What is a CRA Net Worth Audit?
Has your CRA auditor informed you that your audit will be a Net Worth Audit? Are you wondering what that means? We previously wrote about Net Worth Audits and Assessments which you can find here. This blog provides more information about net worth audits, what they are, why they occur, and what can be done to fight them.
Net Worth Audit
Generally, a standard audit consists of reviewing a taxpayer’s accounting records (i.e., bank statements) as well as other related records. However, in cases where the CRA finds the taxpayer’s records insufficient, the CRA may initiate a Net Worth Audit. Once initiated, the CRA will consider a multitude of factors to arrive at a taxpayer’s taxable income. This can include a review of bank records, assets, and liabilities, along with accounting records. In a way, the CRA is assuming the taxpayer’s unreported income when utilizing a Net Worth Audit. The CRA justifies this type of audit when they claim there is any indication of irregularity or insufficiency in the financial affairs and records of the taxpayer.
The auditor may even increase taxable income if they feel that a taxpayer’s respective tax returns do not support his or her lifestyle (also referred to as a CRA lifestyle audit). This can result in a financial gift from a parent turning into taxable income, or even unidentified bank deposits being termed income. The overall goal of a CRA Net Worth Audit is to increase a taxpayer’s taxable income. If the taxpayer’s books and records are in poor shape, it will be much easier for them to do so.
When will CRA use the Net Worth Audit Method?
The CRA refers to a Net Worth Audit as an indirect verification of income. The CRA may rely on the Net Worth Method, if:
- Your books and records are inadequate and indicate potential errors;
- You mix personal and business income into one bank account. For instance, one account may be used for both personal and business transactions;
- The income you reported does not support your lifestyle;
- If the business you are in is in an industry where tax evasion is common; and/or
- If comparable businesses report higher income then your business.
These are all factors that the CRA may rely on to initiate a Net Worth Audit.
How do you challenge a Net Worth Audit Tax Assessment?
CRA auditors have immense discretion. Additionally, there is a reverse onus in tax law, meaning that it is on the taxpayer to prove his or her income (as the Canadian tax systems is a self-reporting system). In practice, auditors are allowed to assume facts that a taxpayer must then rebut.
A taxpayer can successfully challenge a net worth assessment by preparing detailed responses and explanations to each assumption of the auditor. The taxpayer’s goal is to demolish the auditor’s assumptions. This is normally done with explanations and documentation rebutting each assumption.
If your audit has been concluded, you may continue to fight the assessment by filing a Notice of Objection and/or appealing to the Tax Court of Canada. The best method to dispute the Net Worth Audit is have your books and records reconstructed to show the difference between the CRA auditor’s accounting and factual assumptions. Providing detailed and accurate records of your finances is key.
At R&A Tax Law, we have represented several clients during and after a Net Worth Audit. If a taxpayer wants to appeal a Net Worth Audit tax assessment, we can file a Notice of Objection, challenging the assessment before a CRA Appeals Officer. If you are going through a CRA Net Worth Audit, or have had one completed that you disagre with, and you need assistance, contact us today! We are here to help!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer.