Published: July 10, 2025
Introduction – Net Worth Audits Before the Tax Court: What Taxpayers Should Know
In Mann v. The King, 2023 TCC 151, the Tax Court of Canada reaffirmed the Canada Revenue Agency’s (CRA) authority to use the net worth method under subsection 152(7) of the Income Tax Act when a taxpayer fails to keep adequate books and records.
Between 2008 and 2013, the taxpayer, a certified management accountant and former CRA employee, engaged in the acquisition and sale of multiple residential properties, several of which were legally held in the names of her adult daughters. Unable to reconcile the taxpayer’s reported income with her observed lifestyle and significant bank deposits, the CRA initiated a net worth audit covering the relevant taxation years.
The tax audit originally alleged over $5.5 million in unreported income. Following a notice of objection and internal review, the CRA revised the reassessments to approximately $473,000. The CRA also imposed gross negligence penalties under subsection 163(2) in respect of key amounts it found had been knowingly or recklessly omitted.
The Tax Court largely upheld the CRA’s revised position, maintaining the substantial portions of unreported income. However, it disallowed some more minor inclusions—such as family gifts and previously reported income—and vacated gross negligence penalties where it found the taxpayer’s error was plausible or based on a misunderstanding of legal concepts, such as beneficial ownership.
This tax article explores the Court’s treatment of net worth assessments, its limited role in reviewing CRA tax audit conduct, and the standards for gross negligence under subsection 163(2) of the Income Tax Act. In particular, it analyzes the Court’s response to challenges involving procedural fairness, the appropriateness of the net worth methodology, statute-barred reassessments under subparagraph 152(4)(a)(i), and the application of gross negligence penalties. For any individual or corporation audited under the net worth method, Mann provides a cautionary roadmap of what Canadian tax authorities and tax courts expect, reinforcing the importance of working with an expert Canadian tax lawyer in complex audit or tax reassessment scenarios.
Challenging CRA’s Conduct: A Jurisdictional Wall
The taxpayer argued that the net worth reassessments should be vacated because they were the product of an “illegitimate process,” including alleged harassment by CRA officials and misuse of internal tax audit policies.
The taxpayer submitted that the Tax Court had jurisdiction to invalidate reassessments tainted by unfair or abusive conduct. However, the Court reaffirmed long-standing jurisprudence that its role is limited to determining whether a tax assessment is correct under the tax act, not whether the CRA acted fairly in its audit process.
This position was squarely rejected by the Tax Court, relying on the Federal Court of Appeal‘s guidance in Main Rehabilitation Co. Ltd. v. R., which established that an appeal under section 169 of the Income Tax Act concerns only the validity of the tax assessment itself, not the process by which it was made. Similarly, in Ereiser v. R., the Court confirmed that even serious misconduct by CRA officials is not grounds to vacate a reassessment, as the Tax Court’s role is limited to determining whether the assessed amount is properly owing under the Tax Act. In the absence of a properly pleaded Charter violation, procedural fairness arguments fall outside the Court’s jurisdiction.
Understanding Net Worth Assessments
The CRA may perform a net worth audit of a taxpayer who appears to have unreported income by measuring assets less liabilities at the beginning and end of a period, adding estimated expenses, and then presuming the difference to be income. Subsection 152(7) confirms that this can be done with a cheerful disregard for what the taxpayer has reported. Net worth assessment is often referred to as a method of “last resort”.
When Can the Net Worth Method Be Challenged?
The taxpayer argued that the facts of this case did not support the use of net worth assessments. The CRA made the assumption that the taxpayer had not maintained proper books and records. In response, the taxpayer claimed that much of her documentation had been lost in a flood in the basement in July 2013.
However, the taxpayer provided no corroborating evidence, such as insurance claims or photographs. Moreover, her Canadian tax lawyer declined to provide key documents for statute-barred years unless the CRA disclosed its reasons for reviewing those years, further limiting transparency.
