The determination of whether a transaction is a ‘sham’ has been a longstanding issue in tax law, but one that has seemingly been the focus of a number of CRA projects across a number of different industries, including a current project in the international long-distance minutes business, where the CRA says that businesses are involved in the so-called carousel sham!

Sham / Carousel Overview – Shams and carousel schemes started in the UK, where the UK VAT was in place since January 1973, and the CRA now believes that they have travelled to Canada. The CRA describes the essence of a “carousel” sham as “engaging in transactions intended to deceive and divert tax revenue from the Minister”, and typically denies that any real commercial activities are taking place, then denying all related input tax credit (ITCs) claimed by the targeted taxpayer. The targets of these audits are usually unsuspecting Canadian businesses with zero-rated or exported goods and services. Typically, the CRA asserts the business was either knowingly engaged in collusion with other bad actors (usually the supplier of the business’s inputs), or was wilfully blind to fraudulent activities taking place. (In tax law, wilful blindness – sometimes spelled “willful blindness” – is akin to a “voluntary act”, and tantamount to tax evasion in the CRA’s eyes).

For some reason, the sale of zero-rated international minutes in the telecommunications industry (and related sales of high volume, low-margin digital communications products like voice-over-internet-protocol / VOIP services) has drawn the ire of the CRA.   Using the Tax Court’s definition of the “carousel scheme” from Cherniak v. The Queen, the CRA has suggested that these sales of international minutes are, in fact, fictitious zero-rated supplies that allow the seller to receive large refunds in connection with tax that was never remitted in the first instance by a prior unscrupulous seller. Subsequent buyers and sellers being “inserted into the transaction flow to mask what is really going on". Effectively, in the CRA’s view, “paper transactions [are] part of an elaborate ruse to defraud the government of tax revenue".

At this point, the CRA typically contends that the business activities of wholesalers of long-distance international minutes are not true business activities, and thus do not amount to the carrying on a “commercial activity” (the pre-requirement for claiming ITCs). In one recent case from our office, CRA “Audit contend[ed] that engaging in a carousel scheme is not a true commercial activity”, which meant that the “extent of consumption, use, or supply in commercial activity is nil, and the amount eligible to be claimed as a ITC is also nil”. Using this, the CRA denied millions of dollars in ITCs!

Director’s Liability – For taxpayers wound up in alleged “sham” or “GST carousel” schemes, an awful situation arises; not only is the corporation’s wellbeing affected (it is required to immediately start paying the assessment), but so is the livelihood of its directors, who can be held personally liable for the amounts assessed against the corporation, if not paid by the corporation.

What to Do? – When faced with “sham” or “GST carousel” allegations by the CRA, it is advisable to obtain IMMEDIATE legal advice. Now! Not after the audit. Like yesterday!

One reason for this is the likelihood that CRA is already in the process of using any statements received from the audit or audit interview process against the taxpayer and is lining up a series of admissions that may make it more difficult for the taxpayer to dispute the CRA’s position in Court later. Almost like a form of entrapment!

Takeaways – The takeaway point from this is that CRA allegations of “sham” or “carousel” transactions are extremely serious, with potentially catastrophic consequences on the corporate business and each director’s economic well-being.

Legal assistance – from a properly-trained experienced lawyer, not an accounting firm – is required, on an urgent basis, in our view.

Do you require assistance in this area? If so, contact us here.

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