What is the Tax Gap?
Broadly defined, the tax gap is the difference between the taxes that would be paid if all obligations were fully met in all instances, and those that are actually received and collected. As a concept, it can encompass revenues lost to tax evasion, taxpayer error, and unpaid liabilities. It includes both domestic and international dimensions.
The high degree of difficulty and resources required to measure the tax gap and the uncertainty of the estimates are widely acknowledged.
Measuring the tax gap
Most countries do not estimate the tax gap. In fact, according to the OECD's Tax Administration Series 2013, well over half of member revenue bodies surveyed -- 33 of 52 -- do not measure it. Still fewer - 13 of 52 - reported that estimates are made public.
Developing a methodology to estimate the tax gap and conducting analysis are costly. Further, there is no internationally agreed-upon methodology, making comparisons impossible. Jurisdictions commonly cite limitations and challenges to the accuracy of the calculation, including the difficulty in estimating the impact of the informal economy and international or offshore transactions. Only Sweden actually includes an estimate of its international tax gap as part of its total tax gap, while at the same time noting the estimate has a high degree of uncertainty.
Countries that attempt to estimate the tax gap do so in two ways:
- the top-down approach, which is used when looking at indirect domestic taxes like the GST, compares current tax revenues with estimates of the taxes that should be paid, based on broad measures of economic activity, such as gross domestic product. Because of its general nature, the top down approach can't provide any helpful information to a tax administrator on which groups or sectors of taxpayers may be at risk of not paying their taxes, so can't be used to help target compliance activities;
- the bottom-up approach, which is used for direct taxes like income tax, compares current tax revenues with estimates of the taxes that should be paid, based on an estimated level of tax non-compliance in the full taxpayer population. This estimate of non-compliance is determined using data from audits, surveys, etc. The bottom up approach also has significant limitations - it can be expensive and burdensome on taxpayers, and may not identify all possible elements of non-compliance.
Further, estimates of the tax gap using either approach are usually done only periodically and for tax years that occurred several years before the year of measurement. That makes them unhelpful in understanding the medium- to short-term impacts of changes to tax policy or tax administration.
Canada's approach to addressing non-compliance
The domestic underground economy, international tax evasion, and aggressive tax avoidance are hard to quantify because, by definition, they involve undeclared or under-declared income and assets that are deliberately hidden from the government. Although some countries do produce an estimate, there is no commonly accepted methodology and, in fact, there is much debate worldwide about the accuracy, reliability, and usefulness of any methodology used to estimate a tax gap. The Government of Canada has invested its resources where they can deliver results - in helping taxpayers understand and meet their tax obligations before costly errors or non-compliance occurs, and in identifying and pursuing tax evasion and aggressive tax avoidance when they do occur.
The CRA has taken significant steps to understand taxpayer behaviour, especially where there is a higher risk of non-compliance, in order to ensure our programs are doing what Canadians expect - ensuring a fair system where everyone pays the taxes they owe.
The Agency continues to refine its sophisticated risk assessment tools, helping to focus audit resources on the highest-risk files. It also performs random audits to establish a better understanding of the risks associated with, and rates of, non-compliance.
These measures concretely assist the Agency in understanding, documenting and reducing tax non-compliance.
Other measures to reduce non-compliance
Using the knowledge gained from its research, the Government of Canada is taking strong measures to ensure the integrity of the tax system and protect Canada's revenue base:
- Over 85 measures were introduced, including an investment of $30 million over five years for the CRA to implement a number of measures announced in Economic Action Plan 2013 to combat international tax evasion and aggressive tax avoidance, such as:
- the requirement for financial intermediaries including banks to report international electronic funds transfers (EFTs) of $10,000 or more to the CRA, starting in January 2015, to help better identify higher risk taxpayers and files and, in turn, more effectively identify taxpayers who participate in international aggressive tax avoidance and attempt to conceal income and assets offshore;
- the establishment of the Offshore Compliance Division, a dedicated team comprised of 70 CRA employees with expertise in the fields of data analysis and auditing;
- the launch of the new Offshore Tax Informant Program (OTIP) in January 2014, which allows the CRA to pay individuals who provide credible and specific information about major international tax non-compliance a percentage of federal tax collected;
- a strengthened Foreign Income Verification Form (T1135), which introduced new reporting requirements for Canadian taxpayers with foreign property holdings to report more detailed information;
- the extension of the reassessment period by three years for taxpayers who have failed to report income from a specified foreign property on their annual income tax return and who have failed to file the T1135 accurately or on a timely basis, providing the CRA with more time to identify and audit this information; and
- the streamlining of the legal process for the CRA to obtain information concerning "unnamed persons" from third parties, such as banks.
