Tips on running a high-quality tax practice

Tax is one of our profession’s most challenging areas and continues to be as Canada’s tax system evolves. So, when it comes to insurance claims, it’s easy to understand why tax tops the list. In fact, statistics show tax service issues are the largest source of professional liability insurance claims against small and mid-sized firms — in both volume and value.

In this blog, we:

• update you on some of the current trends driving tax claims
• present practical suggestions and examples of how you can reduce tax risk while also making your practice more efficient and profitable
• focus on two of the top areas of tax risk — capital dividend account (CDA) elections and estate planning — and explore what makes this work so risky
• highlight some resources from CPA Canada to help you run a high-quality tax practice

Tax claims on the rise

The latest statistics from CPA Canada Liability Plan Inc. (CPA Plan) show that in the last ten years, tax claims have climbed by 60 per cent, while costs per claim have tripled.

CPA Plan EVP Malcolm D’Souza shared with us some of the persistent issues that are fuelling these claims. They are:

Rectifications

In the past, rectification orders served as a useful way for taxpayers to correct a variety of tax mistakes. However, the Supreme Court of Canada decisions in Canada (Attorney General) v Fairmont Hotels Inc. (2016 SCC 56), and Jean Coutu Group (PJC) Inc. v Canada (Attorney General) (2016 SCC 55) have greatly restricted the ability to use this remedy. This makes it even more important to implement good quality control processes in your practice to avoid unnecessary tax mistakes.

Estate planning

The volume of estate planning work done by members is increasing significantly. Tax planning in this area can be extremely complicated — so complicated that related claims have doubled in the past five years. We discuss these risks and how to manage them in more detail later in this blog.

We also continue to see tax-related claims arising from the same issues we saw in the past: inadequate technical expertise, lack of attention to detail, inadequate communication and lack of documentation. See our previous blog for more information.

Best practices of a high-quality tax practice

We asked a number of small and medium practitioners (SMPs) to share the best practices they have in place to mitigate tax risks in their firms. The feedback we received was consistent, allowing us to identify the key actions these firms are doing in three crucial areas:

• education and training
• systems
• communications and documentation

We discuss each of these areas below. At the end of this blog, you’ll find a checklist setting out the key features of a high-functioning tax practice in each area. Experience shows that SMPs that implement these practices and adhere to them closely not only attract fewer insurance claims but also win gains in efficiency.

Education and training

Tax rules are constantly changing. If you and your staff do tax work for clients, you need to ensure your tax knowledge is up-to-date, relevant and appropriate for that work. Formal professional learning and development is important. It’s equally vital to encourage learning through informal on-the-job discussions while performing work.

You also need to ensure that you have the knowledge and skills to not only perform your services but to also determine when to call in an expert. Engaging expert advice is an excellent way to reduce risk. It can also improve efficiency by allowing you to focus on work that is squarely within your competence.

Systems

A good tax practice is founded on strong systems designed to flag and mitigate areas of tax risk. This includes policies and processes for client acceptance, risk tolerance, and the tracking and management of files and deadlines. Issues around cybersecurity and privacy should also be considered.

Of course, the best practices will only succeed if they are closely followed. SMPs should also develop checklists and other tools for performing and monitoring these processes.

Communications and documentation

For a well-run practice, it’s imperative to maintain records of the work you perform on an engagement and all of the related communications, whether with internal colleagues, clients, the Canada Revenue Agency (CRA) or others.

This record keeping should start by having a signed engagement letter in your files that sets out the engagement’s agreed scope. A high-quality tax practice also has guidelines on how to document communications and work performed during an engagement. Developing clear directions on what is expected for each file will help create consistency across all your firm’s work and ensure you have the right records in place if a dispute arises later on.

Managing common tax risks: Capital dividend elections, estate planning

In our recent presentation at CPA Canada’s The ONE Conference and Expo, we discussed two common areas of concerns and how to reduce the related tax risks.

Capital dividend elections

Issues related to a corporation’s capital dividend account (CDA) and capital dividends are a perennial source of significant tax risk.

These issues arise because of the two steps involved in paying a capital dividend: declaring a dividend under corporate law and then electing to treat that dividend as a capital dividend. Mistakes are often made either by paying the dividend at the wrong time or by paying an excess amount. In either case, an excessive election may have been made and Part III tax would apply, or an election would have to be made to treat the excess amount as a separate taxable dividend.

The two-step process makes dealing with the excess difficult – you need to either adjust the amount of the dividend or the timing of its payment, raising legal issues and potentially requiring rectification. Given the Supreme Court’s recent findings on rectifications, additional caution is warranted to avoid these issues.

Any time a capital dividend is declared, some key questions you should ask include:

Questions about the capital dividend amount:

• When was the CDA balance last verified with the CRA? Have differences between their calculation and yours been investigated?
• Are you dealing with a new client? If so, do you have their complete history? Does the CDA balance factor in the effects of, for example, assessments and corporate reorganizations?
• What source are you relying on for the balance: the CRA, the client, or the client’s previous accountant? Whatever the source, be sure you communicate it to the client in the engagement letter.

