If you're looking for some holiday cheer this year, don't ask Canada Revenue Agency (CRA) to provide it. Scrooge might as well have been a tax collector. In Dickens' story, Scrooge acted a lot like CRA today.
There are times when CRA has the opportunity to do what is right and good, but chooses not to do so. In a recent situation, CRA unfairly assessed a taxpayer, costing him $135,000. And in a manner that can only be described as apathetic, CRA chose to brush the taxpayer off. Bah, humbug.
Martin Smith (not his real name), a resident of British Columbia, inherited $550,000 in 2001 from a deceased relative who lived in California. The money was in an individual retirement account (akin to a registered retirement savings plan). Mr. Smith had to withdraw $375,000 from the plan just to pay the U.S. estate taxes owing by his deceased relative.
Since Mr. Smith made a taxable withdrawal from the IRA, he reported the full $375,000 withdrawal on his Canadian tax return. Article XVIII of the Canada-U.S. tax treaty, however, requires Mr. Smith to pay tax only on the amount that would have been included in his taxable income in the United States had he been resident there. In short, the amount that should have been reported in Canada was about $50,000, not $375,000. The tax balance owing on his 2001 return is $115,000 higher than it should be. With interest, the total owing is now up to $135,000 (add this to the $375,000 paid to the IRS and the total tax paid is $510,000 on an inheritance of $550,000).
The mistake went unnoticed until this year when Mr. Smith visited Mark Feigenbaum, a well-known cross-border tax specialist, with the U.S. law firm Juroviesky and Ricci in Toronto. It was too late for Mr. Smith to file a notice of objection to correct the mistake. And so Mr. Feigenbaum filed an adjustment request with CRA back in April to correct the problem.
CRA quickly dismissed the adjustment request. In a four-line explanation, CRA concluded that had Mr. Smith been a resident in the United States, he would have paid tax on the full $375,000, and therefore should have to pay tax on that amount in Canada. But this ignores the fact that Mr. Smith would have been entitled to a significant deduction equal to the estate taxes paid had he been a resident in the United States. (Internal Revenue Code 691(c)). Therefore, he should have been entitled under the tax treaty to this deduction in Canada.
The bottom line? A junior CRA employee who doesn't properly understand the technical U.S. tax issues in question dismissed Mr. Smith's request for an adjustment using a poorly reasoned -- and most tax pros would say blatantly incorrect -- four-line explanation. Denying the adjustment also left Mr. Smith with no option to dispute the issue further, since the deadline for a notice of objection had passed -- a technicality.
The crime in all of this is that the emphasis by CRA should be on getting the amount of tax right - not in taking as much tax as possible based on a technicality.
The moral of this story? Count on CRA to be more like Scrooge than Santa. Make sure your tax planning and tax filing is done properly -- from the start. Going back and trying to adjust a tax return after the fact doesn't always work. If this means visiting a tax pro, then do it. It could save you thousands.
Tim Cestnick, FCA, CPA, CFP, TEP, is author of Winning the Tax Game 2004, and The Tax Freedom Zone. He is managing director, Tax and Estate Planning, at AIC Ltd.
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