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1998 June Report of the Auditor General of Canada

Report to the House of Commons and to the Ministers of Finance and National Revenue—Examination of the Requirement to Report Specified Foreign Property Under Section 233.3 of the Income Tax Act

Terms of Reference and Scope of Examination

Summary Conclusions

The reporting requirement is an appropriate mechanism

Background

Basic tax rules regarding residency and taxation of worldwide income

Concerns about non-reporting of foreign-source income

The reporting regime for offshore investments

Description of the reporting requirement for specified foreign property

Objectives for the reporting requirement for specified foreign property

Need for Information on Offshore Investments

Canadians are increasingly investing abroad

There are indications of non-comppance in reporting foreign-source income

Revenue Canada needs information to verify taxpayers' self-assessments

Revenue Canada cannot compel offshore third parties to provide information

Alternative Mechanisms to the Reporting Requirement for Specified Foreign Property

Repeal the reporting requirement and increase enforcement of existing laws

Allow new Canadians to negotiate their Canadian tax pabipties for a period of time

Implement a check-the-box system

Privacy, Economic and Investment Issues

Suggested Modifications and Improvements

Technical Modifications to the Reporting Requirement Should Be Considered to Reduce the Comppance Burden and Address Taxpayer Concerns

Faciptation Needs Further Improvement

Faciptating the reporting of foreign-source income
Need to inform new Canadians about their tax obpgations
Pubpcize the voluntary disclosure popcy

Using the New Information to Enhance Comppance

Revenue Canada and the Department of Finance need to maximize their use of the new information

Monitoring and evaluation of the reporting requirement are needed

Level of enforcement for foreign-source income needs to be reviewed

About the Examination

Terms of Reference and Scope of Examination

1. On December 19, 1997, the Governor General in Council, on the recommendation of the Minister of Finance and the Minister of National Revenue, asked the Auditor General to:

    (a) examine whether the requirement set out in section 233.3 of the Income Tax Act to report foreign property over $100,000 is the appropriate mechanism to enhance compliance with the law;
    (b) examine alternative mechanisms to the reporting requirement referred to in paragraph (a) to ensure that Canadian residents voluntarily report their worldwide income;
    (c) consider the broader implications of the reporting requirement referred to in paragraph (a), including privacy, economic and investment issues; and
    (d) report to the House of Commons, the Minister of Finance and the Minister of National Revenue on the matters referred to in paragraphs (a) to (c).
2. This examination was carried out pursuant to section 11 of the Auditor General Act. We called for submissions from the public, interviewed tax professionals and business leaders in Canada and abroad, interviewed officials in the departments of Finance and National Revenue, consulted experts in the areas of taxation, privacy and economics, compared Canada's reporting requirements with those in other jurisdictions and examined alternative mechanisms. In coming to our conclusions we analyzed all of the information we received. Further details about the examination can be found in About the Examination at the end of this report.

Summary Conclusions

The reporting requirement is an appropriate mechanism
3. Based on our examination, and after careful consideration of several concerns and possible alternatives brought to our attention by taxpayers during the course of our work, we have come to the following conclusions:

    (a) The requirement contained in section 233.3 of the Income Tax Act is an appropriate mechanism within an overall strategy to both enhance compliance with the laws that require reporting of foreign-source income and provide Revenue Canada with information to verify taxpayers' self-assessments. We note that the requirement is a compliance tool and does not impose any new taxes. At the same time, we believe that some modifications should be considered and these are set out in the report. The strategy also includes other important reporting requirements with respect to foreign affiliates and non-resident trusts that we did not examine, as well as enforcement programs at Revenue Canada. We recommend improvements to Revenue Canada's facilitation programs including its voluntary disclosure policy to maximize the benefits that can be achieved from the reporting requirement.
    (b) We asked departmental officials and those who made submissions to suggest alternatives. We examined all that were suggested to us and have grouped them into three alternatives. We concluded that repealing the requirement and increasing enforcement would not meet many of the objectives set for the reporting requirement. In addition, without information it is difficult to target audits, which would diminish the prospects for success. The suggestion that new immigrants be allowed to negotiate their Canadian tax liabilities on foreign-source income for a period of time is not a viable alternative, primarily for equity reasons. A check-the-box system is an alternative that could be considered but, in our view, would not be as effective as the existing requirement because it would meet only some of the objectives.
    (c) We studied the serious and deep-felt concerns that taxpayers raised about privacy, economic and investment issues. We found that many of the concerns had their root cause in Canada's relatively high tax rates, its requirement to pay tax on worldwide income and a poor understanding of Canada's tax system. It was apparent to us that while the reporting requirement was a focal point, it was not the main concern.
4. A detailed discussion of how we arrived at these conclusions follows. In the Appendix to this report, we discuss taxpayers' concerns and why we concluded that, although they are serious, most stem from matters outside the reporting requirement we were asked to examine.

