What Is a CRA Net Worth Audit and How Do You Respond in Canada?

If the CRA has told you it is comparing your assets and spending to your declared income, it is using what is called a net worth audit. It can feel alarming because it looks at your whole lifestyle, not just one return.

This article explains how the method works, why it is used and how you can respond and challenge the result.

This article covers Canadian federal tax law, which applies in every province.

What the method does

The CRA calls net worth the most common method of indirect verification of income. It compares changes in assets, liabilities and personal spending against reported income, and can include the financial records of a spouse and household members.

Indirect methods are used where records may be unreliable, accounts are mixed, lifestyle does not match reported income, or a business consistently reports income lower than similar businesses in its sector.

An audit generally moves through stages: the auditor contacts you by mail or phone, examines records on site or at a CRA office, and the outcome is no change, a reassessment owing more tax, or a refund. The CRA gives no fixed audit length. Duration depends on the condition of the records, the scope of the audit, delays from missing records and consultation with other parts of the CRA, and good records and co-operation reduce the time.

An authorized person may inspect, audit or examine books, records and property, may enter premises where a business is carried on or records are kept, and may require the owner or person in charge to give all reasonable assistance and answer proper questions. An auditor may enter a dwelling-house without the occupant's consent only under a warrant, which a judge may issue on proof that entry is necessary and has been or is likely to be refused.

How the calculation works

Under the Audit Manual, net worth income for a period is the increase in net worth plus personal expenditures plus non-deductible losses, less non-taxable income. Any positive variance is treated as unreported income.

Non-taxable sources such as gifts or lottery winnings are part of the calculation. That is where you may be able to correct an estimate.

The Minister is not bound by a return or information supplied by or on behalf of a taxpayer and may assess tax payable even if the information was inaccurate. An assessment is deemed valid and binding despite any error, defect or omission, subject to being varied or vacated on objection or appeal.

How to challenge the estimate

• Document non-taxable sources, such as gifts or winnings, with bank records and written evidence, since they are part of the calculation.
• Check the opening and closing asset and liability figures for errors.
• Review the personal spending assumptions.
• Remember that records of a spouse and household members can be included, so confirm which figures relate to you.
• Provide records promptly, since missing records can cause delays.

If the CRA assesses after the normal period, on appeal the burden of establishing misrepresentation lies on the CRA. Once the right to reassess is established, the onus shifts to you on the amount. If a penalty under s. 163 is involved, the burden of establishing the facts justifying it is on the Minister.

Books and records must generally be kept for a minimum of six years, and computer-based records must be kept in an electronically readable format. A requirement for documents or information must stipulate a reasonable time for compliance in the notice. If a person does not comply, a judge can on summary application by the Minister order compliance, and refusing the order can be found to be contempt of court. That order is not available for information or documents protected by solicitor-client privilege.

Your options after a proposal or assessment

After an audit you have 30 days to agree or disagree with the written proposal, which is CRA practice rather than a statutory deadline. Before objecting formally you can contact the auditor and then the team leader.

For an objection, most individuals must serve it by the later of one year after the filing-due date and 90 days after the notice of assessment was sent. You may then appeal to the Tax Court of Canada within 90 days of the notice of confirmation or reassessment, or once 90 days pass with no decision.

You can avoid paying personal tax amounts in dispute until an impartial review, but interest still accrues and undisputed amounts must be paid.

There are also time limits on how far back the CRA can go. For individuals, the normal reassessment period ends three years after the earlier of the date of the original notice of assessment and the date of the original notification that no tax is payable. Mutual fund trusts and corporations other than Canadian-controlled private corporations have four years. After that, the CRA can reassess only if an exception applies, such as misrepresentation attributable to neglect, carelessness or wilful default, or fraud, in which case there is no fixed time limit. Even then, the reassessment is allowed only to the extent it can reasonably be regarded as relating to the matter that triggered the exception.

What to do next

Interest on unpaid tax runs at the prescribed rate for as long as it is outstanding, and rates are set quarterly. The CRA may also cancel or waive penalties and interest under its taxpayer relief provisions. How this applies depends on your situation, so it is worth confirming with a lawyer or accountant.

• Write down the years covered and the dates in every letter.
• Collect statements for all accounts, loans and major purchases.
• Gather proof of gifts, inheritances, loans or winnings.
• Keep copies of everything you provide.
• Speak with a lawyer or accountant before replying to a proposal, since the figures can be large and interest keeps accruing.

Frequently asked questions