One Large Tax Bill

...please explain where the money for these deposits came from...


n Nowak v. The Queen (2011 TCC 3) the Tax Court of Canada addressed the issue of the Canada Revenue Agency's reassessments of an individual with unreported income.

The facts of the case are cloudy for a number of reasons. The taxpayer's records of his income and expenses were incomplete and inconsistent. He was reluctant to answer questions posed by the auditor. And documents provided by the taxpayer raised more doubts and questions in the mind of the judge.

The CRA claimed the taxpayer had unreported income in excess of $290,000 during the two tax years in question. The auditor determined these amounts from an analysis of banking records. In essence, the records showed deposits that were clearly not reported as income.

As the judge notes, the burden is on the taxpayer to demonstrate the money received is not income subject to tax.

In this case the judge writes,

[25] The first issue is whether the Appellant failed to report income in his 2000 and 2001 taxation years. This issue turns mainly on the credibility of the Appellant and his spouse, and for the reasons that follow, I do not believe their testimony concerning the source of the unidentified bank deposits. I find their explanations unconvincing and implausible, and very little in the way of corroboration was presented to the Court. The few documents they did produce raise as many questions as they answer.
[42] I find therefore that the Appellant has not shown on a balance of probabilities that the unidentified bank deposits were not income to him in his 2000 and 2001 taxation years.

It would appear the taxpayer spun a story about where the money came from and it wasn't credible, hence he lost.

The second issue raised was the assessment of the gross negligence penalty under subsection 163(2) of the Income Tax Act. The provision can be summarized as: a 50% penalty of the tax owing where a taxpayer knowingly makes a false statement in a tax return. In this case, did the taxpayer knowingly understate his income?

In citing previous cases on this issue, the judge points out the burden of proof is on the government to show the taxpayer knowingly misrepresented his income.

Once the Ministère establishes on the basis of reliable information that there is a discrepancy, and a substantial one in the case at bar, between a taxpayer's assets and his expenses, and that discrepancy continues to be unexplained and inexplicable, the Ministère has discharged its burden of proof. It is then for the taxpayer to identify the source of his income and show that it is not taxable.
[49] These comments would appear equally applicable in a case such as this one where it has been shown that the taxpayer has had a substantial unexplained increase in his assets. I find that the Respondent has shown that there is a substantial discrepancy between Mr. Nowak’s income in the form of deposits to his bank account and his reported income, and that at the end of the day, this discrepancy remains unexplained.

In losing his appeal, the taxpayer faces a large tax bill. First, there is the tax owing on the unreported income for the 2000 and 2001 tax years. Second, there is arrears interest covering a period of a decade--that's a lot of interest. Finally, there is the 50% penalty. Add up these amounts and it's between two-thirds to 100% of the unreported income.

The lesson. First, don't understate your income. You'll get caught and be subject to a larger tax bill than if you had reported the income and paid tax on it.

Second, if in the past you have unreported income and the CRA hasn't started an investigation, it's time to consider the Voluntary Disclosure Program.

Posted 2011/04/28 at 16h11ET in Tax Law.