Net worth contributions: definition and explanation
In Canada and Quebec, the tax system is based on the principle of self-declaration and self-assessment.
This means that it is the taxpayer himself who undertakes to submit his tax return and pay the amount of tax requested by the tax authorities.
In such cases, taxpayers may make mistakes in their tax returns, fail to declare their income, or even file manifestly false or incomplete returns.
To this end, the tax authorities (Revenu Québec and/or the Canada Revenue Agency, hereinafter “RQ” and “CRA”) have developed tools for verifying returns, including net worth.
What does this method involve and what should you do if your returns are checked using this method?
I. What is the net worth contribution?
Although this technique is used mainly as a last resort by the tax authorities, it has nonetheless proved its worth and produced results.
Net worth assessment is an accounting method used to determine amounts that the taxpayer may have failed to declare.
To establish the amounts, tax authorities such as the CRA and/or the RQ will audit a taxpayer’s assets, analysing them year after year.
When might the tax authorities use this method?
For example, when a taxpayer’s ‘lifestyle’ does not appear to be consistent with the contents of his tax return, the authorities will use this technique, among others, to determine what amounts the taxpayer may have omitted to declare.
Let’s take an example: an individual acquires a new car and a lakeside cottage, for a total value of $200,000, while for the same year, the taxpayer declared income of $50,000 to the tax authorities.
It is this clear discrepancy between the expenditure incurred during the tax year and the income declared by the taxpayer that will attract the attention of the authorities and lead them to carry out more detailed checks.
In such a situation, the tax authorities will determine that $150,000 has not been duly declared, and will then issue a notice of assessment for that amount, as well as, possibly, administrative penalties equal to 50% of the amount allegedly not declared.
II. The net worth method: presumption, arbitrariness and speculation
As we have seen, this method is used mainly when a taxpayer fails to file a tax return, files a manifestly false tax return, refuses to provide information that could establish the reliability of his or her return, or during a tax audit when the taxpayer does not have the supporting documents.
This method is also used when the ministry or agency suspects fraud or undeclared income.
However, this method is based on the presumption, which is often incorrect, that a taxpayer’s enrichment over a given period can be explained entirely by his taxable income (some or all of which he may have failed to declare).
This method therefore places the burden of proof on the taxpayer.
This means that it is up to the taxpayer to show that all or part of his or her enrichment between two dates comes from income that is not subject to tax, and therefore from a legitimate source.
Often described as arbitrary and speculative, the results obtained by the tax authorities using this method can be challenged if the taxpayer provides evidence that the difference in net worth is in fact based on non-taxable income.
Although the burden of proof rests with the taxpayer, it should be noted that this method is incomplete and imprecise, and the resulting amount is merely an estimate based on the presumption that all income available to an individual is taxable.
In this case, the taxpayer can completely contradict the results: for example, the difference in income presumed by the authorities can be explained by the fact that the taxpayer received an inheritance in the same year, repaid a loan granted in the past or received a gift from a close friend or family member.
III. What should I do if an opposition agent checks my account?
To determine this presumed and estimated gap, the tax authorities will, among other things, cross-reference various sources of expenditure.
For example, they will cross-reference data collected from the SAAQ, travel agencies or estate agents and compare it with declared income.
Une fois qu’une inéquation est observée, les autorités fiscales formuleront alors dans un premier temps une première demande de « courtoisie », souvent, sous la forme de demande d’informations ou d’explications supplémentaires.
Once a discrepancy has been identified, the tax authorities will initially make an initial “courtesy” request, often in the form of a request for further information or explanations.
In other words, the tax authorities will ask you to justify your standard of living and your new acquisitions.
While you are under no obligation to comply with this request at this stage, it is still preferable to cooperate with the authorities.
However, don’t be left on your own at this stage: the tax authorities will ask you to fill in questionnaires that can be long and laborious to establish this alleged net worth discrepancy.
A tax lawyer and accountants can help you through these steps if you are faced with audits using this method of calculating net worth.
Whether it’s a question of reviewing questionnaires from the tax authorities to establish a difference in net worth, or of represent you in negotiations or objection to notice of assessment or even legal challenges our specialist tax lawyers will be able to help you.
NOTE: This article does not constitute legal advice or a legal opinion. It is intended solely to inform readers of certain aspects of the laws surrounding net worth contributions in the province of Quebec and in Canada.
