Don’t know what you need to know about audits? Want to know your responsibilities? Want to know your rights?
Tax Dispute Process in Canada
Did you receive a Notice of Reassessment? Do you know how to read your notice?
Do you know how to prepare a Notice of Objection? What is the Tax Court of Canada procedure?
What are your penalties & interests? Have you heard about the Voluntary Disclosure Program?
Common Tax Dispute Issues
Voluntary Disclosure Program
Watch video from CRA
The Income Tax Act provides that a taxpayer may avail himself or herself of penalties for improperly reporting income if the taxpayer voluntarily discloses the error. The Act provides relief for penalties that arise from the error, but does not provide for relief of taxes from the error.
There are certain conditions that must be met for a voluntary disclosure to be accepted:
- The disclosure must be made voluntarily (before CRA takes action to require compliance);
- There must be penalties associated with the error;
- The error must be at least one year overdue; and
- The information provided must be complete (cannot be a partial disclosure).
The Income Tax Act only provides for relief from penalties for the period that is ten years before the filing of the application.
After a voluntary disclosure application is made, the taxpayer is expected to remain compliant. The CRA will not accept a voluntary disclosure from the same taxpayer for the same matter.
Directors’ Liability for Corporate Tax
Canadian tax legislation provides that directors may be liable for certain tax amounts that were unremitted by their corporation to tax authorities. It is worth noting that working with a tax professional can make a huge positive impact on getting the person off the hook for directors’ liability.
Circumstances of Directors’ Liability
Often, people are put at directors of a company by a simple mistake of the accountant or lawyer. In rare circumstances a spouse may be on the hook without their knowledge. For instance, a husband who is facing credit issues may list their wife as the director of the company. If the partners break up, and the husband stops paying the company’s taxes, the CRA will go after the wife.
De Facto Directors
The CRA may find individuals to be de facto directors and be liable as directors even when they are not officially registered as directors of a company. An individual will be considered a de facto director when that individual has responsibilities similar to a director and represents himself or herself as a director to others.
Due Diligence & Two-Year Limitation Period
The Income Tax Act and Excise Tax Act state that where a director exercised the “degree of care, diligence and skill that a reasonably prudent person would have in similar circumstances”, then the director will not be liable.
The CRA is required to commence an action under these provisions within two years of the date a person ceased to be a director. Further, it is recommended that directors avoid acting as de facto directors after resigning.
Income Tax Act & Excise Tax Act
The Income Tax Act provides for liability of directors in subsection 227.1(1) of the Act:
A director may be liable for the amount that ought to have been withheld on payments such as salary, wages, certain benefits, and payments out of certain plans, and payments to a non-resident that would be subject to withholding requirements.
Similarly, subsection 323(1) of the Excise Tax Act also provides for liability on directors:
Directors are liable for GST/HST collected by the company but not remitted, and net GST/HST refunds to which the company is not entitled.
SR&ED Tax Incentive Program
Read Special Article: SR&ED Tax Credit PART II – Did Your SR&ED Claims Get Denied? Here is What to Do.
Watch video from CRA
The Canadian Scientific Research and Experimental Development Tax Incentive Program (SR&ED) encourages research and development by offering support to businesses that conduct scientific research or experimental development in Canada. The SR&ED tax incentive program allows businesses to deduct SR&ED expenditures from their income and also provides SR&ED Investment Tax Credit (ITC) to reduce Part 1 tax.
Subsection 248(1) of the Income Tax Act (the “Act”) provides for the definition of SR&ED. In Northwest Hydraulic Consultants Ltd. v. Canada, the Tax Court of Canada interpreted the provisions of the Act and found a five step approach to determine if an activity is SR&ED:
- Was there a technical risk or uncertainty – an uncertainty that could not be removed by techniques, procedures and data that are generally accessible to competent professionals in the field?
- Was a hypothesis formulated for the purpose of reducing or eliminating that technological uncertainty?
