From: AlanBaggett@volcanomail.com   
      
   Vern Krishna: Beware the Canada Revenue Agency net worth assessment : CRA SOTW   
      
   You really, really don't want to have a net worth assessment happen to you   
      
   The Canada Revenue Agency has an extraordinary power when it comes to   
   calculating the tax owed by people who fail to file a tax return or who   
   misrepresent their income in filings.   
      
   It’s called the “net worth” assessment, and you really don’t want to   
   have it happen to you.   
      
   Looking at the numbers, the vast majority of Canadians avoid net worth   
   assessments by voluntarily filing tax returns. One-third of the 27.5 million   
   tax returns Canadians submit each year are non-taxable and are filed to claim   
   tax benefits. The remaining    
   two-thirds pay about $196 billion in tax annually. Most taxpayers file their   
   returns without complications and the CRA assesses them quite quickly.   
      
   Sanctions   
   However, some taxpayers choose not to file their returns even when they have   
   taxable income, or misrepresent their income in their filings. The sanctions   
   for failing to file and filing false returns are severe, but different, for   
   the two groups.   
      
   Although taxpayers are required to voluntarily file their tax returns, the CRA   
   is not bound by the tax return or any information filed. The CRA may   
   “arbitrarily” assess the taxpayer using any appropriate method for   
   determining the tax payable by the    
   taxpayer.   
      
   This is where an arbitrary “net worth” assessment of tax payable enters   
   the mix.   
      
   When the taxpayer does not file a proper tax return, has insufficient records,   
   or provides inaccurate information in his return, the Minister of National   
   Revenue can issue a “net worth,” or arbitrary assessment of the tax   
   payable. The consequences of    
   a net worth assessment and any related penalties depend on the nature of the   
   taxpayer’s delinquencies in filing or non-filing.   
      
   A net worth assessment estimates a taxpayer’s income for a year by valuing   
   the appreciation in his or her wealth between two dates, then adjusting for   
   consumption.   
      
   For example, if the taxpayer had net assets of $100,000 on Jan. 1 and $400,000   
   of net assets on Dec. 31, the increase is $300,000. If the taxpayer consumed   
   $150,000 during that year, his or her income would increase to $450,000 for   
   the year. The    
   government typically overestimates the taxpayer’s income and leaves it to   
   the taxpayer to establish whether any of the receipts are from non-taxable   
   sources.   
      
   So, a net worth assessment is prone to errors. Inaccuracy is inherent in the   
   method of calculation. A net worth assessment is a blunt instrument at best   
   and the government is prone to maximize the taxpayer’s income.   
      
   Net worth   
   Flaws aside, a net worth assessment is valid and binding notwithstanding any   
   error, defect, or omission in the assessment. The CRA needs only to   
   demonstrate that the taxpayer’s net worth, adjusted for consumption,   
   increased in the taxation year. It is    
   not required to prove the taxpayer’s sources of income. Once the CRA   
   demonstrates a net increase in wealth, the taxpayer has the onus to separate   
   his or her taxable income from other various sources, such as, for example,   
   business income, capital gains,   
    or non-taxable sources receipts.   
      
   The explanation that taxpayers most often provide for undisclosed increases in   
   net worth is that they had windfall gambling gains, or received a substantial   
   bequest from a deceased elderly aunt in a distant land. The reason those   
   explanations purport to    
   support their claims is that gambling gains are usually not taxable to   
   amateurs, and gifts are never taxable.   
      
   Given the frequency of the “generosity of elderly aunts” explanation, the   
   CRA has a jaundiced view of such justifications, and will require   
   substantiating evidence in support of the assertions. Of course, it is usually   
   difficult to provide such    
   evidence because it is the very absence of adequate records that led to the   
   assessment in the first place.   
      
   Where the assessment is outside the normal assessment period of three years   
   for individuals, the onus is on the government to prove, on a balance of   
   probabilities, that the taxpayer made misrepresentations that were   
   attributable to neglect, carelessness    
   or willful default for the relevant year.   
      
   Deadlines   
   There is no assessment deadline if the taxpayer does not file a return and the   
   minister of national revenue has not produced an initial assessment. In a net   
   worth assessment, the clock begins to run from the date of the assessment.   
   However, the CRA says    
   that failure to file a return when tax is payable may be willful   
   misrepresentation that there is no tax payable, and, therefore, open to   
   indefinite assessment.   
      
   A special rule applies when a taxpayer does not report his or her disposition   
   of real or immovable property. In such a case, there is no limitation period.   
   The purpose of this recently enacted rule is to discourage taxpayers from not   
   declaring taxable    
   gains on speculative real estate flips.   
      
   The consequences are more severe where the taxpayer files a tax return, but   
   the government issues a net worth assessment because of the inadequacy of the   
   information filed. In these circumstances, the minister of national revenue   
   can also impose gross    
   negligence penalties, which will add an additional 50 per cent tax on the   
   undeclared income.   
      
   However, the penalty applies only to a misrepresentation in a return, and not   
   to the lack of filing of a return. The sanctions for failure to file and   
   filing false returns are anomalous. The Income Tax Act imposes a penalty for   
   misrepresenting a return,    
   but not for failing to file a return that falsely implies that there is no tax   
   payable for the year. The sin of omission is less severe than the sin of   
   commission.   
      
   The net worth assessment is an extraordinary power, but taxpayers can avoid it   
   by filing returns that tell the full story on their sources of income.   
      
   Vern.Krishna@TaxChambers.ca   
   Vern Krishna is a professor in the common law section of University of Ottawa   
   Law School and counsel with TaxChambers LLP in Toronto.   
      
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