Tax Shelters, Technology, and the Future?- The Demise of the Software Tax Shelter and Lessons to be Learned for the Investor

• Author: David W. Chodikoff & Natalia E. Bitton
• Pages: 55-80

55

Chapter 4

Tax Shelters, Technology, and

the Future? The Demise of the

Software Tax Shelter and Lessons

to be Learned for the Investor

david w. chodikoff & natalia e. bitton

A. INTRODUCTION

Every f‌ive to ten years, an individual or a group of creative people invent a

new way to save people money by creating some t ype of novel tax savings

plan. In our tax system, some of these plans, more commonly referred to as

tax shelters, have been found in t he f‌ields of real estate, mining, f‌ilm, and

scientif‌ic research and development. In this chapter, we not only examine

the concept of a tax shelter, but we specif‌ically discuss the rise and fall of the

software tax shelter. We further provide our views on the lessons that can be

learned from the failure of this particular form of tax shelter. As a general

rule, f rom the participant’s viewpoint, we think t hat a failure means that

the costs of participation (f‌inancial, emotional, and psychological) outweigh

the actual benef‌its (ty pically, ta x savings). In light of our comments, the

question that we leave the reader to ponder is whether participation in a tax

shelter has real lasting value.

B. WHAT IS A TAX SHELTER?

To many, a “tax shelter” is simply a method of writing off or reducing tax.

To others, the term “tax shelter” has a negative connotation: it means some-

thing that is il legal or some form of tax avoidance. Typically, what comes

to mind is the idea of a wealthy businessman funnelling his money to an

offshore jurisdict ion in order to avoid the payment of taxes. However, tax

56 david w. chodikoff & natalia e. bitton

shelters are in fact lega l1 arrangements established to reduce tax, although

recognizing this is hardly intuitive given t he government’s aggressive ac-

tions to t hwart the availability and use of t ax shelters regardless of t heir

supposed legality.

Generally speaking, a “tax shelter” is def‌ined broadly to mean “any

technique which allows one to legally reduce or avoid ta x liabilities”2 or as

“an investment that offers ta x benef‌its by deferring or reducing t axable in-

come”;3 most other def‌in itions tend to be some form of variation of these

two general themes.

1 For a discussion of the di fference between tax avoida nce and tax evasion, see V. Krishn a,

The Fundam entals of Canadian Incom e Tax, 8th ed. (Toronto: Thomson Carswell, 2004) at

991 (“Tax evasion is the comm ission of an act knowingly w ith the intent to decei ve so that the

tax reported b y the taxpayer is less tha n the tax payable under the law. . . . Tax avoidance is

concerned with t he minimization of tax . It can be ‘lawful’ or ‘unl awful’ either because of

the manner or the mot ive with which it is execute d. Lawful tax pla nning is the mitigat ion of

taxes that wou ld otherwise be payable in t he absence of the plan. Tax avoidance is unlaw-

ful, but only where it offend s established judicial doc trines or prescriptive leg islation such

as GAAR. O therwise, it is lawfu l”). See also P.S. Taylor, “Everyone’s Guide to Tax Shelters”

Money Sense (D ecember/January 2007) 46 –49. (The author compares tax avoid ance, which

involves takin g advantage of the rules to mi nimize a tax bill and is le gal, with tax evasion ,

which involves delibe rately trying to hide income or de ceive the tax man and is ille gal. Tax

shelters are essentia lly a strategy “to exploit loopholes i n tax laws in order to earn outsi zed

tax deduction s.”)

2 Online: www.investorwords.com.

3 Online: www.inves tordictionary.com. See also K rishna, above note 1 at 1707 (any invest-Online: ww w.investordictionary.com. See als o Krishna, above note 1 at 1707 (any inve st-

ment sold on the basis that t he investor can receive accelerated deduct ions and/or credits);

D.S. Infanti, “ Tax Flavoured Investments — What do Investors Need to Know?” ( Paper

presented at the 2002 Brit ish Columbia Tax Conference) (Vancouver: Canadi an Tax

Foundation, 2002) at 1 (ta x shelters are investments promoted on the ba sis that they offer a

reduction or deferra l of income tax); A. Joseffer, “U.S. Tax Opinion s and Practices” (2004)

12:3 Canadian Tax Hi ghlights, online: w ww.ctf.ca/articles/News .asp?article_ ID=2293 (In

the U.S., a “tax shelt er includes any partnersh ip or other entity or any investment pla n,

other plan, or ar rangement with a signif‌i cant purpose of avoidance or evasion of a ny tax

imposed by the [Inter nal Revenue] Code”); T. Edgar, “Policy Foru m: Interest Deductibilit y

Restrict ions — Expecti ng Too Much from REOP?” (2004) 52:4 Can. Tax J. 1130 at 1138 (“ta x

shelter” refers to a tra nsaction that generally incor porates the following featu res: acquisition

of an asset that provide s for the recognition of expenses b efore the recognition of revenue;

recognition of revenue subjec t to preferential tax rates; bor rowing to acquire the asset a nd/

or an interest in an entit y holding the asset; and us e of an investment vehicle that prov ides

investors with t he benef‌it of limited liabilit y for private-law purposes a nd conduity treat-

ment for income tax pur poses); J. Bankman, “The Tax She lter Problem” (2004) 57 Nat’l Tax

J. 925 at 925 (while there is no agre ed-upon def‌inition of a tax shelter, t he author suggests

that the literat ure describes a “tax she lter” as being “a tax-motivated t ransaction unrelated

to a taxpayer’s norma l business operations that, u nder a literal reading of some releva nt

legal authority, produces a loss for t ax purposes in excess of a ny economic loss, in a manner

inconsistent with leg islative intent or purpose”).