A CRA Net-Worth-Reassessment – Now What?

Canada’s tax system is based on self-assessment, but CRA has substantial powers and latitude to assess and reassess those returns as it sees fit, leaving the onus to prove otherwise with the taxpayer.

This is a particularly prevalent power in a Net-Worth Audit, as legislation within the Income Tax Act (ITA) gives CRA the ability to conduct and assess taxes payable based on net-worth.

ITA S.152(7) - Assessment not dependent on return or information — The Minister is not bound by a return or information supplied by or on behalf of a taxpayer and,
in making an assessment, may, notwithstanding a return or information so supplied or if no return has been filed, assess the tax payable under this Part.

A net-worth assessment is actually used in a relatively small minority of cases involving the assessment of a taxpayer’s obligations; however, it is a powerful tool within CRA’s arsenal.  There may be many reasons why CRA would assess based on net worth (inadequate records, income reported inconsistent with standard of living) but the bottom line is that it is the taxpayer's responsibility to prove the assessment wrong – not CRA’s responsibility to prove it correct.

The Net-Worth Reassessment

CRA conducts a net worth assessment or reassessment by following a theory and pre-determined outline to arrive at the amount of income that they believe is justified.  In order to do this, four separate sets of working papers are developed:

Net-Worth Statement – The working papers begin with a net-worth statement - based on known facts at the year-end immediately before the audit period.  Like all net worth statements, it consists of assets, liabilities and net equity as of the year-end.  Therefore, on an audit of a two year period, the net-worth statement will consist of net worth as of December 31st 20X1, 20X2 and 20X3 with X2 and X3 being the audit periods.

Withdrawal Analysis – This set of working papers examines and lists every withdrawal, regardless of the type of withdrawal, from every bank account, credit card or line of credit available to the taxpayer.  Withdrawals that can be identified as business related expenses or payments to credit cards and lines of credit are identified and eliminated from the assessment.  If the withdrawal cannot be identified, it is considered personal use.

Deposit Analysis – This set of working papers works exactly the same as the withdrawal analysis, but is designed to identify source of deposits.  If the source of the funds cannot be traced and identified, it is treated as unreported income.

Summary and Adjustments – Takes all this information and summarizes the totals to arrive at income per a net-worth assessment.  The measurement between funds withdrawn and deemed personal use is added to the annual increase in net worth to arrive at unreported income.

Needless to say this can be a very high number being added to income and, because gross negligence penalties are applied, it drives the balance owing to CRA even higher.

Next week we’ll take a look at how to defend a net-worth reassessment under objection.