Canada Revenue Agency Annual Report to Parliament 2013-2014

Compliance

The CRA's compliance activities protect the integrity of our self-assessment tax system by identifying, addressing, and deterring non-compliance with Canada's tax laws. Our compliance measures escalate from promoting compliance to enforcing it. We promote compliance by increasing taxpayers' understanding of their tax obligations through outreach activities and targeted taxpayer assistance, and by educating taxpayers about their reporting responsibilities. We also undertake examinations, audits, and criminal investigations at the domestic and international level to ensure taxpayers comply with Canada's tax laws.

 International and large business

The CRA is responsible for ensuring the reporting compliance of Canada's largest and most complex business entities through a variety of means including strategically directed audit measures, ongoing legislative reviews and research to identify tax loopholes and mitigate emerging non-compliance risks, and targeted outreach and education.

We are moving forward with our business transformation agenda. This includes refining our risk-assessment models and processes to more effectively target the highest-risk taxpayers within the large business population. We continue to implement new ways of supporting voluntary compliance by increasing transparency and strengthening mutual trust and cooperation with Canada's largest business entities.

The CRA's approach to large business compliance takes into account the taxpayer's and tax intermediary's compliance risks and promotes responsible corporate tax management behaviour. This approach divides large businesses into three broad compliance risk segments: high, medium, and low. When dealing with large businesses, the CRA conducts open and transparent discussions on the CRA's determination of their compliance risk and behaviour. Businesses considered to be the highest risk are subject to a full compliance audit. Taxpayers in the medium risk category may be subject to a full compliance or limited scope audit, and taxpayers who are at low risk are subject to periodic compliance assurance reviews. The approach to large business compliance strategy allows the CRA to focus its audit resources on the highest-risk cases of non-compliance within the large business population, and reduce the compliance burden for businesses at low risk.

In recent years, offshore non-compliance has become a large concern for many industrialized countries. In response to this increasing risk, Canada's Economic Action Plan 2013 introduced a number of measures to help strengthen the CRA's ability to address offshore non-compliance. To administer these new measures and better coordinate the CRA's offshore compliance activities, specialized teams have been created in the Victoria, London, and Quebec City tax services offices. In addition, another specialized team in the London tax services office has been established to conduct research to identify offshore compliance risks, improve how files are selected for audit, and foster links with other CRA programs to share intelligence efficiently.

In 2013-2014:

• We continued to improve our risk-assessment capacity. This included work on automating of the risk assessment of taxpayers in the large-business taxpayer segment.
• We strengthened our quality assurance program for large files, the Continuous Program Integrity Review, by adopting improved audit control measures and business analysis.
• Regional and local offices worked hard to assess all outstanding legacy files and close low-risk files where appropriate. By closing these files we are achieving greater audit currency and significantly increasing our capacity to focus existing audit resources on higher-risk cases.

Aggressive Tax Planning

Many taxpayers, including individuals, corporations, and trusts, use tax planning to structure their tax affairs and reduce their amount of tax owing. Registered retirement savings plans and tax-free savings accounts are two examples of legal, beneficial ways ordinary Canadians can reduce their taxes owing. However, taxpayers are not allowed to engage in aggressive tax planning arrangements deliberately designed to circumvent the object and spirit of tax laws.

Aggressive tax planning or abusive tax avoidance occurs when a person undertakes transactions contravening specific anti-avoidance provisions of the law. This includes situations where a taxpayer reduces or eliminates tax through a transaction or a series of transactions that may comply with the letter of the law but violate its spirit and intent.

Aggressive tax planning is a global problem threatening to undermine the ability of nations to generate tax revenues they need to advance and prosper. The strategies the CRA uses to identify and address these unacceptable arrangements are multi-faceted and include audits, legislative change, education, awareness campaigns, and working internationally to support efforts to promote greater international cooperation and increase our ability to access accurate and timely tax and financial information from offshore tax jurisdictions.

