Aggressive International Tax Planning Framework

Final Report

Corporate Audit and Evaluation Branch
June 2010


Table of Contents

Executive Summary

Background: Addressing Aggressive Tax Planning (ATP) is one of the five Reporting Compliance priorities in the Canada Revenue Agency's (CRA) Summary of the Corporate Business Plan 2009-2010 to 2011-2012. Deliverables related to this priority include implementing an international tax compliance action plan and enhancing the risk assessment and identification of high-risk international tax avoidance cases.

As part of the February 2005 Federal Budget, CRA received annual, ongoing funding of $30 million to enhance and provide stronger focus on Aggressive International Tax Planning (AITP) activities. Approximately $15 million of the AITP funding was allocated to the Compliance Programs Branch (CPB). The remaining funds were allocated to complementary program areas such as Appeals, Debt Management, and the Department of Justice.[Footnote 1]

Approximately 80% of CPB's AITP resources were used to increase audit coverage of the files most at risk of having an AITP component. The remaining 20% of CPB's AITP resources were used to increase CRA's research and analytical capability to enhance identification methods with respect to AITP. This included the establishment of Centres of Expertise (CE) to conduct research on international tax avoidance and aggressive tax planning practices and the development of risk assessment models.

The International and Large Business Directorate (ILBD) within CPB has functional authority over the ATP compliance priority, which includes AITP. Funding and operational accountability for AITP is shared between the International Tax and Aggressive Tax Planning divisions.

The objectives of the enhanced focus on AITP are to:

Objective: The objective of the audit was to determine whether the International Tax and Aggressive Tax Planning divisions in CPB have implemented a framework to support the achievement of the AITP objectives. The focus of the audit was on the controls in place for operational planning and monitoring and reporting. This did not include an assessment on the progress achieved to date on each of the AITP objectives.

Conclusion: Although the International and ATP divisions of ILBD have established a framework to support the achievement of the AITP objectives, opportunities exist to strengthen the internal controls within that framework.

The objective of the AITP research activities was to have an enhanced risk assessment model in place after the third year. AITP schemes are complex and evolving in nature and successes with individual projects do not always result in risk indicators or algorithms that can be applied nationally. For the period 2005 to 2009, 171 requests were made to the Risk Assessment Section to test, modify, and validate new proposals on existing data; however, progress has been limited to one new national risk indicator. CPB ILBD should develop, and communicate to stakeholders, a comprehensive plan that identifies deliverables, timelines, and accountabilities for AITP research activities. They should also develop and/or refine performance measures to enable monitoring of progress, successes and challenges of the AITP research activities.

The controls that ILBD established to track both results and resources for the AITP audit coverage need to be enhanced to ensure the accuracy and relevancy of data captured. CPB ILBD should clarify their reporting methodology for AITP audit coverage and, on an ongoing basis, update and communicate guidelines/interpretations on the definition of AITP files to ensure the validity and accuracy of results reported.

Action Plan

CPB agrees with the recommendations and the action plans with related timelines are included in this report.

Introduction

Addressing Aggressive Tax Planning (ATP) was identified as one of the four compliance priorities from the comprehensive Agency Compliance Review exercise that was completed in 2004, and continues to be identified as one of the five Reporting Compliance priorities in the Canada Revenue Agency's (CRA) Summary of the Corporate Business Plan 2009-2010 to 2011-2012. Deliverables related to this priority include implementing an international tax compliance action plan and enhancing the risk assessment and identification of high-risk international tax avoidance cases. Increased globalization and labour mobility have resulted in a rise in international transactions and cross-border investment opportunities. Technology has also made offshore financial transfers and investments more accessible to a wider range of taxpayers.

