What to do before the tax man comes ?

As many of us are aware, the Canadian Tax System was put in place as a temporary measure to fund the war effort. Over 90 years later it is still going strong with no signs of fading any time soon. That said, our tax system is said to be voluntary in that it is based on self-assessment. Each taxpayer, as defined under the Income Tax Act (Canada) (the "Act"), must, among other things, file returns on a timely basis, report all income completely and accurately and pay the resulting taxes. Failure to meet some or all of these obligations may result in interest charges, penalties or even criminal sanctions. It is not uncommon for various reasons for people to find themselves in a situation where they know they have not met their obligations under the Act. Whether it be unreported or under-reported income, claiming ineligible expenses or failure to file entirely, people can find themselves in a tax rut. The longer the situation persists, the deeper the rut becomes as penalties and interest continue to rise.

Fortunately, there may be a way to get out of the rut. The Act (and the Excise Tax Act for GST) provides for relief from penalties and prosecution and partial relief for interest if the interest relates to 3 or more years prior to the current year. The program is called the Voluntary Disclosures Program (VDP). While the name suggests that you can just show up, drop to your knees at CRA’s door and walk away, the truth is that compliance with the VDP is very technical and only a "valid disclosure" will entitle a taxpayer to relief. The rules of the game are embodied in the Act and outlined in Information Circular IC00-1R2 (the "Circular"). The Circular was released in October 2007 replacing a previous version. If anything, the Circular has raised the bar on what qualifies as a valid disclosure. The purpose of the VDP, as stated in the Circular, is to "promote compliance with Canada’s tax laws by encouraging taxpayers to voluntarily come forward and correct previous omissions in their dealings with the CRA." The Circular goes on to state that the VDP is not intended to serve as a vehicle for taxpayers to intentionally avoid their legal obligations under the acts administered by the CRA. It is important to keep these principles in mind when navigating the compliance rules.

There are two methods of disclosure: Named Disclosure or No-Name Disclosure. Under both methods the disclosure must be in writing and involves the same considerations. However, CRA will not commit to a final and determinative decision until the identity of the taxpayer is revealed. The taxpayer has 90 days to reveal the identity from the effective date of disclosure. The no-name route can be used to test the waters before revealing the identity. Under either method the same conditions for a valid disclosure apply. There are four conditions as follows:

• Voluntary-the disclosure must come before any audit, investigation or other enforcement action.
• Complete-the disclosure must be full and accurate for all years where there was previously inaccurate, incomplete or unreported information.
• Penalty-the disclosure must involve the application or potential application of a penalty.
• One Year Past Due-the disclosure must generally include information that is at least one year past due.

There is a growing body of administrative policy on the exercise of discretion on these conditions, particularly as it relates to the voluntary nature of the disclosure. A taxpayer must be careful in their presentation to ensure that the disclosure qualifies as a valid disclosure. The information required is very detailed and includes the type of omission, reason for the omission and how the four conditions above have been met.

There are a number of additional rules to keep in mind. There is a ten-year limitation period on disclosure so anyone getting close should make their decision on how to proceed or lose the opportunity. A No-Name submission only gets one kick at the can. You cannot go back again on the same information on a no-name basis. Similarly, a taxpayer will normally only be allowed to use the VDP once. In extenuating circumstances, CRA may allow a second opportunity but this will not be the norm. It is expected that once a taxpayer goes through the VDP they will be compliant. The VDP can be a huge benefit to a taxpayer. Penalties can run into tens of thousands of dollars, or greater. Worse yet, certain omissions can result in criminal sanctions. The VDP can provide the proverbial "get out of jail free card" but only if handled properly. Otherwise the opportunity could be blown.

Harold Feder is a partner with the law firm of BrazeauSeller LLP. He practices in the areas of tax and estate planning for individuals and business owners. BrazeauSeller.LLP is an Ottawa business law firm that provides expert legal counsel, innovative solutions and responsive service to its clients. The exclusive Ottawa member of Meritas Law Firms Worldwide, we provide clients with access to trusted, dependable legal representation anywhere in the world that their business takes them.