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 illegal.
Tax Avoidance vs Tax Evasion
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?
Tax avoidance refers to legally reducing taxable income or the amount of tax owed through various methods. It’s not about evading tax payments, but rather using legal strategies to minimize tax liability.
The CRA classifies tax avoidance as any form of tax planning that falls into the realm of being “unacceptable” or “abusive”.
It goes beyond aggressive tax planning that tests the boundaries of the law; tax avoidance also involves strategies that may comply with the letter of the law but contradict its intended spirit.
What Is Tax Evasion?
Tax evasion is when you or your business avoid paying taxes illegally, 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.
One of the biggest differentiating characteristics of tax evasion is the criminal side of it. Unlike tax avoidance, those who practice tax evasion can be pursued in criminal court. This means you’ll not only incur penalty fees but you may face prison time.
File your taxes with TurboTax
Get StartedForms Of Tax Avoidance vs. Tax Evasion
Here are some typical methods used to avoid or evade taxes in Canada.
Forms Of Legal Tax Avoidance
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 or defer paying taxes on the money you earn from investments.
- 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.
- Pension Income Splitting. If you receive a pension, you can use a strategy known as pension income splitting to reduce the amount of taxes you owe. It involves transferring up to 50% of your eligible pension income to your spouse or common-law partner. That way you reduce your taxable income and hopefully lower your tax bracket. This generally only works if your partner has a lower income than you and can remain in the lower tax bracket even after you’ve split your income with them.
- Charitable Donations. Donating to registered charities can also be an effective method of tax avoidance. When you make charitable donations, you can claim these contributions as deductions on your tax return. This lowers your taxable income, which in turn can reduce the amount of tax you owe. The CRA provides tax credits for charitable donations, which can be beneficial if you’re in a higher 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.
Forms Of Illegal Tax Evasion
Even though tax evasion sounds similar to tax avoidance, they have very different consequences. Here are a few different tactics that can qualify as tax evasion:
- Not Declaring Overseas Income – If you’re earning other incomes 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.
- Purposely Inflating Expenses – If you inflate your expenses to receive larger deductions is considered tax fraud.
- Making Fake Claims – Lying on your income return to receive benefits or refunds you are not eligible for.
- You Don’t Declare Your Income – One of the most common forms of tax evasion occurs when a business or worker collects cash income but doesn’t declare it.
- Using Offshore Accounts To Conceal Income: Illegally using offshore bank accounts or entities to hide income and assets from the CRA is another form of tax evasion. This involves transferring money to foreign accounts or investments to avoid reporting income and evading taxes in Canada. While holding offshore accounts is not illegal in itself, failing to declare the income earned from these accounts or using them to conceal assets specifically to evade taxes is against the law and can lead to serious legal repercussions.
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 tax professional 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 income 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 takes 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:
Considering the complexity of tax laws and the potential for financial penalties, it’s advisable to consult with a tax professional to ensure that your tax strategies remain within legal boundaries.
Contribute To Your RRSP
The funds in a Registered Retirement Savings Plan are tax-sheltered. When you contribute, your taxable income will be lowered by an equal margin. However, you’ll get fully taxed when you withdraw, so save your funds for retirement. For 2024, the RRSP contribution limit is $31,560.
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 2024 tax year, the annual TFSA contribution limit in Canada is $7,000 ($95,000 cumulatively).
Contribute to Your FHSA
Like the RRSP, contributions to a First Home Savings Account (FHSA) can reduce your taxable income. This account is specifically designed to aid in saving for a first home. When you contribute to your FHSA, the amount is deducted from your taxable income, similar to an RRSP contribution. However, the advantage of an FHSA is that the withdrawals, when used for a qualifying home purchase, are tax-free, similar to a TFSA.
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.
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. However, you are allowed to 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 or you want to report something else, file a request online or by mail (processing time is about 2 to 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. Keep in mind 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. 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 push 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. 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.
