With the 2021 tax season nearly over (self-employed taxpayers and their spouses or partners still have until June 15 to file), it’s important to remind clients that failure to file a tax return or to provide appropriate backup for expenses claimed can lead to the Canada Revenue Agency issuing an “arbitrary assessment” for tax owing, along with costly penalties.
That’s what happened in a recent tax case (Eva Enterprises Inc. v. The Queen, 2022 TCC 1) decided earlier this year.
The taxpayer, a truck driver who operates his business through a private corporation he owns with his wife, is the company’s sole employee. He transports produce, meat and other goods across the Canada-U.S. border.
The taxpayer didn’t file tax returns for his trucking company for the 2012, 2013 or 2017 tax years. (He claimed he did, but the CRA never received them.) In May and June 2018, the CRA wrote asking him to file corporate returns for the missing years, but never received them.
Consequently, the CRA issued “arbitrary assessments” for the corporation’s 2012, 2013 and 2017 taxation years. With an arbitrary assessment, the CRA can assess tax owing based on its best estimate of a taxpayer’s income and expenses for a particular taxation year.
The agency estimated the corporation’s gross income in each of those years by referring to its GST return for the nearest calendar year. It then deducted 30% as an estimate of reasonable expenses, as well as the salary expense reported on the corporation’s payroll records.
The CRA assessed federal back taxes owing of more than $20,000 for the three years reassessed, plus nearly $12,000 in failure-to-file penalties.
To fight an arbitrary assessment, the taxpayer must essentially disprove the assumptions underlying the CRA’s assessments.
The taxpayer testified that he kept the corporation’s financial and tax data for 2012 and 2013 on QuickTax software on a laptop, which he kept in his truck. In July 2018, the taxpayer was involved in a serious crash while driving his truck in the U.S. He spent one day in hospital followed by months of recuperation. He testified that he was unable to retrieve anything from the truck following the crash, including his laptop.
While the judge was unconvinced that the taxpayer couldn’t have retrieved the laptop following the crash — either by asking the towing company, the police or anyone else to do so on his behalf — in the absence of the laptop, the taxpayer needed some form of backup to justify his claim for business expenses.
The corporation did not have an accountant or a bookkeeper. The taxpayer testified that he kept corporate receipts and invoices at his Toronto home, yet he chose not to bring any of those receipts or invoices to the hearing, saying they were in “big boxes.”
Instead, he produced a one-page summary of revenue and operating expenses for the corporation’s 2012 and 2013 taxation years, which he said were assembled using the corporation’s receipts and invoices. The taxpayer claimed an additional $11,269 of expenses in 2012 and $27,435 for 2013, but didn’t provide reliable evidence to support those expenses.
The judge was skeptical about the figures listed on the summary. Fuel costs were listed at exactly $15,000, and hotel and food costs at exactly $2,000 for 2012. As the judge remarked, “Those amounts appear to have been rounded up or down. It is unlikely that they reflect the total of actual invoices or receipts. It is more likely that they are simply estimates. But there is no way of knowing without reviewing the source documents themselves.”
Under the Income Tax Act, anyone carrying on business is required to “keep records and books of account… at the person’s place of business or residence in Canada… in such form and containing such information as will enable the taxes payable under this Act… to be determined.”
The judge stated that either such records do not exist or, if they do exist, that they probably would not have not supported the taxpayer’s case. The judge concluded the CRA’s use of the arbitrary assessment rule was “reasonable in the circumstances.”
The judge also upheld the failure-to-file penalties, as the taxpayer was unable to produce any confirmation that he had filed his returns for the missing years or copies of any Notices of Assessment.
Jamie Golombek, CA, CPA, CFP, CLU, TEP is managing director, tax and estate planning, at CIBC Private Wealth in Toronto