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Canadian Tax Practitioner’s Guide to Net Worth Assessments – Halls V The Queen, 2022 TCC 14

Introduction: Net worth assessments

David J Rotfleisch, CPA, JD is the founding tax attorney of Taxpage.com and Rotfleisch & Samulovitch PC, a Toronto-based business tax law firm.

Net worth assessments may be performed by the tax auditor when the Canada Revenue Agency (CRA) deems a taxpayer’s return to be inaccurate or when the taxpayer has not kept adequate records of their income for one or more years. Subsection 152(7) of the Canadian Act income tax law provides that the CRA is not bound by any information or statement submitted by or on behalf of a taxpayer when assessing the taxpayer’s tax payable under Part I of the Income Tax Act. Simply put, a net worth valuation is an estimate of the taxpayer’s income, which involves comparing the taxpayer’s net worth (i.e. the taxpayer’s assets minus the taxpayer’s liabilities) at the beginning of tax audit period with the net worth of the taxpayer at the end of the tax audit period. The resulting difference, less reported income, is presumed to be the taxpayer’s unreported income, unless otherwise rebutted by the taxpayer.

Like a net worth assessment is a rough estimate of a taxpayer’s income for a given year, it is not surprising that many tax cases have been brought to court by Canadian tax litigation lawyers to challenge the results and accuracy of a net worth assessment. On February 9, 2022, the Tax Court of Canada rendered a decision, Halls c. The Queen, 2022 TCC 14, on whether the CRA was justified in applying the net worth test to assess the income of a taxpayer who operated a restaurant business.

Facts of Halls c. The Queen, 2022 ICC 14

To understand the decision rendered by the Tax Court, we will review the facts of this case.

Ms Halls ran a restaurant with her common-law husband, Mr Liske, called Roadster’s Smoking Gun Barbecue (“Roadster’s”), which opened on March 10, 2010. Despite their best efforts, they were unable to keep the restaurant open. afloat. Therefore, at the end of August 2014, they closed the restaurant. During Roadster’s years of operation, Ms. Halls has consistently reported net business losses. From 2011 to 2014, it declared a loss of $71,087, $26,227, $20,324 and $56,810 for each respective year. The CRA initially assessed Ms. Halls for the 2008, 2011, 2012, 2013 and 2014 tax years. However, Ms. Halls then requested that the CRA reassess for the 2008 tax year applying the non-capital losses carried back from the 2010 and 2011 taxation years.

After the reassessment, Ms. Halls’ returns were selected for review by the tax audit division of the CRA. The CRA decided to review his returns using a net worth assessment for the following reasons: restaurants tend to operate in cash, business losses regularly reported by Roadster, accounting records of the restaurant were not properly maintained and Ms. Hall’s personal financial records were not separated from business records. Moreover, Ms Hall’s reported income was not enough to fund her and Mr Liske’s lifestyle, even though they both lived relatively modestly.

As a result of the net worth assessment, the CRA reassessed Ms. Halls: (i) disallowing the non-capital loss carryback from 2011 to 2008, (ii) including unreported income for the 2011 to 2013 tax years, (iii) disallowing non-capital losses against capital losses for the 2014 tax year, and (iv) the imposition of penalties for negligence serious for the 2011 to 2013 taxation years. Ms. Halls then objected to the reassessment. The CRA upheld its 2008 reassessment, but reduced its unreported income for the 2011 to 2013 tax years, allowed non-capital losses to be carried forward from 2011 and 2012 to 2014, and reversed gross negligence penalties for the 2011 to 2013 tax years. Dissatisfied with the CRA’s decision, Ms. Halls’ experienced Canadian tax litigation lawyer then appealed the decision to the Tax Court .

The Tax Court ruling on the CRA’s use of the net worth method

To determine whether the CRA’s use of the net worth test was appropriate in the taxpayer’s circumstances, Justice Masse, writing for the Tax Court, turned to the relevant case law for guidance on the nature of net worth assessments and the circumstances that may warrant the use of a net worth assessment.

Case law provides that the net worth method is generally a method of last resort, used when all other methods have failed. Since net worth valuations, such as deposit analysis, are alternative valuations that are inherently inaccurate, these alternative valuation methods are used in special circumstances, namely when a taxpayer has not produced of income tax returns, filed manifestly insufficient returns or failed to keep adequate records. to support the filing request or the elements declared in the declarations filed.