Over the past several years, the CRA has been working hard to create an expansive network of treaties and tax information exchange agreements. As of March 31, 2014, Canada was party to 92 tax treaties and 19 tax information exchange agreements. In November 2013, Canada ratified the Convention on Mutual Administrative Assistance in Tax Matters. This convention provides for the exchange of information between parties to the convention. By expanding information sharing and international cooperation, the CRA is significantly improving its ability to identify, address and stop aggressive international tax avoidance and evasion.

The CRA also plays a leading role in many international forums actively working to address International non-compliance, such as the Organisation for Economic Co-operation and Development (OECD), and the Forum on Tax Administration.

In February 2013, the OECD launched a project on base erosion and profit shifting. This project addresses the international tax planning strategies that multinational enterprises use to inappropriately minimize their taxes, by shifting corporate profits away from the jurisdictions where the economic activity has taken place. The leaders of the G8 and the G20 have endorsed the work of the project, and recommendations are being developed to respond to the concerns raised in the action plan, released by the OECD in July 2013. The CRA is an active participant in this process and is making a significant contribution to moving forward with the action plan on base erosion and profit shifting.

The CRA continues to work closely with the Department of Finance and the Department of Justice to develop the legislative tools needed to challenge aggressive tax planning schemes and protect the integrity of Canada's tax system. In recent years the Government has introduced dozens of important measures to close tax loopholes and address international aggressive tax avoidance.

Budget 2014 recently announced several new legislative measures to close known aggressive tax planning loopholes. These included measures to:

• prevent avoidance of Canadian tax on income associated with the insurance of risk through insurance swap arrangements;
• ensure offshore regulated bank provisions cannot be used to circumvent the foreign accrual property income rules through foreign affiliates that are not part of a Canadian financial institution group; and
• ensure non-residents cannot avoid Canadian withholding tax by entering into loan arrangements with third-party financial intermediaries.

Successfully addressing aggressive tax planning requires an ongoing commitment and an effective long-term strategy. For example, over the past several years we have witnessed a sharp decrease in the number of taxpayers participating in gifting tax shelter schemes. Part of the reason for this decline has been the CRA's long-term strategy of focusing audit efforts on taxpayers engaging in these tax shelter schemes. In recent years, participation in these schemes has declined dramatically from 48,000 participants in 2006 to just over 2,500 in 2013.

Key results:

• We completed the review of 19,463 international and large business files.
• We completed the review of 15,823 aggressive tax planning files.
• Our international and large business audit activities identified over $6.1 billion in fiscal impact.^4,5
• We conducted 35 third party penalty audits which resulted in $65.7 million in penalties being imposed upon third-parties (e.g., promoters and tax preparers).

Small and medium enterprises

The small and medium business population is large, diverse, and critically important to Canada's continued economic well-being. Small businesses are important engines of economic growth and innovation in the Canadian economy.  According to Industry Canada, between 2002 and 2012, 77.7% of all private-sector jobs in Canada were created by businesses with less than 100 employees. Small and medium-sized businesses vary greatly in size and sophistication and range from one-person operations to businesses with dozens or even hundreds of employees. Within the small and medium business population, many businesses operate in sectors of the economy characterized by frequent cash transactions, such as the hospitality and construction industries. As a result, there are often tempting opportunities to engage in underground economy activities.

In addition, the relative survival rate of small businesses is low, and thousands of these entities enter and exit the taxpayer population each year. As a result of the dynamic and complex nature of Canada's small and medium enterprise taxpayer population, ensuring they comply is a significant challenge for our tax administration.

An important tool used by the CRA to ensure the reporting compliance of businesses is the audit, but we also consult, educate, and collaborate with stakeholders. In addition, recent advancements in business analytics are allowing us to increasingly use targeted and proactive non-audit interventions, such as tailored client assistance, to support and positively influence the compliance behaviour of taxpayers who represent a low to medium risk of non-compliance.

In 2013-2014, the CRA took several steps to transform and modernize its approach to business reporting compliance. We are investing in proactive approaches to support voluntary compliance up-front in an effort to reduce the need for more costly audit interventions later. On January 17, 2014, the Minister of National Revenue, the Honourable Kerry-Lynne D. Findlay, announced a three-point plan to improve reporting compliance and provide greater support to Canada's small and medium business community.

