Audits and investigations by Canada Revenue Agency

Posted on By Louise Polcaro
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The CRA is the federal agency that administers tax laws for most provinces and territories, as well as the Canadian government. The Canadian tax system is based on self-assessment, which means that every corporation and every taxable individual, estate or trust is mandated by law to file an annual income tax return. In order to maintain the self-assessment tax system, the CRA performs detailed and continuous inspections. Such reviews range from “processing reviews” of a single item or line in the tax return, matching of slips filed with CRA to the tax return, to tax audits of one or several amounts of income or expense.

CRA’s reasons for auditing a taxpayer

  1. Screening Process: CRA performs computer review of filed returns. Tax returns are sorted by various categories, considering unusual items, CRA’s prior experience with certain income or expense items, or industries, and the risk evaluated by CRA of potential tax loss. This review generates lists of returns for potential audit selection. Specific files are chosen for audit regionally. This is the most common method for selecting files to audit.
  2. Audit Projects: The compliance of a particular group of taxpayers is tested. If the test results suggest that there is significant non-compliance within that group, its members may be audited on a project basis.
  3. Leads: Information from other files, audits, investigations or outside sources may lead to a file being selected for audit.
  4. Secondary Files: A file may be selected for auditing because of its connection to another file that was also selected for audit.

Technically, everyone and anyone can be audited. Practically speaking, however, CRA narrows in on certain categories of taxpayers, who raise red flags in the tax system. Some of these categories of taxpayers include:

  • Self-employed individuals
  • Businesses which are heavily cash-based, such as construction or restaurants
  • Individuals who own offshore assets

CRA Tax Audit

When a tax return is assigned for audit, the auditor will review the return or income/ expense items and request the taxpayer to provide supporting information for examination, such as:

  • Business records (such as invoices, receipts, contracts, and bank statements);
  • Personal records (such as bank statements, mortgage documents, and credit card statements); and
  • The personal or business records of other individuals or entities not being audited (such as a spouse or family members).

During an audit, the auditor will identify issues with the tax return and discuss them with the taxpayer. There are two potential outcomes from the audit process:

  • No reassessment: If the auditor determines that the original or previous assessment was correct, nothing further is required. The taxpayer will be notified by letter and the audit will be closed.
  • Reassessment: If the auditor determines that the tax return requires reassessment (meaning that more taxes must be paid or that the taxpayer is entitled to a refund), the taxpayer will receive a proposal letter outlining the reasons for reassessment. Typically, the taxpayer is given 30 days to advise whether they agree or disagree with the proposed reassessment. If no response is given, CRA will reassess according to their proposal.

When the audit is complete, a final letter and any reassessment will be sent to the taxpayer.

CRA investigation

Unlike a tax audit, a tax investigation is a deeper review where the CRA looks for evidence to criminally prosecute an individual. In a criminal investigation, the Crown must prove beyond a reasonable doubt that the taxpayer intentionally violated Canadian tax laws. If convicted, a tax payer may be required to pay court fines and/or face imprisonment.

CRA’s Criminal Investigations Program (“CIP”) investigates substantial cases of tax evasion, and where appropriate, refers cases for criminal prosecution. Tax evasion is a criminal offence that involves deliberately ignoring the law to evade paying taxes. CIP is designed to focus on the most serious of cases. Those convicted of tax evasion can face court fines ranging from 50% to 200% of the taxes evaded, and up to five years in prison.

When dealing with the CRA…

Tip #1: Seek Professional Advice Immediately

Seek an advisor who specializes in dealing with the type of audit or investigation you are facing. It is important to have your tax advisor attend any meetings you may have with CRA. As noted above, your ability to dispute or object to CRA’s findings is often only available for a limited amount of time. Depending on the circumstances you may be required to act within 30 – 90 days. Notifying your advisor of the CRA correspondence immediately will ensure your advisor can help you meet these deadlines or obtain extensions from the CRA where available.

Tip #2: Answer Questions

If being investigated, answer what you have been asked truthfully. It is generally preferable, however, to ensure answers are limited to what is asked rather than providing additional information that may broaden the investigation.

Tip #3: Cooperate

If the CRA asks you to send a certain document, send it. Ensure that your records and supporting documents are organized and easily accessible.

For further information, or assistance with tax disputes, please contact a TEP.

I made a Mistake on my Tax Return. What do I do?

Posted on By Louise Polcaro
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Mistakes happen, even on tax returns!

If you’ve filed your tax return timely, you can request the Canada Revenue Agency (CRA) to amend and reassess the return to include the income omitted or deductions missed. The request should be made in writing to the CRA.