- Were the procedures used consistent with established and objective principles of scientific method, including trained and systematic observation, measurement and experiment, and the formulation, testing and modification of hypotheses?
- Did the process result in a scientific or a technological advancement?
- Was there a detailed record of the hypotheses, tests and results kept as the work progresses.
The Canada Revenue Agency has since adopted the test provided for by the Tax Court.
There are further conditions for SR&ED credits even if the above test is satisfied. Other conditions include, but are not limited to: the expenditures must all or substantially all be for SR&ED, the activity must be performed in Canada, and the activity must not be for commercial production.
If there are concerns regarding the SR&ED being claimed that is not resolved with discussions with the SR&ED staff at the CRA, then you should ask for an Administrative Second Review so that the Assistant Director of the SR&ED program or a person assigned by the Assistant Director will reconsider your case.
If the decision is maintained after the Administrative Second Review, then a Notice of Assessment will be issued. If you disagree with the decision, then a Notice of Objection must be filed within 90 days.
  T.C.J. No. 340,  3 C.T.C. 2520 at para. 12
 SR&ED Policy Review Project December 12http://www.cra-arc.gc.ca/txcrdt/sred-rsde/clmng/srdplcyrvwprjctpdt-eng.html
Read Special Article: The Panama Papers: What are they and what do they mean for you?
You must report to the CRA through the form T1135 (Foreign Income Verification Statement) if you have at any time in the year foreign assets (“specified foreign property”) that amounts to more than C$100,000 (in adjusted cost base).
What constitutes a specified foreign property is defined in subsection 233.3(1) of the Income Tax Act:
“specified foreign property” of a person or partnership means any property of the person or the partnership that is
(a) funds or intangible property, or for civil law incorporeal property, situated, deposited or held outside Canada,
(b) tangible property, or for civil law corporeal property, situated outside Canada,
(c) a share of the capital stock of a non-resident corporation,
(d) an interest in a non-resident trust,
(e) an interest in a partnership that owns or holds specified foreign property,
(f) an interest in, or right with respect to, an entity that is non-resident,
(g) indebtedness owed by a non-resident person,
(h) an interest in, or for civil law a right in, or a right — under a contract in equity or otherwise either immediately or in the future and either absolutely or contingently — to, any property (other than any property owned by a corporation or trust that is not the person) that is specified foreign property, and
(i) property that, under the terms or conditions thereof or any agreement relating thereto, is convertible into, is exchangeable for or confers a right to acquire, property that is specified foreign property,
but does not include
(j) property that is used or held exclusively in the course of carrying on an active business of the person or partnership (determined as if the person or partnership were a corporation resident in Canada),
(k) a share of the capital stock or indebtedness of a non-resident corporation that is a foreign affiliate of the person or partnership for the purpose of section 233.4,
(l) an interest in, or indebtedness of, a non-resident trust that is a foreign affiliate of the person or partnership for the purpose of section 233.4,
(m) an interest in a non-resident trust that was not acquired for consideration by either the person or partnership or a person related to the person or partnership,
(n) an interest in a trust described in paragraph (a) or (b) of the definition “exempt trust” in subsection 233.2(1),
(o) an interest in a partnership that is a specified Canadian entity,
(o.1) a right with respect to, or indebtedness of, an authorized foreign bank that is issued by, and payable or otherwise enforceable at, a branch in Canada of the bank,
(p) personal-use property of the person or partnership, and
(q) an interest in, or for civil law a right in, or a right to acquire, a property that is described in any of paragraphs (j) to (p).
The Government of Canada is active in identifying and pursuing those who hide their assets outside of Canada. The taxpayers should be aware that not disclosing foreign assets could lead to legal consequences. Form T1135 should be filed if it is applicable to you. When in doubt, you should contact a tax professional for legal advice.
The dispute process with the CRA and the Tax Court of Canada can become complicated and could be costly if it is not prepared and carried out correctly. Our leading Tax Litigation Lawyers have extensive experience dealing with this matter and can help solve your tax issues.