Three-point plan to support small and medium-sized business compliance:

• The Liaison Officer Initiative (LOI) is designed to provide information and in-person support to small businesses at key points as their businesses grow. This initiative helps small businesses to navigate the tax system and get it "right from the start." Early in 2014, LOI pilot projects were launched in the Ontario and Quebec regions.
• A proposal for a Registration of Tax Preparers Program (RTPP). Under the proposed RTPP, tax preparers who prepare individual and corporate tax returns for a fee would be required to register with the CRA. The RTPP would then allow the CRA to work with these tax preparers to help identify issues of concern and prevent reporting errors before returns are filed. Public consultations on this program began in February 2014. The results of these consultations will guide the next steps for this proposal.
• The final element of this three point plan will see the use of advanced business intelligence to improve file selection. Analysis of business intelligence data enables auditors to identify the most appropriate files for audit. Specialized audit teams will also be used when managing compliance in certain high-risk areas. Small and medium business audit programs will also explore the use of proactive approaches, such as sector-specific letter-writing campaigns, to positively influence the reporting behaviour of taxpayers.

These new approaches will give the CRA an opportunity to increase its presence in the small and medium business population by offering more help and assistance to low-risk taxpayers who may be struggling to meet their obligations. The proactive and focused nature of these new approaches will help reduce the compliance burden for low-risk taxpayers and allow them to avoid unnecessary audits and potentially costly errors. At the same time, this approach will make it more difficult for taxpayers who do not comply, by allowing us to focus our audit resources on files at the highest risk of non-compliance.

Business Intelligence and Quality Assurance

As part of the CRA's business transformation and integrity agenda, we have implemented the Business Intelligence and Quality Assurance (BIQA) program. BIQA was implemented in the small and medium business audit programs for income tax and GST/HST in September 2013. Following this successful implementation, BIQA was expanded to include the GST/HST Refund Integrity program.

The business intelligence component of BIQA institutes a new regional approach to selecting audit files. Specialized regional teams develop and select income tax and GST/HST audit workloads. The teams are responsible for gathering, analyzing, and applying the business intelligence used to identify the most appropriate files for audit. This new approach is a more systematic and comprehensive risk-based way to achieve strategic program objectives at the local, regional, and national levels.

In addition to BIQA, a good example of a more systematic approach to workload management is our National Leads Centre. The centre was established in Scarborough, Ontario, in June 2013. It coordinates and evaluates all informant leads the CRA receives to ensure the information is incorporated in our risk assessment systems, and then refers the lead information to the appropriate compliance program and tax service office for follow up.

The quality assurance component of BIQA, delivered through our Audit Quality Assurance program, establishes strong internal audit control measures to ensure greater audit consistency and quality. Strong audit protocols and procedures help to strengthen the quality of our audits by making staff and managers more accountable. Audit Quality Assurance creates mechanisms for quickly identifying areas needing improvement and improves evidence-based decision-making.

The Audit Quality Assurance process randomly selects audits and examination files for review and is designed to meet the following goals:

• ensure and promote the consistent application of quality standards in compliance activities;
• communicate best practices;
• identify learning needs; and
• provide management with assurances that audit standards are being met.

The program helps us to continuously reinforce quality and professionalism in our audit activities.

The Underground Economy

Underground economy (UE) activity is generally defined as economic transactions that are unreported for tax purposes. The CRA considers the underground economy to include both unreported and under-reported income, which may involve:

• not filing or registering
• not reporting a business activity
• not reporting part of a business activity or income
• not reporting employment income

Combatting the UE is a high priority for the CRA and we have a dedicated program in place to deal with businesses and individuals who participate in the underground economy.

UE activity undermines Canada's tax base. It also threatens future economic growth. The tax revenues lost to UE activity restrict the Government's ability to balance its books and fund important government services and economic action plans. But the most insidious effect of the UE is the unfair advantage it gives to people who are willing to cheat the system, undermining the natural competitive advantages of more innovative, productive, and profitable businesses.

