The Canada Revenue Agency (CRA) is warning that Canadians could unknowingly participate in an “aggressive” tax scheme and face serious consequences, including penalties, court fines and even jail time.

The agency issued a news release saying the scheme involves critical illness insurance arrangements that may be designed to avoid paying taxes. The arrangements are often complex transactions that involve borrowing money and using it to pay for insurance, which can result in serious tax consequences.

“These arrangements are problematic because they appear to be legitimate insurance transactions, but are actually designed to let shareholders take money from their company without paying taxes,” it warned.

The products often do not meet the standards of valid insurance policies and are only used to support the tax scheme.

Participants in the scheme will be reassessed and denied the tax benefits they’ve received while the CRA may apply third-party penalties to the scheme’s promoters and advisors, it said.

“The CRA actively investigates these arrangements and has taken serious compliance and enforcement actions when they are found to be illegitimate or non-compliant,” it added.

The schemes are typically promoted by a group of companies or individuals based in Canada or abroad who arrange for a shareholder to borrow money from a third-party lender connected to the promoter group.

The shareholder transfers the borrowed funds to their corporation and the corporation then uses the money to buy a critical illness insurance policy, often from an offshore provider. The corporation would record the loan as a liability, allowing the shareholder to withdraw funds tax-free.

The security for the loan in step one cancels the shareholder’s obligation to repay the loan. The structure creates a circular flow of funds, the CRA said.

The CRA has previously issued warnings about similar schemes, including those involving offshore disability insurance plans and offshore leveraged insured annuity plans.

To avoid getting involved in such schemes, the tax agency recommends that Canadians seek independent advice from a qualified and reputable tax professional before entering into any complex financial arrangement.

“Be cautious of any scheme that promises to reduce taxes through complicated insurance or loan structures,” it said.

Anyone who suspects a business, charity or individual of tax or benefit cheating in Canada can report it to the CRA.

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