PACC Committee Report

INTRODUCTION
OBSERVATIONS AND RECOMMENDATIONS
CONCLUSION

Pursuant to Standing order 108(3)(e), the Standing Committee on Public Accounts has the honour to present its

The Standing Committee on Public Accounts has considered Chapter 2 of the April 1999 Report of the Auditor General of Canada (Revenue Canada – Underground Economy Initiative) and the Committee has agreed to report the following:

As reported by the Office of the Auditor General, reliable estimates indicate that the underground economy results in tax evasion and represents an estimated loss of federal and provincial tax revenues of up to $12 billion each year.

Tax evasion is not a victimless crime. It puts honest businesses at a competitive disadvantage and, in some cases, out of business. It also causes honest taxpayers to bear the tax load of those who cheat. The integrity of the tax system is based on the public belief that Revenue Canada operates with the basic expectation that everyone must and does pay his or her fair share of taxes due under the law.

Revenue Canada has always had compliance programs to combat tax evasion. For example, the Department’s special investigations and non-filers program for both GST and income tax and for various other enforcement programs. However, in the early 1990s there was a general perception that the underground economy was a growing problem.

To deal with this problem and to preserve the integrity of the tax system, Revenue Canada announced a new initiative in 1993 to combat the underground economy by allocating 200 staff to its non-filers and non-registrant program and 1,000 staff to the audit of small businesses.

The initiative was intended to increase the chances that unreported income would be detected, to enforce the payment of taxes from unreported income, to develop new activities to support taxpayers in meeting their responsibilities and to deter taxpayers from participating in the underground economy.

The Auditor General focussed on the results of the implementation of the Underground Economy Initiative.

It was with these issues in mind that the Standing Committee on Public Accounts decided to consider the findings of chapter 2 of the April 1999 Report of the Auditor General of Canada on Revenue Canada – Revenue Canada: The Underground Economy Initiative. The Committee met on the 11 May 1999 with Mr. Shahid Minto (Assistant Auditor General) and Mr. Barry Elkin (Principal, Audit Operations Branch). Representing Revenue Canada were Mr. Barry Lacombe (Assistant Deputy Minister, Verification, Enforcement and Compliance Research Branch), Mr. John Kowalski (Director General, Audit Directorate) and Ms. Dominique Short (Director General, Compliance Research Directorate)

OBSERVATIONS AND RECOMMENDATIONS

In his opening remarks, the Assistant Auditor General, Mr Shahid Minto, stated that as it was planned, the Underground Economy Initiative was a balanced approach to combating tax evasion and the underground economy, combining enforcement activities and initiatives designed to encourage voluntary compliance.

After five years into the implementation of the initiative, the Auditor General made the following observations; 1) Revenue Canada did recover additional taxes and, to a degree, 2) has sent a message to tax evaders that the department is determined to deal with the problem.

The Auditor General expected Revenue Canada to measure and report the tax impact and other results of the Underground Economy Initiative. However, the Auditor General noted that Revenue Canada does not fully report all Underground Economy Initiatives and their long-term effects on tax compliance.

Revenue Canada reports a $2.5 billion tax impact but as the Auditor General observes the amount includes results of regular, ongoing enforcement programs. The Auditor General estimates the Underground Economy Initiative tax impact at $ 500 million of tax reassessments over the last five years. The Auditor General realises that the amounts of tax collected will be less than the amounts assessed.

The Auditor General also believes that Revenue Canada needs to adjust its tax assessment strategy. Instead of focussing on four sectors, it should reallocate its resources and efforts to identify taxpayers with the highest risk of unreported income in all sectors. Finally, the Auditor General noted that there had been a recent decline in the frequency of the department's community visits. Most of the Initiative’s activities had focussed on tax audits and other enforcement efforts at the expense of facilitation and education activities to combat the underground economy.