Recent information from Statistics Canada suggests the relative size of the UE as a percentage of the economy is shrinking (from 2.9% in 1992 to 2.3% in 2011). Four industries accounted for almost 65% of Canada's total estimated UE: construction – 28%; finance, insurance, real estate, rental, leasing and holding companies – 13%; retail trade – 12%; accommodation and food services – 12%.

The CRA is committed to tackling the UE and protecting the integrity of Canada's tax system by:

• working with other federal departments, provincial and territorial governments, professional organizations, and key industry groups;
• using a multidimensional compliance strategy including outreach, education, and targeted compliance actions;
• working with international partners to share best practices and identify emerging UE risks and trends;
• conducting compliance research and focusing on sectors where UE activity is prevalent;
• taking a leadership role internationally on the underground economy. In 2011, the CRA led the development of a study on reducing opportunities for tax non-compliance in the underground economy for the OECD Forum on Tax Administration's Subgroup on Small and Medium Enterprise Compliance; and
• providing business cases for new legislative measures to strengthen our ability to identify and address UE activity.

In 2013-2014:

• New Electronic Suppression of Sales legislation took effect on January 1, 2014. The legislation provides civil penalties for using, possessing, acquiring, manufacturing, developing, selling, possessing for sale, offering for sale, or otherwise making available Electronic Suppression of Sales software. The new legislation also includes criminal offence provisions for developing, selling, or using this software. To ensure all stakeholders know about the new legislation, a public awareness campaign was conducted until August 31, 2014.
• We created specialized point-of-sales audit teams to address the use of electronic suppression of sales software. The teams are made up of electronic commerce audit specialists and auditors from the income tax and GST/HST small and medium business audit programs. They are involved in applying new civil penalties to people who use or sell sales suppression software and are now working in major urban centres across Canada.
• We established underground economy specialized teams with advanced training in identifying unreported and under-reported income to function as UE centres of expertise. These teams are now operational in 20 tax services offices across the country.
• The Government's Economic Action Plan 2013 introduced legislative measures to streamline procedures for getting information on unnamed persons from third parties such as banks. These measures will complement the audit tools the CRA uses now.

Key results:

• The small and medium enterprise program conducted 1,213 underground economy outreach visits.
• We reviewed 39,221 files.
• We audited 7,971 underground economy files.
• Our audit activities identified over $1.1 billion in fiscal impact.

Goods and Services Tax/Harmonized Sales Tax

The implementation of regional and national inventory models to select and prioritize files for audit is improving our ability to target limited audit resources to files at the highest risk of non-compliance. In addition, by using advanced data analytics we are better able to identify high-risk files based on patterns and trends in the data that GST/HST registrants file. The CRA's GST/HST pre-assessment national inventory model is an excellent example of how we are using analytics to effectively and efficiently identify risk and prevent unwarranted refunds from being paid.

Schemes designed to exploit value-added tax systems commonly found in the European Union have begun to make their presence known in Canada. Our Aggressive GST/HST Planning Program is working closely with our international partners to share best practices to address these emerging aggressive GST/HST planning schemes.

These schemes are a significant non-compliance threat and are being addressed by our GST/HST compliance program. In 2013-2014, the program exercised new authorities under the Excise Tax Act for the first time by successfully identifying and assessing a significant third-party civil penalty against an individual who made and participated in the making of false statements or omissions in relation to a Excise Tax matter.

In 2013-2014:

• The technical capacity of staff continued to be augmented through a series of national technical capacity building forums. These knowledge-sharing sessions allow subject matter experts to provide up-to-date information on interpretive positions.
• The CRA continued to refine its GST/HST pre-assessment national inventory model by adding new algorithms and rules to better identify files at risk and prevent the payment of unwarranted refunds. These changes are helping the program identify more cases of identity theft, fictitious claims, and abusive schemes.
• The risk assessment of GST/HST large business audit files has been significantly improved through the introduction of a new three-tiered risk assessment process. This new process helps focus audit resources on the highest-risk files. Regional risk assessment committees rank files for audit and then incorporate them into regional work plans to establish which files should be audited and in which order.

