Tax Shelter Definition :

  • A financial arrangement designed to reduce tax liability.
  • Tax shelters are any method of reducing taxable income resulting in a reduction of the payments to tax collecting entities, including state and federal governments. The methodology can vary depending on local and international tax laws.
  • A method used by investors to legally avoid or reduce tax liabilities.

Direct Definition from the CRA AGENCY Website.

Tax shelters are defined in the Income Tax Act. In very general terms, a tax shelter includes either a gifting arrangement or the acquisition of property, where it is represented to the purchaser or donor that the tax benefits and deductions arising from the arrangement or acquisition will equal or exceed the net costs of entering into the arrangement or the property. Also, a gifting arrangement where the donor incurs a limited recourse debt related to the gift will be a tax shelter. Generally a limited recourse debt is one where the borrower is not at risk for the repayment.

The General Overview:

Tax shelters, as put in to perspective by the definition are an arrangement that reduces tax liabilities. Less tax liability means more disposable income or Retained Profit.  It’s because of this that many businesses have resorted to illegal forms of Tax havens. Tax Shelters include investments in equipment leasing, breeding and cattle feeding programs, real estate, and gas and oil companies. There are some Tax Shelters which are legal and there are some which are illegal.

Legal Tax Shelter.

  • Tax-Free Savings Account (TFSA) is a flexible investment account that can help you meet both your short- and long-term goals.
  • Registered Retirement Savings Plan (RRSP) is a personal savings plan registered with the Canadian federal government allowing you to save for the future on a tax-sheltered basis.

TFSA

•No maximum age
•Not tax-deductible
•Savings grow tax-free
RRSP
•Until the end of the year in which you turn 71
•Yes, reduces taxable income
•Savings grow Tax-deferred (not taxed until withdrawn)

Major developments

Illegal forms of Tax Shelters

Financing arrangements:

This is a common form of illegal financing arrangement as it would see the business or individual paying high levels of interest to another party thus reducing the investment income even to the extent of recording a loss. However the individual will actually create a massive capital gain when one withdraws the investment. The tax benefit comes from the fact that capital gains are taxed at a lower rate than the normal investment income such as interest or dividend.

Canada has had its fair share of illicit Financial arrangements. An example would be that of the

Offshore Companies

In most jurisdictions authorities will not seek to tax companies which they treat as non-resident, save perhaps for a nominal fee -$350 BVI, £320 Isle of Man etc. Taxation legislations differ from country to country, and it is because of this that some countries will choose to avoid taxation in their home country or in a host country. This is mainly done in a bid to reduce the Tax liability and thus Tax benefits can be exploited. Example: If an Import company buys $1 of goods from India and sell for $3, Import Co. will pay tax on $2 of taxable income. However, tax benefits can be exploited if Import Co. is to setup an offshore subsidiary in the foreign nation to buy the same goods for $1, sell the goods to Import Co. for $3 and sell it again in the domestic market for $3. This allows Import Co. to report taxable income of $0 (because it was purchased for $3 and sold for $3), thus paying no tax.

Here is a video to further illustrate this: http://www.youtube.com/watch?v=PhD6je4fQu8

The Penalties

  • For providing misleading information upon the application for a Tax shelter scheme, the principal or agent is liable to a penalty greater than a $500 minimum fee of CAD$500.
  • For misrepresentation in tax planning arrangements, the principal will be liable to a minimum penalty of CAD$1000
  • For failing to provide the tax shelter identification number, the principal is liable to pay CAD$100.
  • Providing an incorrect tax shelter identification number
    • A fine from 100% to 200% of the cost of the tax shelter interest.
    • Imprisonment up to two years.
    • Both a fine and imprisonment.
  • Accountants across the world have lost their integrity.
  • This mainly because it is the accountants that are responsible for recording overstated balances and for preparing false receipts that will be assessed by the government.
  • However Tax shelters were set up to promote good behavior and offer assistance to the masses. It is the poor behavior of the few that has tarnished this image and with it the Image of Accountants.

Tax shelters are usually created by the government to promote a certain desirable behaviour, usually a long term investment, to help the economy; in turn, this generates even more tax revenue. Alternatively, the shelters may be a means to promote social behaviours.

Citations

•          Santiago. (2010). Legal Tax Shelter Programs Can Save You Money…Find Out How. Retrieved March 24, 2011, from <http://www.mytaxmoneyback.com/canadaincometaxguide/2010/04/27/tax-shelters-are-not-a-legal-form-of-tax-avoidance-myth-buster-file-3-3/>

•          RBC Royal Bank.(2011) Comparing TFSAs and RSPs: How do they stack up? Retrieved March 24, 2011, from < http://www.rbcroyalbank.com/products/taxfreesavings/tfsa-vs-rsp.html>

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