The Tax Court rejected the taxpayer’s position, concluding that the CRA was entitled to use the net worth method given the lack of reliable records and the taxpayer’s insufficient cooperation. Based on the case law of Truong v. R., Guibord v. R., and Mensah v. R., the Court noted that the taxpayer’s documentation was incomplete, the evidence was questionable in parts, and the conduct during the tax audit did not meet the standard of a taxpayer with credible and meticulous records.
In contrast, in Mensah, where the taxpayer maintained detailed and organized records, the Court did not accept the CRA’s use of the net worth approach.
Ongoing support from a Canadian tax lawyer can help ensure that records and transactions are adequately documented, thereby reducing the likelihood of future net worth audits.
Principal Residence Claims: What Courts Look For
In 2008, the CRA reassessed the taxpayer for a capital gain of $99,607 arising from the sale of the Mineola Gardens property, following a deposit of $502,788 into her bank account. The taxpayer claimed the property qualified as her principal residence, but she neither reported the disposition in her return nor designated the property as such.
Although she testified that she lived there temporarily in 2007 after separating informally from her spouse, the Tax Court found that her use of the property was minimal and inconsistent with “ordinary habitation” under section 54 of the tax act. Factors such as negligible water usage, a vacancy insurance certificate, and the fact that mail continued to be sent to her primary address on Bay St. undermined her position.
The Court concluded that the property did not meet the statutory definition of a principal residence and that the exemption did not apply. Therefore, clear, consistent evidence of regular use as a primary residence is essential for a successful claim.
Crossing the Line: Misrepresentation, Statute-Barred Years, and Gross Negligence Penalty
The taxpayer also argued that the 2008 taxation year was statute-barred. As a general rule, the CRA may not reassess a taxpayer more than three years after the date of the original assessment. However, subparagraph 152(4)(a)(i) of the Income Tax Act provides an important exception: the CRA may reassess at any time if the taxpayer has made a misrepresentation that is attributable to neglect, carelessness, willful default, or fraud.
In this case, the Court found that the taxpayer’s failure to report the capital gain on the sale of the Mineola Gardens property, combined with her failure to designate the property as a principal residence, constituted a misrepresentation within the meaning of this provision.
As a long-time CRA employee, the taxpayer was expected to understand the reporting requirements. Accordingly, the Court held that the reassessment of the 2008 taxation year was valid despite being outside the normal limitation period.
Finally, the Court upheld a gross negligence penalty under subsection 163(2), but only in respect of the unreported capital gain. Drawing on Guindon, Venne, and Khanna, the Tax Court stated that the taxpayer’s conduct, claiming an exemption without living in the property in the ordinary sense and without a formal designation, fell far below the standard of a reasonable taxpayer. The penalty was limited to the amount related to the $99,607 gain.
Legal Title Isn’t Enough: How Beneficial Ownership Triggers Tax Liability
In 2012, the CRA reassessed the taxpayer for unreported capital gains totalling over $246,000 from the sale of two residential properties, 2615 Stillmeadow Road and 1608 Ogden Avenue. Although her adult daughter held legal title to both properties, the taxpayer had fully funded the purchases, and the net sale proceeds were deposited into her bank accounts.
She argued that both properties were gifts to her daughter, who briefly lived in each home before returning to the family residence. Since she was not on title, the taxpayer claimed she had no taxable obligation related to the disposition.
The Tax Court disagreed, concluding that the daughter held legal title as a bare trustee and that the taxpayer was the beneficial owner of both properties. Citing De Mond, Pecore, and Fourney, the Court affirmed that where a parent transfers property to an adult child without consideration, a presumption of resulting trust arises.
In this case, the taxpayer failed to rebut that presumption. The Court held that the evidence showed that the taxpayer made the decisions to purchase, renovate, and sell; proceeds from both sales were deposited into her accounts; and she later used the funds to acquire another property through her corporation, Mimar Holdings. As a result, the Court found that the taxpayer, rather than her daughter, retained the benefit of the properties and was the beneficial owner for tax purposes.
