Canadians pay relatively high taxes compared to the rest of the world, especially in provinces like Ontario, British Columbia and Quebec. It’s only natural to want to keep as much of your income as possible. That’s why individuals and businesses across the country hire bookkeepers, accountants, and wealth managers — to keep your income high and tax burden low. If you’re tax-savvy, you probably have a few tax deductions you like to rely on, like RRSP contributions or home office expenses. But there’s a very fine line between sound tax deductions and the general anti-avoidance rule, often called the general tax avoidance rule. The consequences of crossing that line could result in additional taxation, and possibly legal fees. However, it’s on the Canada Revenue Agency (CRA) to prove foul play and on you to defend yourself in the event of an audit or legal court case.

Let’s explore that gentle, fine line and learn how to prepare for it in this guide. 

What is the General Anti-Avoidance Rule for Avoiding Income Tax?

The General Anti-Avoidance Rule (GAAR) is a tax policy that restricts transactions made solely for tax benefits. In addition, it prevents taxpayers from applying rules from the Income Tax Act (ITA) in a way that the rules were not intended to be applied. But isn’t that every deduction you could think of? Not quite. Aren’t there grey areas in the Tax Act that can be interpreted in various ways? Sure, but you have to tread with caution.

To classify situations where the CRA can apply the General Tax Avoidance Rule, these three conditions must be met: 

  1. A tax benefit arose from the transaction(s);
  2. The transaction(s) is/are an avoidance transaction(s);
  3. The transaction is abusive of the tax system.

You can deduct to experience tax benefits; you can even deduct to avoid paying taxes. But when you cross the line from rule following to abuse, that’s where the CRA can take action against you.

If your transaction is found to meet the GAAR, the CRA can invalidate it, causing you to lose the tax benefit. In other words, you will have to pay the tax you attempted to avoid. You may also be subject to additional penalties. 

Could your business or individual transactions be subject to the GAAR? Seek legal and financial advice immediately. You’re not automatically at fault, but defending yourself against the GAAR is notoriously difficult. In the same vein, the CRA would really need to make a case for the GAAR, too. If this has you worried, keep in mind that application of the General Tax Avoidance Rule is very rare. In addition, there would have to be a substantial amount of tax recoverable for it to be worth the CRA exploring.

What’s the big deal about tax avoidance? It’s not the same as tax evasion, is it? Keep reading to find out. 

Related Reading: Selling a Business in Canada: Tax Implications

Tax Avoidance vs Tax Evasion

Tax avoidance is legal within reason; tax evasion is illegal on all fronts. So how do you know if commonplace tax avoidance crosses into evasion grounds?

Tax evasion is much easier to identify compared to GAAR. In most tax evasion cases, there is a clear pattern of not paying taxes or submitting fraudulent returns. On the other hand, with general tax avoidance, the parameters are more challenging to define.

What happens if you evade your taxes? And if the CRA doesn’t notice? Nothing… for now. Keep in mind the CRA can generally audit tax returns back four years. But if they suspect fraud or tax evasion, they have the right to audit back further.

And if they do notice? First, you’ll get an audit, and at a minimum, you’ll have to pay taxes on the amounts not accurately encompassed in your original filing. The next step is penalties. In cases of tax evasion, you could even face criminal charges and prison time. Earlier this year, a man in Toronto and another individual in Calgary were found guilty of tax evasion. They both faced penalties in the 6-figure range, plus time in prison.

Taxes may be high in Canada, but it’s definitely not worth it to evade taxes and face a 6-figure penalty or troubles with the law. Besides, who wants tax evasion resting on their conscience? You’ll sleep better at night knowing you paid your dues!

Crossing into GAAR territory will also earn you an audit, but the consequences are usually less severe. Often, GAAR violations are related to a single transaction or series of transactions related to a particular event.

