POTENTIAL CRA AUDIT AREAS
We have been advised that the local office of CRA added an additional 550 people to assist in the audit function. We have heard that they are planning to look at Income Trusts, Flow Through Shares and that 12,000 – 15,000 assessments are expected.
It has also been indicated that there is software being promoted to the food industry which does not record billings properly and that CRA is about to implement a project directed specifically at this item.
The following are some of the items that CRA is currently targeting for audit and/or reassessment along with some of the other initiatives that CRA is currently undertaking:
- Self-Employed Taxpayers and the GST
- Payroll Deductions
- Employer Provided or Business Use Automobiles
- T-Slip Matching Program
- Corporate Tax Accounts
- Real Property Rentals and Capital Gains
- Offshore Investments
- Immigrants to Canada and Residency
- Tax Shelter Gifting/Donation Arrangements – UPDATED
- RRSP and RRIF Tax-Free Withdrawal Schemes
- Flow Through Shares
- Other
- General Comment
Self-Employed Taxpayers and the GST
GST — CRA is pursuing collection of GST from self-employed taxpayers. Self-employed individuals are reminded that they are not required to collect nor remit GST if their delivery of taxable supplies during the year is less than $30,000. If delivery of taxable supplies in a year is greater than $30,000 then the self-employed individual is required to register for GST and remit the tax to CRA. GST paid on business purchases (input tax credits) can also be claimed back by from CRA.
Self-employed individuals with less than $30,000 of taxable deliveries during the year can voluntarily register for the GST if desired. While requiring the "small supplier" to collect GST this also provides the benefit of being able to claim input tax credits on business purchases as well. The CRA publication "RC4022 (E) Rev 07 — General Information for GST/HST Registrants" available on the CRA website (www.cra.gc.ca) provides detailed information on the GST along with guidance as to whether an individual or business should register for the GST.
Management Fees — Some owner-managers or shareholders receive management fees from their incorporated businesses. Taxpayers are reminded that if they receive management fees from their incorporated business that they must charge and the corporation must pay GST to the taxpayer in respect of such fees. The taxpayer is then required to remit the GST collected to CRA. The requirement for the taxpayer to charge and the corporation to pay GST on management fees is applicable even if the management fees are for an amount less than $30,000. There have been instances where failure on the part of the taxpayer to collect and remit and the corporation to pay GST on management fees has resulted in the full amount of the management fee denied as a deduction to the corporation while still being taxed in the hands of the taxpayer (effectively double taxation, once at the corporate level and again in the hands of the taxpayer).
Payroll Deductions
Owner-managers or shareholders conducting their business through a corporation should be aware that there is a requirement to remit payroll deductions (CPP and income tax deductions) on owner-manager or shareholder remuneration to CRA on a monthly basis. Some such individuals draw funds out of their corporation(s) on a regular basis without making the requisite payroll remittances choosing to pay the full amount of personal tax and CPP upon filing of their personal tax return. CRA has taken the position that such regular draws out of the corporation are in fact salary/payroll and that the corporation is obligated to withhold CPP and income tax source deductions and remit them on a monthly basis, along with the corporations matching CPP contribution, to CRA. Failure to remit source deductions on a monthly basis can result in the application of penalties and/or interest to the amounts that should have been remitted to CRA. All owner-managers or shareholders conducting their business through a corporation should be set up on a regular payroll to ensure that the requirement to remit source deductions is met.
Self-employed individuals who report their business income and expenses on their personal tax returns may also be required to remit monthly or quarterly income tax installments to CRA. If such installments are requested from the taxpayer by CRA failure to remit the minimum installments can result in penalties and/or interest if income tax owing upon filing of the individual's personal tax return is greater than the minimum tax installments requested.
Employer Provided or Business Use Automobiles
Owner-managers, shareholders and individuals who have personal use of a corporate or employer owned automobile are reminded that CRA requires that automobile logs be kept to track the business and personal kilometers driven. This is necessary to assess the personal benefit that must be included in the taxpayer's personal income in respect of all personal kilometers driven (operating cost benefit). Failure to produce an up to date vehicle log to CRA, if requested, can result in complete denial of the business use portion of the automobile and full inclusion of the associated cost in the taxpayer's personal income as a benefit.
Taxpayers are reminded that they are also subject to a personal income inclusion (stand-by charge) in respect the cost (purchase price or lease payments) of the vehicle to the corporation or employer.
The income tax rules in respect of automobile benefits (operating benefits and stand-by charges) are very complex. Owner-managers, shareholders or employees who have a corporate or employer provided automobile should consult their professional tax advisor for advice in this area.