Employee vs. Independent Cotnractor
There is an inherent conflict of interest between employers and the CRA. For an employer, classifying a worker as an independent contractor can minimize its obligations such as EI and CPP payroll contributions. On the other hand, CRA wants a worker to be classified as an employee since there is a higher chance that taxes will be paid since the employer will be required to make source deductions.
It is in the best interest of both the employer and workers to know how the classification works. This classification is determined based on not a single factor but many. Some of these factors are: the degree of control the employer has over its worker and whether the worker is provided with tools and equipment by the employer.
Taking the factors into consideration, you should review whether your worker does indeed fit into the classification that you want. If you have independent contractors, the CRA might assess you by classifying your worker as an employee. Click here for more information on Employee vs Independent Contractor.
Real Estate – House Flipping Tax Implications
With the increase in housing prices, people look for opportunities to flip houses. The plan is simple – buy an old house, fix it up, sell it for a profit, and then repeat. What fuels this activity is the assumption that because of the Principal Residence Exemption (PRE), you will not be subjected to tax when you sell that house. Another plan is to buy a house, sit on it until the price increases, and then to sell it for a profit.
But you need to be aware that the CRA is constantly on the lookout for these types of activity. There are three possible outcomes to flipping houses: (1) the proceeds are tax-free under the PRE and none of the proceeds are taxable; (2) the proceeds get taxed as capital gains and only 50% of the proceeds are taxable; or (3) the proceeds get taxed as business income and 100% of the proceeds are taxable.
There are different factors that are taken into consideration in determining what sort of tax treatment the proceeds of the sale will receive. Some of the factors include: the length of the period of ownership and the frequency of similar transactions made. The intention or motive at the time of acquisition of the house is important too. If you are contemplating a sale of your house but you are uncertain as to what sort of tax treatment it will receive, contact a tax professional for advice. Click here for more information on PRE.
Net-worth assessment is one of the methods used by the CRA to go after taxpayers. When an individual is targeted, the CRA assumes that the taxpayer has failed to disclose certain amounts on their reported income. It can start with the CRA requesting that you provide them with financial records such as bank and credit card statements.
Anyone can be targeted but obvious targets are individuals who drive luxury cars and live in expensive houses well beyond their means while not having the reported income to back them up. However, ordinary cash businesses (such as restaurants) and individuals who are owner-manager are often targeted as well.
Essentially, the CRA does an analysis of an individual’s net worth. They calculate and compare an individual’s net worth over a period of time while taking factors such as reasonable living expenses into consideration. Then, the CRA can reassess the taxpayer for the discrepancies in the net worth and the reported income.
Because the CRA does not have complete information, their assessment can be inaccurate. It is up to the taxpayer to show that the CRA has made an error in their calculation. Therefore, it is crucial and a good practice to maintain your financial records in an accessible and well-organized manner.
If you are having difficulty paying the tax debt, you may want to consider negotiating the payment terms with the CRA. For instance, if you can’t pay the entire balance owing, you might be able to enter into an agreement with the CRA to make smaller payment over time until you pay all the outstanding debt. Also, you may be able to obtain relief.
Ultimately, if you have taxes owing, the CRA can take actions to recover the debts. For example, the CRA can garnish your wages or put liens on your property just like other creditors. If you declare bankruptcy, your tax debts may be discharged subject to certain conditions such as you fulfilling your duties under the Bankruptcy and Insolvency Act. However, not all your tax debts might get automatically discharged upon bankruptcy.
You can’t declare bankruptcy to deal specifically with your tax debt only. If you declare bankruptcy to avoid paying the tax debt, the CRA may challenge your bankruptcy in court. As such, declaring bankruptcy should be used as a last resort.
