Definitions for Tax shelters
A limited-recourse amount is the unpaid principal amount of any indebtedness for which recourse is limited in any way. If a person (or any other person not dealing at arm's length with the person) incurs a limited-recourse amount, the amount of any tax benefits to which the person would otherwise be entitled to may be reduced.
For example, the amount of any expenditure that is the cost or capital cost of the person's tax shelter investment is reduced by the amount of any related limited-recourse amount incurred by the person (or any other person not dealing at arm's length with the person).
This provision is meant to ensure that participants' deductions will be limited to funds that are actually at risk.
A taxpayer reports an investment of $100,000 in a tax shelter. The investment is composed of $10,000 in cash, and financing $90,000.
Where, for example, the only collateral for the debt is the tax shelter property itself, or potential income from that property, the $90,000 would be a limited-recourse amount. As such, under tax shelter rules, the cost of the investment would be $10,000 not $100,000.
The Canada Revenue Agency (CRA) also consider the unpaid principal amount of a financing to be a limited-recourse amount unless all of the following requirements are met:
- interest is payable at least annually at a rate equal to or greater than the prescribed rate of interest at the time the indebtedness arose, or during its term
- interest is paid every year during the term of the indebtedness no later than 60 days after the end of the taxation year
- there are bona fide arrangements in writing, at the time the indebtedness arose, for repayment of all principal and interest and the repayment will occur within a reasonable period not exceeding 10 years
However, in some circumstances the CRA may consider loans repayable within 10 years to be a limited-recourse amount. For example, the maximum 10 year time period for repayment cannot be avoided through a series of loans and repayments. Also, where the investor is a partnership, the indebtedness is a limited-recourse amount if recourse against any member of the partnership is limited in respect of the unpaid principal amount.
Limited-recourse debt in respect of a gift or monetary contribution
A limited-recourse debt in respect of a gift or monetary contribution made after February 18, 2003 includes all of the following:
- each limited-recourse amount that relates to the gift or monetary contribution that is incurred by a person (or any other person not dealing at arm's length with the person)
- each limited-recourse amount that relates to the gift or monetary contribution that is incurred by another person dealing at arm's length with a person but that directly or indirectly holds an interest in the person
- any other amount that is unpaid indebtedness of a person described in a) or b) that relates to the gift or monetary contribution, if there is a guarantee, security or other indemnity or covenant in respect of that or any related indebtedness
A limited-recourse debt includes the unpaid principal of any indebtedness, that can reasonably be considered to relate to the gift or monetary contribution, for which recourse is limited, even if that limitation applies only in the future or contingently. It also includes any other indebtedness of the person that can reasonably be considered to relate to the gift or monetary contribution if there is a guarantee, security or similar indemnity or covenant in respect of that or any other indebtedness.
For example, if a donor enters into a contract of insurance whereby all or part of a debt will be paid upon the occurrence of either a certain or contingent event, the debt is a limited-recourse debt in respect of a gift if it is in any way related to the gift.
Such indebtedness is also a limited-recourse debt if it is owed by another person dealing at non-arm’s length with the person or by another person who holds an interest in the person.
Property is defined in subsection 248(1) of the Income Tax Act and means property of any kind whatever, whether real or personal and whether tangible or intangible, including a right of any kind and a share or a chose in action (right to sue). Two types of properties excluded from the definition of a tax shelter are flow-through shares and prescribed property.
Third-party civil penalty
The objective of the third-party civil penalties is to deter third parties from making false statements or omissions in relation to income tax or GST/HST matters. These penalties are directed at ensuring tax compliance and deterring inappropriate behaviour.
Section 163.2 was added in 2000 to address promoters of abusive tax shelters, and also all tax professionals dealing with the Income Tax Act. It is applicable to statements made after June 29, 2000.
Information Circular IC01-1, Third-Party Civil Penalties, outlines the guidelines and processes of the CRA for the application of third-party penalties. The legislation provides for two penalties—one directed primarily at those who prepare, sell, or promote a tax shelter or tax shelter-like arrangement, and the other directed at those who provide tax-related services to a taxpayer. These may apply to, among others, tax return preparers, accountants, advisors, practitioners, brokers, tax or financial planners, appraisers, valuators, and tax shelter promoters.
The third-party civil penalties are meant to apply to those persons who counsel and assist others in making false statements when they file their returns or who are wilfully blind to obvious errors when preparing, filing, or assisting another person in filing a return. They are also intended to apply to arrangements and plans that contain false statements, often without the knowledge of the client.
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