Handling disputes with the Canada Revenue Agency: The audit phase

By Adam Aptowitzer, Drache LLP - Tax, Estates & Charity Law, Ottawa June 26, 2006 Since June 2005, the Canada Revenue Agency (CRA) has had the power to impose penalties on charities for breaking certain rules which stop short of revoking the charity's registered status. These intermediate penalties range from a $500 penalty for not filing a charitable information return, to paying 110% of an undue benefit bestowed upon a third party. (I have outlined these intermediate sanctions in a previous article). In addition to new penalties, there is also a new way of appealing such a penalty. This new system of dispute resolution is the same system used by individuals and corporations when the agency reassesses them for tax and/or penalties. The new system first requires an appeal to the CRA's internal Appeals Division, and if unsatisfied with the Appeals Officer's decision, it is open to the taxpayer to appeal to the Tax Court of Canada. As charities are generally unfamiliar with this new process, it is critical for them to become aware of every step that might be taken by the CRA, and what their rights and responsibilities are in fighting a possible intermediate penalty. In order to fully explore the charities options, this will be the first of a three part series of articles dedicated to informing charities of their rights and responsibilities under the new system. Choosing which charity to audit The process generally begins with a CRA audit of a charity. The agency has several factors that go into choosing which charities to audit. If the system regarding individuals and corporations is any indication, the CRA will use news reports, snitch-lines, sector specific sweeps and random statistical means to choose which charities to audit. It is also likely the CRA will red-flag the charitable information return - the T-3010 - to audit charities that report extraordinary items. Once a charity is chosen to be audited, the CRA may begin by collecting information without informing the charity. This may include a review of the different information returns that have been submitted by the charity. It may also include a collection of the donation tax receipts that have been included in the income tax returns of donors, or reviews of related charities either in Canada or overseas. Obviously, there is little charities can do to stop the CRA from collecting whatever information it wants, especially if that information has already been submitted to the CRA by both the charity and the donors. After the collection of information from outside sources, the CRA may contact the charity. This contact may come by way of an informal call from a CRA auditor or it may be an official request for information that would require the charity to produce all of its books and records within a specific time, usually within 30 days. The charity does not have to comply with an informal request but if the auditor does not get the required information by informal means then he or she may issue a formal legal request. The decision to cooperate with an informal request should not be coloured with the idea that if one is cooperative with the CRA then they will "go easy" on the charity. CRA auditors

have a job to do and past experience has shown that they will apply the Income Tax Act regardless of whether or not the charity has helped make their job easier. Thus, the appropriate response to an informal request is to ask for a formal request for information, this will outline exactly what the CRA needs and can be provided for them within the time period allotted. Your rights and how to enforce them A formal request may state that the items are to be brought to the CRA offices; this is not necessarily a requirement under the Income Tax Act. You may wish to have the auditor review the documents on your premises. Indeed, in fulfillment of Parkinson's Law that work expands to fill the time allotted to it, when the CRA has unlimited access to a taxpayer's documents it takes far longer to resolve an issue. Moreover, experience has shown that the CRA is not above losing documents. However, if the charity does provide documents so the CRA can review them at their offices, the CRA should provide an inventory of documents that are in their possession. Inventory lists should be as detailed as possible to avoid disputes as to which documents are actually in the CRA's possession. During the course of the audit, the auditor may have additional questions that must be answered in order for the audit to be completed. Depending on the issue, it may be wise to ask the auditor to record their questions on paper for a full documented response. It must be remembered that the absence of information or the collection of inaccurate information may find its way into an audit and result in more difficulty resolving issues later. So, to ensure that information is as complete and accurate as possible, and at the earliest possible stage, questions and answers should be recorded in documentary form. Moreover, answers should be provided by knowledgeable personnel (or the charity's lawyer), not by individuals who may simply be guessing and providing inaccurate information. What happens after the audit? Once the auditor has completed his/her audit he/she will produce a letter outlining the proposed assessment of penalties. The purpose of this letter is to provide the charity with a chance to correct any misconceptions or inaccurate information or to argue on the basis of principle that the auditor has made a mistake of law and the penalty should not be levied. It is critical at this stage not to admit guilt (unless you want to accept the consequences); the reason for this is that all documents may become evidence against the charity in court. Another option for a charity may simply be to remain unresponsive to the auditor's position. The audit stage is fluid and if the auditor can be convinced their position is wrong they may try to find another way to attack the charity. If that is the case, then it might be best letting a weak or false argument by the auditor through to the Appeals Officer. At this stage, the mandate of the officer is simply to determine the merit of the assessment, not necessarily to find a justification for it. (The next article in this series