For circumstances where the omission or mistake would result in a penalty, a voluntary disclosure program (VDP) may be used. The VDP offers taxpayers a chance to correct errors on a previously filed tax return, or to file a return which should have been filed but was not.

The VDP provides two streams, one for income tax disclosures and one for GST matters. Tax professionals should always be contacted first when using the VDP.

1. Income Tax Stream

Income tax applications to the VDP are processed under “two tracks”: (1) the general program and (2) the limited program. Each case is assessed individually as to which track will apply.

General program

This program provides relief to taxpayers who intend to correct unintentional errors. If an application is accepted into this program, the taxpayer will not be subject to any penalties, nor referred for criminal prosecution. The taxpayer may also be granted partial relief of interest for assessment for a certain number of years.

Limited Program

This program limits the relief available for taxpayers who intentionally avoided their obligation to pay taxes. If a taxpayer is accepted to this program, they will not be referred for criminal prosecution, or charged gross negligence penalties, but may be charged other penalties as applicable. No interest relief will be provided.

CRA considers the following factors in determining acceptance into the limited program:

  • Efforts were made to avoid detection through the use of offshore vehicles
  • The dollar amounts involved
  • The number of years of non-compliance
  • The sophistication of the taxpayer

The existence of one or more factors does not automatically make the taxpayer ineligible or eligible for the limited program.

2.GST/HST stream

Registrants and other taxpayers required to report GST/HST apply to this stream of the VDP. This program provides taxpayers the opportunity to voluntarily correct inaccurate or incomplete GST/HST information, or disclose any information that should have been reported initially but was not.

Applications under this stream of the VDP are processed under three categories: (1) the wash transactions program, where one party may have reported and another has not; (2) the general program; and (3) the limited program, similar to the income tax limited program.. The determination of which category the application will be processed is based on a case-by-case assessment.

Executors and Powers of Attorney

If you are acting under a Power of Attorney or as an executor and notice that taxes have not been reported properly, you can apply on behalf of the grantor or deceased to the CRA’s VDP.

For further information, or assistance with voluntary disclosure, please contact a TEP.

How is an estate taxed?

Posted on By admin
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Canada does not have an estate tax. However, capital gains and income taxes are generally triggered by death.

An executor must file the deceased’s final income tax return for the year in which they died and pay any tax owed up until the date of death (including taxes on any deemed disposition of assets, see below). This final return is called a “terminal return”.

An executor may also need to file an estate income tax return for each taxation year of administration to report income earned and capital gains and capital losses realized while the deceased’s affairs are being administered (i.e., until assets are distributed to beneficiaries).

Prior to distributing assets, the executor may request that the Canada Revenue Agency (CRA) issue a “clearance certificate”, which certifies that all taxes of the deceased for have been paid.

In addition, some provinces and territories also have additional taxes in the form of probate fees, sometimes referred to as Estate Administration Tax, Probate Tax, or Probate Charges.

Is a clearance certificate required from CRA?

It is important that the executor pays any final tax owed prior to distributing anything from the estate. An executor can be held personally liable for any outstanding taxes of the deceased if a clearance certificate is not obtained prior to distribution of assets. Accordingly, it is generally prudent to seek a clearance certificate from the CRA (though it should be noted that processing times for the clearance certificate can be quite long).

In some cases, executors may make interim distributions when:

  • The assets are sufficient to do so;
  • There is enough certainty with respect to the potential tax; and
  • The executor has obtained indemnities or releases from the beneficiaries.

What is a “deemed disposition” and why does it matter?

When someone dies, CRA treats any capital property owned at the time of death as though they were sold on the day the person died. For example, if the deceased owns stock, it would be presumed for income tax purposes that the stock was sold the day the person died. Any accrued gains (or losses) would be taxed accordingly.

Deemed dispositions of property may trigger additional capital gains tax to be included in the terminal tax return.

What is a Qualifying Spousal or Common-Law Partner Trust (QST)?

The creation of a QST allows the payment of capital gains tax to be deferred until both spouses or common-law partners are deceased.

A QST allows spouses to provide for the surviving spouse or common-law partner during their lifetime and then have any remaining assets transfer to their own chosen beneficiaries (e.g., children from a first marriage). The surviving spouse or common-law partner must be entitled to the QST’s annual income and can (but need not) be able to access the assets of the QST during their lifetime.

Detailed estate taxation planning – including setting up a QST should be undertaken with the assistance of a licensed professional such as a TEP.

How is an estate taxed?

A deceased’s estate is treated as a trust for tax purposes and a T3 trust tax return must be filed to report any taxable income earned during estate administration.

