Subsection 152(7) of the Income Tax Act and subsection 299(1) of the Excise Tax Act both state that the Canada Revenue Agency (CRA) is not bound by the information provided by any person. This means that if taxpayers provide their books and records to an auditor, and that auditor determines they are unreliable, the auditor can perform a net worth assessment instead of a regular audit.
Typically, net worth assessments are used by the CRA when a taxpayer is found to have significant assets, cash, property, etc., which the taxpayer could not have purchased based on his or her reported income.
Essentially, the taxpayer’s lifestyle does not match his or her reported income.
An auditor will add up all assets (cash, value of property owned, and living expenses) of the taxpayer. If the taxpayer cannot provide amounts for living expenses, the auditor will typically use Statistics Canada figures.
The auditor will then add up all liabilities (loans, lines of credit, etc.) of the taxpayer, which are then deducted from the assets to come to an amount. This new amount is now the net worth of the taxpayer.
If the net worth of the taxpayer for any year under audit is greater than his or her reported income, the difference is charged as unreported income and gross negligence penalties are typically applied as well. This is known as the net worth assessment.
Problems with Net Worth Assessments
When the CRA conducts a net worth assessment, they ignore the taxpayer’s books and records in their entirety. This creates an issue because overzealous auditors looking to find unreported income may perform net worth audits instead of regular audits even though the books and records are in good order.
Typically, auditors will not be able to locate all of a taxpayer’s living expenses. They will then go and use Statistics Canada numbers, but they do not understand that all Canadians are different. Simply because a majority of families of four spend a certain amount of money, does not mean it would be the same for the family of four being audited.
Auditors will complete a bank deposit analysis, and anything without proper documentation is counted as income. This means your birthday presents, cash from your grandparents, all that is counted as income.
Another issue is the dreaded “Other” column. When auditors go through taxpayer’s expenses, they are separated into columns such as food, shelter, clothing, etc. When an auditor does not know what category to place an amount, it is put in the “Other” column. It can be extremely difficult for taxpayers to justify these “Other” expenses.
The only truly effective way of disputing a net worth assessment is a complete reconstruction of a taxpayer’s income for a year.
If you are going through an audit, or have been issued a net worth assessment, please give us a call today to see how we can help!
Siddiqi v. The Queen, 2001 CanLii 688 – Correctness of Net Worth Assessments
Seto v. The Queen, 2007 TCC 489 – Net Worth Assessments and Gross Negligence Penalties
Martin v. The Queen, 1999 CanLii 526 – Challenging Net Worth Assessments
Naguib v. Canada, 2004 FCA 40 – Beyond the Normal Reassessment Period
Guibord v. Canada, 2011 FCA 344 – Gambling and Net Worth Assessments
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.