Keep Good Records! : CRA SOTW

Keep good records in case of net-worth assessment by CRA.

By Arthur Drache

Published: Tuesday, August 28, 2007

One of the main tools the taxman employs in chasing alleged tax evaders is a process called a "net-worth assessment." It is used when the Canada Revenue Agency becomes suspicious that somebody is living beyond his or her means, as indicated by prior years' tax returns.

A person who drives a paid-for Mercedes and lives in an $800,000 home who has regularly shown $25,000 a year in income on tax returns would be a prime candidate.

In a nutshell, the CRA auditors do an assessment of how much the individual is worth, less debts. They then look at declared income for the period in question, take into account living and other expenses and any other relevant factors. If there is a "gap", the CRA will assume it represents undeclared income and will come after the individual for the tax, interest and penalties.

Of course, there may be a host of valid explanations. Maybe the individual won the lottery. Maybe he or she inherited money or had it given to them. Maybe the money isn't theirs, but belongs to somebody else.

All these factors may go to rebut the presumption that there has been substantial amounts of unpaid tax ? but it takes a fair degree of hard proof by the individual to persuade Revenue or, in some cases, the court.

Some aspects of our tax system have made net-worth assessments more important to the taxman than in years gone by. Thirty years ago, when Canada had both estate taxes and succession duties, a lot of undeclared income showed up in cash at death.

Almost every lawyer from that era recalls the formal opening of safe deposit boxes (in the presence of tax officials) to find bundles of cash, usually money skimmed from a legitimate business.

And most had stories about clients who had been robbed and could not report the scope of their losses because they were keeping the money in cash, at home. With the elimination of death taxes of these types (not to mention gift taxes) the ability of the government to trace hoards of money was diminished.

It is not surprising that many of the net worth assessment cases involve immigrants. Many come from countries where there is little trust in the banking system and they bring cash and other valuable but portable types of wealth with them.

Because they do not have to declare what they bring to Canada, their starting capital never is identified properly, especially if they do not immediately buy a home, business or put the assets in a bank or with a broker.

Years pass and a net-worth assessment identifies a gap between declared income and net wealth, raising the question. The individual then claims that he or she brought the money with them but without firm evidence, they may be unsuccessful in court, where the onus is on them to prove their case, not on the taxman.

Sometimes they claim the money does not belong to them but to relatives who may still be abroad. Almost 30 years ago, we had a client from an African country whose family had a luxury car dealership. It was forbidden to export funds from that country and the family, being of a minority group, always felt under threat.

They arranged for foreign car manufacturers in Germany to "kick back" part of the purchase price and to send it to our client, a cousin in Canada. When he came to ask about the tax implications, we arranged a meeting with Revenue Canada, which understood the situation.

Revenue decided that he held the money in trust for a nonresident. All the taxman wanted was the appropriate non-resident withholding tax on the interest. The department also agreed that nowhere in their official records would it "name names" of the true owners of the money.

Several years later, in the wake of an uprising, the family escaped from home and came to Canada to receive a nest egg, which was the genesis of a business that thrives today.

The key to beating a net-worth assessment (assuming you haven't been cheating on your taxes) is to document the receipt of any significant funds you receive particularly when the funds come from outside Canada. Good paper almost always will prevail, but in a contest of your unsupported word against Revenue, you'll almost always lose.

Arthur Drache, CM, QC. is an Ottawa lawyer with Drache LLP. He is also counsel to Miller Thomson LLP, a national law firm. His e-mail address is adrache@drache.com
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