliance;
  4. a sophisticated taxpayer;
  5. the disclosure is made after an official CRA statement regarding its intended focus of compliance or following CRA correspondence or campaigns; and
  6. any other circumstance in which a high degree of taxpayer culpability contributed to the failure to comply.”[10]

As the information circular is silent on exactly how the CRA intends to determine whether a VDP meets these categories or not the taxpayer is left with less certainty until after the time in which he or she has made at least a partial disclosure.

Additional Condition

While the current four conditions described above (voluntariness, completeness, inclusion of a potential penalty, and at least one year passed due) would continue to exist for the CRA to provide relief under the new VDP, an important fifth condition has been included in the proposed new version: the payment of the estimated tax owing. This is a fundamental change to the list of conditions as payment will now be required prior to the relief being granted. As a result the taxpayer will have the added risk of having to pay the estimated tax owing, without knowing whether he or she will be approved. While the information circular is silent on this, if the taxpayer is eventually not approved we don’t anticipate the CRA would be willing to return the original payment to the taxpayer as there would be a high degree of certainty that the CRA is owed this money.

Additional Exclusions

The group of experts who developed the proposed amendments to the VDP have also proposed several additional exclusions to the VDP based on policy considerations:

  1. applications that deal with transfer pricing;
  2. applications involving corporations with gross revenue exceeding $250 million; and
  3. applications that involve income stemming from the proceeds of crime.

While the exclusion of applications involving the proceeds of crime is likely in the public interest (and frankly somewhat surprising that it was not excluded under the current programme), the other two exclusions are more complex. Whether it is in the public interest for taxpayers falling into these two categories to be encouraged to come forward and be given an incentive for disclosing unreported income, there is also an argument to be made for holding them to a higher standard due to their sophistication and access to resources thereby allowing them to seek the advice of counsel. In any event though these groups will not be excluded under the new VDP programme.

Other Changes

Several other changes are anticipated to the VDP. The amendments foresee the VDP dealing solely with income tax matters, and separate programmes being established to deal with GST and HST matters. The proposed VDP will also change the way that interest is calculated, in favour of the CRA. Finally the new VDP will provide avenues for the CRA to cancel any relief granted to a taxpayer under the programme if it is subsequently discovered that the taxpayer wilfully made a misrepresentation on their application or otherwise used deceit when asking for relief under the VDP.

What This Means for People Considering the VDP

The working group which developed the amendments did so with an aim to improving the VDP to make it more fair and efficient. They “recommended the continuation of the VDP but proposed to tighten the criteria for acceptance into the program… to finding the right balance to ensure tax fairness for all Canadians.” As a result obtaining relief under the programme will soon become harder, and the relief obtained under the VDP will be less than it currently is. If an initial disclosure is received by the CRA after 1 January 2018, all of the new provision will almost certainly come into place, and the monetary cost of this could be quite sizeable.

CONCLUSIONS

The VDP is a generous programme that allows non-compliant Canadians an avenue to regularize assets and income without facing the harsh interest, penalties, and prosecution that could stem from the CRA discovering the non-compliance in another manner. The current VDP is relatively simple and straight forward.  There are two statutory requirements, and four CRA conditions, to receiving relief under the programme.  Under the current programme an applicant can expect to pay taxes as appropriate, but partial interest on those taxes, associated penalties, and the threat of prosecution, are all waived. The proposed amendments to the VDP, if implemented, will result in sweeping changes to the VDP which are not favourable to the taxpayer.  The most significant amendment to the VDP though will be the categorization of applicants into two streams: the General Programme and the Limited Programme.  The relief available under the Limited Programme category will be severely curtailed.  Consequently, there is no benefit to wait to file a VDP; if you have undisclosed assets, are at all unsure about your level of compliance with Canadian tax law, speak to a tax lawyer today. Filing a VDP after 1 January 2018  will therefore almost certainly result in a penalty that is much harsher and much costlier than if the VDP had been filed this year.  The math and the law are simple: the longer you wait, the more you will have to pay.

By Jonathan N. Garbutt and Barrister & Solicitor and Joshua Wasylciw, Student-at-Law.

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This Blawg is provided on a “For your information” basis only, and is not intended as, does not constitute and should not be seen as legal advice with regard to tax or family law matters.

[1] Information Circular IC00-1R4, Voluntary Disclosures Program at paragraph 12[IC].

[2] R.S.C. 1985, c. 1 (5th Supp.), as amended, at subsection 220(3.1).

[3] IC, supra note 1.

[4] Ibid at paragraph 2.

[5] Ibid at paragraph 13; see also Bozzer v Canada (2011 FCA 186).

[6] IC, supra note 1 at paragraphs 31-42.

[7] Ibid at paragraph 19.

[8] Ibid at paragraph 25.

[9] Ibid at paragraph 26.

[10] http://www.mondaq.com/canada/x/608042/sales+taxes+VAT+GST/CRA+Announces+Proposed+Changes+To+The+Voluntary+Disclosure+Program