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What happens if I get audited?

Posted by admin on December 2, 2008 in Taxes

I am never sure if there is some devilish intent in the tax-collectors in Canada and the U.S. having the name “revenue” in their department. If nothing else, it shows you what the true role of these departments are- they are the revenue makers for the government. As general tax revenues decrease in down-times, guess what the revenue departments are doing?

Yes, finding ways to maximize revenue by combing through our tax returns and denying deductions. Basically, expect a lot more questions in the future about your tax returns if you have been an aggressive deducter of expenses. If you are being asked questions, or go into a full blown audit, are there things you need to know? Of course.

First, let me be clear. Tax avoidance and tax evasion are two different concepts. Tax avoidance is using LEGAL means to reduce your taxes. Tax evasion is breaking the law. No one, especially me, supports tax evasion and this post is not a means to evade taxes. It is used as an informational piece to give you some sense of the process. This is a process piece not a substantive piece. As usual, this is not advice but information only. Please seek qualified professional help if you are subject of an audit.

Why am I being audited?

This is usually the first question asked. Generally, one of two things has happens: (i) someone ratted on you; (ii) your tax return had something extremely unusual in it. For example, your deductions are unusually large or your taxable income shows a blip from previous returns which is not easily explainable. If you are in a small business, large petty cash entries are usually a red flag (and justifiably so) or the business shows a loss year over year for a long period of time.

People spend a lot of time and energy wondering why this happened or who ratted on them. You know what? It is what it is. You are on the radar and you might as well spend your energy on productive efforts and not trying to track down your enemies (because the tax department will not tell you why the investigation began).

What is the general process?

This is for Canada only:

1. Tax return is vetted through pre-assessment screening.
2. CRA may ask a taxpayer for additional information such as receipts.
3. At the end of pre-assessment, if CRA has picked up something, it issues a Notice of Re-assessment indicating there are adjustments in the taxpayer’s return and what they are. There is a right of appeal.
4. CRA also has the power, as a follow-up to a Notice of Re-Assessment to audit the taxpayer by written notice requesting more information. This is a full-blown audit.
5. Upon receipt and review of information, CRA can either: (i) indicate no changes will be made to the taxpayer’s Notice of Re-Assessment or (ii) send a Proposal to Reassess which indicates that CRA are proposing to reassess the taxpayer for X dollars plus interest and penalities (its the interest and penalities that get a taxpayer).
6. If a taxpayer receive a Proposal to Reassess, there is a 90 day window to file a Notice of Objection which is an appeal to CRA’s position.
7. A Notice of Objection is considered by the Appeals Office of CRA and that decision can be further appealed to the Tax Court of Canada. In practicality, most audit cases are settled between when a Notice of Objection is filed and going to the Tax Court.

If a taxpayer missed something in its tax return (a chartiable receipt is missing or the math is wrong), the process typically stops at #3 with a Notice of Re-assessment indicating what the tax return should have been since this is more of a clerical issue than a substantive issue.

Who do I go to?

A qualified lawyer who has dealing with the tax collection departments. Why? Lawyers have duties of confidentiality to their clients. This means they cannot reveal any information a client says or writes to a lawyer unless compelled by the Court or under special circumstances. The reasoning for this is to ensure that the client gives full disclosure to a lawyer without fear that the information can be used against him. This concept is known as client-solicitor privilege.

An accountant has no such privilege. In other words, the tax-collectors can use your accountant’s information obtained during the course of responding to audit questions against you. Yes, your own accountant may have to testify against you.

A lawyer can hire an accountant to assist in responding to the audit and, in doing so, cover the accountant’s work under privilege.

When do I go?

Depends on the seriousness of the questioning in part #2 of the process. Most lawyers provide free consultations. If the questions in #2 are of a pretty serious nature (i.e. more than, please provide your receipt for money you made in an income trust you forgot to include in your last tax return), then see a lawyer on a free consultation to understand your rights.

Should I appeal?

Some audit processes (depending on jurisdiction) give you a right of appeal in which you can go to some special committee Ask your professional whether you should exercise it or not.

The primarily right of appeal is not to stop the clock on penalities and interest but on enforcement proceedings since doing nothing is an admission you agree with the audit’s findings (which you may or may not agree with) and enforcement of tax revenue begins. Invoking the right of appeal is sometimes used to extend the time for the parties to discuss the audit as well (government is not exactly known for a quick turn-around on things). Thus, it depends on circumstances.

What can a lawyer do?

If the taxpayer does owe money, usually negotiate reasonable payment terms (the horse-trading usually involves waiving interest and penalities for some immediate payment and a reasonable payment plan). If the taxpayer has a case, settled on mutually satisfactory terms. If the government has clearly missed the mark and is belligerant in its position, argue the case in front of the appeals bodies.

How long will it take?

Months and sometimes years depending on the complexity of the case. If the taxpayer has no case and there was no malice in the underpayment, it still take months to negotiate.

Again, this post is meant to give you some sense of the process involved on an informational basis. The substance of an audit depends from case to case so please do consult a professional but please do take the process seriously. Best of luck.