NET WORTH ASSESSMENT METHOD FROM CRA – SUGGESTIONS FOR FAMILIES WITH HIGHER NET WORTH ASSESSMENT

The net worth assessment method is a method by which the Canada Revenue Agency uses the increase in net worth to extrapolate a taxpayer’s income when the taxpayer’s records are unavailable or unreliable. This method has been mentioned in our company’s tax lectures in the past few years, and it is not newly introduced by the CRA. However, only in recent years, such cases which net worth assessment has been applied is more often observed, so more clients are consulting on this issue.

First, let’s briefly explain how the CRA assesses income? The CRA believes that the taxpayer’s income can be deduced according to the following formula: taxpayer’s income = increase in net assets in the current year + total consumption in the current year; increase in net assets in the current year = net assets in the current year – net assets in the previous year; The net assets of the taxpayer = the total assets of the taxpayer in the current year – the total liabilities of the taxpayer in the current year.

This formula is theoretically correct, but when may experience difficulties when calculating such income. Even people with minimum financial knowledge know that it’s difficult record each personal assets and liabilities like a company, and personal consumption is generally not recorded as such either. Furthermore, when CRA performs checking, that will require collection and sorting of data from years ago, which will be difficult to achieve accurate data. Thus, the above method is only an evaluation method. It feasible to evaluate the asset and liability for the year, however the expense for the year can only be roughly estimated. Since there are many estimation factors in this method, we believe that the CRA should carefully consider it, and only use it after special review and approval in some cases. However, the fact of the past few years is that the CRA uses the net asset assessment method to reassess the taxpayer’s income for the year, and the taxpayer is required to pay back taxes and pay a penalty of up to 50%! We have experienced cases where it is unfair and unreasonable. However, due to the incompleteness of the taxpayer’s usual evidence and written record availability, it is difficult for the taxpayer to prove innocence!

In order to avoid the occurrence of the above situation, it is recommended that families with higher net worth assessment keep transfer evidence of large amounts of income and expenditure in the bank and indicate the reason for the transfer on the bank statement. If the transferred funds are overseas remittances, please keep the account information of the overseas remittance account. If the remittance is made through a remittance company or a friend, you must keep the source account of the overseas remittance. If there is no relevant evidence to prove that the overseas remittance is overseas assets, overseas borrowing or overseas gift, the CRA will determine that the overseas remittance as income. For large bank transfer or expenses, a record for transfer reasoning is also recommended, unless there is a reason to prove that these transfers are not for personal consumption, all bank expenses will be summarized by the CRA and included in the total consumption of the year. It’s shown from the above formula that the total consumption of these years will also be added to the taxpayer’s income of the year.

Additionally, family members with higher net worth assessment families, including adult children, should try to avoid getting involved in industries with frequent and large cash transactions, such as catering, education, small retail, small online stores, and construction industries. If you need to engage in these industries, you must pay attention to setting up personal and business firewalls, including personal and business bank accounts that must be operated independently, and try not to mix them; the accounts of usual business income must be very clear, and cash and WeChat collections must be deposited into a separate bank account.

For taxpayers who are already under the net worth assessment audit review by the CRA, our suggestion is to stay calm, collect and sort out the reasons and original documents for bank including credit and debit transfers as much as possible, especially overseas remittances which in many are not income.  At the same time, it is also necessary to complete the statistics of your own debts as much as possible. However, despite our best efforts to find relevant evident, we may not be able to convince the CRA. In the case where both parties disagree, the taxpayer can choose to go to the tax court and have the judge decide accordingly.