How to Challenge a CRA Net Worth Audit
Under Subsection 152(7) of the Income Tax Act (ITA), and subsection 299(1) of the Excise Tax Act (ETA), the Minister of National Revenue isn’t bound to accept information or returns from a taxpayer while determining their assessment.
If the Canada Revenue Agency (CRA) suspects that a taxpayer has earned more than reported on their tax returns, they can use these ITA and ETA provisions to conduct a “net worth audit” (also known as “net-worth assessment”) to ascertain the taxpayer’s income.
Understanding a CRA Net Worth Audit
A net worth audit is a specific audit type the CRA uses to examine a taxpayer’s standard of living. If it appears higher than what the reported income on their tax returns could reasonably support, the CRA may conduct this audit.
The CRA usually performs a net worth audit when a taxpayer has substantial assets, cash, or property that seem inconsistent with their reported income. If the reported income is inadequate to support their lifestyle, the CRA will assess them for undeclared income and impose interest and penalties through a net worth audit.
High-risk candidates for a net worth audit by the CRA include individuals operating cash businesses, those reporting low income or consistent losses, and those with poor record-keeping.
The Audit Process
A net worth audit calculates a taxpayer’s income by examining their family’s net worth changes over time that the reported income to the CRA cannot explain.
Typically, a net-worth audit happens when:
- The taxpayer lacks sufficient documentation to back up their filed returns; or
- Initial findings during a tax audit uncover substantial inconsistencies between the taxpayer’s spending/lifestyle and reported income.
A net worth assessment requires collecting a lot of information, data, and documentation during the audit stage. The CRA auditor must meticulously scrutinize the taxpayer’s bank transactions to determine expenses and analyze cash deposits.
Net Worth Audits for Businesses
A business net worth audit is similar to a personal net worth audit but focuses on a business rather than an individual. The CRA might conduct a net worth audit to verify a business’s financial reporting accuracy and to ensure compliance with tax laws and regulations. The CRA may review financial records such as balance sheets, income statements, and tax returns to determine the business’s net worth and tax obligations.
The Burden of Proof and Onus in CRA Net Worth Audits
In assessing a taxpayer, the CRA may make assumptions about a taxpayer’s income and expenses, and the burden of proof falls on the taxpayer to demonstrate that these assumptions are inaccurate. In other words, the taxpayer must provide evidence to show that the factual information used by the CRA to make the assessment is incorrect.
Therefore, when the CRA conducts a net worth audit, it is assumed to be valid and accurate. The burden of proof falls on the taxpayer to show that the assessment is incorrect, rather than the CRA having to prove its validity.
How to Challenge a CRA Net Worth Audit
In the 2020 Tax Court of Canada (TCC) case of Saini v The Queen, the Tax Court ruled that a taxpayer may challenge a net worth audit on three bases: necessity, methodology, and patent errors.
Necessity
The taxpayer must provide evidence showing sufficient records exist to determine their actual income.
Methodology
A taxpayer may challenge the auditor’s incorrect methodology. However, this requires a solid understanding of accounting and the methods used by the auditor.
Patent Errors
A taxpayer can challenge a net worth audit if they believe it includes patent errors. Identifying these errors often requires a level of accounting or tax knowledge.
If you are facing a net-worth audit, don’t hesitate to book your FREE consultation or contact us.
We’ll deal directly with the CRA auditor on your behalf and guide you through the audit process. We’ll also assist you in gathering and organizing the necessary documentation and help tailor your response to the CRA audit.
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By Kaveh Rezaei – Attorney at KR Law Firm
**Disclaimer
This article contains information of a general nature only and does not constitute legal advice. All legal matters have their own specific and unique facts and will differ from each other. If you have a specific legal question, it may be appropriate to seek the services of a lawyer.