For the first 36 months from the date of death, the estate may qualify as a graduated rate estate (GRE). Qualification as a GRE may have significant tax advantages, including the ability to access graduated tax rates, certain exemptions, special tax rules regarding losses realized in the first tax year and flexible charitable donation claims.

What happens when property is distributed from an estate?

A deceased’s assets can be given directly to a beneficiary or as discussed below, put into a trust for their benefit.

Generally speaking, assets can be given to a beneficiary without triggering any further capital gains tax on any increases in value. Instead, the beneficiary will pay tax when they actually dispose (or are deemed to dispose) of the property.

What is a testamentary trust, and how is it taxed?

Generally, a testamentary trust is any trust that arises on death due to the operation of a Will.

A testamentary trust creates a legal relationship between the deceased person, the trustee and the beneficiaries. The trustee is often the executor, but can be a separate person named in the Will. The beneficiaries are the family members or other persons specified in the Will. The trustee is responsible for payments to the beneficiaries based on the terms specified in the Will. Beneficiaries can have a fixed interest or discretion may be given to the trustee to make allocations amongst the beneficiaries.

Since 2016 all ongoing trusts created under a Will (except qualified disability trusts) are subject to tax at the highest marginal tax rate for individuals. If the trust’s income is paid out to a beneficiary it will be taxed in their hands at their rates which may be lower than the trust’s tax rate. The trust must file an income tax return for each calendar year reporting its income earned and prepare a T3 reporting slip for any allocations made to its beneficiaries.

Why use individual trusts for my children?

If gifts are made to an adult child using a trust instead of being made directly, the adult child may be able to split the income of the trust with their own children. Depending on the number of grandchildren and their age, and the amount of income being produced in the trust, this could offer significant tax savings. For more information on the benefits of individual trusts, speak with a TEP.

Does this mean beneficiaries pay no tax for inheritances?

In most cases, inheritances are received after-tax and the beneficiary acquires the property at a cost equal to the deceased’s deemed disposition value. For instance, if a beneficiary is left a house, they will pay no tax on receiving that property. Once the house is in their hands, they will be liable for standard taxes such as property tax and income tax if the house is sold for a profit and was not their principal residence.

Note that some jurisdictions outside Canada tax beneficiaries by way of an inheritance tax. As such, it is possible that a foreign beneficiary will be subject an inheritance tax while the Canadian estate is subject to capital gains tax on the deemed disposition of the deceased’s assets. A TEP should be consulted for advice on how different tax systems will impact estate planning for foreign beneficiaries.

What are Probate Fees / Estate Administration Tax?

Probate fees (known in some provinces as probate tax, probate charges, or estate administration tax) are fees or taxes charged in relation to obtaining a grant of probate (or Certificate of Appointment in Ontario). The name of the fee/tax and amount of tax charged varies from province to province and territory to territory.

Are there any exemptions from Probate Fees?

The list of items and estates eligible for exclusion from probate fees varies from province to province. Estate planning can be undertaken in certain provinces to minimize probate fees through the use of Multiple Wills. For more information on probate exclusions and rates, please refer to the “What is Probate?” and “Probate by Province” sections of this website.

For further information or assistance in administering an estate, please consult a TEP.

Do I need to declare my cryptocurrency to CRA?

Posted on By Joanna Pegum
Attending to paperwork

Yes. Digital currencies, including cryptocurrencies, are subject to taxation under ordinary income tax rules. Gains and losses from buying and selling cryptocurrencies must be reported as part of income when filing a tax return. Since cryptocurrencies are not government-issued currency, they are treated by the Canada Revenue Agency (“CRA”) as a commodity.

Depending on the extent of the trading activities, the transactions may be characterized as being on account of income or capital. Generally, if an individual is in the business of trading cryptocurrency, any gains or losses will be treated as being on account of income. If an individual is not engaged in the business of trading cryptocurrency, any gains or losses will be treated as being on account of capital.

Using cryptocurrency to pay for goods or services is viewed as a barter transaction and is subject to the barter rules of the Income Tax Act. The monetary value or equivalent of the cryptocurrency is counted as the amount of the payment, or receipt, and the transaction is reportable for tax purposes.

Trading cryptocurrency for another type of cryptocurrency

Generally, when you trade one type of cryptocurrency for another type of cryptocurrency, CRA believes that the barter transactions rules will apply to that transaction. For example, if a taxpayer converted Bitcoin to Ethereum, CRA would consider this a disposition for tax purposes. This disposition for tax purposes must be reported on your income tax return as either business income (or loss) or a capital gain (or loss) depending on your specific circumstances.