The CRA can issue arbitrary assessments, also known as involuntary CRA tax assessment, if you have failed to file your tax returns on time. What this essentially means is that the CRA will file the tax returns for you based on their estimate of your income and issue you an assessment. The amount on that assessment will often be higher than if you had filed your tax returns on time, leaving you with a tax bill that is higher than originally anticipated.
If you have been arbitrarily assessed, you need to contact a tax professional right away. Also, to challenge the CRA’s assessment, it is crucial that you file the missing tax returns in a timely manner. If you fail to act in time, you are deemed to have agreed to the assessment amount and are required to pay the taxes that comes with it (Section 152(8) of the ITA).
False Statements or Omissions Penalty
There are many penalties that can be imposed on the taxpayer. One of the penalties that you should be aware of is the false statements or omissions penalty.
As the name suggests, the CRA under section 163(2) of the ITA can impose penalties on taxpayers for making false statements or omissions. There are two elements under which you can be given the penalty: (1) if you knowingly make false statements or omissions; or (2) if your actions amount to gross negligence with respect to false statements or omissions. Unlike other penalties where a taxpayer will be found liable for failure to act, the CRA must prove on the balance of probabilities that the taxpayer’s actions constituted one of the two elements. The penalty is the greater of either: $100 or 50% of the understated tax and/or overstated credits related to the false statement or omission.
Luckily, there are defences available to taxpayers. One of these defences is the reliance on professional advice. For example, if relied on your accountant and he/she made false statements or omissions, you might get off the hook. However, the CRA might still argue that you knew of what your accountant was doing or that you were grossly negligent in failing to notice the mistakes made by your accountant.
If you did or think you committed one of the two elements, you shouldn’t wait until the CRA founds out and comes after you. Under the Voluntary Disclosure Program, if you come clean on what you did before the CRA takes any audit actions against you, the penalties may be waived.
Click here to for more information on the CRA Voluntary Disclosure Program.
Taxpayer Relief Provisions
There are four categories under which the Minister may cancel or waive the penalty or interest. The CRA describes them in detail: extraordinary circumstances; actions of the Canada Revenue Agency; inability to pay or financial hardship; and other circumstances.
As the title suggests, relief is granted if there are situations beyond the taxpayer’s control such as natural disasters that prevented the taxpayer from filing on time or meeting his or her tax obligations.
Other examples include: emotional distress caused by death in the family, fire, and other accidents.
Actions of the Canada Revenue Agency
Sometimes, the CRA makes an error when providing information to the taxpayer or there are delays in processing your file such that those delays lead to the taxpayer not being informed of the amount he or she was owing. In situations like these, the CRA may cancel or waive the penalty or interest.
Another example is unreasonable delays in completing the audit process.
Inability to pay or financial hardship
Generally, the CRA does not grant relief under this category unless there are exceptional circumstances beyond just the inability to pay or financial hardship. The CRA considers many factors before granting such relief. For instance, the CRA may grant the taxpayer a relief if a payment of interest or penalty would prevent access to basic necessities such as food. As for a business, the CRA may grant a relief if a payment of interest or penalty to jeopardize the financial stability of the business leading to loss of employment for its employees.
Another example is financial hardship brought on by loss of employment.
In any case, taxpayers seeking a relief under this category should be prepared to provide the CRA with financial statements to show that they are experiencing financial hardship.
The CRA may grant relief for circumstances other than those described in the first three categories.
One of the perks of operating a business is the ability to deduct expenses associated with running the business. While not all expenses are deductible, there are some business expenses you may be able to deduct such as:
- Business start-up costs
- Legal, accounting, and other professional fees
- Meals and entertainment (up to a certain portion)
- Office expenses
- Salaries, wages, and benefits
In addition, you should know the difference between current and capital expenses. Generally, current expenses are 100% deductible whereas capital expenses are deductible up to the Capital Cost Allowance. Click here for more information on the difference between the two.
You should review what can be claimed as business expenses to avoid discrepancies in your tax returns which can be the subject of a review or an audit. Click here for more information on business expenses.