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The estimated three million income tax reviews the Canada Revenue Agency (CRA) carries out each year usually start out as fairly routine. Most are easily resolved, but when the CRA decides to ramp it up to an audit, things can get very serious.
A front-line financial advisor’s familiarity with a client’s tax situation is often limited to matters strictly relating to investing. That’s when a good advisor can take the lead in mounting a defence that could require a team of financial experts.
Stefano Pannu, principal and certified financial planner at Noble Pannu Wealth Management in Kelowna, B.C., sees his role as a sort of triage doctor – consoling the client, assessing the scope of the audit, and providing whatever information he can to keep their investment plan on track.
“We put the information in one clean package … anything that triggers a taxable event from the investment side in that particular year,” he says.
Investment-related documents normally include tax slips detailing taxable investment income, or information on registered retirement savings plans (RRSPs), registered retirement income funds, or tax-free savings accounts (TFSAs).
But if the audit goes beyond that, Mr. Pannu says it’s time to call in the tax professionals. As a financial planner, he includes tax planning with his investment plans, but in many advisor-client relationships, investors either file their own taxes or hire accountants.
“We have a process in which we work closely with all our clients’ accountants as a way to have the lines of communication open,” he says. “Outside of that scope, you would refer them over to the tax advisor.”
Calling in a tax expert
Tony Salgado, founder and president of AMS Wealth Inc. in Toronto, says advisors should know their limitations when it comes to dealing with clients under audit.
“If you are strictly an investment manager and what’s being audited is outside of your realm of expertise, have a conversation with the client and be frank that it’s not within your bailiwick,” he says.
As a trained accountant, he also cautions against relying on accountants to resolve CRA audits.
“You could have a good bookkeeper or accountant, but that doesn’t necessarily mean you have a good tax advisor,” he says.
A CRA audit could focus on many things outside an advisor’s realm, such as discretionary expenses like child care, moving and charitable donations.
As an example, the CRA has been cracking down on residential real estate speculators taking advantage of the principal residence capital gains exemption, which eliminates a capital gains tax on the profit of a home sale provided it’s the owner’s principal residence.
Mr. Salgado says the first step for a tax advisor when assessing an audit is to determine its scope and severity.
“What type of transaction is being audited? What’s the size of the potential exposure? he asks. “Are you failing to comply with something where we’re looking at an insignificant $100 penalty or penalties and interest in the thousands that could disrupt your original financial plan?”
Audits also often focus on income from self-employed individuals if there’s a discrepancy between income and HST filings – an area Mr. Salgado admits can be beyond his expertise and would be bumped up to a tax specialist.
The consequences of audits
Depending on the complexity of the audit and level of service required, retaining tax specialists to deal with an audit could be costly, but not as costly as ignoring it, according to tax expert Evelyn Jacks, founder and president of Knowledge Bureau Inc. in Winnipeg.
“An audit usually means you have to pay something back. The CRA is not a patient creditor,” she says. “It’s going to expect you to pay that back within 30 days or it’s going to start charging you interest.”
Any penalties imposed will generate interest at the current rate of 4 per cent, which is subject to change every quarter as interest rates spike in the broader economy, she adds.
“In severe circumstances, [the CRA] has the power to garnishee wages and seize assets. In severe cases, there are jail terms if the government proves fraud,” she says.
On the bright side, Ms. Jacks says a tax specialist with a broad view of a client’s tax situation can sometimes ease the financial impact of an audit.
“If someone panics and just pays the bill, they might be pulling it out of an RRSP and creating a tax liability for next year,” she says. “They’re eroding their retirement funds and might be pulling money out of the market in a bear slump.”
Taking money out of a TFSA could be a better source, sh] says.
“There are no tax consequences [from a TFSA withdrawal) and you can put the money back in later.”
Ms. Jacks goes even further by adding that a good tax specialist can sometimes find longer-term tax savings by going back to past returns.
“A tax specialist might find errors and omissions that will generate a refund or with some RRSP planning, you can actually increase benefits that the family is qualifying for like the child tax benefit,” she says, adding that some audits can require documentation from as far back as 10 years.
“It might be that with proper financial planning by next year the government is going to owe you money because you missed something,” she says.
A really common example is when clients are not applying capital losses properly, she says.
“They can be carried back three years against capital gains. That can generate refunds to pay your tax bill.”
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