Watch out for asset liquidation and business wind-up schemes
The Canada Revenue Agency (CRA) is warning Canadians about getting involved in avoidance schemes that claim to eliminate or significantly reduce taxes owed when selling business assets or winding-up a business.
What are asset liquidation and business wind-up tax schemes
Tax schemes are plans or arrangements that promise to reduce the taxes owed, often through large deductions, tax credits, or promises of tax-free income. These arrangements may involve misleading or unsupported claims about the tax benefits available.
Depending on the circumstances, they may involve aggressive tax planning, tax avoidance, or even illegal tax evasion. Promoters or advisors may market certain tax schemes to taxpayers who are selling high-value property or winding-up a business. They promise to reduce the taxes owed through large deductions or tax-free corporate distributions. Sometimes, they are also aimed at avoiding the collection of properly assessed taxes.
Taxpayers may only be given a few details and are told the arrangement is allowed under the Income Tax Act. The arrangement purportedly allows them to avoid paying taxes by sheltering their capital gains or business profits from tax by using, for example:
- purported losses from partnership(s)
- foreign exchange trading
- capital cost allowance on computer software
- capital cost allowance on pharmaceutical patents
- other various deductions
Why these schemes raise concerns
Normally, when a business is sold, any gains are subject to tax. In the case of an asset sale, the cash that remains after taxes have been paid is typically distributed to shareholders, most often as dividend payments.
In these tax schemes, the business's assets are sold and the owners of the business typically sell their shares to the promoter's corporation. The schemes claim to eliminate all taxable gains within the corporation and even promise payouts that are more than the after-tax proceeds from a legal asset sale. These arrangements typically rely on inflated valuations or offsetting trading positions to generate artificial deductions or losses that are then claimed to offset the corporation's gains on liquidated assets. Generally, the promoters or advisors are aware that the effectiveness of these transactions under the Income Tax Act is questionable. They attempt to insulate the participants from CRA actions by moving assets around to make it hard for the CRA to collect the taxes owed.
How they work
An asset liquidation and business wind-up scheme is an arrangement sold by a promoter or advisor to an individual or a corporation looking to sell their assets. The plan involves a series of pre-arranged transactions that includes the insertion of an intermediary corporation between the seller and the real buyer.
The promoter or advisor sets up a newly created intermediary corporation to create the false appearance of arm's length transactions. After a complex series of transactions, shareholders receive the corporation's asset liquidation proceeds without any tax having been paid.
Promoters or advisors who use these arrangements claim these transactions are legal and may:
- offer to share the tax savings
- involve private lenders and lending institutions to help carry out the transactions
- promise protection if the CRA challenges the scheme
- use escrow accounts to hold funds for possible disputes with the CRA
- insist the arrangements are time-tested and have a proven track record
The CRA has found that many tax schemes use deductions that are either unsupported or false. As a result, the deduction is denied and the corporation becomes liable for taxes. However, by then, the corporation typically has no assets. Transferring assets deliberately to avoid the collection of tax is not legal tax planning.
Your actions may have serious consequences
Through increased audits of promoters and advisors, improved intelligence gathering, and strengthened communication with taxpayers, the CRA continues to identify and combat abusive tax schemes.
People who participate in these asset liquidation and business wind-up schemes may face serious consequences. This includes gross-negligence penalties for participants, third-party penalties for promoters and advisors, and other potential avoidance penalties. Following a corporation's asset liquidation and business wind-up, any original shareholder to whom any of the corporation's property is distributed or transferred, directly or indirectly, may have to pay the corporation's tax liability.
What you can do
The CRA encourages all Canadians to seek an independent second opinion from a reputable tax professional on important tax matters.
By acting promptly, you may be able to correct your tax affairs through the Voluntary Disclosures Program: Canada.ca/taxes-voluntary-disclosures.
If you suspect tax cheating, you can report it online at Canada.ca/taxes-leads or by calling 1‑866‑809‑6841. The CRA will protect your identity. Also, you can give information anonymously.
For more information
Visit the CRA's page on beware of tax schemes that promise to reduce your taxes.