CRA demands arrears interest on donation tax shelter bought by ex

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Under our tax system in Canada, each individual files his or her own tax return and is taxed on the income they earn on an individual basis. The United States, on the other hand, allows the filing of joint tax returns in which both spouses can pool their income on the same return, with higher joint-tax brackets for the couple than for a single taxpayer.

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There are, however, a few places on the Canadian tax return where spouses or common-law partners have an opportunity for tax planning by choosing on which return to claim certain income, expenses or credits.

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Perhaps the most well-known opportunity for spousal tax planning is the ability to split eligible pension income with your spouse. Pension splitting allows you to save income tax where one spouse is in a lower tax bracket upon retirement than the other, and may also allow you to preserve income-tested government benefits and credits, such as your Old Age Security pension or the age credit. To reap the benefits of pension splitting for 2024, both you and your spouse must complete Canada Revenue Agency Form T1032, Joint Election to Split Pension Income and file the forms with your tax returns.

Another opportunity for tax savings between spouses is when it comes to claiming medical expenses. For the 2024 return, you can claim medical expenses if your household’s total eligible medical expenses exceed the lesser of three per cent of your net income, or $2,759. As a result, it’s often advisable to pool all the family’s medical expenses together and claim them on the lower-income spouse’s tax return.

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Finally, when it comes to charitable donations, it’s generally best to pool all donations on one spouse’s return, because there is a lower federal credit of 15 per cent for the first $200 of annual charitable donations. (Alberta taxpayers may be the exception owing to Alberta’s high provincial donation credit of 60 per cent on the first $200.) In addition, for high-income earners (income over $246,752 in 2024), the federal donation credit rate jumps to 33 per cent, meaning that the high-income spouse should generally claim donations if they are the sole spouse with income over that threshold.

But it’s important to remember that if you do choose to claim a donation tax credit in your return, even if the donation was made by your spouse, you’re the one who is ultimately responsible should the CRA ever challenge the validity of your donation. Take the recent case, decided earlier this month, of a taxpayer who went to federal court seeking a judicial review of a decision by the CRA denying her request for relief of arrears interest accruing since 2005 on a donation tax shelter purchased by her now ex-husband.

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The taxpayer’s troubles began back in 2005, when she claimed a tax credit in respect of a $41,616 donation to the Canadian Humanitarian Trust (CHT). The donation was arranged by her ex, even though she claimed it on her own tax return. The CHT was a donation tax shelter scheme in which thousands of Canadians participated. Participants made a cash donation to the CHT, which then generated an in-kind donation that the participants claimed on their tax returns. In 2005, the taxpayer’s cash donation was $11,340 while the in-kind donation represented the difference between this amount and the $41,616 claimed on her tax return.

In June 2008, the CRA reassessed the taxpayer’s 2005 tax return, and denied the donation tax credit in full. She was consequently reassessed for an additional amount of $18,460 of tax owing, plus arrears interest. In December 2008, the taxpayer filed her first notice of objection. In February 2009, the CRA informed her that given the high number of Canadians who had participated in the CHT tax shelter, her objection would be held in abeyance until a final judicial decision on the validity of these donations was rendered.

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Fast forward to February 2015, when the CRA advised the taxpayer that her 2005 tax return would be reassessed to allow only the cash portion of the donation, and that the arrears interest would be adjusted accordingly. The CRA then provided the taxpayer with two options: she could either waive her objection or appeal rights and the CRA would cancel the interest for the in-kind portion of her donation, or she could pursue her objection, in which case arrears interest would continue to accrue on her outstanding balance. The letter also indicated that silence would be interpreted as selecting option two.

The taxpayer never responded to the CRA’s letter, and in July 2015, the taxpayer’s 2005 tax return was reassessed to allow only the cash portion of the donation, with her outstanding tax owing reduced to $13,551, plus arrears interest. The taxpayer again objected, but her objection was held in abeyance pending a final decision in two lead test cases relating to the validity of in-kind donations to the CHT.

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Finally, in May 2020, the Federal Court of Appeal ultimately ruled that the CHT was, in fact, a donation tax shelter scheme, and disallowed claims for charitable tax credits for in-kind donations. In January 2021, the Supreme Court of Canada denied leave to appeal, thus officially ending the legal journey.

The CRA then resumed processing objections relating to the reassessment of CHT donations and in June 2022 the taxpayer was issued a notice of confirmation that the in-kind donation of $30,318 was disallowed as a charitable donation. The CRA did agree to waive some arrears interest for 2020 because of the CRA’s response to the pandemic, and from part of 2021 through 2022, because of the CRA’s delays in processing objections after the final resolution of the two test cases.

The taxpayer objected and went to tax court. In February 2024, that court dismissed her appeal, determining that the taxpayer “could not shift responsibility onto her ex-husband, as she claimed the donations on her 2005 tax returns and now she must live with the consequences.”

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The taxpayer, faced with a large tax bill and 20 years’ worth of arrears interest, wrote to the CRA requesting interest relief. This was twice denied by the CRA, so the taxpayer went to federal court seeking a judicial review of the CRA’s decision not to waive interest.

Earlier this month, the federal court judge dismissed the taxpayer’s case, finding that the taxpayer “has not met her burden to demonstrate the unreasonableness of the (CRA’s) decision to deny her taxpayer relief.”

The case serves as an important reminder to all of us this tax season: make sure you’re comfortable with anything you claim on your personal return.

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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