The CRA has superhuman powers to demand information from all Canadian taxpayers. Do those super powers get used for good or evil? Many Canadians fear evil rules the day. I can say, without hyperbole, that the end of the world is sort of looming up on us. Mad scientist type CRA employees in Ottawa use their superpowers to conduct experiments on unsuspecting villagers (AKA Canadian taxpayers). These experiments are called “special project audits.” These audits differ from regular audits in that they are usually controlled from afar. Taxpayers and their advisors have little advance explanation about the basis for the audit, the questions being asked or the documents demanded. In the hope that they will not be harmed, taxpayers allow themselves to be examined, poked, prodded and inquired of. Okay, so maybe I have a slightly melodramatic way of looking at the world...
One of the most interesting recent experiments, -- um er -- “projects” is what appears to be a CRA national audit of family trusts. A trust can be a wonderful tool for tax planning purposes, but it is essential that the trust be properly maintained. In the current project, the CRA has written to trustees and required a response to a multi-page questionnaire. The questionnaire is intrusive, but the CRA has the right to enquire whether the trust has been operating properly since establishment. While the questionnaire can be daunting, problems usually arise only if the trustees have not kept adequate records. The trust minute book should contain minutes of any trustee meetings and resolutions of any trustee decisions.
In particular, the CRA is looking at whether resolutions show that funds were paid to a beneficiary or to a third party on behalf of a beneficiary. In order for a trust to be able to deduct amounts that are distributed to beneficiaries, the amount must be paid (or have become payable via promissory note) by December 31st of the year in question. A failure to properly document a corporate dividend payable to a shareholder trust and a distribution of that dividend to a beneficiary may result in the CRA imputing income to the trust. A disallowed deduction would mean that the trust would have income taxed at the highest marginal rate in the year.
If you receive a trust questionnaire or any other notice advising you that your trust is the subject of an audit, contact your advisors before providing the CRA with any information (if you need a recommendation for a good tax law firm, just ask). Your first inclination may be to send everything over to the CRA -- or you might put the CRA letter in the “do not open – contains bad news” mail pile and go back to watching hockey.
Be careful in your responses. You do not want to include privileged planning material that the CRA is not entitled to receive or give answers when you do not understand the implications of the question. For example, the CRA may ask a beneficiary of the trust whether the trustee is likely to act in accordance with the beneficiary’s wishes. Not fully understanding the tax implications of that question, the beneficiary may be inclined to answer yes based on the belief that the trustee should take the beneficiary’s wishes into account. The CRA could use that answer to conclude that the trustee is not managing the assets or that no trust really exists. Trust me, that is not a good result.
The best kryptonite to the CRA’s audit super powers is to ensure that the trust is properly maintained and that all distributions and decisions are properly documented. If you don’t like superheroes, try a hockey analogy(I know that’s all any of us think about these days).: Properly establishing your trust is like winning the President’s Trophy. To beat the CRAcago Blackhawks, you’ve got to do the little things: follow the trust rules, document transactions, inject caffeine into the Sedins. Creating the trust is a great first step and sets you off in the right direction, but you’ll lose in the first round if you don’t maintain that trust. Achieving your goals (be it tax reduction or the Stanley Cup) means you can’t slack off. Understand? Good, now get out there and hit someone (hockey analogy) or (superhero analogy) travel back in time by flying faster than the speed of light around the world in the direction opposite to its current rotation and properly document the trust before it gets audited.
- Shelley J. Spring
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.
