Tax Articles

1. How does a tax audit work?

Tax audits can be instigated in a number of ways. They are:

b. Through a CRA “special project”. Each year, CRA targets 2 or 3 groups of businesses such as: auto body shops, jewellery exchanges and real estate agents. They select these “targets” due to the fact CRA regards them as being a “cash business” or one in which taxpayers tend to exaggerate their deductible expenses.

c. Through variance analysis from a year-to-year review of your income tax submissions. These variances are usually the result of some type of volatility in revenue and certain expense categories. For example, large swings in income from year to year may trigger a “red flag”. CRA may want to investigate on the basis that perhaps all income is not being reported because they assumed that income should be more stable than what is being reported.

d. Failure to file tax returns or reports will lead to an audit. If you fall behind in filing GST returns or payroll remittance forms, you can be certain you will receive a call from CRA asking to audit your records.

e. By e-filing your personal tax returns, you will increase your chances of being audited. This is because when you e-file your return, CRA never sees any of the actual receipts supporting such deductions as: charitable donations, child care expenses, tuition slips and medical expenses. Therefore, the likelihood that e-filed returns are being filed with “exaggerated” claims is more likely than with “paper filed” tax returns. “Paper filed” returns, my personal choice of preference, submits the tax returns with all receipts attached. Thereby, eliminating the “need” for CRA to contact you to ask you about a particular receipt supporting a deduction you may have claimed, as well as other “aspects” of your return.

Bearing this in mind, you are then contacted by a CRA representative by phone, by mail or in person. You are usually given an appointment and asked to prepare and gather a series of supporting documents. For example, for a business tax audit you are going to be asked for:

bank statements and cancelled cheques;
invoices-both sales and purchase
general ledger, trial balance, balance sheet and income statement
copies of mileage logs for your vehicle
copy of the leasing agreement or purchase agreement for the vehicle
GST remittance forms, if you are a GST registrant
a visit to your home, if you claimed a home office.

Usually, it is at this point you would contact your professional tax preparer and have the auditor get in contact with him. Other than the home visit (which you cannot avoid, since the auditor wants to ensure that you qualify for such a claim), you should have the audit conducted at your CA’s office.

You should always be co-operative with the auditor and provide all the information that is asked of you. However, having an accountant as the “go between” is probably the best way to go. The expertise of a CA trained in these situations will pay dividends in the end after the audit is completed.

A tax audit may take up to a few weeks to a few months to be completed.

Auditors always have a budget before they start an audit. They are usually assigned a budget of 50 hours to complete a simple personal tax file. Always try to be organized and provide everything that is requested, within reason, so as to not prolong the audit. By prolonging the audit, you are actually putting pressure on the auditor to find an “upwardly increasing” amount of tax recovery. An auditor’s performance is based on recovery of tax dollars and number of files completed during the year. The more time that an auditor has to spend on the file will “force” him to make assessments that he otherwise wouldn’t have made in order to ensure his “tax recovery” is in line with hours spent on the file.

2. What is Voluntary Disclosure or VDP?

The Voluntary Disclosures Program (VDP) allows taxpayers to come forward and correct inaccurate or incomplete information or to disclose information they have not reported during previous dealings with the CRA, without penalty or prosecution.

A disclosure may be made for Income Tax and Goods and Services Tax/Harmonized Sales Tax (GST/HST) purposes, as well as for charges under the Softwood Lumber Products Export Charge Act, 2006, or the Air Travellers Security Charge Act.

A valid disclosure must meet four conditions. These conditions require that the disclosure be voluntary, complete, involve the application or potential application of a penalty, and generally include information that is more than one year overdue. If the CRA accepts the disclosure, the taxpayer will have to pay the taxes or charges owing, plus interest. However, the taxpayer will not be subject to penalty or prosecution for those amounts accepted as a valid disclosure.

If a taxpayer disagrees with a VDP decision, they may request a second review of their file by contacting the Director of the TSO where the original decision was issued. In addition, the taxpayer may pursue further recourse through the judicial review process.

(excerpts from the Canada Revenue Agency website)

3. What are the Fairness Provisions or Tax Relief Provisions provided for by CRA?

Since the 1990s, the taxpayer relief provisions have given the CRA common-sense ways to help taxpayers who, because of extraordinary circumstances, are unable to meet their tax obligations.

