Income Tax: Guilty Until Proven Innocent?
We all know that we have to pay taxes. Taxes are important and provide the funds for many of our social programs that we hold dearly. But what if you get on the wrong side of the Canada Revenue Agency (CRA). Will you be treated fairly? Will you be presumed to be innocent until proven otherwise?
For many Canadians, taxes are the single largest expenditure we make in a year. We think that if we file our tax return, report all of our income and pay our taxes, we are fine. But what if the CRA disagrees? What if the CRA accuses you of under-reporting your income? What if the CRA audits you and hits you with a massive reassessment that you believe is wrong. Do you assume that the CRA will believe you? Do you assume that you are protected by a presumption of innocence unless the CRA can prove otherwise?
If you do, you are wrong. There in no presumption of innocence in tax law unless you are accused of a criminal act such as tax evasion.
Income tax reassessments can be scary. They can be financially devastating. They can be emotionally draining, and in some cases, a large reassessment can wipe you out financially or force you into bankruptcy. In some cases, they can be worse than a criminal charge.
With so much at stake, you would think that there are processes in place to protect you. There are. You can object to the CRA, and if you aren’t successful, you can appeal to the Tax Court. But this appeal process can be slow and expensive and, in some cases, so unfair that it is easier just to pay than to go through the ordeal with the CRA. In my over 30 years in practice, I can safely say that many taxpayers will pay a tax reassessment even though they know it is incorrect rather than go through the process of fighting it.
Sometimes it is too small to fight it, so you just pay it even though you shouldn’t have to. Sometimes the auditor will threaten to audit other issues if you don’t agree to the reassessment. Sometimes you don’t have the means or ability to fight, and so it just goes to the CRA Collections unit.
And in some cases, the reassessment is so complicated that you don’t even know what you are alleged to have done wrong. The two worst areas that I see are: (1) Arbitrary or Net Worth Assessments, (2) Gross Negligence Penalties.
An Arbitrary or Net Worth Assessment is where the CRA reassesses you on what they think your income was. It’s a very powerful tool. I can certainly see situations where it needs to be used, such as if a person simply refuses to file a tax return, or if the person has unreported income from criminal activities. The Courts have acknowledged that extraordinary measures are needed in some circumstances but recognize that an Arbitrary or Net Worth Assessment should be a tool of last resort if there is no other way to determine a person’s income.
But I am seeing it used in too many situations where other normal audit techniques should be used. Effectively, a net worth assessment is a complicated process that estimates what your income should be based primarily on the bank deposits and withdrawals of you and your family members over a three- year period. Once you are reassessed, you are guilty unless you can prove that the CRA’s complicated spreadsheets have an error somewhere in them. These calculations are massively difficult to decipher, even for experienced accountants. There are no safeguards or guidelines for their preparation that I have seen.
I have helped people for over 30 years to prove that reassessments are incorrect. So I know that the CRA makes mistakes. Taxpayers make mistakes too. Usually a mistake can be fixed. But with an arbitrary or net worth assessment, the cost and effort required to fix the mistakes are usually well out of proportion in relation to the amount of the reassessment. Effectively, there is no fairness or due process. The process itself is part of the punishment.
The second area is Gross Negligence Penalties. These are penalties of 50% of the tax you owe. These usually arise when the CRA identifies that you have made a mistake. The CRA reassesses you to charge you the correct amount of tax and charges you interest. But the CRA also has the discretion to impose 50% gross negligence penalties on top of the tax and interest.
Note that gross negligence is not tax evasion. That is a criminal charge. Gross negligence penalties are a civil penalty if the CRA thinks you knew or “ought to have known” that your tax return was incorrect. I have seen the CRA increasingly impose or threaten to impose gross negligence penalties. Why is this? Is this a new source of revenue for the Government? Is it a way to get taxpayers to acquiesce to audit adjustments?
The Courts have said that the standard to impose gross negligence penalties is very high and should be imposed in the clearest of cases. But that is not my experience in reviewing tax audits.
Don’t rely on the Charter of Rights or the Taxpayers Bill of Rights to protect you if you are audited by the CRA. Get professional assistance and, if you can, be prepared to go to Court to be treated fairly and impartially.