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Donation Shelters: A Tale of Financial Misadventure

Due to my conservative nature and my belief that something that looks too good to be true often is, I have been always nervous about people participating in what appear to be very aggressive charitable donation shelters and people who promote them, particularly shelters which appear to catch the attention of the Canada Revenue Agency (“CRA”) from inception.

Recently, I read about a case about a taxpayer who participated in such a shelter that led to really serious consequences, perhaps due in large part to his own behavior, and appeared to have led to certain financial ruin.

In Monaghan (Re) DTC 5097, an individual invested in a charitable donation tax shelter. The charitable registration was subsequently revoked by CRA, and a reassessment was issued against the taxpayer. That reassessment went unpaid and, subsequently the CRA garnished the taxpayer’s bank accounts. The taxpayer then declared bankruptcy and the CRA filed a proof of claim for outstanding taxes and interest.

The bankrupt taxpayer applied for an absolute discharge from bankruptcy and his application was opposed by the CRA. The bankrupt taxpayer argued that while his bankruptcy was tax-driven, he could not be justly held responsible for his financial circumstances as he had been the victim of fraud, in his reliance on professionals who suggested and promoted the illegitimate tax shelter scheme. The CRA took the position that the integrity of the bankruptcy system would be threatened if, in the circumstances, the bankrupt was going to be discharged without the imposition of any deterrence. The CRA sought a suspension of any discharge and an order requiring repayment of a portion of the tax debt.

The discharge was suspended for a period of 12 months and an order for repayment imposed. As the income tax debt made up more than 75% of the unsecured proven claims in the bankruptcy and the amount of that tax debt was of a significant amount, the bankruptcy was a high-tax bankruptcy, to the provisions of the Bankruptcy and Insolvency Act. The Registrar in Bankruptcy held that in a discharge application to which these provisions applied, she was required to consider the circumstances in which the income tax debt arose, any efforts made to pay that debt, whether any other debts had been paid in preference to the tax debt and, finally, the bankrupt taxpayer’s future financial prospects.

The Registrar reviewed the bankrupt taxpayer’s history and current circumstances in light of those factors, as well as the jurisprudence considering high tax and tax shelter bankruptcies. She noted, in particular, that after the bankrupt had received his first reassessment in 2008 and had been made aware of the CRA’s concerns with respect to the legitimacy of the tax shelter, he continued to participate in the scheme, claiming significant tax credits. As well, the bankrupt had not made any voluntary payments of his tax debt following reassessment but, during the time there was an outstanding debt to the CRA, had made payments on other debts. Finally, the Registrar noted that the bankrupt taxpayer had no surplus income and, owing to age and ill health, there was little prospect that he would work again.

Based on the Registrar’s review of the bankrupt taxpayer’s history, the Registrar concluded that the taxpayer had brought on, or contributed to, his bankruptcy through reckless conduct. Specifically, the bankrupt had ignored red flags in the form of the CRA’s notifications of their intention to revoke charitable registration status and their issuance of a reassessment. Instead of mitigating his risks, the bankrupt taxpayer continued to claim charitable donations tax credits for another six years. As well, the bankrupt possessed exempt assets in the form of RRSPs and other assets, which amounted to more than twice the amount of his total outstanding tax debt. With such an asset to debt ratio it was, in the Registrar’s view, difficult to rationalize how bankruptcy was the only option available. The Registrar concluded that the bankrupt was not an honest but unfortunate debtor. She held that, in light of the bankrupt’s conduct and the Court’s obligation to deter such conduct on the part of taxpayers, the appropriate disposition was to suspend the bankrupt’s discharge for a period of one year and to require him to pay the amount of $100,000 to his estate, by way of monthly instalment payments of not less than $1,000.

About Steven Frye
CW LLP is a firm of professional advisors providing a comprehensive suite of services to a diverse client base. Our experienced and skilled team can provide personal and corporate solutions to maximize growth potential, wealth and value. Email: sfrye@cwcagroup.com

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