Background

Basic tax rules regarding residency and taxation of worldwide income
5. As a matter of fundamental tax policy, Canada levies income taxes on all those who are resident in Canada. Many countries do the same, while other countries have different rules. For example, the United States levies income taxes on all of its citizens regardless of where they reside.

6. Residence is not defined in the Income Tax Act (except for certain deeming provisions for non-residents); it is determined on the basis of all the facts and circumstances of each case and in accordance with relevant jurisprudence. The courts have held that an individual is resident in Canada for tax purposes if Canada is the place where, in the settled routine of life, the individual regularly, normally or customarily lives.

7. As well, Canada levies income taxes on worldwide income. In other words, all income of Canadian residents that falls within the ambit of the Income Tax Act, whether earned in Canada or outside, is taxable in Canada. Many other countries do the same, including the United States. There are countries that levy taxes only on income earned within their jurisdictions. Canada has entered into tax treaties with many countries to avoid double taxation in situations where Canada and the other country would otherwise both tax the same income.

8. It is important to understand these basic rules; our examination indicated that not everyone is clear about them and some people simply do not want to accept them. This results in unintentional or deliberate non-compliance.

Concerns about non-reporting of foreign-source income
9. In his 1995 Budget, the Minister of Finance announced that Canadian individuals and corporations who hold or acquire investments outside Canada would be required to disclose additional information on their interest in such investments. This decision was made because, as the Minister said, he was concerned about the growing popularity of tax havens as a place for Canadians to invest their money and thereby avoid taxes. He was also responding to recommendations by the Public Accounts Committee that the Income Tax Act be amended to end the tax avoidance schemes used by Canadian corporations operating foreign subsidiaries.

10. In releasing the draft reporting requirements, the Minister noted that they signified the government's commitment to preserving the integrity of the Canadian tax base, particularly with respect to the use of foreign tax havens by Canadians. He also said that the reporting requirements would give Revenue Canada more ability to scrutinize offshore investments held by Canadians and to ensure the complete reporting of income. The Minister of National Revenue said that it would be unfair to Canadians to allow some to hide financial assets offshore to avoid paying their fair share of taxes.

11. In announcing the Auditor General's examination of the reporting requirement for specified foreign property, the Minister of National Revenue explained that the government is committed to ensuring fairness in the tax system and combating tax evasion through the use of tax havens.

The reporting regime for offshore investments
12. Following the announcement in the 1995 Budget, four reporting requirements related to offshore investments were introduced into the Income Tax Act. These requirements make up an overall regime that is designed to cover all types of offshore investments. The requirements deal with:

  • investments in foreign affiliates;
  • transfers and loans to non-resident trusts;
  • distributions and loans from non-resident trusts; and
  • investments in specified foreign property in excess of $100,000.
13. Details about the four requirements are outlined in Exhibit 1.

14. It is the last requirement, contained in section 233.3 of the Income Tax Act, that the Governor General in Council asked the Auditor General to examine. All four reporting requirements are in the Income Tax Act but the government has announced a delay in implementing the last one only, pending the Auditor General's examination.

Description of the reporting requirement for specified foreign property
15. Section 233.3 of the Income Tax Act (see Annex) requires most taxpayers, whether individuals, corporations, partnerships or trusts, to report their specified foreign property annually. It is important to note that this requirement is a compliance tool and does not impose any new taxes. The section defines what is included in specified foreign property and what is excluded. Essentially it includes assets, such as bank accounts, portfolio investments and rental property, that generally give rise to property income as defined in the Act. It also includes an interest in a non-resident trust. However, the definition specifically excludes, among other things, property used exclusively in carrying on an active business, investments in foreign affiliates and personal-use property.

