When assessing a taxpayer’s income, the CRA has an often-overlooked auditing power that allows it to consider a taxpayer’s net worth at specific points in time and use it to calculate the taxpayer’s unreported income. This is called a ‘net-worth assessment’. This alternative audit methodology is often employed when the CRA finds that the books and records of the taxpayer are either incomplete or unreliable—and can result in assessments on undeclared income and unremitted GST/HST!
A recent case from the Tax Court of Canada (“TCC”) dealt with this issue. In Bordonaro v The Queen (2019 TCC 130), the court considered an appeal by the titular Alessandro Bordonaro of his net worth assessment which added nearly $150,000 to his income between the 2008 and 2010 taxation years. In his income tax returns, Mr. Bordonaro reported income of only $4,859, $13,864, and $7,459 for the 2008, 2009, and 2010 taxation years. These numbers were problematic because they were out of step with Mr. Bordonaro’s lifestyle, which included two Scotiabank accounts, a tax-free savings account, seven vehicles, a residence in Laval, and a rental property in Montreal. In fact, Mr. Bordonaro’s reported income did not cover even half of the municipal taxes payable on his residence!
At trial, CRA’s auditor explained that Mr. Bordonaro was uncooperative with tax authorities during the assessment process. When Mr. Bordonaro was asked for details of his finances for the years in question, he sent them only a copy of his divorce judgment, a partially completed survey showing the details of his personal expenditures, and some financial information about his rental income.
This led the CRA to apply the net-worth methodology to determine Mr. Bordonaro’s income. The methodology works by calculating the taxpayer’s change in net worth over the course of a year and adding that to the taxpayer’s expenditures for the year, less non-taxable receipts, and accretions to existing assets. The difference between the number calculated and the taxpayer’s reported income for is then assumed to be the amount of unreported income for that year.
However, this method has problems. The TCC noted that “it is at best an unsatisfactory method, arbitrary and inaccurate”. Despite this, the TCC continues, “sometimes it is the only means of approximating the income of a taxpayer” (Biganyan v The Queen (1999 CanLii 86 (TCC)).
Ultimately the TCC concluded that Mr. Bordonaro’s testimony was neither reliable nor credible, and that he could not explain the discrepancy between his reported income and transactions his lifestyle supported, like a $55,000 payment towards a mortgage.
Mr. Bordonaro’s case was further skewered by the fact that he admitted during his divorce proceedings that he had undeclared income.
In the end, the TCC was satisfied that Mr. Bordonaro had earned unreported income during the assessed tax years and that the CRA’s calculation of the unreported income using the net-worth method was reasonable – and dismissed his appeal.
Taxpayers who find themselves subject to a net-worth assessment have a couple options to dispute the findings of the CRA. According to the TCC in Biganyan, the best method is to put forth evidence of what the taxpayer’s income is. However, since the net-worth method is typically deployed as a last resort when few taxpayer records exist, this solution is usually not practical. The other method is to demonstrate that the net-worth assessment calculation itself was wrong and that a more accurate number should prevail.
Taxpayers subject to a net-worth assessment might also suffer additional consequences if they operate a commercial business as a source of income. In those cases, the CRA will assume that the business made unreported taxable supplies (which contributed to the taxpayer’s undeclared income) and assess the business for unremitted GST/HST—further compounding the bill!
The takeaway point is that GST and income tax assessments can be issued for unreported sales/income, wherever the taxpayer’s lifestyle is not supported by his or her “reported” income.
Do you require assistance in this area? Please contact us by clicking here.