Key results:

• The CRA completed 78,310 GST/HST audits
• The total additional fiscal impact as a result of GST/HST audits is slightly over $2 billion

Scientific research and experimental development

The Scientific Research and Experimental Development (SR&ED) program provides tax assistance and investment tax credits to Canadian businesses as an incentive to conduct qualifying industrial research and development activities in Canada. The CRA also administers film and media tax credits. The CRA's role is to ensure all claims under these programs are made in accordance with legislative requirements.

We review the technical and financial aspects of all claims submitted to ensure the work and expenditures claimed meet the specific requirements of the Income Tax Act. We also focus on identifying high-risk claims and ensure the program operates as intended.

Because the scientific research and experimental development tax credit is the largest single source of federal government support for industrial R&D in Canada, we work hard to give applicants the information and timely access to services they need. Our goal is to make sure tax credits or cash refunds are delivered quickly, consistently, and predictably.

In 2013-2014:

• In January 2014, the SR&ED program launched the self-assessment learning tool. This online tool helps businesses determine if their R&D work meets the requirements for the SR&ED program. It includes focused questions, clear explanations, and tips on how to structure an SR&ED claim.
• The CRA introduced the First-Time Claimant Advisory Service. This service provides in-person help for first-time SR&ED claimants. Local CRA staff meet with first-time claimants at their place of business to help them to better understand the SR&ED program and to give them the tailored information they need for a successful claim.
• In January 2014, we began piloting webinars on the SR&ED program. These webinars are designed to complement the in-person seminars currently held across the country.

These new initiatives are designed to help SR&ED claimants successfully access the SR&ED program and benefit from the incentives it offers. By proactively supporting our clients and helping them become better informed, we are increasing their chances of a successful claim, reducing the time lost through processing delays, and lowering their administrative burden. This additional support is expected to give SR&ED claimants more opportunities to create jobs and grow Canada's economy.

Key results:

• The SR&ED program processed 24,794 claims.
• The program provided more than $3.3 billion in tax assistance in support of industrial research and development.
• The CRA identified over $534 million in non-compliance.

Criminal investigations

The Criminal Investigations Program (CIP) is transforming to become a world-class criminal investigations unit. It will focus on the most egregious tax evaders, including those who promote tax evasion schemes such as a few unscrupulous tax consultants, tax preparers, and tax protestors, as well as those who illegally hide their money offshore.

The financial resources dedicated to identifying and addressing those who commit tax fraud have not been reduced. The transformation plan for the CIP includes a number of transitional factors that have affected the FTE variance. These include:

• the reclassification of investigators to higher grades and levels;
• the consolidation of the program from 32 offices to 6, located in cities that align with our key stakeholders such as the Royal Canadian Mounted Police and the Public Prosecution Service of Canada in the cities of Vancouver, Calgary, Toronto, Ottawa, Montreal, and Halifax; and
• transitional costs for training, tools, and facilities.

The CIP has adopted national strategic file selection. This ensures consistency and our ability to leverage the expertise of investigators nationally, as well as the capacity to effectively work on egregious and complex tax evasion cases.

Our new national workload selection process has enhanced the strategic selection of files by considering local, regional, national, and government priorities. Files selected through this process eliminate the potential for unilateral decisions to investigate files that do not meet national program priorities.

The CIP will also proactively utilize all communication avenues to promote the results of successful prosecutions, and it will release prejudgment information on significant criminal investigations actions such as searches, seizures, and laying criminal charges. This type of information serves to maintain the integrity of the tax system and warns Canadians about potential fraud schemes.

The CIP has been aggressively staffing and recruiting. With the exception of two offices, the program expects to be fully staffed by March 2015. We expect the remaining two offices to be fully staffed in 2015-2016. Program lapses have been invested in training and tools for our new and existing investigators, as well as in compliance-related activities.

The CIP investigates suspected cases of tax evasion, fraud, and other serious violations of tax laws. And it recommends cases to the Public Prosecution Service of Canada for criminal prosecution.

Tax evasion and fraud are serious offences. The success of our criminal investigations acts as a powerful deterrent to people who might otherwise be tempted to commit these crimes.

