Can CRA require a taxpayer to prepare net worth audit schedules under the new section 231.1?

Changes to Section 231.1

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm.

Subsection 231.1(1) of the Income Tax Act (ITA) outlines the powers of the Canada Revenue Agency during a tax audit or examination. Before the legislative changes in 2022, the text read as follows:

231.1 (1) An authorized person may, at all reasonable times, for any purpose related to the administration or enforcement of this Act,

• (a) inspect, audit or examine the books and records of a taxpayer and any document of the taxpayer or of any other person that relates or may relate to the information that is or should be in the books or records of the taxpayer or to any amount payable by the taxpayer under this Act [...]

And for those purposes the authorized person may:

• (d) require the owner or manager of the property or business and any other person on the premises or place to give the authorized person all reasonable assistance and to answer all proper questions relating to the administration or enforcement of this Act and, for that purpose, require the owner or manager to attend at the premises or place with the authorized person.

Post-December 15, 2022: The 2022 Amendment

Subsection 54(1) of the Fall Economic Statement Implementation Act, 2022, S.C. 2022, c. 19, received royal assent on December 15, 2022, and amended subsection 231.1(1) of the Tax Act. This amendment modernized and expanded the scope of the provision. The revised text reads as follows:

231.1 (1) An authorized person may, at all reasonable times, for any purpose related to the administration or enforcement of this Act,

• (a) inspect, audit or examine any document, including books and records, of a taxpayer or any other person that may be relevant in determining the obligations or entitlements of the taxpayer or any other person under this Act; [...]
• (d) require a taxpayer or any other person to give the authorized person all reasonable assistance, to answer all proper questions relating to the administration or enforcement of this Act, and
• • (i) to attend with the authorized person, at a place designated by the authorized person, or by video-conference or by another form of electronic communication, and to answer the questions orally, and
  • (ii) to answer the questions in writing, in any form specified by the authorized person; and
• (e) require a taxpayer or any other person to give the authorized person all reasonable assistance with anything the authorized person is authorized to do under this Act.

Does the CRA have the authority to compel a taxpayer to prepare new calculations during an audit under the new section 231.1?

These amendments broaden the scope of requests that can be made under section 231.1. Courts have generally taken a liberal view of what CRA is permitted to request of a taxpayer during a tax audit. Permitted requests include both information required to be kept and that which isn't required but does exist.

The court in Miller[1] clarified that missing documents can be requested only if they should have been in the taxpayer's records. In determining whether or not a piece of information is "information that is or should be in the books or records of the taxpayer" under s. 231.1, the Supreme Court in the tax case of Redeemer included information that would have been required to comply with the taxpayer's tax obligations under the ITA.[2]

The ability of the authorized person to request answers "in any form specified by the authorized person" means that persons exposed to requirements under section 231.1 may have to incur additional expenses to provide the information in the requested form.

The Explanatory Notes provide some examples of types of information that could be required under paragraph 231.1(1)(d): "For example, authorized persons may require answers to be provided in electronic form, such as by way of an electronic spreadsheet or table. They may also require that questions be answered by means of an organizational chart, or by another similar form of presentation."[3]

According to the Department of Finance, one of the purposes of the 2022 Amendment is to modernize the language of certain paragraphs and render it consistent with the language employed in subsection 288(1) of the Excise Tax Act (ETA).[4]

It is apparent from a reading of s. 231.1 that, similarly to s. 288(1) of the ETA, it too is worded in an extremely broad manner with respect to the kinds of assistance that a taxpayer is required to provide to an authorized person. In making s. 231.1 of the Income Tax Act consistent with s. 288(1) of the ETA, the Department of Finance intentionally used the same broad language.

The Federal court in Tella[5]expressly authorized the use of s. 288(1) to compel the production of documents to assist the CRA, stating that "the power to request or require documents to be provided so that the authorized person can conduct the inspection, audit or examination effectively." This indicates that s. 288(1) of the ETA likely gives the CRA the power to compel calculations on their behalf from a taxpayer, and so s. 231.1 of the ITA likely provides the same power to the CRA as well.

Does this power extend to the preparation of schedules to assist with calculating a household's net worth at a point in time?