16. During our examination we noted a great deal of confusion about the types of assets that are included in the definition of specified foreign property and those that are excluded. For example, we heard many concerns about having to report the details of foreign businesses. If those businesses are active businesses, then they are excluded from the definition and do not have to be reported as specified foreign property. However, if those businesses are incorporated, they may fall into the definition of a foreign affiliate of the taxpayer. In that case, there is a separate reporting requirement under section 233.4 of the Income Tax Act. We have not been asked to examine that requirement.

17. Exhibit 3 shows the current draft of form T1135 for reporting specified foreign property in excess of $100,000. The form sets outs the various types of specified foreign property and requires details on cost (not on fair market value, as some people have suggested) and income.

Objectives for the reporting requirement for specified foreign property
18. The government has set out several objectives for the reporting requirement for specified foreign property. These objectives can be broadly summarized as enhancing compliance with the tax laws that require reporting of foreign-source income, by increasing taxpayers' awareness of the laws and providing information to Revenue Canada to verify taxpayers' self-assessments. The Department of Finance's specific objectives are set out in Exhibit 2.

Need for Information on Offshore Investments

Canadians are increasingly investing abroad
19. The Technical Committee on Business Taxation established by the Minister of Finance in 1996 has recently noted that the Canadian economy is one of the most open among larger developed countries. Almost 40 percent of our gross domestic product is derived from exports and about 20 percent of our business capital has been provided by foreign investors. Moreover, Canada has evolved into a significant capital-exporting nation as well as a capital importer. Statistics Canada data show that Canadian investment abroad has grown from $326 billion in 1993 to $550 billion in 1997. As well, immigrants with significant offshore wealth are settling in Canada.

20. This growth in investment abroad has serious implications for the Canadian tax system. The government has to ensure that the income earned on this investment is taxed in accordance with the rules in the Income Tax Act. As already noted, Canada taxes its residents on their worldwide income, including income earned offshore.

There are indications of non-compliance in reporting foreign-source income
21. There are several indications that non-compliance with requirements for reporting foreign-source income exists and that likely it is significant. The Department of Finance and Revenue Canada have been unable to quantify the level of non-compliance because the available data lack sufficient precision to permit an estimate.

22. However, the departments have indicators that suggest a problem exists. We examined these indicators and interviewed tax professionals to understand the problem more thoroughly.

23. Many of these tax professionals, both in Canada and abroad, told us that the problem is serious and that the potential for erosion of the Canadian tax base is significant. Offshore structures have been marketed heavily as a legitimate way to avoid Canadian tax on investment income. Many of these structures rely on the thinnest of technical arguments to allow those involved to take the position in filing their tax returns that they were not subject to Canadian tax on income earned offshore. As well, in many cases the promoters stressed the secrecy that tax havens provide for investors.

24. Tax professionals and business leaders abroad told us that there is a serious problem of non-compliance among many Canadian taxpayers who hold offshore assets. In some cases, the people did not want to comply because they felt that it was unfair for Canada to tax the income earned on wealth they had accumulated before coming to Canada.

25. The OECD recently released a report entitled Harmful Tax Competition: An Emerging Global Issue. The report recommends that countries that do not have rules concerning reporting of international transactions and foreign operations of resident taxpayers consider adopting such rules and that countries exchange information obtained under these rules.

26. In 1996 we audited Revenue Canada's program to combat tax avoidance schemes. During that audit we became aware of a number of ways that tax havens can be used to avoid Canadian taxes. In our report on that audit we illustrated the variety of offshore arrangements that may be available.

27. While Revenue Canada has directed relatively few audits specifically at discovering unreported foreign-source income, the results of those audits indicate a problem. In recent years Revenue Canada has also received a number of voluntary disclosures of previously unreported foreign-source income, sometimes amounting to several million dollars.

28. In our view, the lack of reliable information makes it impossible to determine the precise magnitude of the problem. But we believe that there is enough indication of a potentially serious problem to warrant action to increase compliance with Canada's tax laws and maintain the integrity of our tax base.

Revenue Canada needs information to verify taxpayers' self-assessments
29. Under Canada's self-assessing system for income tax, taxpayers calculate their own taxes using the rules in the Income Tax Act and remit the taxes to the government. Revenue Canada's role is to facilitate the system by issuing forms and guides to taxpayers, to process and verify taxpayers' self-assessments and to carry out any enforcement actions needed to maintain the integrity of the system.

