What is a Net-Worth Assessment?
Canadian’s often think that the Canada Revenue Agency either has to accept the values they are provided with or have to prove their case if they want a different result. This belief is very far from the truth. The Canada Revenue Agency can make assumptions about your income and expenses that you, as the taxpayer, have to prove wrong. One situation where this power to make assumptions often comes up is when the CRA conducts a net-worth assessment.
Net-worth assessments or a net-worth audit is an extremely powerful tool that the Canada Revenue Agency can use when they don’t think that the taxpayer is truthful about their income or expenses. The effect of a net-worth audit is that the CRA can assess a taxpayer on an amount of unreported income, and therefore results in taxes owing, interest, and penalties. Combine this with the rule that an assessment is presumed to be correct, irrespective of errors in it, and you have a recipe for financial disaster. Once you are the victim of a net-worth assessment, it is up to you to prove the CRA wrong. This can be a very challenging and time-consuming task.
Obviously, the best way to avoid getting stuck in this tax-quagmire is to ensure that the CRA has no reason to think that you aren't truthful when filing your taxes, that you keep accurate and complete books and records, and that you are actually filing your taxes and are doing so on time. Not filing taxes on time or at all is the most common reason that the CRA resorts to a net-worth audit. Appearing to live beyond your means, for example on social-media (that the CRA monitors), can also lead to a net-worth assessment. But what can you do if the CRA has determined that you are going to be subject to net-worth audit?
The best defense is a good offense! By getting a professional involved before the auditor shows up, and having one present to assist and guide the auditor, increases the chances that the outcome will be as favorable to you as possible. Even if you end up being assessed for unreported income, the professional likely has made sure that the potential issues you have to challenge are greatly reduced, saving you a ton of money when objecting and appealing the assessment.
The CRA, during a net-worth audit, will look at changes in your assets and liabilities over the tax-year and also take into account your expenses. The total any increase in assets, plus any decrease in liabilities, plus non-deductible expenses for the year is assumed to be due to your income for the year. If this number differes from what you reported, you will be reassessed unreported income. Your representative will assist in this process by organizing the information, making sure that the tax effect of the changes is properly considered and interpreted, and that the final result represents a fair and accurate representation of taxable income. This takes experience and knowledge.
If you are reassessed for unreported income as a result of the net-worth audit, you have a fight ahead of you. You have to prove the taxman wrong or challenge the use of the net-worth assessment itself. Both of these methods are time-consuming and require detailed analysis. The taxpayer, in addition to proving the CRA’s assumptions and interpretations wrong, has to provide an explanation for the increase in net worth. There are valid non-taxable explanations, but there are also traps into which unwary taxpayer can fall.
If you are faced with a net-worth audit, or have been given a net-worth assessment, get the experts in your corner. Early involvement is best, but it’s never too late to get someone on your side.
NOTE: Faris CPA has successfully challenged and defended against many net-worth assessments. Articles are for general information only and do not constitute tax advice nor can they be relied upon.