The taxpayer relief provisions give us the discretion in certain situations to:

cancel and waive penalties and interest;
accept late-filed, amended, or revoked elections (income tax only); and
issue income tax refunds beyond the normal three-year period (individuals and testamentary trusts only).
Circumstances in which penalties and interest may be cancelled or waived

We can forgive penalties and interest when they result from circumstances beyond a taxpayer's control, including:
natural or human-made disasters, such as a flood or fire;
civil disturbances or disruptions in services, such as a postal strike; or
serious illness or accident, or serious emotional or mental distress (e.g., death in the immediate family).
We can also forgive penalties and interest when they result primarily from the actions of the CRA, including:
processing delays that result in a taxpayer not being informed, within a reasonable time, that an amount was owing;
errors in CRA publications or incorrect information provided to taxpayers;
delays in providing information, such as when a taxpayer is unable to make a payment because the necessary information was not available; or
processing errors that result in a taxpayer being unaware of certain obligations.
We can also forgive interest when taxpayers cannot pay amounts owing because of circumstances beyond their control. For example:
when collection has been suspended because of an inability to pay caused by the loss of employment and the taxpayer is experiencing financial hardship; or
when a taxpayer is unable to conclude a reasonable payment arrangement because the interest charges absorb a significant portion of the payments. In such a case, the CRA may waive all or part of the interest for the period from when payments commence until the amounts owing are paid, provided the agreed payments are made on time.
Circumstances in which certain late, amended, or revoked elections may be accepted

We can accept certain late, amended, or revoked elections under the Income Tax Act when they result from circumstances beyond a taxpayer's control (see previous), or when:
tax consequences result that were not intended by a taxpayer, and the taxpayer took reasonable steps to comply with the law; or
a taxpayer acted on incorrect information given by the CRA.
Circumstances in which refunds beyond the normal three-year period may be issued

We can issue income tax refunds or apply them against a balance owing beyond the normal three-year period for individuals and testamentary trusts when:
the refund or reduction would have been made if the return had been filed on time or the request had been made on time; and
the necessary adjustment is correct in law and was not previously allowed.
(excerpts from the Canada Revenue Agency website)

4. Can I negotiate a payment schedule with CRA?

Usually if you fall behind in paying your personal, corporate, GST and payroll taxes, CRA is willing to negotiate a payment plan, as long as you don’t fall behind with your current tax liabilities. That is, if you owe GST arrears, CRA will be willing to negotiate an arrangement with you, as long as you file and pay your future GST obligations on time.

CRA usually allows a maximum of 6 months for a tax debtor to pay his total tax liability. That is, they would like the debt to be paid off in 6 months. However, based on the circumstances and information that may be requested, they could extend this period to 12 months. In return, they may ask you to fill out a “cash flow” type statement in order to find out what your sources of income and expenses are (usually on a monthly basis). They use this statement to support their decision to extend you more time to pay the debt.

As long as you are reasonable, you should be able to work out a payment schedule with the CRA collections officer that is fair to both you and CRA.

5. What happens if I lose at the tax audit stage?

You can file an objection if you disagree with the assessment you have received or if there is a dispute over how CRA has interpreted personal or corporate income tax, GST or payroll tax legislation.

Filing a Notice of Objection is the first step in the formal process of resolving such a tax dispute with CRA. Usually, the Notice of Objection has to be filed within 90 days of the day that CRA mailed you the Notice of Assessment/Reassessment. There is also a way of obtaining an extension to file the Notice of Objection if you are past the 90 day deadline.

The information that must be included on the Notice of Objection should be:
your name and address
telephone number where you can be reached
date of your Notice of Assessment/Reassessment
taxation year relating to the Objection
facts and reasons for Objection
your social insurance number or business number
name of your authorized representative
copies of your Notice of Assessment/Reassessment
copy of a letter of consent authorizing your representative to act on your behalf with CRA
When this Notice of Objection is ready to be sent in to a district T.S.O.(“tax services office) be sure to send it by registered mail. A letter confirming receipt of your Objection should be received by you and your representative with 2-3 months. An appeals officer will be in contact with you within 4-6 months after receipt of the letter, depending upon their workload.

The appeals officer will review your Objection and contact you or your representative to discuss the matter. To ensure that you understand the reasons for the assessment, CRA can provide the following information to you :
copies of your tax returns;
reports prepared by the auditor to support CRA’s assessment;
working papers prepared by the auditor that are relevant to the issues you are disputing;
records of discussions between an appeals officer and the auditor; regarding your reassessment;
copies of court decision and relevant sections of legislation relied on by the auditor to support your assessment;
scientific, appraisal, and valuation reports relied on by the auditor to determine your assessment; and
information obtained from a third party with whom you are doing business, such as sales invoices, purchase invoices, cancelled cheques, bank statements.
If the appeals officer agrees with you in whole or in part, CRA will adjust the assessment and send a Notice of reassessment to you. However, if the officer disagrees with you, the assessment/reassessment will be confirmed and you will be forced to take your case to the Tax Court of Canada.

