Published: December 11, 2024
In September 2024, the Tax Court of Canada delivered its judgment on Fijal v. The King, 2024 TCC 116. The three main issues in the case are:
- Can the Canada Revenue Agency (“CRA”) reassess the appellant taxpayer, Mr. Fijal, and his company, 3 Bee Contracting, for the taxation years of 2012-2015 past the normal reassessment period?
- Can the CRA conduct a net-worth analysis on Mr. Fijal and 3 Bee Contracting?
- Can the CRA apply gross negligence penalties to Mr. Fijal and 3 Bee Contracting?
The Tax Court of Canada ruled in favour of the CRA for the first two issues and in favour of the taxpayers for the last issue. The main underlying reason for the Tax Court’s judgment is that Mr. Fijal had failed miserably in keeping details of his personal and business finances, highlighting the importance of a business putting in place and maintaining a proper bookkeeping system.
The CRA Can Reassess Anytime in Cases of Misrepresentation or Fraud
Under subsection 152(3.1) of the Income Tax Act, the CRA can reassess a tax return within three years for an individual or a Canadian-controlled private corporation after the original assessment and within four years for a corporation other than a Canadian-controlled private corporation. These time limitations are known as the “normal reassessment period.”
In certain circumstances, the reassessment period can be extended. Furthermore, when the taxpayer is found to have made a misrepresentation attributable to neglect, carelessness or wilful default or has committed fraud, subsection 152(4)(a) allows the CRA to reassess anytime, i.e., there is no time limit.
In Mr. Fijal’s case, the Judge, on many occasions, commented on the character of Mr. Fijal, that he is “reasonably articulate” and “reasonably intelligent” but “quick to answer before listening” and “unconcerned with the minutiae.” The Tax Court found that Mr. Fijal was careless in his bookkeeping.
The business was a one-man show, and Mr. Fijal failed to keep separate folders for his personal and business records. His bank accounts were used for both personal and business purposes. The Judge also hinted that his accountant could have done more in their role.
But ultimately, it was on Mr. Fijal to take charge of his business affairs. He was found to have misrepresented in his returns based on carelessness, and thus, the CRA could reassess him and his company past the normal reassessment period.
The CRA Can Conduct a Net-Worth Analysis Where the Standard of Accuracy is Not Met
Subsection 230(1) of the Income Tax Act requires taxpayers to maintain books and records such that the amount of taxes can be ascertained. Lacking a verifiable source, the CRA has the power under subsection 152(7) to use alternative methods, also known as indirect verification methods, in order to ensure that the income reported is correct.
The net worth analysis is the most common indirect verification method, where the CRA auditor considers the changes in assets and liabilities, personal spending, and other relevant information to deduce the taxpayer’s income.
In Mr. Fijal’s case, he did not keep a live ledger, journal or any sort of bookkeeping. A “ledger” was created at year-end based on whatever bank statements and invoices, co-mingling personal and business matters, he could find. The Tax Court ruled that a net-worth analysis was warranted in this case.
Gross Negligence is a High Bar for the Crown to Cross
On the issue of gross negligence penalty, the Crown bears the burden of proving the taxpayer’s gross negligence. The Tax Court found that Mr. Fijal did try to keep his records, even though he did a poor job at it, lumping everything together. He relied on his accountant who could have done more to help out a one-man operation. Overall, Mr. Fijal had not surmounted the gross negligence threshold.
Pro Tax Tip – Maintaining Proper Books and Records is Essential
It goes without saying that maintaining accurate books and records is fundamental to operating a well-run business.
From the tax perspective, having good books and records is a strong defence against the CRA accusing the business of misrepresentation or fraud, conducting alternative analyses, and levying a gross negligence penalty.
If a business owner is not in a position to take care of accounting, he or she should enlist the help of a capable accountant. Finally, when the taxpayer is alleged by the CRA of not keeping proper books and records, it is advisable to consult with an experienced Canadian tax lawyer immediately to prevent further escalation.
FAQ
Can the CRA always reassess my returns?
No, there are time limitations as to how far back the CRA can reassess a return. The normal reassessment period is three or four years. In some special circumstances, the reassessment period is extended for another three years to six or seven years. Nevertheless, when the taxpayer is found to have misrepresented or committed fraud, the CRA can reassess at any time. In any case, if the taxpayer is being reassessed, it is recommended to contact an experienced Canadian tax lawyer as soon as possible.
When will the CRA use an indirect verification of income method?
The CRA will generally use an indirect verification of income method when they cannot ascertain the taxpayer’s income. There are several indications where the taxpayer’s income is not reliable, such as where books and records are poorly kept, where personal and business accounts are co-mingled, where the taxpayer’s lifestyle does not match the reported income, where the business income is consistently lower than similar businesses in the same sector, or where the sector has high risk of unreported income. Having proper books and records for the business is a strong defence against these assumptions.
DISCLAIMER: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
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