It is that time of year when the wealthy turn their minds to cutting their 2012 tax bill. Much like every year, people with considerable income will be presented with a lovely new crop of tax shelter schemes. Many of these schemes are presented as sure-fire, no-risk, brain-dead-easy ways to cut your taxes. Often, these golden opportunities come to taxpayers’ attention via their church, synagogue, mosque, temple, and in some cases even workplace. As a result, the entire affair seems to have an added patina of wholesomeness to it, particularly if the tax savings are combined with an honest-to-goodness charitable intent.

The recently decided case of Berg v The Queen (see link) illustrates that even if you really do have a proper charitable intent, and you do give the money to the charity of your choice (not one of the charities provided by the promoter of the tax shelter scheme) the $1 that actually comes out of your pocket is what you get to claim as a deduction at 29 cents on the dollar. That’s it, and no more. And sometimes not even that much.

The Berg case is an example of a “Charitable Receipt Inflation Scam” or “CHIS” as I call them. In a CHIS, the selling story is always a variant on the following theme: “you donate $1 to your favourite charity and you get a shiny certificate in return saying that the charity values your donation at $10, then you get $2.90 back from the taxman!” The mechanics of this scheme usually require you to pay cash of, say, $1 for something (in Berg it was timeshare units) and then you issue a “promissory note” for $9 (or $99, depending on how aggressive the CHIS is) to pay for the “rest of it” due in say about 25 years. But, “nudge nudge wink wink; say no more and just between you and me”, that debt is not going to be collected. Of course the moronic drones at the CRA will never figure out that the fix is in because we are so clever and they have never seen anything like this before… The Charity gets a contribution, you get your big charitable tax receipt for the inflated value, and the CRA is none the wiser!

Of course, that is not how it plays out because the CRA is aware of and on the look- out for all tax shelters, especially involving registered charities. However, there are things about the Berg case that stand out from the typical CHIS, and merit discussion.

Mr. Berg was no fool, and he wanted to make sure the sponsor of the scheme did not show up in 25 years along with some guys with big shoulders and try to collect over $3 million on the promissory notes. So he had the counterparty to the “loan” issue a discharge for the entire amount. So how do you justify a deduction for the value of a debt that you do not owe? The answer is: you can’t. And interestingly, once he was audited and reassessed on the matter, and forced to go to trial on the issue, Mr. Berg agreed. At the Tax Court of Canada (TCC), Mr. Berg only disputed the CRA’s position that the whole thing was bogus, and that he should not be able to claim a charitable receipt at all.

There is a long line of cases that says, “if you receive a benefit from a charitable donation, the donation is not really a gift, so you do not merit any charitable tax credit at all.” For example, there are a lot of schemes whereby the taxpayer may donate say $100, but somehow the charity, or a counterparty, then gives the donor say $75 (or gives the taxpayer’s children, spouse, relatives overseas, etc.), or loans them back the $75 at no interest for 25 years, with the loan being conditional to the donation. In such cases, even though the taxpayer really did give a net value of $25 to the Charity after you deduct their quid pro quo, they get no charitable tax deduction because this is not really a gift to charity. Rather, the taxpayer conducted a business transaction with a charity under which the taxpayer merely provided “consideration” and under which both parties benefited. The variation in Berg on this long line of case law was the Crown’s argument that on the facts, given the massively disproportionate size of the charitable receipt to the actual cash outlay, there really was no charitable intent at all. To the CRA, this was just an investment with a clear and quick return, and charity had nothing to do with it.

Justice Bocock summarized the case law regarding the concept of gifts, and found that the disproportionately large charitable receipt did not undermine Mr. Berg’s intent to donate to charity. Mr. Berg may have received an inflated charitable receipt that allowed him to deduct more than he paid in, but the Court found that was no other benefit or “consideration” to Mr. Berg other than that, and therefore his donation was actually a proper gift to the charity.

An interesting thing about this case is that Mr. Berg won, and quite convincingly. He admitted, eventually, that he owed the extra tax, interest and penalties (and compounded interest thereon) because of the charitable receipt’s inflated value, but he objected to the denial of the cash value of the donation as not being charitable. Justice Bocock agreed. Normally, under the Tax Court of Canada Rules, if you win, the Crown has to pay the cost of your legal fees. Or at least part of the legal fees according to the schedule of fees as set out by the Court, which is still better than nothing. However, Justice Bocock did not award Mr. Berg his costs because he was involved in a clearly fraudulent scheme from the beginning, and had also gone out of his way to hide the existence of the discharge of the debt. Mr. Berg also played hardball with the Crown; he abandoned some of his less viable positions at the opening of the trial, thereby also inflating the Crown’s workload. Lastly, the original structure had the obvious purpose of trying to deceive the CRA. As a result of this behavior, the Mr. Berg was denied his costs.

Berg highlights some important concerns that you, your relatives, friends, colleagues or acquaintances should have if approached by someone selling tax shelters:

1) Just because it is charitable, does not mean it is OK;

2) Just because you are approached in a place of worship, or by a tax professional, or someone in some other position of trust, does not mean it is OK (they may be dupes or taking a cut of the fees or both);

3) Just because the structure is “registered with the CRA” does not mean it is OK (all such structures are registered because otherwise there are no deductions allowable at all);

4) Just because the sponsor/promoter has a “tax opinion” from a tax lawyer or accounting firm, that does not mean it is OK. (The opinions are filled with caveats, and always specifically exclude the purchasers of the structure from relying on the opinion. The opinion often does not say that the structure works, it just uses a lot of technical tax jargon to say something very neutral);

5) Just because the shelter has been around for a while does not mean it is OK (the CRA can take a long time to get around to dealing with it, but if there is “carelessness, negligence, willful blindness or fraud” then there is no ‘statute of limitations’ in Canadian tax so the CRA can go back 10, 15, 20 or 25 years and still nail you, and all the while interest is compounding daily. Additionally, as we mentioned in a previous note (see link), the CRA is beginning to withhold charitable tax refunds from taxpayers until the tax shelter itself is audited.

6) If the underlying assumption or the attitude of the promoter or sponsor is that “the CRA are a bunch of morons, and they will never figure this out”, then you know it is not OK.

Although the CRA do not know everything or catch everyone, and even once in while they lose a case like Berg, the CRA have seen it all, the people who work there are not morons. And you can be sure that if they do catch you, they will try to make an example of you. The promoter of the tax shelter will be long gone by that time.

Do yourself a favour, and before entering into any type of tax shelter, leveraged gifting or other tax reduction scheme, please take the time to consult your friendly neighbourhood tax lawyer, just to make sure you understand what you are really getting into.

Jonathan Garbutt & Jonathan Crangle