The Auditor General recommends that the department collaborate with others to get more external sources of information to detect tax evaders and to improve its techniques with audit targeting and file selection. The audit team also signals that additional legislative opportunities exist to deter tax cheats. (1540)

Revenue Canada’s Assistant Deputy Minister, Mr. Barry Lacombe, stated in his opening remarks that the Department appreciates the efforts the Auditor General had made in pointing out a number of areas for improvement, and that the Department agrees with his recommendations. Mr Lacombe went on further to ensure the committee that the new Customs and Revenue agency would continue to honour its commitments to implement the recommendations of the Auditor General with respect with the Underground Economy Initiative. The agency would remain accountable to Parliament for its activities and its performance through the submission of annual reports. The witness concluded that the department is confident that the action plan already implemented along with ongoing work and other planned activities will further enhance Revenue Canada’s continuing efforts to combat the underground economy. (1550)

In his opening statements, Mr. Lacombe indicated that Revenue Canada’s enforcement activities resulted in an overall tax compliance rate of 98 percent. (1545) When the Committee inquired further on this, Mr. Shahid Minto informed the Committee that the 98 percent compliance rate referred only to the number of tax returns filed, not the actual amount of taxes assessed or collected. (1625)

The issue that concerned many committee members was the observed imbalance between enforcement efforts and facilitation activities in the Underground Economy Initiative, most notably in the decline in community visits.

When questioned about this, Mr. Lacombe, shared the Committee’s concerns on this issue. He acknowledged the importance and effectiveness of these community visits, that they performed an outreach and educational function in assisting taxpayers in recognising and respecting their tax responsibilities. He went on further to state that the Department was itself unhappy at the decline in the frequency of community visits and is planning measures this year to rectify the imbalance between enforcement efforts and social marketing activities. (1555)

This prompts the Committee to recommend the following:

Recommendation 1:

That Revenue Canada continue its current and planned measures to redress the balance between its tax enforcement efforts and its education and facilitative activities of the Underground Economy Initiative.

Recommendation 2:

That Revenue Canada report the results of these measures in its annual Performance Report to Parliament, starting 31 October 1999.

Another area of concern was the discrepancy between the Department’s measurement of the tax impact of the Underground Economy Initiative and that of the Auditor General of Canada. According to Revenue Canada, the tax impact of the Initiative was $ 2.5 billion, while the Auditor General estimated a tax impact of $ 500 million for the same Initiative.

The Assistant Deputy Minister, Mr. Lacombe, did not disagree with the Auditor General’s evaluation of the Initiative’s tax impact. According to the witness, the discrepancy mainly resulted from difficulties in precisely attributing the tax impact to specific departmental initiatives. These difficulties arise because underground economy audits are very time consuming, employ indirect methods of verification, and reporting systems upgrades must compete with other continuing upgrade projects such as the Y2K and other changes to reporting systems. (1605)

When questioned whether the Department had systems in place to precisely measure and report the tax impact, Mr. Lacombe stated that Revenue Canada was presently upgrading its reporting systems. The Committee secured a commitment from the witness to report back when proper reporting systems are to be installed along with their implementation timetables. (1610) Mr Lacombe indicated that the required information could be ready within a few weeks. He also volunteered to share with the Committee the planned performance indicators and those already in place. The Public Accounts Committee secured a commitment from the witness to present a report by the end of May 1999. (1610)

The Committee proposes the following recommendations:

Recommendation 3:

That Revenue Canada should record and report the additional gross income identified by its Underground Economy Initiative and non-Initiative enforcement activities, the additional tax due on this unreported income, and how much the reassessed additional taxes the Department actually collects.

Recommendation 4:

That Revenue Canada provide to the House of Commons Standing Committee on Public Accounts with a preliminary report on the progress of these increases in assessments and collections along with a description of planned and actual performance indicators currently in place by 31 May 1999.

Recommendation 5:

That Revenue Canada inform Parliament of the continuing progress of this Initiative through its annual Performance Report to Parliament, starting 31 October 1999.

