How to defend against a Net-Worth Assessment

CRA has applied a net-worth assessment against your client, who now comes to you for help . . . and they are emotional and scared. What do you do first?

Your professional, calm and confident process for taking control of the matter immediately will take care of the emotion. Next, you will need to understand what has happened and receive all the working papers that CRA has used to justify the assessment. This will allow you to determine if you are, in fact, looking at a Net-Worth Assessment or an Arbitrary Assessment.

What’s the Difference?

Arbitrary Assessments are usually used for individual tax returns where there has been a prolonged failure to file. In many cases this involves T4 and other slips that are already available to CRA. Under an arbitrary assessment CRA will basically process the return with the information they have, including all income, either known or assumed, and send out the tax bill.

While this is an assessment and subject to all the same limitations, the purpose is to get the taxpayer to file the returns. A T1-ADJ is not required to correct the assessment; simply file the returns to have them re-assessed correctly.

Unlike the Arbitrary Assessment, a Net-Worth Assessment is the real thing, which will require you and the taxpayer to roll up your sleeves, because your work is cut out for you!

Last week’s article – “A CRA Net-Worth Reassessment – Now What?” –  outlined the basis of CRA net-worth assessments, the general working papers that would be used and their overall purpose to arrive at the assessment. So now let’s have a look at how to defend against the net-worth assessment.

The net-worth assessment is based on a combination of known transactions and assumptions. Unless you can show that the taxpayer is living beyond their visible means from another source, (e.g., lottery winnings, inheritances, trusts) you will need to show that the methodology and procedures utilized by CRA are arbitrary and/or flawed, and have no basis in fact. In other words, CRA assumes your client is guilty—and it’s your job to help them prove that they are innocent.

Net Worth Statement - Because the net-worth statement is a running balance of assets, liabilities and equity, it is imperative that the opening statement be as accurate as possible. Items to check include:

• Are all assets and liabilities entered correctly?
• Is there documentation to support liabilities that existed prior to the audit period?
• Is the math correct?
• Are items included in the subsequent audit years that should or should not be included?
• Are any assets joint ownership?

The objective is two-fold:

1. Ensure that all liabilities (and, therefore, the lowest equity position) are accounted for and documented on the opening statement.
2. Ensure that subsequent transactions that affect net worth are included where required.

Next time, we’ll discuss the financial withdrawal analysis. Getting caught in a Net-Worth Assessment is a potentially huge eroder of time and money. Have a critical conversation with your client: Help them make this project a priority with you.