T-Slip Matching Program
CRA has a program to match the information provided to them by issuers of T-slips (T4s, T3s, T5s, T5013s etc) to the T-slip information reported to CRA by taxpayers on their personal tax returns to ensure that all income has been reported. Generally this is domne in the fall of each year. In a first case of an unreported T-slip amount by a taxpayer CRA will automatically adjust the taxpayer's personal income tax return. However, CRA may automatically impose a federal 10% penalty in respect of any unreported T-slip income in circumstances of a second case of an unreported amount in a three year period. Most provinces also have a corresponding 10% penalty thereby resulting in a 20% penalty for a second adjustment in a three year period. There is no minimum or maximum amount to which these penalties may be applied.Corporate Tax Accounts
Corporations are reminded that CRA is now holding back refunds until all outstanding amounts in all corporate tax accounts (tax, GST etc) for all prior years, if any, are cleared. To avoid CRA holding back refunds, particularly GST refunds, it is important that all tax filings be kept current.Real Property Rentals and Capital Gains
There have been significant investments by taxpayers in recent years in residential rental properties resulting in rental income/expenses being reported on personal tax returns along with capital gains associated with rental property sales. Taxpayers are reminded to ensure that they have in place and retain for their records all receipts and other supporting documentation in respect of rental property income, related expenses and property sale/purchase transactions in the event that CRA requests this documentation.Offshore Investments
Taxpayers are reminded that all foreign property owned at any time during a taxation year with a total cost of $100,000 (Canadian dollars) or more must be disclosed and reported on the taxpayers annual personal income tax return using Form T1135. CRA is applying penalties on the late or non-filing of these forms.Immigrants to Canada and Residency
Immigrants to Canada are reminded that Canadian income taxation is based on the concept of residency (i.e. job, family, dwelling place, personal property are located in Canada, among other factors). If a person is considered a resident of Canada in a given year, that person is subject to Canadian income tax for that year on all sources of income, regardless of where that income is earned (i.e. on worldwide income). Determining residency can be complex in some situations and taxpayers should consult professional legal or tax advice to determine their residency status if they are uncertain as to whether they are subject to Canadian income taxation.Tax Shelter Gifting/Donation Arrangements
CRA is auditing all (100%) gifting/donation arrangements. They have recently revoked a number of Registered Donation programs, including the Parklane Financial Group, Lacrosse Association, Wrestling Canada, Biathlon Canada, Little League Canada and the Canadian Wheelchair Basketball Association to name a few. In general, CRA is attacking all areas of aggressive tax planning – they may issue a refund however they are sending notifications that the return is being held for reassessment and accordingly the normal period for being statute bared no longer applies – they will return when the court cases are finalized and they have indicated that they will assess penalties and interest to the taxpayers. We have heard of CRA seizing bank accounts and personal residences is settlement of their assessments
Taxpayers must be aware that there has been changes to the Bankruptcy Act that have resulted in CRA having a unique status regarding any debts owing to CRA. Bankruptcy no longer protection for personal debts owed to CRA.
CRA now has a special website area – "Tax Alert" www.cra-arc.gc.ca/alert/ – here you fill find their notices on donations, underground economy, tax havens, mail scams and others. Here also is their "Listing of Canadian registered Charities". We suggest that all clients have a look at this website.
To date every audit completed to date has resulted in a reassessment of tax, plus interest (9% non-deductible) and in many cases the CRA has denied the gift completely. The CRA is assessing additional penalties, especially where an investor was audited and reassessed for previously participating in a gifting arrangement.
To date the CRA has reassessed over 65,000 taxpayers who participated in these schemes and denied approximately $2.5 billion in donations claimed. Audits of another 20,000 taxpayers involving $550 million in donation claims are nearing completion. Audits on other arrangements involving over 50,000 taxpayers are underway.
New tax shelter gifting schemes are currently being marketed that claim to be different from those for which the CRA has previously issued warnings. Taxpayers should avoid all schemes that promise donation receipts for more than the actual cash payment. CRA has taken the position that proposed legislation, effective since 2003, will apply to reduce the donation credit to no more than the actual cash payment.
Packages promoting these schemes sometimes include letters of commendation about the particular charity which can give the impression of endorsing the scheme itself. These letters should not be interpreted as providing any assurance that these schemes do what they claim to be doing or that the promised tax benefits are in accordance with the Income Tax Act.
This Taxpayer Alert further advises taxpayers that CRA generally has three years for the date of assessment to reassess taxpayers and that audits can take over a year to complete. The fact that investors have not been contacted and/or reassessed should not be interpreted as the CRA's acceptance of their claim.