6. How does CRA calculate and apply the late filing penalties for personal tax situations?

The penalties applied by Canada Revenue Agency on late personal tax filings is based on the following events:

First Letter (“TX11”)
The first CRA letter (called a “TX11”) is sent out by computer to a taxpayer who is late in filing his personal tax return. A “normal” penalty of 5%, plus 1% per month up to a maximum 12 months (maximum 17% penalty) of taxes owing is levied. Regardless of the TX11 being sent, this penalty automatically applies whenever a taxpayer is late in filing.

Second Letter (“TX14”)
The 2nd letter sent is called a “TX 14” demand letter. The “enhanced penalty” of 10% plus 2% per month up to 20 months (i.e.40%) of taxes owing could be applied. (Potential tax penalty of 50%) This enhanced penalty applies if taxes were owing in the current year and you filed late in 1 of the 3 prior years(and owed taxes in that “late filed” year).

Third Letter (“TX14D”)
The 3rd letter is sent by registered mail or delivered personally. This letter is issued, in accordance with section 150(1) of the Income Tax Act of Canada., to notify a taxpayer that he must file his tax return. If no taxes are payable or capital gains realized during this late filed year, the taxpayer may not be required to file a return.

During the course of time that these letters are sent out by computer, the taxpayer’s file may be sitting in a file room and may not be assigned to a CRA officer.

When the file is assigned, a personal phone call from the compliance officer will be made. A further letter may be prepared by the compliance officer which requests the returns that are delinquent.

If the compliance officer gets tax filing before the TX14/TX14D demand letters are sent by computer, the officer may not apply the “enhanced penalty”. Furthermore, the compliance officer usually does not issue a TX14/TX14D since he does not want the “enhanced penalty” to apply when there is verbal contact and reasonable cooperation from the taxpayer or his authorized representative.

7. Can the taxes owed be negotiated with CRA?

This is a question that is always asked by clients.

The tax system in Canada is based on a "self-reporting" honor system type format. Personal and corporate taxes are monies that are owed to the Government based on income reported as being earned. It makes sense that these monies are non-negotiable with regards to whether you have to pay these amounts to the Government.

Payroll taxes and GST are amounts collected on behalf of the Government and are called "trust funds". Not remitting these amounts to the Government is basically deemed to be "theft" in their eyes and dire consequences may follow. However, when I say "dire" I mean interest, penalties and escalating legal proceedings (e.g. garnishees of bank accounts and payroll; liens against assets) and not incarceration or "jail" as some lawyers and other professionals would like you to believe.

The best example that I give my clients is "poker-related". Let’s say you are sitting at a poker game with Canada Revenue Agency. You have a pair of 8s and CRA is sitting with a royal flush, the highest card hand that you can have in the game of poker. With both "players" knowing what the other player has, you are sitting there asking CRA to "split the pot". Why on earth would CRA "split the pot" in this situation? Why would they "negotiate" with you when they have already won?

In other words, at this stage "taxes are not negotiable". In fact, the only stage where taxes may be negotiated is at the consumer proposal stage with a trustee in bankruptcy.

In a sense, taxes may be "negotiable" if you have been "notionally assessed" (whereby CRA has estimated taxes owing because of your failure to file returns-personal, corporate, GST, payroll or otherwise) or if you have been "audited". In these situations, if you feel that you have been wrongly assessed, then you can appeal the decision and/or file the appropriate returns in order to "decrease" or "negotiate" the assessment of taxes to what is realistic.

Interest and penalties may be waived or negotiated downwards under certain circumstances. I believe that this results in the confusion that people have when professionals state "taxes can be negotiated". Under the Fairness Program of Canada Revenue Agency, you can negotiate the "interest and penalties" portion of an assessment if you qualify under their provisions.

8. Do I believe that "disrespecting" Canada Revenue Agency is the way to go?

Canada Revenue Agency is made up of professionals who deserve to be treated as such. I feel that by referring to them as the "Taxman" in a derogatory fashion and dressing them up in all black, wearing sunglasses with an ominous aura in order to instill fear in the public's eyes is unfair and self serving.

If I was working for CRA, I would be greatly offended by these advertisements and would ensure that I make an example of any of these "professionals" clients in the future. After all, we are all human and will react to these types of situations in particular ways.

I have always believed that "you can catch more flies with honey than vinegar". By treating CRA representatives with the respect they deserve, you will surely have different results than by being rude or argumentative. There are situations that may occur whereby requests to replace representatives is required and can be done. However, these situations are few and far between.

You have to remember that CRA representatives are merely trying to do their job. It is not a personal attack or an attempt to disrupt your life. The best results will come by communicating appropriately and by being humane in your dealings with CRA or any other government representatives.