While the CRA's authority under section 231.1(1)(d) is broad, it is not unlimited. The question of whether this power extends to compelling the preparation of schedules to calculate a household's net worth at a specific point in time raises concerns about scope, reasonableness, and legislative intent. Statutory interpretation and case law suggest that such a request may exceed the CRA's authority.

Section 231.1(1) empowers the CRA to ask questions and request assistance pertinent to a taxpayer's "obligations and entitlements" under the ITA. The inclusion of "reasonable" in the phrase "all reasonable assistance" indicates a limit to the CRA's power, preventing unrestricted or overly burdensome demands. The purpose of this section is to facilitate the CRA's determination of tax liability, not to enforce self-audits by taxpayers.[6]

A net worth schedule may not directly relate to tax liability under the Tax Act. Judicial rulings emphasize that section 231.1 grants access to information that is or should be in a taxpayer's records to fulfill tax obligations. However, a net worth schedule often includes non-taxable amounts, such as personal assets or liabilities, which do not form taxable income or deductions. Compelling its preparation risks turning the request into a self-audit, a practice courts have cautioned against.

Preparing a net worth schedule, which summarizes a household's assets and liabilities, poses unique challenges. Such a task can be time-consuming and costly, requiring the recreation of records, such as bank statements, credit card data, or corporate share valuations, that may no longer exist due to retention periods or the passage of time.

Additionally, it often demands specialized expertise, such as hiring accountants with niche skills, incurring significant expenses. Courts have acknowledged that compliance with CRA requests can be significant,[7] and while time constraints have been addressed, the principle may extend to monetary costs. A request could be deemed unreasonable if the financial burden is excessive, though the taxpayer bears the burden of proving this.

The request also exceeds the scope of "answering a question" under paragraph 231.1(1)(d). Rather than a simple response, it demands the compilation of extensive data to create a tool for the CRA, akin to a report.

Case law clarifies that the ITA does not require the creation of records if they are not reasonably expected to be part of tax compliance. Taxpayers do not routinely maintain net worth schedules, and such documents are often completely unrelated to taxable amounts and thus exceed the scope of permitted requests under s.231.

Furthermore, case law describes net worth assessments as a "blunt instrument"[8] and a tool of last resort, used only when no alternative exists to determine income. Courts have allowed challenges to such net worth assessments on grounds of necessity, methodology, or the inclusion of non-taxable amounts.[9] A taxpayer could argue that a net worth schedule, as a precursor to a net worth assessment, is premature and unnecessary if other, more precise methods to assess tax liability are available.

Is a taxpayer entitled to compensation for costs of computations performed on the CRA's behalf?

Section 231.1(1)(a) of the ITA allows the CRA to examine information that "is or should be in the books and records of the taxpayer" or relates to amounts payable under the ITA. Section 230(1) further mandates that taxpayers maintain records and books of account to comply with the ITA, implying that the responsibility, and associated costs of producing these records, lie with the taxpayer.

This aligns with the principle that compliance with tax obligations, including during tax audits, is a taxpayer's duty, and no provision in the ITA explicitly provides for reimbursement.

In scenarios where the CRA requests complex documents, such as calculations or specialized reports, the absence of jurisprudential evidence supporting cost recovery is notable. Courts have not recognized a right to compensation for expenses incurred to meet tax audit demands, even when compliance involves significant time or financial outlay.

However, if a request, such as preparing a net worth schedule, is deemed outside the scope of section 231.1, the question of compensation may be moot, as the request itself may be invalid. For example, a net worth schedule may not be a record required for ITA compliance, nor a simple answer to a question under paragraph 231.1(1)(d).

If other evidence of taxable income has already been provided, such a request could be seen as unnecessary and overly burdensome. Case law also underscores that net worth assessments, and by extension, their preparatory schedules, should be a last resort, not a routine demand.

If a court were to find that such a request falls within section 231.1, compensation appears unlikely, but the lack of clear guidance or case law leaves this an open question.

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm and is a Certified Specialist in Taxation Law who has completed the CICA in-depth tax planning course. He appears regularly in print, radio and TV and blogs extensively.  

With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation. Visit www.Taxpage.com and email David at david@taxpage.com.

Read the original article in full on Taxpage. Author photo courtesy Rotfleisch & Samulovitch P.C.