Introduction: The Net-Worth Method of Assessment
One of the most fundamental rules of the Income Tax Act is that taxpayers who operate a business are required to keep books and records with sufficient detail that the Canada Revenue Agency ("CRA") tax auditors can audit and confirm the amounts reported. When taxpayers fail to do so, the CRA is in the enviable position of being legally permitted to make assumptions about the taxpayer's income and assess in accordance with those assumptions. Though there are many methodologies available to the CRA, the most difficult to deal with for a taxpayer is the net-worth method, which is in its effect both punitive and impossible to rebut without experienced tax professionals.
The most recent case of note to deal with the net-worth audit methodology was handed down by the Tax Court of Canada in Gurpal Saini v. Her Majesty the Queen ("Saini"). While the taxpayer was unsuccessful, the Tax Court helpfully provided a new summary of the defences and arguments available to taxpayers who wish to challenge the net-worth assessment in the Tax Court of Canada.
Saini: The Facts and History of the Appeal
The facts in Saini are not entirely novel. In broad strokes, the Appellant entered into an agreement with some business associates to purchase a gas station and corporation from them and intended on operating this business. He hired an employee and continued to work as a mortgage broker with some of the same people that he purchased the station from. He reported little to no income during these years until the gas-station was closed and went out of business, but the balance sheets consistently showed an increase in the due to shareholder account, meaning that the corporation was racking up debt to its shareholder. He also claimed little to no income from his other work as a mortgage broker.
When the CRA audited they were unable to determine what, if any accounting had been done for the business, and the taxpayer and corporation's books and records were essentially non-existent. The CRA issued requirements for information under the Tax Act for the banking and credit card statements and calculated the taxpayer's increase to his personal net-worth using those documents. The amounts in excess of his reported income were assessed as unreported income to both the corporation and the shareholder/taxpayer and gross-negligence penalties were assessed on top of the tax liability. The taxpayer appealed to the Tax Court of Canada to have these assessments reversed.
The Tax Court of Canada Dismisses the Appeal
At hearing, the Tax Court of Canada determined that there was little to no evidence of the Appellant's business and that the CRA was within its rights to assess the Appellant using the net-worth method. Justice Bocock also helpfully summarized the defences/arguments available to those who challenge the net-worth method of assessment. Justice Bocock summarized these as follows:
- The taxpayer may challenge the need for a net-worth assessment;
- The methodology used by the CRA can be challenged itself; and
- The taxpayer may challenge the quantum of the assessment based on prima facie errors, what Justice Bocock calls "Patent Errors".
Justice Bocock was also quick to point out that any evidence to support these above claims must come from the Appellant because of the nature of the self-assessment system and the CRA's right to make assumptions when reassessing a taxpayer.
In Saini, the Court thus held that because the Appellant was not able to lead any evidence to rebut the assessments, the CRA's tax assessments must stand. The Court was clear that simply arguing against the methodology is not enough; a taxpayer must also present evidence to support why the CRA's method was incorrect, and provide a proper method for the Courts to surmise what the Appellant's income actually was. In the absence of this evidence a taxpayer has no chance of winning their appeal.
Tax Tips: Taxpayers Need Professionals with Experience in Net-Worth Audits
The pitfalls of the net-worth method for taxpayers who do not pick the right tax professionals to represent them are many. As the net-worth methodology is generally used only in the worst cases, most tax professionals in Canada have no experience with attempting to rebut them. If there is to be any hope of success, taxpayers need to consult tax experts with extensive experience not only in the methodology but in the proper litigation of such tax assessments.
Our firm of experienced Canadian tax lawyers has decades of experience working with clients that have been assessed using the net-worth method. We also work with partner professionals and we have developed a proprietary methodology for overturning the net-worth assessment at audit, objection and Tax Court. If you receive a net-worth proposal or assessment from the CRA, your first call should be to our certified specialist in taxation lawyer for tax assistance with lowering these amounts as far as possible.