30. Revenue Canada uses various techniques in its verification work, such as inquiry, review of documentation, comparison with other information and audit. In all of these, information is the key.

31. The Income Tax Act requires many information returns to be filed with Revenue Canada. Sometimes the taxpayer provides the information; sometimes it is provided by a third party. For example, an employer is required to provide an employee with a T4 slip indicating total wages and deductions. The employer files a copy of the slip with Revenue Canada. When the employee files a tax return and reports the wages, Revenue Canada can match the information on the tax return with the information provided by the employer. Other examples are the requirement for receipts to support deductions for such things as charitable donations, contributions to registered retirement savings plans and child care expenses.

32. Revenue Canada also has access to many domestic data bases that contain information about a particular taxpayer's assets or income. Within the limits of the law, it can use the information in those data bases to verify the taxpayer's self-assessment.

Revenue Canada cannot compel offshore third parties to provide information
33. The Act requires third-party reporting for many types of payments, and these requirements are supported by penalties for failure to report. Revenue Canada is able to apply these penalties to domestic third parties because it has the jurisdiction to do so and because the third parties usually have assets in Canada from which to pay the penalties. In the case of offshore third parties, Revenue Canada does not have the jurisdiction to enforce payment of any penalties and so often it is impractical to levy them.

34. For example, the Act requires that every person who makes a payment to a resident of Canada as or on account of interest shall complete a T5 return. Revenue Canada can enforce this requirement with Canadian financial institutions but not with foreign financial institutions. Revenue Canada has told us that it cannot enforce the requirement even for a wholly owned foreign subsidiary of a Canadian financial institution.

35. This problem is exacerbated in tax haven jurisdictions where bank secrecy laws are very strict and where providing the information required by the Act could result in a jail term for the person who provided it.

36. The problem can be dealt with to some extent in countries with which Canada has a tax treaty. In those cases, the treaty usually contains a provision that, under certain conditions, allows the tax administrator in one country to provide information to the tax administrator of another. For example, Canada and the United States regularly exchange information on interest payments made to taxpayers resident in the other country. However, the information exchanged under the treaties does have limitations and is sometimes incomplete.

37. In light of the indications of non-compliance in reporting offshore income, and the difficulties and costs for Revenue Canada of obtaining third-party information about that income to verify taxpayers' self-assessments, the reporting regime in the Income Tax Act now requires taxpayers to provide information about their offshore investments.

Alternative Mechanisms to the Reporting Requirement for Specified Foreign Property

38. As requested by the Governor General in Council, we examined alternative mechanisms. We asked departmental officials and those who made submissions to suggest alternatives. We examined all of the ones that were suggested to us and, for purposes of this report, have summarized them as three alternatives. In all cases, it was important to us to assess whether the alternative would enhance compliance with the law.

Repeal the reporting requirement and increase enforcement of existing laws
39. It was suggested to us frequently that increasing the enforcement of existing laws would be a good alternative to the reporting requirement. As a first step, this alternative would necessitate repealing the reporting requirement, because it is already in the legislation. Others cautioned that this move could send a very negative message to most Canadians unless it could be shown that the reporting requirement was seriously flawed.

40. As well, the reporting requirement is only one part of an overall effort to enhance compliance with the tax laws that require the reporting of foreign-source income. Repealing it could have serious repercussions on the other parts.

41. In Canada's self-assessing tax system, enforcement programs are there to supplement the system, not to serve as an alternative to it. In particular, auditing for undisclosed income is an expensive and intrusive process, even with the help of technology. It usually involves examining bank statements, calculating the source and use of funds, and examining a taxpayer's lifestyle and spending patterns.

42. Revenue Canada devotes limited resources to enforcement. Pursuing more cases would require a significant increase in resources. As well, without information it is difficult to target audits, which would diminish the prospects for success. It is also likely that a large increase in audit coverage would result in a needless burden on compliant taxpayers.

43. While increasing enforcement ought to have some deterrent effect, it would not achieve all of the objectives set for the requirement to report specified foreign property. In particular, because of the limited number of taxpayers that would be audited, it likely would not reveal many offshore investments on which taxpayers had taken aggressive filing positions. It also would not provide important information needed to assess tax policy. These are key objectives that any proposed alternative should meet.

