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A surge of tax audits of staff at a prominent Prince Edward Island hospitality group illustrates the growing efficiency of the Canada Revenue Agency's tools for tackling formerly hard-to-pin down tip income and the growing risk to those who don't declare it.

Dozens of staff at PEI's Murphy Hospitality Group – possibly as many as 200, management says – received letters from the Canada Revenue Agency in January, accusing them of low-balling the gratuities they earned in 2014 and 2015. The agency is claiming some individuals failed to declare as much as tens of thousands of dollars – and is asking for back taxes on it, with potential further financial penalties of up to half of what's owed. A number of service staff reached out to The Globe and Mail to signal their frustration with what they believe was a sudden shift in the CRA's enforcement tactics.

Canada's tax-collection agency insists it's simply making sure all Canadians pay their fair share of taxes. The Murphy Hospitality Group staff's stress, though, is amplified by the chain's dominance in the small province – and it draws attention to the changing ways in which service-industry workers' tips can be accounted for, and in turn how much effort they must now put into determining their real income.

The dominance of debit and credit in today's payment ecosystem means tips are easier than ever to track. In an e-mailed statement, CRA spokesperson Etienne Biram said the agency "conducts a number of review activities" each year to assess whether taxpayers are complying with the law, "to maintain the integrity of the Canadian tax system, as well as the confidence of Canadians in the fairness of the system. The hospitality sector is one of many sectors that the CRA addresses through its risk-based approach to identifying non-compliance. Audits related to this sector occur regularly across the country, and have for many years."

The Murphy chain employs hundreds across PEI and the Maritime provinces, including at Charlottetown's Gahan House and Brickhouse Kitchen & Bar. At the core of its servers' contention is a decades-old informal guideline used by many in the service world – that service staff should declare a small portion, often equivalent to 10 per cent of their official income, as gratuities on their tax returns.

When tips were mostly paid in cash, real figures were hard to confirm. But because of widespread debit and credit-card payments, exact tip figures can now be traced back through point-of-sales-machine records.

This kind of mass audit is not new – a similar case in St. Catharines, Ont., was reported earlier this decade – but payments have only become more digitized and trackable with time. The agency also conducts "lifestyle analyses," looking at factors such as property ownership to see whether a taxpayer's declared income is congruent.

The Murphy service staff who reached out to The Globe said they'd declared tips, but generally had been advised by someone at some point in their career – such as a colleague or family accountant who might not be familiar with the industry – to follow some variation of that guideline. But tax and service-industry experts warn that doing so today, when tips are so easily traceable, is asking for trouble.

"Before, it might not have made sense to go after a bunch of individual servers to make $1,000 on each one," says Paul Hewitt, a Toronto-based chartered professional accountant who ran restaurants for nearly 15 years and now advises a number of service-industry clients on tax and audit issues.

"But now you can go into one restaurant, get all the tip information and review all the servers at once."

Mr. Hewitt and other restaurant specialists, including the lobby group Restaurants Canada, recommend service staff keep detailed records of all gratuities they receive, as often as each shift, so they don't get dinged at tax time.

The Globe has seen three of the CRA letters, spoke to four affected current and former staff, and received correspondence from several others – all of whom asked not to be identified for fear of retribution from either the CRA or their employer.

While some workers recognized it was their mistake for not accurately reporting their tips, most expressed frustration about the CRA's execution: suddenly targeting the undeclared income of a concentrated group of primarily young, low-income workers from one geographic area.

The servers' employer is also confused by this approach. "There's bigger fish to fry – if they want to raise tax revenue, they can do it in other ways," said Ben Murphy, the Murphy Hospitality Group's chief operating officer, in an interview. "If they do decide that this is how they want to go about raising tax revenue, put out a letter and say, 'Starting in 2019, we're going to start enforcing this rule more strictly.'"

Many Murphy Hospitality Group staff are not sure how the CRA calculated the tips they earned in 2014 and 2015, and are just as unsure how to independently confirm such old details. If the figure came from point-of-sales machines, some staff argue, it's possible the assessments did not account for "tipping out" – the division of a night's tips to the rest of the service and kitchen staff – and were in turn inflated. (Asked about this, the CRA said "every taxpayer has an opportunity to provide written representations in response to a proposed tax reassessment.")

At least one server worries the financial penalties mean she won't be able to afford to go back to school next year. Some are concerned that repayments will mean they'll be priced out of Charlottetown's rapidly tightening rental market. Others fear bankruptcy, or at least years of struggle to keep up with the costs of newly bought homes or young families.

The CRA's language about financial penalties in the letters is vague, including that it was "considering" imposing penalties of up to 50 per cent of the tax owed on omitted earnings, further confusing the staff. But the agency spokesperson said each case is considered independently.

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