If a taxpayer is considering investing in a tax shelter gifting arrangement it is very important that independent legal and tax advice be obtained prior to making the investment.
View the latest CRA Tax Alert on tax shelter gifting schemes here.
RRSP and RRIF Tax-Free Withdrawal Schemes
The CRA issued a Taxpayer Alert on November 29, 2007 entitled "Investing in schemes that promise you tax-free withdrawals from RRSPs and RRIFs could result in you losing your retirement savings".
The CRA is finding an increasing number of questionable RRSP and RRIF tax-free withdrawal schemes. The CRA is warning that investing in such schemes could result in the taxpayer losing their entire retirement savings to unscrupulous promoters and in a reassessment of tax returns.
To date, the CRA has reassessed over 3,100 taxpayers who participated in these schemes resulting in additional taxable income of approximately $144 million. Audits of another 1,800 taxpayers with $84 million in RRSP and RRIF investments are currently under way. Audits on other arrangements are scheduled to begin in the near future.
Taxpayers should avoid schemes that promise the following:
- Withdrawal of funds from an RRSP or RRIF without paying tax. Promoters often promise to return part of the taxpayer's investment by offshore debit or credit cards, offshore bank accounts or loan-back programs;
- Immediate access to assets in "locked-in" RRSPs or RRIFs;
- Income tax deductions of three or more times the amount invested in an RRSP;
- Unrealistic returns on investments.
Typically, promoters of these questionable schemes direct the owner of a self directed RRSP or RRIF to purchase a particular investment through a specific trustee. The particular investment could be shares in a company, units of participation in a co-operative, a mortgage or other types of investments.
Taxpayers should avoid these schemes for two reasons:
The full amount of any withdrawal or ineligible investment is included in the taxpayer's income in the year the investment was made or the withdrawal occurred. This means that taxes are assessed on these amounts as well as any applicable interest. Penalties may also be levied for amounts not reported. Taxpayers should keep in mind that if a RRSP is used as security for a loan, the value of the RRSP has to be added to the taxpayers taxable income. Similarly, if an RRSP is used to purchase shares of a private corporation and the shares are not a "qualified investment" under the rules, then the value of the shares will be added to the RRSP holder's taxable income.
These arrangements can put the taxpayer's retirement savings at risk. In some cases the promoter walks away with all the funds and cannot be found. Many Canadians have lost their entire retirement savings to unscrupulous promoters by participating in such arrangements. There is a high potential for fraud in respect of these types of schemes.
Taxpayers should also be aware that these schemes are actively promoted to look legitimate and professional. Various promotional methods are used including the internet, local newspaper advertisements and promotional meetings. Promoters also often provide opinion letters from professionals that give the impression that the letter writer endorses the scheme. These letters should not be interpreted as providing any assurance that these schemes do what they claim to be doing or that the promised tax benefits are in accordance with the Income Tax Act.
If a taxpayer is considering investing in one of these types of arrangements it is very important that independent legal and tax advice be obtained prior to making the investment.
Flow Through Shares
CRA has been reassessing tax deductions available to taxpayers through investment in flow through shares. One of the main reasons for the tax deductions being disallowed is that the issuer of the flow through shares have not incurred the expenditures claimed. Taxpayers are reminded to carry out thorough due diligence before investing in flow through shares to satisfy themselves that tax losses associated with flow through shares will be deductible.Other
Areas for which CRA is frequently requesting supporting documentation and receipts are as follows:
- Moving expenses — In addition to supporting documentation and receipts CRA is frequently asking for written confirmation (i.e. from the taxpayer's employer) as to any portion of moving expenses that were reimbursed to the taxpayer or paid for by the employer;
- Additional deductions – examples: foreign pensions exempt under a tax treaty, foreign support payments, foreign capital gains exempt from Canadian tax, employment with a prescribed international organization, adult basic education tuition assistance;
- Infirm dependents 18 years of age and older;
- Medical expenses — Receipts and supporting documentation are frequently requested;
- Other deductions – examples: legal expenses to appeal a tax assessment or collect support payments, repayments of shareholder loans, split income, etc.;
- Support payments and separation agreements — CRA is frequently asking for copies of the written separation agreements and other documentation (sometimes on an annual basis) as well as cheque copies to evidence that support payments have actually been made and to whom;
- Student loan interest;
- Education amounts (for part-time students).
If you will be claiming any of these types of deductions on your personal income tax return there is a high likelihood that you will be asked to send your supporting documentation and receipts to CRA, likely at some time subsequent to your receiving your Notice of Assessment