Related Reading: Luxury Tax Canada

Common Practices of Tax Evasion

  • Actively avoiding taxes: We are all human which means we’re prone to mistakes. Taxes are complicated so mistakes can definitely happen, especially if you’re managing them on your own. However, there is a difference between making a mistake and actively avoiding taxes. If you’re going to great lengths to avoid taxes, or doing questionable things in the name of tax avoidance, you might be looming into tax evasion territory.
  • Not declaring income: Did you offer a customer a discount for paying in cash? If you don’t declare it on your taxes, that’s tax evasion. If you’re a business owner who voids paid transactions, an audit will catch that. Similarly, omitting any income from your tax filings entails evasion, whether it’s earned as a business or individual. Another big no-no is keeping two sets of books, one for the CRA and one for personal records: if the numbers don’t match, that’s tax evasion!
  • Filing false or ineligible deductions: This could look like a few things. For example, perhaps you overstate the value of deductions on your filing. Or, you could make personal purchases and claim them as eligible deductions when they aren’t. The tax rules around expenses and deductions are more complex, so be sure you’re following the rules as they’re written.
  • Hiding income through other taxpayers: Do you pay your children a $100,000 salary for cleaning your house? That’s a sure sign of hiding income and is considered tax evasion. Transferring funds to lower-income bracket individuals is permitted only under specific circumstances or authentic work relationships. 

How to Prepare for General Tax Avoidance Rule

If you plan on making a series of transactions to reduce your tax burden, tread carefully. You might spark an audit or a case with the CRA. If the transactions are caught under GAAR, a judge can invalidate them, causing you to pay more taxes than you planned. Although, if you’re prepared for the consequences of taking a taboo or aggressive approach with your taxes, it may pay off in the long run. Just be sure that you know your stuff in the event that you do get a general tax avoidance rule notice from the CRA!

So how do you prepare? The best way is to consult a professional early, ideally before you file. Remember, ignorance of tax laws will only get you so far. The CRA can find you guilty of gross negligence, even if you feign ignorance. 

Knowing how the end result will turn out in every case is tricky. Let’s give you a general idea about a famous precedent in Canada. 

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Case example: Canada Trustco Mortgage Co. v. Canada

The Canada Trustco Mortgage Co. v. Canada is one of the most famous Canadian tax law cases involving the GAAR. Like many GAAR cases, this one disputed the third condition under GAAR (whether the transactions were abusive). 

McLeod, a British Columbia lawyer, had a trust account with Canada Trustco, a financial institution and lender. He also had a joint bank account with another lawyer at that same branch. So we’re at two accounts, one of them a joint account. While McLeod owed taxes to the Government of Canada, he started depositing cheques payable to himself into the joint account he had with his co-account holder (the second lawyer). In essence, he was avoiding taxes through a clever loophole.

You might be wondering, how is this tax avoidance? Well, the tax debt McLeod was trying to avoid was his, personally. Since he was depositing cheques into a joint trust account, it could not be seized by tax authorities. Eventually the situation escalated resulting in an appeal in the Tax Court of Canada. Trustco was taken to court over whether or not they were required to pay the tax debt on behalf of McLeod to the Minister.

Canada Trustco took the case all the way to the Supreme Court of Canada in appeals, where the judge ruled the GAAR could not be applied. This decision was significant because it pertains to the role of cheques in commercial transactions and the CRA’s power to garnish funds deposited with financial institutions.

Even though this case ended favourably for Trustco, it was a massive case that brought on stress and likely tons of legal fees. This is why it’s important to consider the general tax avoidance rule!

Related Reading: Trust Return Guide

Keep the General Tax Avoidance Rule in Mind this Tax Season

Are you planning a bunch of last-minute transactions before filing your taxes this season? Then, prepare for the GAAR by consulting a tax professional. Ask them about their experiences with this specific rule and ensure you feel confident in their guidance. In addition, a professional can advise you best on the tax rules and what you can and can’t do.

Remember, tax avoidance isn’t illegal; and neither is crossing into GAAR territory. You can still deduct those business dinners and that home office massage chair (just don’t push it). However, GAAR can smack you with unexpected costs by invalidating previously tax-beneficial transactions. And if you step closer to tax evasion? You’re in for a wild ride with the CRA, through penalties and criminal charges. Stay smart this tax season!

Read More: Considerations for Canadian Investors: Year-End Tax Tips

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