Our tangled tax system needs an overhaul
I think it’s undeniable that Canada’s tax system is becoming too complex and its compliance demands too difficult for both taxpayers and tax administrators to properly manage. It’s time for a review of the Income Tax Act with the aim of ensuring the system remains workable going forward.
Why is the system becoming so complicated now? Some of the reasons may include international pressure to combat aggressive tax planning, profit shifting, money laundering and terrorist financing, along with domestic pressure to redistribute wealth, deal with deficit financing and minimize tax avoidance and evasion. Technology also plays a role, providing governments with a newfound ability to data mine copious amounts of collected information. We’re also seeing a growing reliance on the federal tax system to solve current problems, such as the economic disruption caused by Covid.
Another change that is creating an excessively difficult system is an evolution in legislative drafting. The focus has changed from specific, targeted anti-avoidance provisions that were implemented only when they became necessary to much wider-reaching provisions under which all taxpayers undertaking certain broadly defined transactions are caught and only those that meet narrow exceptions are released.
We are also seeing problems in legislative drafting for tax incentives such as the recent green technology investment tax credits and employee ownership trust rules, where the rules are narrow and complex, and often go beyond tax policy to legislating government-approved commercial terms and conditions. Complexity waters down the effectiveness of tax incentives to promote certain behaviour when it becomes too difficult for taxpayers to understand the rules and determine whether they qualify.
As the government finds more ways to use the federal income tax system to accomplish a wide range of goals beyond revenue collection, we are starting to see a breakdown of the basic principles on which the system is built, such as certainty, simplicity, effectiveness, predictability, fairness and efficiency. This situation disproportionately hurts small businesses more than larger ones, who are better able to hire advisors to help them navigate the system.
We don’t have to look very far to see evidence of increasingly difficult tax compliance demands:
Trust reporting
This new policy was intended to combat money laundering and terrorist financing. However, when bare trusts were added to the legislation, the level of uncertainty was significantly increased, making compliance so difficult that CRA needed to exempt bare trusts from the reporting rules for 2023. This exemption came just days before the filing deadline and cost an estimated $1 billion in taxpayer resources for unnecessary compliance.
Underused housing tax
These provisions aimed to address the housing crisis by focusing on vacant foreign-owned residential properties. However, the negligible number of such properties contrasts starkly with the actual housing shortage. This tax led to extensive reporting by Canadians who indirectly owned their residential property through a corporation, partnership or trust, necessitating deadline extensions. CPA Canada advocated for the exclusion of Canadians with indirect ownership, which eventually resulted in legislative changes.
Mandatory disclosure rules
These rules broadly define "avoidance transaction" to include regular tax planning and impose harsh non-compliance penalties. The rules' vagueness leads to high administrative and compliance costs, pushing professionals to report extensively to avoid penalties. Given that vagueness, the CRA was forced to produce its own interpretive guidance to make the regime workable.
General anti-avoidance rule
Recently enacted GAAR amendments also bring uncertainty, particularly around transactions significantly lacking economic substance. This ambiguity will likely compel over-reporting by taxpayers and practitioners seeking to sidestep possible penalties. Following the 2024 federal budget’s change to the capital gains inclusion rate, the CRA’s Income Tax Rulings Directorate has stated that the “crystallization of an accrued gain, solely as a means of ensuring access to the current inclusion rate, would not, in itself, be subject to GAAR.” With the potential lack of economic substance in crystallization transactions, this statement may actually create further confusion about the general application of GAAR.
While tax rules aim to achieve policy objectives, their design is as crucial as the objectives themselves. Recent approaches have led to broad, complex rules that increase compliance costs and administrative burdens. What’s needed is a thorough review of the Act, a sentiment shared by CPA Canada in our 2024 pre-budget submission, which recommended prioritizing a principled approach to tax policy and administration that is driven by purpose and vision. Such a review can help ensure that Canada’s tax system remains guided by good basic principles so that compliance costs can remain reasonable and taxpayers can have simplicity, fairness, predictability and certainty of outcome.