As part of the February 2005 Federal Budget, CRA received annual, ongoing funding of $30 million to deal with Aggressive International Tax Planning (AITP). The purpose for this incremental funding was to increase, enhance and provide stronger focus over compliance activities used to counter the growth of offshore tax avoidance and offensive tax schemes. Approximately $15 million of the AITP funding was allocated to the Compliance Programs Branch (CPB). The remaining funds were allocated to complementary program areas such as Appeals, Debt Management, and the Department of Justice (DOJ).[Footnote 2]

The International and Large Business Directorate (ILBD) within CPB has functional authority over the ATP compliance priority, which includes AITP. ILBD was created in 2006 as a result of CPB's Functional Activity Review (FAR) and involved the amalgamation of three specialized areas: the International Tax Directorate, the Large Business Audit Section and the Tax Avoidance and Special Audits Division. The new Directorate aimed to strengthen the Branch's capacity for the horizontal and integrated delivery of international tax administration, and thereby contribute to the Agency's overall mandate of ensuring Canada receives its fair share of taxes from international business and financial transactions. Funding and operational accountability for AITP is shared between the International Tax and Aggressive Tax Planning divisions.

The objectives of the enhanced focus on AITP are to:

According to the 3 Year Update Report for Treasury Board Regarding Omnibus Funding for the Aggressive International Tax Planning Initiative, presented in May 2008, approximately $12 million or 80% of CPB's AITP resources were used to increase audit coverage of the files most at risk of having an AITP component. These resources were set aside to focus on achieving increased coverage rates in the Large File, Basic File, and Small and Medium Enterprise populations.

The remaining $3 million or 20% of CPB's AITP resources were used to increase CRA's research and analytical capability to enhance identification methods with respect to AITP. This included the establishment of Centres of Expertise (CE) to conduct research on international tax avoidance and aggressive tax planning practices and enhancing the development of risk assessment models.

In 2005, the CRA established 11 CE at the Halifax, Saint John, Laval, Montréal, Ottawa, Toronto West, London, Winnipeg, Calgary, Burnaby-Fraser, and Vancouver Tax Services Offices. ILBD coordinates and facilitates the research activities to prevent overlap in the regions. Using the information gathered by the CE, ILBD works with the Compliance Research and Risk Assessment Division (CR & RA) of the Research, Risk and Business Management Directorate to integrate risk indicators into risk assessment models. ILBD also works with the Legislative Policy and Regulatory Affairs Branch (LPRAB) to recommend legislative changes and coordinates work with international partners such as the Joint International Tax Shelter Information Centre (JITSIC), the Seven Country Working Group on Tax Havens, the Leeds Castle Group and the Organization for Economic Co-operation and Development (OECD).

Objective and Scope of Audit

The objective of the audit was to determine whether the International Tax and Aggressive Tax Planning divisions in CPB have implemented a framework to support the achievement of the AITP objectives. The focus of the audit was on the controls in place for operational planning and monitoring and reporting. This did not include an assessment on the progress achieved to date on each of the AITP objectives.

Examination work was conducted in the summer and fall of 2009.

The audit was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing.

Findings, Recommendations and Action Plans

1.0 Operational Planning

A comprehensive plan should be in place to facilitate communication and keep all stakeholders progressing towards the objective of an enhanced risk model. Although some elements of a plan are in the ILBD Planning Guidelines, the Draft CE Detailed Strategy, and the International Compliance Strategy Implementation Plan, deliverables, timelines and accountabilities for AITP research activities are not clearly identified or communicated to stakeholders.

When additional resources were received in 2005 for the increased focus on AITP, ILBD set up Centres of Expertise and established targets and tracking mechanisms for AITP audit files. A new Cross Border Tax Avoidance Course was also developed and delivered to auditors. Regional and national ILBD learning conferences were held on a regular basis to communicate AITP guidelines and procedures as well as clarify roles and responsibilities of stakeholders.

Communication initiatives related to AITP activities were developed and implemented. Internally, ILBD and the Revenue Collections Operations Directorate (RCOD) of the Taxpayer Services and Debt Management Branch (TSDMB) signed a Memorandum of Understanding (MOU) to foster a partnership between the directorates and to demonstrate a coordinated compliance front to address AITP schemes. Furthermore, an MOU signed between ILBD and the DOJ in 2009 has resulted in earlier DOJ involvement during the audit stage on complex AITP files.

Externally, ILBD is developing a pamphlet on tax havens to support the AITP objective of educating the public. ILBD, along with Public Affairs Branch, has developed a coordinated plan for issuing Tax Alerts. ILBD also actively participates in international organizations including the Seven Country Tax Haven group, OECD Working Party Eight and JITSIC to keep current on emerging schemes as well as exchange best practices.