Some committee members inquired about the merits of tax amnesties as a means of further encouraging disclosure of unreported income and ensuring compliance with tax laws. Mr Lacombe indicated that there were serious shortcomings associated with such an approach. The witness stated that studies on tax amnesties suggested that they may increase tax collections in the short run, but in the long run tax revenues decline as a result of taxpayer compliance problems. (1635)

To support Mr Lacombe testimony, the Assistant Auditor General, Mr. Shahid Minto, quoted the first conclusion from a report prepared by the Joint committee on Taxation of the United States Congress:

The Staff of the Joint Committee on Taxation estimates that the federal tax amnesty program would result in a net revenue loss for the federal government. This net revenue loss occurs primarily because the federal tax amnesty is estimated to have long-run effects of reducing overall taxpayer compliance with federal laws. (1640)

In lieu of considering tax amnesties, Mr Lacombe indicated that there was already an established voluntary disclosure program which is designed to encourage and foster voluntary compliance of Canadian tax laws. Under the program, if a taxpayer has given incomplete information in a return and subsequently submits voluntarily the missing information, the taxpayer will not be required to pay the penalty, but only the tax owing on the adjusted income, with interest.

The Committee thus recommends the following:

Recommendation 6:

That Revenue Canada develop initiatives to improve the promotion and enhance the public profile of its Voluntary Disclosure Program as a means of further encouraging disclosure of unreported income and ensuring compliance to Canadian tax laws.

Recommendation 7:

That Revenue Canada provide information on the progress of these initiatives in its annual Performance Report to Parliament, starting 31 October 1999.

Concerns were raised about immigration trusts. According to paragraph 22 of the Auditor General of Canada Special Report - Examination of the Requirement to Report Specified Foreign Property Under Section 233.3 of the Income Tax Act:

This is a non-resident trust that an individual can set up before immigrating to Canada. Any or all of the individual’s offshore assets can be placed in the trust. As long as the assets are left in the trust and are not brought into Canada, income generated from them will not be taxed in Canada for a period of five years. After that, the regular rules will apply and the investment income on those assets to those who remain in Canada will be taxed. This effectively gives a new Canadian relief from taxes for five years on all income from investment left offshore in the trust.

Mr. Shahid Minto indicated that given that it is now possible to apply for Canadian citizenship and passport after three years as a Canadian resident, the opportunity exists for individuals to set up an immigration trust, come to Canada for three years and apply for a passport. Once a passport has been issued the individual can then become a non-resident without paying any Canadian taxes on world-wide income. (1655)

The committee inquired about what actions Revenue Canada intended to undertake to deal with this loophole. Mr Lacombe replied that the Department was currently exchanging information with Citizenship and Immigration to deal with this particular issue. He also proposed to communicate the Committee’s interest in the matter to the Department of Finance because, according to Mr. Lacombe, this is a tax policy issue.

When the Committee inquired about the penalties regarding the failure to report foreign income, the Assistant Deputy Minister, Mr. Lacombe indicated that in terms of foreign income verification, the penalty for not accurately reporting was equivalent to five percent of the value of unreported assets.

Mr. Shahid Minto, commented that the statement was substantially accurate but added there was uncertainty as to whether the penalties would be actually enforced considering a ministerial announcement indicating the enforcement of rules would be waived for the first two years.

Mr Lacombe replied that this practice was not unusual. Penalties would be applied in cases of blatant non-compliance, but the Department preferred to provide assistance to people in order to ensure the proper reporting of foreign income. Mr. Shahid Minto reiterated the Auditor General’s position that the act is in place and that it is unusual for the tax administration to deliberately not enforce its own tax laws. (1700)

After listening to the testimony, the Committee is concerned that this practice may send a mixed message to taxpayers about Revenue Canada intention to enforce tax laws. In light of this, the Committee urges:

Recommendation 8:

That Revenue Canada review and clarify its position concerning the application of penalties on undeclared foreign income and ensure the equitable and consistent enforcement of these tax laws.

CONCLUSION

The Standing Committee on Public Accounts acknowledges the Department’s current and planned initiatives regarding the underground economy. However, it is concerned about the Department’s ability to properly measure and record the tax impact directly attributable to the Underground Economy Initiative. Also of concern, was the current emphasis on enforcement efforts at the expense of education and facilitation activities, and the Department’s application of the provisions of the Income Tax Act regarding the reporting of foreign income. The Committee urges Revenue Canada to follow through with proper corrective measures to address all the shortcomings identified in the Auditor General’s report.

Pursuant to Standing Order 109, the Committee requests that the Government table a comprehensive response to this Report.

A copy of the relevant Minutes of Proceedings (Meeting No. 62) is tabled.

Respectfully submitted,

JOHN WILLIAMS