How much tax will I pay on my cryptocurrency?

If transactions are characterized as being on account of income, the net income will be taxed at an individual’s marginal income tax rate. If transactions are characterized as being on account of capital, 50% of the realized capital gains will be taxed at an individual’s marginal rate.

If I gift my cryptocurrency, am I liable to tax?

When any item is donated or gifted for a value different than its acquisition cost, CRA will treat the donation or gift as a disposition of property. Accordingly, this applies to a gift or donation of cryptocurrency. The cryptocurrency will be valued at fair market value at the time of donation, and any capital gain or loss from the disposition must be reported. If the gift is made to a qualified donee (such as a registered charity), it may be possible to receive a tax receipt from that donee. The amount of the gift for tax purposes will be determined by the fair market value of the cryptocurrency at the time of the transfer.

How will CRA know about my profits?

Not reporting income from cryptocurrency transactions is illegal. In order to ensure a fair tax system, the CRA actively pursues non-compliance with respect to reporting income from cryptocurrency trading. Cryptocurrency exchanges increasingly require personal information in order to set up an account. CRA may be able to access this information and verify it with other sources to identify individuals who seek to avoid paying taxes on transactions.

What if I have made a loss?

Individuals in the business of trading cryptocurrency can deduct losses when computing income from a business. Losses that occur as a result of theft are likely deductible if they can be considered an inherent risk in carrying on the business and if the loss is reasonably incidental to the normal income-earning activities of the business.

How is cryptocurrency mining treated by the CRA?

Mining cryptocurrency involves solving complex computer problems in exchange for an award of cryptocurrency. This type of computer problem requires high processing power, often resulting in high electricity costs. The CRA has suggested personal mining may be treated as a non-taxable hobby or personal activity, whereas mining for commercial or business purposes should be reported as income. The electricity costs reasonably attributable to the cryptocurrency business may be deducted as business income.

What if I fail to declare any taxable profits?

It may be possible to correct a declaration made to CRA by pursuing a voluntary disclosure or by filing an amended return. Consult a licensed professional in order to ensure that these steps are taken appropriately and without risk of further penalty.

For further information, or assistance with tax planning, please contact a TEP.

Why is CRA investigating my deceased relative’s tax affairs?

Posted on By Louise Polcaro
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When a loved one dies, and you are named executor of the will, or you are assisting the executor with their duties, you may deal with the process of estate administration, filing tax returns and distributing all or portions of the estate. At what can be a stressful time, it may be difficult to find that the Canada Revenue Agency (CRA) is reviewing your deceased loved one’s affairs.

CRA may start an investigation for different reasons, including screening processes, audit projects, and information from connected files that have been selected for auditing. If a CRA auditor notices problematic information on your deceased relative’s tax return, such as inconsistences with information provided, that return may be selected for review or audit. If selected, the auditor will consider several types of records, including previously filed tax returns, business records, and personal records. Accordingly, it is important to keep well-organized records of your deceased relative’s tax information, business records, and personal records in the event of an audit.

I found a mistake on my deceased relative’s tax return. What do I do?

If you are acting under a Power of Attorney or as an executor and notice that taxes have not been reported properly, you may be entitled to apply to the Voluntary Disclosure Program (“VDP”).

The VDP offers taxpayers, dead or alive, a chance to correct errors on a tax return they had previously filed, or to file a return they should have filed, but did not. Voluntarily disclosing mistakes or newly found assets of your deceased relative may avoid some penalties that CRA would otherwise impose. For more information on the VDP, see Voluntary Disclosures Program – Introduction.

Updating CRA with any newly obtained information is important. An estate trustee can be held personally liable for any outstanding taxes on assets of the estate if assets are distributed prior to obtaining a clearance certificate from CRA. However, clearance certificates are issued on the assumption that information provided by the applicant is accurate and up-to-date. If new information comes to light, it should be disclosed to the CRA.

If you are uncertain whether you should enter the VDP and disclose newly found information to the CRA, it is possible to commence anonymous preliminary discussions with a CRA official to gain insight into the program and better understand the risk and benefits. Such discussions are meant to be informal and non-binding and can occur without disclosing the taxpayer’s identity. It is imperative to contact a tax professional before deciding how to proceed with the VDP.

How long after death can CRA reassess my relative’s affairs?

CRA can reassess tax returns for individuals for up to three years from the date of the original Notice of Assessment. After this date, returns may only be reassessed if the taxpayer made careless or neglectful misrepresentations to CRA.

For further information, or assistance with voluntary disclosure, please contact a tax professional.