Filling the Gap - CFA Society Toronto

Filling the Gap

May 20, 2020

PROTECT YOURSELF

Recently, the Canada Revenue Agency (CRA) completed a tax gap analysis on personal income tax and harmonized sales tax (HST). A “tax gap” is a term to describe taxes that should have been collected by the government but haven’t for various reasons (e.g., the underground economy). A tax gap analysis looks at the size of the economy and its tax rates to calculate the amount of tax the government should—theoretically—have collected.

Some tax practitioners suspect that the CRA decided to do this because it was getting pressure from the government. Many countries, including the U.S. and the U.K., have completed this type of analysis with results fairly comparable to those of Canada (though different methodologies and assumptions make international comparisons somewhat difficult).

Based on the CRA’s current analysis, personal income tax is estimated to have a tax gap of $8.7 billion; HST, a gap of $15 billion. But the CRA is not finished; it intends to study other components of the tax system, and its next analysis, on international tax, is expected to be completed in 2018. And, as a direct result of the personal income tax and HST analysis, the federal revenue minister has invested $1 billion to hire more tax auditors to narrow the tax gaps.

PERSONAL INCOME TAX

Based on my observations as a practising tax accountant, here are a few areas the CRA has targeted for personal income tax. The CRA’s objectives are better compliance and revenue generation. In fact, the CRA uses these two criteria to select the specific files it audits. While personal tax returns generally deal with smaller amounts than corporate returns, many of these personal tax returns are often considered “easy targets” for CRA auditors. And, because there’s a lower number of taxpayers represented by tax accountants, taxpayers generally have fewer resources and less knowledge to defend themselves or to formulate effective strategies to deal with the CRA.

By the same logic, it’s less often that personal tax return taxpayers have to file a Notice of Objection or bring their case to the Tax Court of Canada. But the CRA’s threshold for individual taxpayers is lower than for larger taxpayers: for example, while employees claiming home office expenses amounting to 30% of their employment can generally expect a CRA audit, corporate taxpayers claiming the same expenses with the same percentage might be overlooked.

TAX CREDITS OR DEDUCTIONS	CRA CONCERNS
CHARITABLE DONATIONS	Are the donations made to legitimate charitable organizations? Are the amounts in donations reasonable, given the taxpayer’s level of income?
FOREIGN TAX CREDITS	What type of foreign tax has been paid and to which country? Is there sufficient supporting documentation?
CHILD CARE EXPENSES	Which spouse can claim the deductions? Are the expenses eligible for child care deductions as per the Income Tax Act?
MEDICAL EXPENSES	Are the expenses considered eligible medical expenses defined legally? Is the amount in medical expenses reasonable, given the taxpayer’s circumstances?
EMPLOYMENT EXPENSES	Are the expenses claimed allowed to be claimed as employment expenses for the particular employee? (Ordinary employees and commissioned employees are governed by different Income Tax Act provisions.) Can the employee claim employment expenses? Has the employer signed the T2200 form?
MOVING EXPENSES	Are the expenses claimed considered to be eligible moving expenses? Can the taxpayer claim moving expenses?

HST

Most businesses are required to collect HST on behalf of the government. (And, remember, they collect HST on behalf of the government—not themselves.) The HST money they collect belongs to the government, and if the businesses don’t remit the taxes, they’re stealing (a criminal offence!) from a trust account.

In the past, it was rare for the CRA to charge a business criminally for not remitting HST—except in the case of larger amounts. However, the situation has changed—at least since 2017. Tax auditors routinely consider charging a business (or, more appropriately, its directors or officers) criminally, and the number of actual criminal charges has increased rapidly.

Compliance has been a significant issue in this area of the tax system. Fraudulent HST refund claims have been frequent, and businesses have also failed to file and remit HST, as well as failing to register for HST in the first place. And, the amounts involved are generally larger than those of personal tax returns. As a result, the number of HST audits has increased significantly (much more than personal tax returns, I believe personally) and all HST refund claims are now scrutinized more closely. Based on my own tax practice, 90% of HST refund claims over $1,000 result in a full audit, or at least in an information request.

So, if you’re a business, take the following advice:

Ensure your business is required to charge HST. While financial services are HST exempt, the term financial services is defined differently from its everyday meaning.
Find out who in your business will be criminally responsible—directors, officers?
Deal with your HST issues promptly and, preferably, with the assistance of an experienced tax accountant.
Don’t wait until your file has been sent to the collections department. It’s easier to negotiate with a tax auditor.
Don’t wait until someone in your business has been criminally charged.

With the CRA’s higher level of scrutiny, individuals and businesses should take steps to avoid time-consuming, stressful, and costly CRA audits. Be proactive and take preventive measures.

Date May 20, 2020

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