Allow new Canadians to negotiate their Canadian tax liabilities for a period of time
44. Many new Canadians are coming from a low-tax regime, and it takes time to adjust to the new, relatively high-tax regime. Several people suggested to us that new Canadians be allowed for a period of time after immigration to negotiate their Canadian tax liabilities on income earned on assets acquired prior to immigration, rather than comply with the requirement to report specified foreign property.

45. In our view, this would tax new Canadians on a different basis from other Canadians, particularly others with foreign-source income. This could be viewed as unfair and inequitable by other taxpayers. We note that the Income Tax Act already allows new Canadians a significant concession, through the immigration trust provision (see paragraph 22 in the Appendix), to help them adjust to the Canadian tax system.

Implement a check-the-box system
46. A check-the-box system is one that would require taxpayers to answer yes or no to a series of questions, but would not require them to provide any details in the tax return. One option would be to ask taxpayers whether they had specified foreign property in excess of $100,000. Then they could be asked whether this was in the form of bank accounts, portfolio investments, real estate, and so on. They could also be asked if they had reported income from this property in the year. As part of its verification and enforcement program, Revenue Canada would ask some taxpayers to provide more details to support their answers.

47. This system has advantages and disadvantages. The biggest advantage is that it would be less intrusive for many taxpayers: it would not involve listing specified foreign property, and this would address many of the privacy concerns that were raised with us. At the same time, it would not be likely to reduce any compliance costs to affected taxpayers because they would still need to gather and retain the same information.

48. The Department of Finance told us that a check-the-box system would likely require a reworking of the penalty structure. The current penalties for not reporting foreign assets are there to serve, in part, as an extra incentive to report the income earned on the assets. If there were no requirement for reporting of assets, another incentive would have to be found, such as steep, automatic penalties for underreported income. There could also be difficulties penalizing taxpayers who did not check the boxes correctly.

49. A check-the-box system would also make it more difficult than the existing mechanism to achieve some of the objectives of the requirement to report specified foreign property. Revenue Canada would have to go through two steps instead of one before it received detailed information on offshore investments. But it may lack sufficient information to help it target the second step properly. Since Revenue Canada would be asking for more details from only a sample of taxpayers, many offshore investments on which taxpayers had taken aggressive filing positions would be more difficult to detect. However, this difficulty may be partially offset by a significant infusion of new enforcement resources that would allow for a larger sampling of taxpayers. Finally, this alternative may not provide important information needed to assess tax policy.

50. For these reasons, we have concluded that a check-the-box system would not be as effective as the existing requirement.

Privacy, Economic and Investment Issues

51. Our examination of the privacy issues related to the reporting requirement has led us to conclude that Revenue Canada has the authority to collect the information under the Privacy Act. However, because of cultural and security reasons, some people will continue to be concerned about providing Revenue Canada with information about assets. We noted that information is required only about certain assets and that Revenue Canada can already obtain similar information about domestic assets. As well, Revenue Canada is bound by the strict confidentiality provisions of the Income Tax Act and the Privacy Act and by treaties with other countries. While Revenue Canada has controls in place over the information it will exchange with other countries under the treaties, we found that these controls are not binding and are subject to interpretation. Therefore, Revenue Canada will have to remain vigilant in protecting the confidentiality of the sensitive information provided to it under this requirement. In our view, educating taxpayers about the controls would help alleviate some of their concerns.

52. Most of the concerns about economic and investment issues came from individuals and organizations in British Columbia. We consulted economic experts and were advised that there are several important factors in the current downturn in the British Columbia economy that appear to have a greater impact than the reporting requirement. Canada's relatively high tax rates and broad tax base were cited more often than the reporting requirement as disincentives to investment in Canada. As well, while the United States does not have a reporting regime similar to Canada's for specified foreign property, it levies taxes on the basis of citizenship and it has a more stringent regime for reporting information on foreign affiliates and non-resident trusts. It also requires taxpayers to report information on foreign financial accounts that exceed $10,000.

53. There will be some additional compliance costs associated with the reporting requirement for specified foreign property. However, a close examination of the proposed form indicates that those costs are not likely to be excessive for most taxpayers, as much of the information is already used in preparing the annual tax return or is required for purposes of capital cost allowance claims and eventual capital gains. The Income Tax Act allows new Canadians a year to gather the information necessary to comply with the reporting requirement and become more familiar with the tax system. As well, immigration trusts provide relief from taxes for five years for eligible new immigrants. We also note that some new Canadians have already made a declaration of their net worth for immigration purposes. We set out below some modifications that could reduce the compliance burden.

