No hiding behind inadequate records

A recently released judgment from the Tax Court of Canada testifies to the importance of good record-keeping and exemplifies a clever method that the Canada Revenue Agency (CRA) invokes when investigating taxpayers who hide behind inadequate records.

The case of Zhang v. The Queen, (2013) TCC 19, reviews the business activities of Wen Zhang. Zhang and his Chinese relatives live near Nanaimo, B.C., and in relative proximity to a good mineral source. Zhang, who was educated as an engineer and immigrated to Canada in 2001, thought a good source of income for his unemployed family members would be to sell minerals online. Since they were not computer savvy or fluent in English, Zhang helped them register for Ebay and PayPal accounts, as well as administer the business.  Zhang testified that he didn’t want to be compensated for his efforts, but his family members insisted and that they ultimately settled on a modest rate of remuneration of about 3%. The business did very well.  

From 2006 to 2008, Zhang also earned income from a consulting business operated by his brother and sister in China. The CRA began investigating when it became aware that Zhang had more than 40 bank accounts associated with the Ebay mineral business to which significant deposits were made.

As the CRA was not provided with any business records to verify the income that was reported by Zhang on his income tax returns for that period, it appeared there was some sort of tax avoidance. As a result, the CRA determined income by using the “application of funds” method. First, the CRA determined Zhang’s actual personal expenditures. These amounts were then reduced by known sources of funds, and the balance was assumed to be unreported income from the consulting business.

Justice J.M Woods struggled to find any accuracy in  Zhang's submissions. He stated at paragraph 20 that: “Mr. Zhang’s calculation does not add up to 3%. The calculation suggests that 97% of the funds were transferred to the brother and sister and 3% was split between the commission and the wire transfer fee to send the 97% to China. Nothing seems to add up.”

Zhang also offered strange explanations for his lack-lustre record keeping. He explained, at paragraph 21, that in two of the income tax returns he reported more than the amount earned in order to satisfy Canadian immigration officials that a visa should be issued to his parents-in-law. Obviously, the legal requirement to maintain financial information for taxation purposes has no relation to the administrative process of immigration.

In concluding remarks, Justice Woods stated: “The lack of contemporaneous documentation is a serious problem in this case because there is nothing to corroborate Mr. Zhang’s self-interested testimony. Taxpayers are required to keep satisfactory records so that their income can be verified.”

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.