Tax Evasion vs. Tax Avoidance
Sometimes taxpayer’s tax plans are right on the edge of tax evasion or tax avoidance. While the two appear similar in meaning, their characteristics, penalties, and administrative processes are quite different. This article will first outline the difference between tax evasion and tax avoidance, and then demonstrate the different investigation and administrative processes that the Canadian government uses to combat these issues.
Tax evasion is a criminal offence. One must deliberately make false declarations related to their income to be liable for this offence. This most commonly includes concealing all or parts of their income, declaring inflated expenses, or even inventing fake expenses to reduce one’s total tax owing. Though not ‘tax evasion’ in the literal sense, even falsely claiming taxable credits that lead to a fraudulent tax refund would be considered a criminal tax offence.
Tax avoidance as a general concept is not illegal. As set out in Inland Revenue Commissioners v. Duke of Westminster,  AC 1 (HL), a long-standing principle in Anglo-Canadian law is that taxpayers are entitled to organize their tax affairs to pay as little as legally allowed. This means that subject to legal decisions and legislation, a taxpayer is within their rights if they engage in a specific activity to pay fewer taxes. Refer to “Should I Pay Myself Salary of Dividends?” to see how one can set up compensation two different ways depending on their goals.
“Abusive” Tax Avoidance
Abusive tax avoidance is illegal but will not result in criminal penalties. If a taxpayer’s tax affairs are seen to be abusively avoiding tax, they will be reassessed on the taxes that the CRA believes they owe, and they may be subject to fines and penalties. Unfortunately, the line between lawful tax planning and “abusive” tax planning is blurry.
Abusive tax avoidance refers to someone engaging in activity that blatantly takes advantage of the specific wording in the Income Tax Act (The “Act”) and use it in a way that is not intended. The recently enacted “General Anti-Avoidance Rules” allow the court to find any transaction unlawful if it is against the “object and spirit” of the Act. An example of an abusive tax avoidance is a sham transaction, where a taxpayer structures their tax information to show a situation that is not reflected by reality, such as a taxpayer “going into business” with several business partners to split the income when in reality, the “business partners” are not actually working.
Procedural Differences: Investigation of Taxpayers
Investigating taxpayers civilly and criminally creates two different processes and two differing sets of powers for the government. As explained below, the CRA has a much broader scope of authority investigating a taxpayer’s affairs for assessment purposes and civil fines than for criminal reasons.
Under section 231 of the Act, the CRA has broad powers to investigate both the taxpayer and third parties during a civil investigation for the purpose of reassessing certain tax years and potentially assigning penalties. Parties can be compelled to provide documents and oral statements with respect to the investigation, and unlike in a criminal investigation, there are no Charter protections and no right to remain silent.
Notably, the investigation powers are so broad that the CRA has recently requested information from international institutions. In a recent Federal Court of Canada hearing, Levett v Canada, 2021 FC 295, the court found it lawful for the CRA to request information about a taxpayer from the Swiss Federal Tax Administration. The case has been appealed, but if upheld, it demonstrates the broad scope of power that the CRA wields in their investigations.
If the investigation causes the CRA to reassess, a taxpayer may still submit a notice of objection, and follow the usual administrative and appeal routes afforded to them.
Once the predominant purpose of the investigation becomes to prosecute a person criminally, the broad powers given to the CRA for the purpose of civil investigation are withheld. Also, any evidence obtained while using the civil audit powers cannot be used for the purpose of investigating a criminal offence. Therefore, though the civil powers are extensive, they cannot assist in a criminal conviction.
The criminal investigation process under section 239 of the Act begins with CRA officials conducting a quasi-criminal investigation. They must follow established criminal procedures especially with regards to warrants. If, during the criminal investigation, the CRA officials believe that the person should be prosecuted, the CRA will refer the case to the Public Prosecution Service of Canada, which handles criminal prosecutions. At that point, the taxpayer will follow the route of a defendant in a criminal proceeding.
If you or someone you know has questions about CRA audits or investigations, please contact us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.
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