deals with the appeals stage in more depth). Hence, it might be easier to fight off an audit at the appeals stage. This strategy must only be undertaken with experienced professional advice. It is a dangerous game to play chicken with a CRA auditor in the hopes that the arguments will be dismissed at the appeals stage. If the charity does decide to respond to the auditor's letter, it can request an extension of time to do so. Often an auditor states a response is required within 30 days but the charity should not fear asking for an extension. The letter should only deal with the issues raised by the auditor and even then must be a persuasive letter written with reference to the appropriate sections of the Income Tax Act and case law. The letter can and should be written to the attention of the auditor. However, if the charity and the auditor are going to go back and forth on a particular issue and the charity is finding that the auditor is less then responsive (or outright hostile), the charity has the option of requesting a meeting with the auditor's supervisor or simply providing the auditor's supervisor with a copy of the correspondence and the letter illustrating the problems. The obvious hope is that the auditor's supervisor will recognize the charity's concerns and either overrule the auditor or simply appoint a new one. When the auditor has finished the audit, he or she will provide the charity with a letter stating its position. The charity will then receive a Notice of Assessment or Reassessment formalizing the CRA's decision on the matter. At this point the process enters the Appeals stage. This will be dealt with in more detail in my next article. This article first appeared in Charity Law Insights, a law newsletter for charities and not-for-profits. It is reprinted with permission. Adam Aptowitzer distributes the above information on the understanding that it does not constitute legal advice or establish the solicitor/client relationship by way of any information contained herein. The contents are intended for general information purposes only and under no circumstances can it be relied upon for legal decisionmaking. This article is current only as of the date above and does not reflect any subsequent changes in the law. Readers are advised to consult with a qualified lawyer and obtain a written opinion concerning the specifics of their particular situation Changes to Charity Rules Adam Aptowitzer, January 30, 2006 The advent of 2006 will bring with it the fulfillment of several proposed changes that affect charities and which have been promised or in the planning stages for some time. Considering that the Charities Directorate is more determined and more capable than ever to be an effective enforcer of the law it is important for charities to have a basic idea of the changes in store for them. Here are the five changes charities should keep in mind as we begin the New Year. 1) Changes to Receipts In addition to the information required on charitable receipts prior to 2005, receipts issued after the beginning of 2005 are also required to show The “Canada Revenue Agency” and “http://www.craarc.gc.ca/charities”. The new development for 2006 is that while the CRA has stated they will not penalize charities for not including the information for receipts issued in 2005,

