Personal Investor: 3 golden rules for tax season
It’s tax filing season and while the average Canadian may have already filed their seemingly simple tax returns, anyone is bait for a review by the Canadian Revenue Agency (CRA), according to some experts.
“There’s no way to prevent a review or audit. It’s more a function of how your tax return looks and the size,” said Lorn Kutner, chief taxation officer at Northwood Family Office in Toronto. “So if you’re driving a Maserati and you’re reporting $75,000 on your return, that won’t jive.”
But how does the tax man look out for things that don’t add up?
“People boast about things they’ve done, whether it’s an offshore account or taking vacation while writing it off as a business expense,” said Kutner. Whether it’s a jealous neighbour or scorned lover, he says there’s always a chance that someone will rat you out using the CRA Informant Program, or “snitch line.”
While it’s one way a “net worth audit” can be triggered, Stevan Novoselac, Canadian leader of Gowling WLG’s tax resolution team, points to how the CRA now has a more robust infrastructure to crack down on tax avoidance schemes involving big and small fish alike. “It’s moved away from a random approach to a more risk-based one,” he said.
In the latest federal budget, Ottawa proposed to invest an additional $150.8 million over the next five years towards hiring more auditors and creating a new data quality examination team. The government estimates these initiatives will help bring in $369 million in additional tax revenue.
Novoselac, who has serviced clients in tax disputes with the CRA for over 25 years, identifies the following as red flags that can put you on the tax authority’s radar for an audit:
- Having an offshore investment account: As a result of expanding their audit manpower since 2015, the CRA says there are more than 1,100 offshore audits currently underway that have resulted in 50 criminal investigations.
- Earning large amounts of income in a TFSA: Having a balance that well exceeds the current cumulative contribution room of $63,500 can indicate hidden gains from prohibited investments or activities like day trading securities, which are subject to an “advantage tax” of 100 per cent of the gain.
- “Buy-low-donate-high” charitable donations: This can involve anything including art, medicine, time shares, wine and more, whereby one colludes with a dealer to buy these items relatively cheap, and then makes a donation for a tax receipt from a registered charity at the higher market value.
- Reporting income that’s not consistent with lifestyle: The CRA launched a Postal Code Project in 2017 whereby high-priced real estate in five regions of the country were used as an indicator of wealthy individuals. Novoselac even says that whenever he’s retained by a client, “I Google search addresses.”
- Repeat non-compliance: If you’ve been subject to an audit one year or are missing returns, you can be perceived to be hiding an aggressive tax structure.
While most individuals are rarely audited unless they’re self-employed, here are some line items that are “almost always” checked by the CRA as part of a review, according to Kutner:
- Line 232 (other deductions): Includes specific legal fees incurred.
- Lines 230 and 220 (support payments, alimony): Separation or divorce papers and proof of payment is required. “It’s a total waste of time but they do check,” said Kutner.
- Line 330 and 331 (medical expenses): This is one Kutner calls unfair and causes undue hardship especially for the elderly. “It may take them months to gather medical bills, but then the accountant is going to charge a fee,” he said.
- Line 229 (employee expenses): This pertains to employees with company cars, for example. “This is an easy win for the CRA because if you don’t have a log, they will 100 per cent deny your claim,” said Kutner.
Items that require having to provide proof year after year, like child care expenses for example, may be an annoyance but it’s not unusual in this age of e-filing. Kutner recalls one client who had to provide evidence of $5,000 in tuition credits claimed on behalf of his son. This was despite the client paying more than $3 million in taxes that year.
Vivian Leung, senior tax principal with CPA Canada says it’s in the CRA’s capacity to conduct random reviews of line items that require filers to provide additional information by mail or electronically by a given time frame. Leung advises filers keep documents for at least six years.
An audit however is a formal process that involves a deeper dive of your tax return which starts off with a phone call or mail specifying a date, time and location of the audit.
The national body that represents professional accountants works with the CRA to advise on tax policy changes. A current example is the Northern Residents Deduction whereby those who live in a prescribed zone can qualify for a tax deduction. “It’s strange that you have to verify your address every year,” says Leung. “We work with the CRA on these types of complaints.”
She agrees that while the CRA is improving processing efficiencies, the tax agency should be shifting resources to combat earners of a growing sharing economy like Uber drivers and Airbnb landlords. “Technically, you’re self-employed,” she said.
If the tax man comes calling, Kutner advises people provide yes or no answers. “It’s like you’re on the witness stand,” he said. “Don’t give additional information that may push them to question other areas they weren’t previously looking at.”
Kutner also recommends individuals seek out professional advice if they’re ever audited. “The first line of defence is to develop rapport with the auditor,” he said.
One of his clients, for example, received a large inheritance from his parents that was challenged by the CRA. After six months of reviewing bank statements, wire transfers and wills, the client finally got off the hook.
“It was the first time I had an auditor apologize,” he said.
Cathy Miyagi is a segment producer with BNN Bloomberg, and is also a chartered professional accountant (CPA, CMA).