The key objective of the AITP research activities is to enhance risk-assessment models and CRA's capacity to identify AITP schemes. According to the 2005 Treasury Board Submission, an enhanced risk‑assessment system would be fully implemented after the third year.

Within CPB, the CR & RA Division has a Risk Assessment Section where through ad-hoc requests, the CE, among other areas, can test proposals to improve their ability to select the most appropriate files for audit activity. For the period 2005 to 2009, 171 requests were made to the Risk Assessment Section to test, modify, and validate new proposals on existing data. Interviews with CR & RA staff indicate that research work performed by CE from 2005 to 2009 has resulted in one new algorithm or risk indicator that can be applied nationally. Few research papers prepared by CR & RA link to AITP and the work of the CE. Similarly, the selection of research projects undertaken by the CE does not appear to link to research studies prepared by CR & RA. AITP schemes are complex and evolving in nature and successes with individual projects do not always result in algorithms that can be applied nationally. However, increased coordination between the CE and CR & RA would support progress towards an enhanced risk model.

Similar issues related to leveraging the knowledge in CR & RA have been identified in previous internal audits including the Compliance Research and Quality Assurance Audit in 2001, the Use of Enforcement and Legislative Provisions Audit in 2006, and the Underground Economy Initiative Audit in 2008. In 2004, the OAG expressed similar comments in their Small and Medium Enterprise Audit.

Recommendation

CPB ILBD, in consultation with CR&RA, should develop, and communicate to stakeholders, one comprehensive plan that identifies deliverables, timelines, and accountabilities for AITP research activities.

Action Plan

CPB has developed an action plan for 2010-2011 which addresses CAEB concerns. This plan is under review at the Director/Director General level and will be communicated to relevant areas by October 31, 2010.

Regarding consultation, deliverables, accountabilities, roles and responsibilities and timelines, CPB will establish for each research project: expectations, deliverables and timelines, and create a mechanism which will link them to set accountabilities for the research activities. CPB will revisit, with all CE and their managers, the objective of each research project, its deliverables, timelines, and accountabilities to ensure all stakeholders are aware of what is expected, get their buy-in and ensure they are aware of all the resources available to support them in their AITP research activities.

As to monitoring and reporting, CPB will review quarterly progress reports on each project with a view to prioritizing projects to ensure our resources are focused on the projects with the greatest potential. The goal is to streamline the workload to increase the flexibility of the CE giving them capacity to take on higher priority projects, and dealing with current challenges as they arise.

With respect to communication, CPB will communicate and consult with stakeholders and seek their input on an ongoing basis. To further encourage the sharing of knowledge and information not only with Headquarters, but also with the CE and the regions CPB will increase the flow of information through the use of e-mail, conference calls, newsletters, and when appropriate and fiscally feasible, to perform outreach or visits in the CE and in the regions. CPB will use these opportunities to inform them of activities and collaborate with stakeholders on the subjects of our research and the improvements to our risk assessment system.

The expected completion date for these activities is December 31, 2011.

2.0 Monitoring and Reporting

2.1 Research Activities

ILBD developed a number of controls to monitor the progress of the various AITP research projects being conducted in the eleven Centres of Expertise (CE) across the country. This included individual project quarterly reports, time codes, internal order numbers, and the establishment of a CE Advisory Committee. Also, the 2005-2006 Planning Guidelines for both International and ATP list some performance indicators for AITP research activities including resources utilized, direct time utilized, pilot projects tested, initiated and expanded, fiscal impact and legislative recommendations.

Without a comprehensive plan that identifies deliverables, timelines, and accountabilities for AITP research activities, these existing controls and performance indicators do not provide an effective and efficient process to measure and monitor the progress, successes, and challenges of these AITP research projects. Also, it was not evident that yearly results from CE were analyzed with respect to the performance indicators listed in the Planning Guidelines. While some challenges to research activities have been identified, including limited access to both internal and external data sources, and formatting and indexing inconsistencies between databases, formal analysis work with action plans to address these challenges was not evident.

The inherent nature of research activities makes the development of meaningful performance measures challenging. However, comprehensive performance measures would provide ILBD management with the information needed to make informed decisions on improving the efficiency and effectiveness of AITP research activities. Continuous monitoring and reporting on these measures would enable ILBD to assess or demonstrate CRA's improved effectiveness at identifying and selecting the highest risk files.