9. Do you really need a lawyer to deal with Canada Revenue Agency?

I am sure that you have heard or seen the tax lawyer’s commercials on the radio and television that state "don’t use an accountant when dealing with sensitive tax issues with CRA since they can give testimony against you in a court of law".

Although this may be a remote possibility in the legal world, this is simply a "ploy" to scare you into running to that particular professional for his all encompassing "protection" when dealing with CRA.

I have always told my clients and prospective clients that I have never, in the past 12 years of public practice, ever been called to give testimony against my clients by CRA. I have been through hundreds and hundreds of audits and dealt with thousands of CRA, Ministry of Finance and WSIB representatives over my tenure.

In fact, I have always told them logically why would CRA ask me to do this? In cases of late filing of returns; non-payment of taxes owing; audits and appeals; voluntary disclosure and fairness program situations, the issue is not legal protection but simply in providing "hard and cold facts" to CRA in order to support your filings. People don’t understand that with regards to CRA, this will never be a "paperless" society. You are required and must have supporting documents (e.g. receipts, invoices, deposit books, bank statements and cancelled cheques) in order to support your tax filings to CRA. If you have this supporting and factual documentation, then you will have no problems. CRA is not as cold and heartless as people believe them to be. In situations where documentation is "lost" or unavailable, CRA will do their best to assist in allowing reasonable expenses or using logic to determine the validity of expenses claimed (i.e. even without gas receipts, CRA may allow a reasonable claim for gas since they understand that you cannot operate your automobile without gas).

One other point for your consideration is the fact that Canada Revenue Agency is made up almost entirely of "accountants". Unless, your accountant has fraudulently prepared your financials, tax returns or other filings, I don’t believe that CRA would call the "accountant" or preparer of such information to give testimony as to how the filings were prepared when CRA’s own auditors and other staff would be well versed in knowing what "a debit or a credit is".

This is not to say there aren’t circumstances where you may require the assistance of a tax lawyer. These circumstances tend to be more of a criminal nature. For example, obvious tax fraud situations (e.g. greatly understating GST filings); businesses of an illegal nature (e.g. prostitution, sale of illegal drugs) or fraudulent conveyances of assets in order to avoid paying taxes.

Just because a professional tells you that your late filing of a tax return could lead to criminal prosecution by CRA, does not make it so. You have to understand that CRA merely wants to collect the monies, plus interest and penalties, due to them. They do not want to prosecute you in a court of law. I hope that this makes sense to you. Logic should prevail in these types of situations regardless of how scared or embarrassed you are.

Most people don’t understand that most tax lawyers do not prepare personal and corporate tax returns; GST returns; RST returns or do bookkeeping. Therefore, by approaching such a professional (aside from the $4,500. to $9,000. legal retainer that is usually asked for) you will be required to utilize "their" accountants to prepare the required tax returns and financials. This will undoubtedly result in "double professional fees" being paid out. At this point, you have to ask yourself "can I really afford to do this?"

For most people, this option will not be financially or logically feasible.

10. Who should you use? A Chartered Accountant or a Tax Lawyer?

Myth regarding Lawyer - Client Privilege

Law firms would like you to believe that they can provide you with the optimal protection or "tax amnesty" because of their "lawyer-client" privilege. These firms are trying to convince you that by quoting sections 238(1) and 239(1) of the Income Tax Act, that state that not filing a return, filing more than one year late if tax is due, or failing to declare taxable income from any source, is criminal tax evasion.

They want you to believe that you will not only be subject to civil penalties (e.g. interest and penalties on taxes owing) but you may be incarcerated for late filing of a return.

This obvious "fear mongering" tactic used to scare beleaguered taxpayers into seeking out these lawyers for their "protection" is ridiculous and self-serving.

I cannot emphasize this enough. Canada Revenue Agency simply wants to collect the taxes that are due to them. Their way of penalizing you is to make you pay civil penalties.

People ask me all the time whether they should run to the closest lawyer they can find and ask for protection under the "Lawyer-Client" umbrella that some tax lawyers are advocating. I explain to them that the chances of their accountant being called by the CRA to give testimony against them in a court of law is slight at best. I further explain to them that most of the CRA staff is made up of accountants in the first place. The question therefore lies in why a group of accountants (i.e. CRA) would find it necessary to have your accountant give testimony against you in court unless he did something grossly wrong in the first place. If you have done nothing wrong aside from being a late filer of tax returns, why would you need "legal protection"?

It just doesn’t make any sense now does it? In fact, when it comes to filing tax information, the professional that you will most logically need is an accountant. If you seek the protection of a lawyer under the "threat of going to jail", you will undoubtedly be facing two sets of professional fees: accounting fees and legal fees since a lawyer does not usually prepare financial statements and tax returns as part of their practice