The work done by the CIP is highly specialized, difficult, and time-consuming. On average, investigations take over three years-from the time a case is accepted for investigation, to the time it goes to court. As well, these investigations can involve individuals with previous criminal records and, in some cases, even individuals with ties to organized crime.

Investigations are done by skilled technical teams with expertise in search, seizure, forensic accounting, and investigative techniques. This includes the taking of electronic evidence from computer records and electronic devices. The evidence needed to support criminal charges is generally gathered through the use of judicially authorized, investigative tools such as search warrants and production orders. The onus is on the CIP to gather sufficient evidence to allow the Public Prosecution Service of Canada to prove beyond a reasonable doubt that an offence has been committed. Our actions are always subject to scrutiny by the courts. Accordingly, under the Charter of Rights and Freedoms, investigators have to protect the rights of the taxpayers under investigation.

Key results:

• The Public Prosecution Service of Canada conviction rate was 98%.
• The courts awarded $9.9 million in criminal fines and 25 individuals received prison sentences. A total of more than 52 years of jail sentences were imposed.

Voluntary disclosures

The Voluntary Disclosures Program gives taxpayers a way to voluntarily come forward to put their tax affairs in order and become fully compliant. The program promotes voluntary compliance with tax legislation.

Taxpayers who use this program still must pay any taxes owing, plus interest, but they may avoid costly penalties or prosecution. Taxpayers can disclose unreported income from any source, non-filed returns, or can correct errors or omissions on previously filed returns, among other errors or omissions.

For example, as a result of our focus on offshore compliance, taxpayers are using the Voluntary Disclosures Program to disclose offshore income and assets. The number of offshore disclosures received have increased from 1,215 in 2006-2007, to 5,248 in 2013-2014. This represents over $2 billion in total unreported income since 2006-2007.

Encouraging taxpayers to come forward, correct their tax affairs and pay their fair share is a cost-effective way for the CRA to obtain compliance. The Voluntary Disclosures Program also provides valuable insights into taxpayer behaviour that are helping the CRA to meet the compliance and service challenges of the future.

In 2013-2014:

• Voluntary Disclosures Program operations were centralized and now operate out of the Shawinigan, Winnipeg, and Surrey tax centres. Centralization allows the CRA to maximize existing tax centre file processing expertise.

Key results:

• In 2013-2014 we processed 14,624 Voluntary Disclosures, a record and almost 22% more than the previous year.
• The program identified more than $813 million in unreported income.
• The program identified $303 million in unreported income from disclosures related to offshore income and assets in 2013-2014.

Performance results

Footnote 1: Includes audit professional services sub-program (the activities of this sub-program ceased during 2013-2014):
 – planned spending ($60,735,173) and actual spending ($64,147,383)

Footnote 2: The figure represents the actual spending for the CRA on a modified cash basis, based on Parliamentary appropriations used. See pages 106-107 for an explanation of how actual spending relates to results in the CRA Financial Statements – Agency Activities.

Footnote 3: Decrease primarily due to program and overhead savings as well as payments associated with severance, benefit and vacation credits.

Footnote 4: Fiscal impact consists of tax assessed, tax refunds reduced, interest and penalties, and present value of future federal tax assessable arising from compliance actions. It excludes the impact of appeals reversals and uncollectable amounts.

Footnote 5: $409 million dollars of fiscal impact was refunded during 2013-2014 through the resolution of double taxation issues with Canada’s treaty partner countries. This amount had been included in our program results for prior years.

Footnote 6: The difference is due to the Criminal Investigations transformation (for more explanation, see pages 42 and 43). Resources have not been reduced, and lapses were reinvested in staffing, training, tools, and compliance-related activities.

Footnote 7: As noted in the report, as a result of CRA compliance actions, the number of participants in gifting tax shelter schemes has fallen significantly in recent years. Consequently, the number of tax shelter audits performed during the reporting period also fell dramatically, negatively impacting the international and large business audit change rate.

Footnote 8:  See the last paragraph in the criminal investigation section on page 42 for explanation of variance.