54. A full discussion and assessment of the concerns raised with us by taxpayers can be found in the Appendix to this report.

Suggested Modifications and Improvements

Technical Modifications to the Reporting Requirement Should Be Considered to Reduce the Compliance Burden and Address Taxpayer Concerns

55. The Income Tax Act requires that specified foreign property be reported by affected taxpayers on a return "in prescribed form". Revenue Canada has prepared a draft that may become the prescribed form (see Exhibit 3), but there is no prescribed form to date. There are certain taxpayers who already provide Revenue Canada with information that is similar to that requested on the draft form. Given the concerns that have been expressed about privacy and compliance costs, Revenue Canada may want to consider modifications to the draft return. For example, foreign assets that are held in Canadian financial institutions are already subject to third-party reporting and to scrutiny by Revenue Canada. Also, many taxpayers, particularly corporations, already file balance sheets with their tax returns that may provide details about their offshore assets.

56. Revenue Canada could also consider whether it is necessary to have taxpayers file all the information annually or whether it would be feasible for them to report only changes from a previous return. Factors to take into account in considering this modification would include the type of assets being reported and the total cost of all specified foreign property of each taxpayer.

Facilitation Needs Further Improvement

Facilitating the reporting of foreign-source income
57. Facilitation is a key ingredient in a self-assessing tax system. Taxpayers need to understand the rules and have easy-to-use forms and guides to help them prepare their tax returns properly. One of Revenue Canada's main roles is facilitation.

58. We found that Revenue Canada has made improvements in recent years in informing taxpayers about the need to report foreign-source income. For example, the first page of the 1997 T1 return contains a bold notice that says, "As a Canadian resident, you have to report your income from all sources both inside and outside Canada." This is the first year such a statement has been so prominent on the T1.

59. At the same time, our examination work has highlighted a significant level of confusion about the reporting requirement. For example, some people thought that individuals had to list all of their offshore assets. This is not true. Only those assets that are defined as specified foreign property have to be reported. Other people thought that full financial information had to be filed, including financial statements. Again, this is not the case with the return for specified foreign property, although the information is required when filing form T1134B for a controlled foreign affiliate. Finally, some people were confused about the definition of cost for inherited assets or for assets of new residents. Both of these require calculations of fair market value at specific dates.

60. We also found that there is some confusion about who is a resident of Canada for tax purposes, particularly in the case of people who do not spend all of their time in Canada but do have economic and social ties here. As we noted earlier, residence is not defined in the Income Tax Act, but the concept is fairly well developed in jurisprudence.

61. We would encourage Revenue Canada to explore other ways to ensure that Canadians are aware that foreign-source income to residents of Canada is taxable. For example, a separate guide could be produced that outlines the rules with respect to reporting various types of foreign-source income, and this guide could be referred to prominently in the T1 guide. As well, Revenue Canada could find ways to inform Canadians about the potential tax pitfalls of investing in tax havens.

Need to inform new Canadians about their tax obligations
62. Our discussions with tax professionals in Canada and abroad indicated that much more needs to be done to ensure that new Canadians understand their tax obligations. Many are coming from countries with very different taxation systems and it is important that they quickly come to understand Canada's system.

63. This education should start before people come to Canada, so they can take our tax system into account when making a decision to immigrate. While we noted a lack of information about Canada's tax system in the foreign missions that we visited, Revenue Canada told us that in the past year, in consultation with the Department of Foreign Affairs and International Trade and with the Department of Citizenship and Immigration, it has taken steps to remedy this. It has also started to provide training to Canada's officials going to missions abroad so they will be prepared to provide information on Canada's tax system to potential immigrants. In our view, this is an important initiative that should have been in place long ago. We encourage Revenue Canada to continue its consultations with these departments to improve co-operation and, where legally possible, sharing of information.

64. It is also important that new Canadians be provided with more detailed information on our tax system once they arrive in Canada. Again, we are encouraged that in the past year Revenue Canada started a series of information sessions for new Canadians. There are plans to expand this initiative in the coming year and, in our view, this needs to be done.

