Net Worth Audits - How to Beat Them

As regular readers will know I worked for the CRA for many years in all different capacities of audit.  As a result I am able to tell you how you can respond when CRA come and do audits.  Specifically I want to address how to beat a Net Worth Audit.  Before we get too far I want to clarify my last statement.  I am talking about when the CRA make bad choices, inaccurate assumptions, or mistakes.  If you are deliberately cheating or screwing the system and get caught there is nothing I nor anyone else can do to help you.  In my last blog I mention that the CRA will use a net worth approach when you don’t have supporting documents.  They will also use it on individuals if they think that there is unreported income, regardless of how impeccable your records are.

I recently got a new client who had been the victim of a Net Worth audit.  He had done everything correctly, he was not cheating on his taxes.  Truth be told the CRA should not have done a full net worth.  The CRA should have done a “rough net worth” and then asked questions about the areas that they were concerned about.

In a Net Worth audit the CRA look at bank and credit card withdraws and charges respectively.  Basically they look at cash going out and assume that it is for personal expenditures.  They then assess on the outflows and tell you that since you spent the money you must have unreported income.  The problem is that quite often questions are not asked, and any circular flow of money is not traced.  For example, if you loan someone money and they repay it and then you spend it, it will get counted twice.  It gets counted as an expense when you loan it out, and again when you actually spend it after it is repaid.  Taking this to the extreme parents with children quite often loan money in and out on a regular basis, which means that the funds have the potential to be counted numerous times.  Add to that things like selling the child’s principle residence which is not taxable and you have a recipe for big problems.

How to beat the net worth

To beat the net worth you must attack using information to support the deposits you make to the bank account and the payments you make on your credit card(s).  By showing where the money came from you can prove the CRA assertions wrong and thereby refute the net worth, or at least a significant portion of it.

The more documents you can get the better.  You will need copies of cheques from your bank and potentially from your kids’ or friends, if you loaned them money.  You need to be able to show where the money went originally and prove that it was repaid, all of which will show that the funds the CRA is looking at are not taxable events.  Documents to support sales of assets, copies of land titles for properties sold to show ownership, copies of purchase documents and lawyers statements.  These are just some examples, as the documents needed will depend on the nature of the deposit.  Things like inheritances, and loans received also need to be documented with bank statements and cheques.

Don’t wait to start compiling the information.  Find out from the auditor what type of audit they are doing.  If they even mention the words net worth, you need to start looking at all the deposits into your accounts (transfers between accounts, transfers between spousal accounts, loans made or received, money received from non-taxable sources, etc.) so you can refresh your memory and look for items that could be problematic.

Above all else, get help.  Do not go up against the CRA yourself, and do not wait until they have completed the audit, as you will have only 30 days to try and get the documents you need to refute the CRA’s assumptions.  Have help from the start.  Talk to your accountant and find out if they have the time and know how to help.  If they don’t find someone who does to help with the audit.  You can still use your normal accountant afterword, but get the help you need for the audit.

Story Time

Brief story because I know you all like them.  I recently dealt with a net worth after the audit was complete.  I met with the team leader (whom I knew) and the auditor and told them that there were mistakes in their conclusions and the net worth.  They were not happy with my attitude and my assertions.  TFB (To F-ing Bad).  In the end I was right and they were wrong.  The assessment went from $70,000 down to $3,500.  The $3,500 was a legitimate adjustment which both the client and I agreed with.  I would call that a WIN (boooyahhhhh!!!!).

Now you can say what you want but if you cannot show the CRA that they are wrong, then by circumstance they are right.  It is unfair to be sure, but that is the way it is.  If we had not known what to do the client could have been on the hook for about $30,000 in taxes which were NOT true.  Life is not fair and taxes are definitely not fair.  Remember this and get the proper help so you don’t get SCREWED!!