Accordingly, the capital gains were attributed to the taxpayer as the beneficial owner. The Court emphasized that the legal form of ownership does not override the underlying substance in tax law, particularly where the evidence clearly shows that a party holding title is merely acting for the benefit of another.
Although the Tax Court found that the taxpayer was the beneficial owner of both properties, it declined to uphold the gross negligence penalty under subsection 163(2) for the unreported gains. The Court acknowledged that the concept of a bare trust is “a particularly legal one, not readily familiar to those not trained in law,” and thus not necessarily understood by the average taxpayer.
This case highlights the tax risks associated with informal arrangements involving family members, without obtaining proper Canadian tax lawyer advice, particularly when title and control are separated.
The Surrogatum Principle in Action: Taxing Legal Settlements
In 2013, the taxpayer received a $44,167 share from a $132,500 legal settlement arising from a lawsuit she and her daughters initiated against their real estate agent following the sale of the Ben Machree Drive property.
The claim was based on undisclosed legal defects that reduced the property’s value and rental potential. While the taxpayer argued that the settlement reflected personal frustration and was therefore non-taxable, the Tax Court applied the “surrogatum principle”, which requires that the tax treatment of a settlement reflect the nature of what the payment was intended to replace.
Under the surrogatum principle, as articulated by the Supreme Court of Canada in Tsiaprailis v. Canada, the tax treatment of a damages award or settlement payment depends on the nature of the loss it is compensating.
Settlement amounts are not inherently taxable or non-taxable; rather, the inquiry is factual and turns on two questions: (1) what was the payment intended to replace? And, if the answer to that question is sufficiently clear, (2) would the replaced amount have been taxable in the recipient’s hands?
Since the claim in this case sought compensation for lost property value and income, the Court concluded that the full amount was taxable as a capital gain. However, because the CRA had only reassessed $22,083 as a capital gain, and a taxpayer’s appeal cannot result in a reassessment that is more adverse, the Court upheld only that portion.
Taken together, the Court’s findings in Mann v. The King offer valuable insights into how Canadian tax authorities and courts evaluate tax audit disputes, emphasizing the importance of accurate record-keeping, proper legal characterization of ownership, and timely compliance.
As such, given the complexity of beneficial ownership, net worth assessments, and findings of misrepresentation, consulting with a top Canadian tax lawyer is highly advisable at the first sign of a tax audit.
Pro Tax Tips
To mitigate risks identified in Mann, taxpayers should consider the following practical steps:
- Keep detailed, contemporaneous records. In net worth audits, the absence of documentation invites CRA assumptions. Keeping reliable records can prevent aggressive reassessment methods.
- Do not rely solely on legal title. If you fund a property but register it in someone else’s name, CRA may consider you the beneficial owner. It is advisable to consult with a top Canadian tax lawyer before structuring such transactions and to make sure the legal relationship between the parties is fully documented.
- Ensure accurate principal residence reporting. If you claim the exemption, be sure to designate it properly in your return and be able to prove regular, ongoing occupancy.
FAQ
What is a net worth audit, and when does CRA use it?
A net worth audit compares a taxpayer’s assets and liabilities over time to infer unreported income. CRA uses this when it believes a taxpayer’s lifestyle exceeds his or her declared income, especially when records are lacking.
Can I be taxed on a property I do not legally own?
Yes. If CRA determines that you are the beneficial owner, for instance, if you funded the purchase and controlled the asset, the income or gains from that property may be taxable to you.
Are legal settlements always taxable in Canada?
Not necessarily. Under the surrogatum principle, the tax treatment depends on what the payment replaces. If it replaces lost income or capital gains, it is likely taxable.
Disclaimer: This article provides broad information. It is only accurate 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 as tax advice. 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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