Publicize the voluntary disclosure policy
65. Revenue Canada's voluntary disclosure policy is designed to encourage taxpayers to come onside. It can be thought of as an ongoing amnesty program. Under this policy, taxpayers who have not been paying their taxes can come forward and correct their affairs by paying the tax and interest without facing prosecution or penalties. But they must come forward before Revenue Canada begins enforcement action. This policy was introduced for taxpayers who are feeling guilty about evading taxes but are reluctant to approach Revenue Canada for fear of penalties or prosecution.

66. Some taxpayers have expressed concern that reporting offshore assets will highlight the fact that they have not declared their foreign-source income in previous years. The issue for them is whether to start reporting now and face stiff penalties for their past underreporting, or to not report the income or the assets knowing that the penalties for this have increased substantially.

67. Revenue Canada's voluntary disclosure policy can help taxpayers caught in this dilemma. The Department has told us that it plans to give more direction to officials in the field to ensure a full understanding and consistent application of the policy. We support this measure. In our view, it is particularly important during the implementation of the new reporting requirement that the voluntary disclosure policy be heavily publicized and that taxpayers understand the benefits of coming forward on their own initiative.

Using the New Information to Enhance Compliance

Revenue Canada and the Department of Finance need to maximize their use of the new information
68. At the beginning of our examination in November 1997, Revenue Canada had developed a preliminary plan for using the information gathered from the reporting requirement. Near the end of our examination, a more detailed plan was drafted. In our view, this second plan is a reasonable attempt to integrate the information provided by taxpayers on specified foreign property into the Department's overall compliance and enforcement strategy. However, given that the details of the requirement were first published in 1996, we are disappointed that the Department has taken this long to develop a detailed plan for maximizing its use of the information.

69. At the end of our examination, officials from the Department of Finance provided us with a reasonable plan of how they will use the information generated from the reporting requirement in their ongoing analysis of the taxation of foreign-source income.

Monitoring and evaluation of the reporting requirement are needed
70. We encourage the Department of Finance and Revenue Canada to monitor the reporting regime for offshore investments annually. They should also evaluate it in two to three years, to ensure that it is providing the desired information and meeting its objectives of enhancing compliance with the law without being overly burdensome.

71. The monitoring should include an examination of the appropriateness of the $100,000 threshold. The threshold was designed to exempt from the reporting requirement those with minimal offshore investments, although it does not exempt them from the requirement to report the income from their offshore investments. For someone who might have 10 or 20 percent of his or her wealth offshore, $100,000 seems like a reasonable figure, especially given that the $100,000 applies to each member of a family. For a high-net-worth taxpayer who has significant offshore investments, the amount may be low. In December 1996, when the government tabled the legislation for the reporting requirement in the House of Commons, it said it would review the amount after 1998.

Level of enforcement for foreign-source income needs to be reviewed
72. We have already noted that there are indications of a serious problem of non-compliance with the requirement to report foreign-source income. We also found that, to date, Revenue Canada has not conducted many audits directed specifically at detecting unreported foreign-source income. The Department has recently initiated a project to audit a number of taxpayers across the country who represent a high risk of unreported foreign-source income. Given the seriousness of the issues involved, we believe that Revenue Canada should reassess whether it is doing sufficient audit work in this area. The information gathered through the reporting requirement would be a key input to such an assessment.


About the Examination

Scope and Approach

Our examination consisted of the following steps: We called for submissions from the public and received 58. One submission included a petition with over 2,000 signatures. Many of these submissions were from individual taxpayers, primarily from British Columbia and Ontario, and many were from new Canadians. We also received submissions from various tax professionals and their organizations as well as business associations and immigrant associations.

We interviewed tax professionals and business leaders in Canada, Hong Kong and Taiwan. We interviewed officials in the departments of National Revenue and Finance in Vancouver, Toronto, Montreal and Ottawa and officials of the departments of Foreign Affairs and International Trade and Citizenship and Immigration in Hong Kong and Taiwan. We consulted experts in the areas of taxation, privacy and economics. We compared Canada's reporting requirements with those of other jurisdictions and examined alternative mechanisms.

Following our normal working procedures, at various points in the examination we discussed our approach, findings and conclusions with an advisory committee consisting of tax professionals and experts in economic and privacy issues.

Examination Team

Assistant Auditor General: Shahid Minto
Principals: Barry Elkin, Jamie Hood
Director: Marial Stirling

For more information, please contact Barry Elkin.