they “expect” charities to conform to the new regulations by January 1, 2006. 2) Intermediate Sanctions Before the passing of Bill C-33 last year, the CRA’s sole punishment for a charity that broke the rules was deregistration. As the penalty was too draconian for anything but the most severe infractions it was rarely imposed by the CRA. Bill C-33 implemented a variety of lesser penalties for infractions (although deregistration still remains an option of the CRA). This year will likely see the first impositions of these penalties. Below is a chart of the new penalties. See Penalties Chart in PDF format 3) New Tax Dispute Resolution Mechanism Starting in June 2005, (although practically speaking 2006 will likely see the first cases), the tax dispute resolution mechanism for individuals and corporations will apply to charities. The process of levying a penalty will likely begin with an audit of the charity. Where the CRA sees fit to levy a penalty, the charity will receive an official Notice of Assessment. If the charity objects, it will have 90 days to file a Notice of Objection with the CRA. In the normal course, the CRA will assign the file to an internal ‘Appeals Officer’ who will review the CRA’s position in light of any submissions made by the charity and included with its Notice of Objection. If the charity disagrees with the Appeals Officer’s decision, it will have 90 days to file a Notice of Appeal in the Tax Court of Canada. Appeals from the Tax Court go to the Federal Court of Appeal. Questions of registration/deregistration or annulment go straight to the Federal Court of Appeal. The imposition of a new deadline schedule on charities, a group otherwise unaccustomed to dealing with this dispute resolution mechanism, is bound to lead to confusion and missed deadlines. Fortunately, there are mechanisms that allow a charity to file beyond the deadline under certain circumstances. The imposition of these penalties is new for both the CRA and charities and therefore it is critical for charities going through the process to have a professional legal advisor from the audit stage through the Tax Court and Federal Court of Appeal level. 4) Disbursement Quota Changes The disbursement quota is a complicated calculation that stipulates how much each charity must spend on their charitable objects in a year. In 2005, the government passed changes to the disbursement quota that, among other things, further complicated the calculation and dealt with donations of ten year gifts, the definition of ‘enduring property’, and transfers between charities. As a charity's spending requirements for 2006 are based on amounts collected in 2005, this year will see the first impact of the changes in 2005. Given that it still lies with the CRA to deregister a charity that fails to disburse its quota, charities should speak with a qualified professional advisor to ensure that they have properly calculated the quota with the new changes. 5) Possible Implementation of Proposed Changes There are a variety of changes that the Liberal governments tabled in 2005 and preceding years, which are waiting official passage into law. Many of these relate to the use of tax shelters as a way to provide increased donation credits for donated dollars. The CRA policy is to begin enforcement of these provisions from the date of their announcement (when passed they are usually passed retroactive to their date of announcement). However, with the change in government it is possible that some of these provisions will not become law. The more cynical among us may argue that as there is no real difference between the Conservatives and Liberals on these issues, we will see the Conservatives pass the majority if not all of the provisions. However, if this analysis is wrong, we may see the entire sector thrown into disarray before the end of the year.

Infraction Failure to file Information Return Issuing of receipts with incomplete information

First Infraction $500 5% on the eligible amount of the receipt

Second Infraction 10% of the eligible amount on the receipt

Knowingly issuing or participating in the issuance of a false receipt

125% of the amount listed on the receipt or possible revocation

Transferring property to another charity to delay expenditures on charitable activities Knowingly accepting transferred property from a charity attempting to delay expenditures on charitable activities

110% of the fair market value of the property

Revocation

Charitable organization carrying on an unrelated business 188.1(1) Acquiring control of a corporation by a foundation s.188.1(3) Conferring an undue benefit on another individual, corporation or entity s.188.1(5)

5% of business’ gross revenue

100% of gross revenue

5% of all dividends received

100% of all dividends received

105% of the benefit conferred

110% of the benefit conferred

Audit Exemption for Ontario Charities Adam Aptowitzer, October 19, 2006 There seems to be much confusion around the requirements for the auditing of Ontario not-for-profit Corporations. By way of review, a charity can be either incorporated or unincorporated; an organization incorporated under the laws of Ontario would be required by the Corporations Act to arrange for yearly audits of the corporation's financial statements. On April 27, 2005, the Ontario Provincial Parliament introduced a bill which was intended to change the requirements for the audit of a Not-for-profit corporation’s financial statements. The proposed changes of the first reading of the bill are now irrelevant as the bill received royal assent on June 22, 2006 but the final version did not include any changes to the audit requirements currently listed in the Act. Under the old requirements any not-for-profit corporation with annual income of less than $10,000 and the written consent of all members of the corporation to forgo an audit could legally avoid auditing their financial statements. The exception to the exemption occurred where a corporation was incorporated for a religious, educational, charitiable or public purposes, then there was no choice about auditing. Effectively, this removed the exemption for corporations incorporated in Ontario and registered as charities with the Canada Revenue Agency. If your Charity is concerned about the audit requirements and meeting its obligations, please feel free to contact me at aaptowitzer@drache.com.

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