Recommendation

CPB ILBD should refine existing performance measures and, where appropriate, develop new measures to enable monitoring of progress, successes and challenges of the AITP research activities.

Action Plan

CPB will develop a tool to better monitor the results of research activities. This enhanced tool will link the performance indicators to individual research activities improving our ability to measure and monitor progress and make the CE aware and accountable for their resource utilization versus achieved results. Once this tool is in place, CPB will review the existing performance indicators to determine their effectiveness and develop new indicators as appropriate.

CPB plans, with the involvement of the CE, to redesign our communication network to ensure significant achievements, successes and challenges are documented and communicated to all stakeholders on a regular basis. With respect to monitoring the challenges inherent in such research activities (i.e. legislative changes, access to certain information or data bases) CPB will develop a process to monitor and report on the plan and status of these initiatives to ensure the effective and efficient use of resources.

The expected completion date for these activities is December 31, 2011.

2.2 AITP Audit Coverage

The majority of additional resources received for AITP were allocated to the ATP and International programs in the Tax Services Offices (TSOs) to provide additional audit coverage. However, the controls that ILBD established to track both results and resources for AITP audit coverage need to be enhanced to ensure the accuracy and relevancy of data captured and to allow ILBD to appropriately measure the impact from AITP audit coverage.

While new codes were introduced into the Audit Information Management System (AIMS) to record results for AITP audits, and controls are in place to monitor those results, the definition to code AITP files is ambiguous and open to interpretation, particularly in the International program. Consequently, the coding of results was inconsistent. As AITP evolves, updating and communicating the guidelines/interpretations on the definition of AITP files would enhance the validity and accuracy of results reported.

Recommendation

CPB ILBD should clarify reporting methodology for AITP audit coverage.

CPB ILBD should, on an ongoing basis, update and communicate guidelines/interpretations on the definition of AITP files to ensure the validity and accuracy of results reported.

Action Plan

Effective April 1, 2010, Aggressive Tax Planning (ATP) is introducing changes to AIMS to better monitor its program using ReportNet. The change will allow for 1:1 mapping between budget, results and salary utilization. With the recent introduction of the ReportNet tool, and with International Tax Division continuing to use Spare Block 2 in AIMS to track and record results, CPB will be in a better position to monitor program results and resource utilization for all ATP workloads including AITP.

CPB will review this definition on an ongoing basis and modify it as required to ensure that it is sufficiently clear to enable Tax Service Office (TSO) staff to determine whether a case fits the Aggressive International Tax Planning definition. Note that CPB leaves some room for the exercise of professional judgement in determining the identification of a file.

The expected completion date for the establishment of a review process is December 31, 2011.

Conclusion

Although the International and ATP divisions of ILBD have established a framework to support the achievement of the AITP objectives, opportunities exist to strengthen that framework.

The objective of the AITP research activities was to have an enhanced risk assessment model in place after the third year. AITP schemes are complex and evolving in nature and successes with individual projects do not always result in risk indicators or algorithms that can be applied nationally. For the period 2005 to 2009, 171 requests were made to the Risk Assessment Section to test, modify, and validate new proposals on existing data; however, progress has been limited to one new national risk indicator. CPB ILBD should develop, and communicate to stakeholders, a comprehensive plan that identifies deliverables, timelines, and accountabilities for AITP research activities. They should also develop and/or refine performance measures to enable monitoring of progress, successes and challenges of the AITP research activities.

The controls that ILBD established to track both results and resources for the AITP audit coverage need to be enhanced to ensure the accuracy and relevancy of data captured. CPB ILBD should clarify their reporting methodology for AITP audit coverage, and on an ongoing basis, update and communicate guidelines/interpretationson the definition of AITP files to ensure the validity and accuracy of results reported.

Footnotes

[Footnote 1]
3 Year Update Report for Treasury Board Regarding Omnibus Funding for the Aggressive International Tax Planning Initiative, May 2008
[Footnote 2]
3 Year Update Report for Treasury Board Regarding Omnibus Funding for the Aggressive International Tax Planning Initiative, May 2008

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