A tax audit is the procedure whereby taxation authorities ensure a taxpayer’s legality and compliance with tax laws.
As the taxation system in Canada is based on the principle of self-assessment, it is important for taxation officers to have the possibility to audit a taxpayer’s accounting books, records and other such documents in order to ensure compliance with the law, including make sure that what is reported is a reflection of reality.
Difference between a tax audit and a tax investigation
It is important to discriminate between a tax audit and a tax investigation.
A tax audit is strictly an administrative and accounting procedure whereby an auditor reviews the accounts of an individual or a business for purposes of civil enforcement of the law.
A tax investigation is a process that is more of a penal nature, which consists in investigating and determining if penal offences under one or several tax laws have been committed and, if such is the case, whether proceedings should be brought before the courts.
Of course, the distinction is not always so obvious, but still it is important to draw the line between these two concepts, as the applicable procedure and rights that taxation authorities have to deal with are not the same.
The Supreme Court of Canada disposed of this issue in the Jarvis Case, in order to determine at which point a routine tax audit ends and becomes a tax investigation.
Because when dealing with a tax investigation, a taxpayer benefits from all the protection provided by the Charter of Rights, including the right to silence and the right to counsel. Consequently, in the context of a tax investigation, the taxpayer no longer has the obligation to answer to taxation authorities investigators.
This penal law concept, while totally in line with the intent of the Charter of Rights, is fundamentally different from the law which is applicable in the context of a mere audit.
Actually, in the context of a tax audit, a taxpayer does not have the right to silence nor can he refuse to provide any tax information requested by the auditor. The auditor has the right, in accordance with the law, to require that such information be provided.
Is there a limit to an auditor’ information inquiries? When an audit brings into perspective elements of evidence that may constitute a penal offence, does it immediately become a tax investigation?
Such issues require extremely complex answers and a detailed analysis of case-specific facts, in the light of the Jarvis Case guidelines.
Usual powers of taxation authorities in the context of an audit.
A person who is authorized by the Minister under Section 231.1 may inspect, audit or examine the relevant documents, property or processes of a taxpayer or of any other person that relate to the information that is or should be in the records of such taxpayer. That person may also, at all reasonable times, enter a place of business and require from individuals present that they provide all reasonable assistance and answer all relevant questions.
Type of audit
There are two principal ways an audit can be performed: on site or from the tax department’s office. An on-site audit is generally performed in the case of businesses. When auditing individuals, the tax department will often investigate only one or two very precise items and, in general, this is done without an on-site visit but rather by requesting information in writing or by telephone.
Process for the selection of files to audit
Taxpayers who are the subject of a tax audit often wonder why their file has been chosen. Was it selected at random or not?
Taxation authorities have several means to choose which taxpayers to audit. The selection may actually have been done at a random on a routine basis.
There are, however, other more targeted ways which authorities use to select their files.
For example, it can be through an auditing programme targeting a whole group, which for various reasons has attracted the authorities’ attention. For instance, Revenu Québec specifically targets the construction and real estate renovation sector, because it considers that such sector is favourable for unreported work. It is therefore not surprising for a contractor to be audited. Same thing for hairdressers.
Taxation authorities may also be interested in a taxpayer’s file, as a secondary file, after having performed a more important investigation about another taxpayer. This means that if the authorities audit any business and, during such audit, finds irregularities or leads, they will certainly pursue this lead and broaden their auditing mandate. Consequently, such taxpayer will be audited just because one of his clients, suppliers or employers has been audited and certain items led the authorities to him.
Taxation authorities also perform verifications by analyzing data and information available from a great number of government sources. After cross-checking information, the tax situation as reported by a taxpayer may be at variance with other information available to the authorities.
Finally, whistleblowing is also another way an auditing process can be triggered against a taxpayer. It happens a lot more often than people might think.
Generally, at the end of the auditing process, the auditor will provide the taxpayer with a written document known as a draft assessment. Such document explains the changes he intends to bring and the reasons why he wants to make them. A 21-day period is usually granted to a taxpayer to respond to such draft assessment. After this time period, a reassessment will be issued.
Whatever the type of audit or manner in which such audit is performed against a taxpayer, it is always in the best interest of the taxpayer to have the advice and guidance of an accountant or of a tax expert during the process. In order to properly identify auditing items and also safeguard his rights, it is undeniable that help from a professional, at such a crucial step, is self-evident and that an auditor can absolutely not object to fact that a taxpayer is being represented.
Louis Sirois, Tax Lawyer