- In 2014, Kerry-Lynne Findlay, Minister of National Revenue, hosted the inaugural meeting of the new Underground Economy Advisory Committee. The Advisory Committee, comprised of representatives from key industry stakeholder organizations representing a broad cross-section of the Canadian business community and tax professions, is the first of its kind. The Advisory Committee will provide the Minister and the CRA with unprecedented direct access to industry perspectives and input to help inform the Government of Canada's strategy for tackling the underground economy.
- Budget 2014 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.
- Over the past several years, the Government of Canada has created 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's ability to identify, address and stop aggressive international tax avoidance and evasion is significantly improved.
- The CRA also plays a leading role in many international forums where countries are collaborating to reduce international non-compliance. The Government of Canada is an active participant in the OECD/G20 Base Erosion and Profit Sharing (BEPS) initiative which aims to promote international tax standards to address tax planning strategies that exploit gaps and mismatches in tax rules.
These and other measures to combat domestic and international tax evasion are showing results:
- The number of taxpayers using the CRA's Voluntary Disclosures Program (VDP) has increased significantly. In particular, the number of disclosures related to offshore activities received from April 1, 2013 - March 31, 2014 was 5,248 for a total of $303 million in unreported income. In fiscal year 2014-2015, as of January 25, 2015, that number rose to 8,638 disclosures for a total of $594M in unreported income.
- In 2013-2014 alone, the Agency reported $1.7 billion in undisclosed income generated by the Aggressive Tax Planning (ATP) audit program.
- From April 1, 2009 to March 31, 2014, the work of the CRA's Criminal investigations Program led to the criminal conviction of 783 taxpayers for tax evasion involving approximately $150 million in federal tax evaded, court fines totalling approximately $61 million and 2,969 months of jail time. Of these convictions, 44 had links to monies and/or assets held offshore involving approximately $18 million in federal taxes evaded, court fines of approximately $10 million, and 538 months of jail time.
- During this same period of time, the average court fines relating to tax evasion convictions almost doubled: from approximately $55,000 in fiscal year 2009-2010 to approximately $101,000 in fiscal year 2013-2014. For cases where sentencing included jail time, the average jail term increased, from 21 months in fiscal year 2009-2010 to 25 months in fiscal year 2013-2014.
The Liaison Officer Initiative (LOI) helps small and medium-sized businesses to meet their tax obligations by providing in-person support to them at key points in their business cycle, and information that will assist them in understanding their rights, navigating the tax system, cutting through red tape and more easily complying with their tax obligations. By identifying emerging issues and addressing questions earlier on, the CRA can stop them from developing into more serious problems that are expensive for taxpayers to resolve.
How is the CRA working with the Parliamentary Budget Officer (PBO)?
In 2013, the PBO asked the CRA for data that the PBO believed would allow it to calculate the tax gap.
Our obligation to protect the confidentiality of individual taxpayers means that only aggregate statistical data can be provided to the PBO rather than taxpayer-specific records. The Agency is not authorized under the Income Tax Act and the Excise Tax Act to provide any confidential taxpayer information to the PBO, and there is no provision in the Parliament of Canada Act (which sets out the PBO’s powers and mandate) that would override this legal obligation.
The PBO requested information relating to three main types of taxes – individual income tax (T1), corporation income tax (T2) and Goods and Services Tax/Harmonized Sales Tax (GST/HST). Specifically, the PBO asked that information from specific fields on the tax returns for each type of tax be analyzed according to different categories, such as income groups and province.
This request is the largest the CRA has ever received. The individual income tax data alone would contain approximately 110 million statistics. By comparison, the largest previous request the Agency has received comprised about 2.6 million statistics. The CRA estimates that it will take at least six months to produce the data. Further, a majority of the information would either be zero or would have to be blanked out, where the breakdown of numbers is so small that individual taxpayers could be identified, rendering the information incomplete.
Nevertheless, the CRA remains open to providing the requested information to the PBO in a format that protects taxpayer confidentiality, in accordance with the law.
A complete record of the CRA’s written communications with the PBO is available on the PBO website.
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