8 July 2020 CALU Roundtable Q. 1, 2020-0842131C6 - CRA Audit Activities

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Can the CRA provide details on its review of tax promoter schemes and, in particular, provide details on the types of strategies under review that use insurance products to create certain tax benefits?

Position: Please refer to response.

Reasons: Response provided by CRA Compliance Programs Branch.

2020 CALU CRA Roundtable – July 2020

Question 1 – CRA Audit Activities

Background

In December 2019 CPA Canada issued a blog (the “blog”) commenting on the CRA’s review of certain “tax promoter schemes”. The blog specifically mentioned certain strategies involving insurance products which were described as follows:

The promoter offers a complex strategy using life insurance to distribute corporate surplus by increasing paid-up capital or creating a loan payable to the shareholder. The strategy also creates interest and insurance expense deductions. This can similarly be achieved through critical illness or group accident and sickness policies.

Question

Can the CRA provide more details on its review of tax promoter schemes and, in particular, provide more details on the types of strategies under review that use insurance products to create certain tax benefits?

CRA Response

The CRA has been auditing and challenging promoted tax schemes that promise taxpayers large returns on investments, tax-free income, or other creative ways to pay less tax. The CRA has implemented a Promoter Compliance Strategy with the ultimate goal to protect the tax base from individuals/entities that are promoting and marketing offensive tax schemes.

Through increased audits of promoters and participant taxpayers, improved information gathering and informing taxpayers on how to recognize tax schemes, the CRA continues to identify and shut down tax schemes.

These audits suggest that tax strategies involving insurance products continue to be used in Canada as part of aggressive tax planning. While some arrangements have been closed by legislative changes, the changes have not fully stopped the use of certain insurance products in aggressive tax planning arrangements. That is, the CRA continues to identify leveraged structures where purported “insurance products” that form part of an arrangement are heavily interdependent, and which product would not have otherwise been issued in the absence of other interdependent contracts and do not create any insurance risk to the issuers.

Three examples of concern are summarized below.

The CRA is increasingly concerned with such arrangements including those where a private Canadian corporation’s earnings are being stripped through the use of what are purported to be “insurance products”. Generally speaking, otherwise taxable earnings are stripped by the corporation:

(1) Acquiring so-called “group insurance” and deducting the so-called “premiums” for tax purposes. The effect of the scheme is to extract earnings tax-free (i.e., no corporate and personal income tax) through leveraged deductions from income where the participants do not incur risk in respect of the leveraged amount, or

(2) Distributing earnings to shareholders tax-free as repayments of loans advanced to the corporation by shareholder participants in the scheme, or as a tax-free capital dividends.

Key features of the schemes include:

• Limited-recourse loans advanced to participants by offshore lenders. These loans tend to be conditioned on participants agreeing to acquire a so-called “insurance contract”.
• Assignment of the so-called “insurance contract” to the offshore lender to repay the limited-recourse loan.

The CRA is especially concerned with leveraged insured annuity schemes where a “life insurance contract” insuring non-insurable lives or lives for which there is no insurable interest is combined with a “lifetime annuity” where the payments are payable over a maximum number of years and do not provide for a rate of return. Those leveraged insured annuities attempt to circumvent the 2013 amendments to the “LIA Policy” definition in the Income Tax Act and the underlying tax policy objectives.

The CRA is also concerned with leveraged “employer’s (group) disability insurance policies” in which a participant (usually an employer) is obligated to pay the net proceeds of insurance to the issuer under a separate side agreement. The scheme involves a series of complex transactions that result in:

1) the corporation incurring a so-called “insurance” premium expense, and

2) the ability of one or more of non-arm’s length individuals to extract corporate surplus from a corporation over time on a tax-free basis.

In the disability scheme, funds circle into and out of Canada in amounts that are claimed as large expenses in order to avoid Canadian income tax. These deductions are a multiple of the actual funds that the participants paid under the schemes out of their pre-existing wealth with a substantial portion of those actual funds being used to pay the fees (commissions) the promoters charge for allowing a participant to “benefit” from buying the promoter’s product which is supposedly a legal way to avoid tax.

The CRA reviews these products to determine whether they are valid insurance products or just a vehicle to obtain a specific tax advantage. In the event the CRA finds these “insurance products” to be invalid, participants of these schemes may end up owing considerable tax, interest and penalties as a result.

The CRA has also identified abusive tax avoidance arrangements involving insurance products where the general anti-avoidance rule (GAAR) will be pursued to deny the tax benefit sought.

The CRA has identified a need to increase focus towards taking action against promoters of abusive avoidance schemes rather than only the participants in these schemes. The promoters and sellers of these schemes could also be subject to audit and third party penalties.

For more information on the hallmarks of a tax scheme, please visit our tax schemes page: https://www.canada.ca/en/revenue-agency/campaigns/tax-schemes.html

(Response provided by CRA Compliance Programs Branch)

Alex Johnstone
July 8, 2020
2020-084213

Additional Note – At the Roundtable the CRA also verbally commented that although offshore programs are a current audit focus, domestic arrangements with similar characteristics can also be subject to an audit review.