Tax Avoidance vs. Tax Evasion

Although they’re an important part of Canada’s economy, no one likes having to pay income taxes. Thankfully, there are ways to lower your yearly tax bill and even avoid paying certain types of taxes. The only problem is that some methods, like tax avoidance, are legal, while others, like tax evasion, are totally illegal. 

Want to know the key differences between tax avoidance and tax evasion? Here are a few essential details to keep you out of trouble with the CRA. 

What Is Tax Avoidance? 

Despite its name, tax avoidance doesn’t really mean you can simply go without paying taxes. In reality, tax avoidance is the act of reducing your taxable income or tax owed using various legal methods. According to the Canada Revenue Agency, tax avoidance laws include all forms of tax planning that are deemed “unacceptable” or “abusive”.   

Forms Of Tax Avoidance

So, if you’re looking to reduce your yearly tax debt but still comply with the CRA’s legal regulations, you’ll have to implement “effective” tax planning, where any arrangements are consistent with the law. Common methods of tax avoidance include:  

• Investing in Tax-Advantaged Accounts – Some financial accounts, like RRSPs and TFSAs, allow you to avoid paying taxes on the money you invest. RRSPs are tax-sheltered for a limited time, while TFSAs are tax-sheltered and tax-free.  

• Claiming Expenses For Tax Benefits – Some government-approved costs, such as medical bills, sales taxes, tuition fees, and charitable donations will make you eligible for different deductions, credits, and other benefits. 

• Paying Your Spouse Or Dependant – If you own a business and employ your spouse, common-law partner or child, you can overpay them and reduce their taxable income. The CRA may even move your household to a lower tax bracket.   

These methods are all legal and could help you pay fewer taxes from year to year, as long as you fill out the proper documents and let the CRA know what you’re doing, rather than disguising your intentions by evading taxes altogether. 

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What Is Tax Evasion?

Tax evasion is when you or your business avoid paying taxes through illegal means, such as lying about your income or failing to submit any required tax reports. It doesn’t matter if you’re doing it on purpose or if you simply forgot, no federal, provincial or territorial tax authority will let willful tax evasion slide for very long. 

Forms Of Tax Evasion 

Even though tax evasion sounds similar to tax avoidance, there are laws that clearly define both types of tax planning and specific punishments for failing to comply with your area’s tax regulations. Different tactics could also qualify as tax evasion, including:

• Not Declaring Overseas Income – If you’re earning other incomes or holding assets outside of Canada, you must report them to the CRA. For instance, many landlords and homeowners don’t realize that they must declare and pay taxes on the income they’re getting from rental properties they own in another country. 

• Collecting Or Paying Income “Under The Table” – If you’re paying someone who qualifies as an employee, like a nanny or housekeeper, you should be reporting their income to the CRA as well. Similar rules apply when you’re earning self-employment income but neither you nor your employer reports it.

• Having An All-Cash Business Or Earning Illegal Income – One of the most common forms of tax evasion occurs when a business collects cash income but doesn’t declare it. 

The Penalties For Avoiding Your Taxes

As mentioned, different ways of avoiding your taxes come with different legal and financial penalties, so it’s essential to speak with a CRA representative if you’re not sure whether you should be reporting certain types of income. Here’s what could happen if you participate in tax avoidance or tax evasion in Canada:

• Tax Avoidance – Tax avoidance tactics aren’t illegal, but there are potential financial consequences involved. For example, the money in your RRSP is tax-sheltered, which means you’ll have to pay taxes on it when you make a withdrawal.

• Tax Evasion – The penalties for tax evasion are far more severe, especially if you don’t provide a proper explanation. Depending on the size of your tax bill and what incomes you failed to report, you may receive a $1,000 – $25,000 fine or 200% of what you owe, along with a criminal record or up to 5 years in prison.

How The CRA Monitors Tax Avoidance

Some forms of tax avoidance are acceptable, others can involve serious legal penalties. Due to these kinds of complications, the Canada Revenue Agency must take measures to verify that all taxpayers are reporting their income properly, such as: 

• Performing audits when someone is committing possible tax avoidance
• Staying up-to-date with the latest tax avoidance rules and methods
• Communicating with CRA auditors to ensure these problems are monitored
• Keeping in contact with the Department of Finance to verify any legislative modifications and combat abusive tax planning among Canadians

Ways To Avoid Taxes Legally In Canada

Paying taxes may not be fun, but there are several ways to reduce your taxable income or get yourself (or your household) moved to a lower tax bracket. Make sure to look up the specific federal and regional rules surrounding each form of legal tax avoidance, because there are still financial penalties you could encounter:

• Contribute To Your RRSP – Registered Retirement Savings Plan funds are tax-sheltered and tax-deductible. When you contribute, your taxable income will lower by an equal margin. However, you’ll get fully taxed when you withdraw, so save your funds for retirement. For 2023, the RRSP contribution limit is $30,780.  

• Contribute To Your TFSA – Also tax-sheltered, a Tax-Free Savings Account is similar to an RRSP, only you won’t get taxed when you withdraw. Plus, it can help you reallocate your investment portfolio. For the 2023 tax year, the annual TFSA contribution limit in Canada is $6,500 ($88,000 cumulatively).

• Make Investments With More Opportunity For Capital Gain – If you invest in non-registered funds, like cash and margin accounts, you’ll pay a capital gains income inclusion rate of 50%. Then again, with registered accounts like GICs and Treasury Bills, your interest income will be taxed at a rate of 54%.

• Claim Everything Possible – Don’t forget, there are many expenses and incomes that you can legally claim on your taxes in exchange for various credits, deductions and other benefits. Eligible claims include certain medical expenses, daycare fees, home office costs, and business income from family employees.

Additional Reading

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What Happens If You Make A Mistake On Your Tax Return?

The CRA only accepts one tax return per year from each taxpayer and you can’t submit a second one if you make a mistake. Don’t worry, because you are allowed to contact the CRA and make adjustments to your tax return. Here’s what you can do:

File A Request With The CRA

Before you make changes, wait for your Notice of Assessment so you can work around any delays or automatic adjustments made by the CRA. If the error is still there after or you want to report something else, file a request online or by mail (processing time is about 2 – 10 weeks). 

Make Adjustments Online

Sign in to your CRA My Account and click “Change Return”. You can then choose a tax year and submit adjustments. Unless your changes are denied, you should receive a Notice of Assessment around two weeks later. Watch out, as you can’t submit a second return until your first is approved.  

Mailing A Paper Request

To file a CRA Adjustment Request by mail, print and complete Form T1ADJ-T1, then send it to your regional tax bureau. Be sure to include all receipts, tax slips or other proof to back your request. Keep in mind, mail-in requests often take longer to process (up to 10 weeks vs. two weeks online). 

Claim Items From Your Previous Tax Returns

If you’re not an experienced taxpayer, it’s possible to lose out on tax benefits, like deductions from past expenses. Luckily, the CRA allows you to request adjustments dating back to a maximum of 10 years, so don’t throw away any eligible receipts or slips.

Protect Yourself From The Consequences Of Tax Evasion

Remember, some forms of tax avoidance are legal but pushing the boundaries of what tax authorities consider acceptable. Plus, tax evasion can come with some serious legal and financial penalties, even if you’re committing it by accident. So, if you’re not sure what you’re doing during tax season, it’s best to hire a tax professional or use certified tax filing software to help you get the most out of your tax return without any problems.