The use of tax havens by the wealthy is not new. Still, the complexity of modern taxation, combined with the ingenuity of those who peddle tax schemes has certainly contributed to the erosion of the tax base of countries with more traditional tax rules. One thing is certain: tax evasion is no more acceptable today than it was in the past. The fact that it receives more media coverage now is thanks to the hard work of investigative journalists and better access to documents from around the world via the Internet.
Recently, CBC News and Ici Radio-Canada conducted an investigation into Canadian taxpayers who were using a tax avoidance scheme involving shell companies in the Isle of Man. The arrangement had been set up by the accounting firm KPMG. In brief, significant sums—several million dollars per taxpayer—were transferred to Isle of Man companies, where the returns are legally exempt from taxes. Apart from some fees payable to the directors, the earnings of these companies could not be granted to anyone except as gifts to eligible persons. It turns out that each company’s financial backer, or a member of his or her family, was precisely such a person. Since money received as a legitimate gift is not taxable income under Canadian law, thanks to this tax planning arrangement, the recipients’ goal was to receive the sums free of Canadian taxes. At least, that is what they hoped.
The documents filed in Peter Marshall Cooper 2015-1070(IT)G, which will eventually be heard by the Tax Court of Canada, allege that between 2003 and 2010 the Cooper family earned almost $3.5 million from the $20 million they had transferred to the offshore company. The documents also allege that over the same time period Mr. Cooper declared a total taxable income that varied between $0 and $7,015, except in 2006, when it was $12,483, and in 2007, when it peaked at $17,576, which means that he allegedly paid federal taxes amounting to $319! Even more shocking, because of the low income he declared over these years, Mr. Cooper received tax credits usually reserved for the poorest members of society.
The arrangement used by Mr. Cooper and other members of his family were uncovered by the Canada Revenue Agency (CRA). However, according to the CBC and Radio-Canada, around 20 other taxpayers also profited from the scheme. Since the tax authorities did not know their identities, the Minister of National Revenue obtained an order from the Federal Court on February 18, 2013, requiring KPMG to provide the list of clients who had used the scheme. Three weeks later, KPMG filed an appeal with the Court requesting a review of the decision. Although the file had appeared to be stalled in Federal Court channels, strangely, it came back to life after the CBC and Radio-Canada conducted their investigation into the file in spring 2015.
Since May 1, 2015, even though the Federal Court had yet to review the decision (it still had not by the time of writing), the CBC and Radio-Canada learned that the CRA had offered KPMG clients whose files had not yet been subject to judicial control (not the Cooper family) an option that would allow them to settle their tax debts simply by paying the taxes they had evaded, with no penalty or prosecution. This represented a substantial reduction of four percentage points on the interest payable on the tax debts accumulated between 2004 and 2010.
The process offered by the CRA is called “voluntary disclosure.” It is based on subsection 220(3.1) of the Income Tax Act, which authorizes the Minister to waive the penalty and interest owed by taxpayers, under certain conditions.
This process is supposed to be initiated by taxpayers who want to settle their tax debts after failing to comply with the Act, whether voluntarily or not. However, the process is not authorized when a taxpayer, or a third party connected to the disclosure, is already being investigated by the tax authorities or has already resorted to the voluntary disclosure program in the past. In the current case, the CRA itself asked KPMG to inform its clients that it would readily accept their voluntary disclosure, without even checking whether they met the prescribed conditions. Furthermore, the offer from the CRA requests that the information provided by these taxpayers and their advisers remain strictly confidential, or the offer will be withdrawn.
What could justify the fact that the CRA offered this procedure to taxpayers who stood behind the legal curtains of the Isle of Man, when an objective of these curtains is precisely to hinder tax courts from tracking down taxpayers? Although the CRA sometimes settles certain files because it has weak legal arguments, and thus risks losing in court, nothing in the circumstances justifies such an offer. Legally, the arguments of the taxpayers concerned simply do not hold water, and the CRA had already obtained an ex parte decision to acquire the list of KPMG clients who had benefited from this scheme. The CRA needed only to be a little patient, perhaps wait another year—which is not long in view of the fact that the scheme was set up almost 15 years ago—for the decision to be approved.
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At issue here is a cornerstone of our own tax system: fairness. The proposal the CRA put forward in this case and, more generally the voluntary disclosure program itself, theoretically rewards alleged crime. How will the CRA be able to seriously uphold the importance of everyone paying their fair share of taxes when it disregards its own rules regarding voluntary disclosure, and offers a fortune to potential cheaters, without even knowing if the necessary conditions outlined in its information circular are met? It is possible that the CRA is already investigating some of the taxpayers concerned, and also that one or more of them have already benefited from voluntary disclosure in a prior file: these are two situations in which the CRA denies voluntary disclosure, according to its own circular. Yet, in this case, the CRA has painted itself into a corner by agreeing to accept the disclosure submissions even before evaluating them. It would be like my giving a student an A+ even before looking at the student’s exam papers.
Furthermore, how can the CRA demand the confidentiality around such an offer? Isn’t this lack of transparency precisely one of the characteristics of tax havens, which have been criticized by the OECD and many countries, including Canada?
Does the settlement offer made by the CRA mean that KPMG, the accounting firm that orchestrated this arrangement, will face no consequences? Regardless of the outcome of the settlement offer, we urge tax authorities to shed some light on this scheme and on the accounting firm’s intentions. Is this a situation where tax planning led to tax avoidance, but without criminal conduct, or is it actual tax evasion coordinated by this international accounting firm?
The exposure of this scheme should be the spark that forces the Canadian government to reconsider the philosophical underpinnings of the voluntary disclosure program. What theory or principle justifies tax evaders resolving their tax obligations by avoiding penalties and a significant part of the interest normally owed, particularly in the case of entirely conscious and voluntary noncompliance?
Various “tax amnesty” programs exist in many countries, although they are usually not as lax as those offered in Canada. Some of these programs come with penalties, albeit small ones. In Italy, for example, the normal penalties for not complying with tax obligations are reduced by a quarter or a half in the case of voluntary disclosure. In the Netherlands, as part of a tax amnesty program that ended on July 1, 2015, the penalties were reduced to 30 percent of the tax evaded; they are now capped at 60 percent, which nonetheless constitutes a significant reduction when we consider that normal penalties vary between 100 percent and 300 percent of the unpaid tax.
Several countries offer periodic intervals when taxpayers seeking clemency have a few weeks or months to resolve their tax obligations. Massachusetts, for example, has just announced a penalty-free tax amnesty that will begin on April 1, 2016, and last two months. In the United States, during the UBS scandal in 2009, US clients of the Swiss bank were able to benefit from a reduced penalty on the condition that they disclose their incomes over the few months allotted for this purpose. Over the following years, other periodic amnesties were offered; however, the applicable penalties increased every year. Recently, the United States established a voluntary disclosure program, in which penalties are adjusted according to the situation and can reach 50 percent when the unreported income comes from foreign countries. Another streamlined procedure, set up for those whose failure to pay taxes is due to non-wilful conduct, caps penalties at 5 for US taxpayers residing in the United States and offers US taxpayers residing outside the United States a penalty-free term to resolve their tax obligations (it is presumed that their failure to pay taxes is due to the complexity and their lack of understanding of the tax system).
Simply put, now is the time to consider how those who have chosen not to participate in the collective tax effort and the experts who support their actions ought to be treated.