After reviewing all of the evidence, Justice Masse concluded that the net worth method was properly used by the CRA to determine Ms. Hall’s income for the years in question. Judge Masse explained that Ms. Halls did not keep adequate or complete records. Ms Halls also combined her personal finances with her business finances. During Roadster’s years of operation, the restaurant reported losses, except for a modest amount in 2013, and the amounts Ms Halls received from her other sources of income were not enough to cover the recorded losses. Finally, since Ms. Halls did not keep adequate records, it was difficult to determine whether she tax liability under the iincome tax law.

After concluding that a net worth assessment was an appropriate method, Justice Masse went on to explain that the burden of proof is on the taxpayer, not the CRA, to show that the reassessment is incorrect. Referring to a previous case, Truong v R, 2017 TCC 22, Justice Masse reiterated the three ways a taxpayer can challenge a net worth assessment: (i) challenge the necessity of the method or the method chosen at trial; (ii) dispute specific aspects of amount, method or inclusions; and/or (iii) provide evidence regarding sources of non-taxable income received by the taxpayer.

With respect to Ms. Hall’s case, Justice Masse found that she had not sufficiently demonstrated that the CRA’s use of the net worth assessment was incorrect. First, since her personal and professional records were not well kept, she did not sufficiently demonstrate that the method was not necessary. Second, she did not raise any type of credible challenge to the method used by the auditor. Third, she did not challenge specific aspects of the net worth assessment; rather, she challenged the methodology on a general basis.

In his case, the specific aspects regarding the net worth assessment were all addressed at the objection stage by the appeals officer. The appeals officer also adjusted the disputed amounts based on additional information provided by Ms. Halls. Fourth, Ms. Halls did not identify any significant sources of non-taxable income that should have been excluded from the net worth test. For these reasons, Justice Masse found that the CRA’s use of the net worth method was justifiable and that Ms. Halls had failed to demonstrate the inaccuracy of the assumptions and conclusions of the ARC.

Pro tax advice: Net worth assessments are questionable

The affair of Halls v The Queen, 2022 TCC 14 points out that a net worth assessment may be appropriate in circumstances where the taxpayer has not kept proper records to adequately discern the taxpayer’s income. Because the net worth method is not an accurate tool, taxpayers can challenge the use of the method in a number of ways, including dismissing the need for the method to estimate the taxpayer’s income, providing evidence that the auditor’s conclusions drawn from the information on which he relied are not persuasive or that non-taxable sources of income were mistakenly included in the valuation.

Also, if you have already been audited under the net worth method, received a notice of reassessment, and still have a significant amount of unreported income that was not captured by the audit , to avoid incurring future penalties and interest, a voluntary disclosure application may be an appropriate option to consider.

FAQs

What is a Net Worth Assessment?

A net worth assessment is one of many tax audit tools used to discern a taxpayer’s income for one or more years. A net worth assessment estimates a taxpayer’s income by comparing the taxpayer’s net worth (assets minus liabilities) at the beginning of the tax audit period with the taxpayer’s net worth at the end of the tax audit period. Essentially, a net worth assessment works backwards from the change in the taxpayer’s overall financial situation for the year to determine the taxpayer’s income for that year.

How do I dispute a net worth assessment?

A net worth assessment can be challenged in three main ways: challenge the necessity of the method or the method chosen in the first place; (ii) dispute specific aspects of amount, method or inclusions; and/or (iii) provide evidence regarding sources of non-taxable income received by the taxpayer.

David J Rotfleisch, CPA, JD is the founding tax attorney of Taxpage.com and Rotfleisch & Samulovitch PC, a Toronto-based business tax law firm and is a Certified Tax Specialist who completed CICA’s in-depth tax planning. Classes. He appears regularly in print, on radio and television and on blogs extensively.

With over 30 years of experience as a lawyer and chartered professional accountant, he has assisted start-ups, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning. , testamentary and succession, voluntary disclosures and taxation. dispute resolution, including tax audit representation and tax litigation. Vto visit www.taxpage.com and email David at [email protected] Read it original article at TaxLawCanada.com. Photo David Rotfleisch courtesy Rotfleisch & Samulovitch PC

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