Questions about timing:

• Is there more than one component of CDA? Has each component been calculated accurately and specifically considering timing?
• Are trusts or partnerships involved? If so, bear in mind that when a capital dividend is flowed through a trust or partnership, the timing is different than when a corporation receives a capital dividend directly from another corporation. Similar issues arise for capital gains and other amounts allocated to beneficiaries and partners.
• When completing Schedule 89, has the timing of all other transactions been reviewed?

These sorts of issues can be effectively addressed through a checklist.

As mentioned above, we believe that a key step is to compare your CDA calculation to that of the CRA. Although the CRA calculation is a powerful tool, it should not be relied upon without independent verification. Should the CRA become aware of additional CDA information after they provide a calculation to you, they will assess based on the revised balance.

Estate planning

With the aging population, tax practitioners are facing more demand for estate planning work. These engagements bear higher than usual risk, and not just because of the technical issues. The risk starts with the term “estate planning” itself since it can mean different things to different people. This makes it especially important to have a clear engagement letter that specifies the work you will do.

Other factors that create engagement risk in this area are as follows:

• Multiple generations or different family members are often involved, and it may be difficult for you to work for all of them without creating a conflict. Be sure to clarify which family members you are taking instructions from and whether others have their own advisors.
• Expertise beyond tax is often required, and issues involving family law, corporate law, financial planning, and other areas may need to be dealt with. Many CPAs act as a quarterback to coordinate this work. A clear plan of who is doing what is critical.
• Family dynamics need to be considered. A good technical plan may fail if these issues are not properly integrated.
• Each specific estate planning area has its own technical issues. Making sure these are recognized is crucial.

For this work, communication and documentation are key. Having a comprehensive checklist of issues to consider in an estate planning engagement is one of the best ways to help identify, manage and mitigate the risks.

Tax practice resources from CPA Canada

CPA Canada has been working on new tax tools and resources to help you build a more effective tax practice. Below, we round up what’s available now and what’s coming soon.

Tools and templates:

Tools that are now or soon available through our practice management, advisory, compilations and tax (PACT) guide include:

• tax compliance engagement letter template
• T1, T2 and T3 compliance checklists
• T1, T2 and T3 transmittal letters
• client acceptance checklist (in progress)
• CDA checklist (in progress)
• estate planning checklist (planned)

Tax risk questionnaire:

We are developing a new Tax Risk Questionnaire to serve as a self-assessment tool that SMPs can use to identify risk issues in their tax practice.

Training and thought leadership:

Many of the provincial/regional CPA bodies offer a comprehensive one-day, online course called “Income Tax – Administration and Risk Management” as either a virtual or on-demand session.  Please visit your provincial/regional website for availability.

As noted, you can also find more details on this topic in our previous tax blog. In addition, watch our presentation at 2021 The ONE Conference on this topic.

Watch for more details

If you adopt the practices suggested in this blog, you’ll be on your way to making your tax practice even more effective and efficient. We will continue to look for opportunities to develop further tools and resources to support your tax practice, and we’ll update you on the latest developments.

Checklist: Key best practices for tax

Education and training

We strongly recommend the following common practices for education and training:

•  set a professional development expectation for staff who do tax work to stay current on tax developments
•  ensure those doing higher-level tax planning work have the right specialist tax training, for example, by having this work completed or reviewed by a staff member who has completed our In-Depth Tax Program or a Master’s in Tax program
•  subscribe to appropriate tax resources, such as tax research platforms and professional development newsletters
•  foster an environment of continuous learning and information sharing within your firm by having regular discussions or meetings on developments within the practice
•  use staff feedback and evaluations as opportunities to educate and explore learning opportunities

Systems

Elements that your systems should incorporate include:

•  a clear set of client acceptance protocols for identifying the risk involved in the engagement, potential conflicts, and whether you have the technical expertise to accept the engagement, as well as consideration of client factors such as litigation history, fee disputes, shareholder or family disputes, and frequent advisor changes
•  a system for determining appropriate skill sets and allocation of tax work, whether a second-level review is required, and also whether you will need to bring in a tax specialist or other professional (e.g. a lawyer, valuator etc.)
•  a comprehensive file management system to keep files organized and well documented, and to help track timelines and filing deadlines
•  the use of tax checklists and manuals
•  up-to-date tax software and systems
•  IT system controls to manage cybersecurity and privacy issues

Communications and documentation

Here are some leading practices for communications and documentation:

•  have a signed engagement letter for each engagement to ensure your client clearly understands the scope and terms
•  set documentation guidelines that ensure the appropriate level of documentation for the engagement, including how to document research, analysis and conclusions made, discussions with clients, and confirmation of client instructions
•  ensure all material advice is made in writing
•  establish rules on the use of email and ensure the review of all advice conveyed by email
•  ensure all client instructions are documented in the file
•  identify which individuals (e.g., client staff, family members etc.) should be communicated with
•  ensure all parties are aware of any material developments

NOTE: The commentary function of this page has been temporarily closed. Unfortunately, because of the volume of feedback regarding COVID-19 tax measures, we do not have the capacity to respond to individual inquiries. We strongly encourage you to visit our Canadian tax news and COVID-19 updates page for information.