Anatomy of a Net Worth Assessment

ANATOMY OF A NET WORTH ASSESSMENT

David E. Graham

Introduction
The "net worth assessment" is one of the many audit tools available to the Canada Revenue Agency
(the "CRA"). While the CRA has been using net worth assessments for decades, their use has
become increasing common in recent years. 1
If done properly, a net worth assessment is very difficult for a taxpayer to challenge. If done poorly,
a net worth assessment has the potential to tax, or even double tax, a taxpayer on non-existent
income.
In an environment in which net worth assessments are being applied more frequently, it is
important for practitioners to understand exactly how net worth assessments work and what
options may be available for their clients to fight them. This paper attempts to provide that
information to practitioners. It examines the following 12 topics:
(i) what a net worth assessment is;
(ii) when net worth assessments are used;
(iii) the specific elements of a net worth calculation;
(iv) what gets missed in a net worth assessment;
(v) negative net worth assessments;
(vi) net worth assessments involving couples;
(vii)net worth assessments involving a closely held corporation;
(viii)the GST issues involved in a net worth assessment;
(ix) options for attacking a net worth assessment;
(x) gross negligence penalties and net worth assessments;
(xi) tax evasion and net worth assessments; and
(xii)other arbitrary assessment techniques. |

What Is A Net Worth Assessment?

A net worth assessment is an audit tool that the CRA can use to determine a taxpayer's income
over one or more years. It has been described by the courts as "an arbitrary and imprecise
approximation of a taxpayer's income" 2 and "a blunt instrument, accurate within a range of
indeterminate magnitude" 3.
Traditional accounting techniques determine a taxpayer's income from the top down. First, the
taxpayer's sources of income are identified. Then, the taxpayer's income is calculated by
quantifying the revenue and expenses related to those sources.
By contrast, net worth assessments determine a taxpayer's income from the bottom up. A net worth
assessment starts with the changes in the taxpayer's overall financial circumstances in the tax year
and works backward to determine his or her income 4. When using a net worth assessment, the
Minister of National Revenue (the "Minister") does not have to identify the source of the taxpayer's
income, only the fact that there is income 5.
Taxpayers have only 3 potential uses for their income:
(i) acquiring assets;
(ii) reducing liabilities; and
(iii) making personal expenditures.
At a primary level, net worth assessments are based on the theory that if the CRA could determine
how much money a taxpayer spent on these three items in a given year, they would know how
much income the taxpayer had in that year. |
The CRA makes this determination using a net worth calculation. The formula for a net worth
calculation can best be described as follows:

By comparing the taxpayer's net worth (i.e. assets less liabilities) at the beginning of the tax year
with his net worth at the end of the tax year, the CRA is able to determine how much money the
taxpayer has used to acquire assets and reduce debt during the year. By adding the taxpayer's
personal expenditures during the year to the increase in the taxpayer's net worth, the CRA is able
to determine the total amount of additional money that the taxpayer must have had available to
him during the year.
However, having determined the total additional money that was available to the taxpayer, the
CRA cannot simply assume that that money represents the taxpayer's taxable income for the
year. The income tax system is far too complicated for that. Before the CRA can determine the
taxpayer's taxable income, they must first make a number of what are best described as "Tax
Related Adjustments". These "Tax Related Adjustments" are discussed in more detail in Part of
this paper. They include reductions in income to account for non-taxable sources of income such
as lottery winnings and increases in income to account for the tax that arises when funds are
withdrawn from an RSP.
The following example illustrates the very basic workings of each of the elements of a net worth
calculation.
Example #1:
Facts: At the end of the previous tax year, Mr. X had $30,000 in the bank. His only liability was
a $20,000 student loan. At the end of the tax year under audit, he still had $30,000 in the bank,
but he had acquired a $5,000 car and his student loan had | been reduced to $18,000. Mr. X
had personal expenditures of $6,000 over the tax year under audit and received a gift from his
grandmother of $2,000.
Analysis: Applying a net worth calculation, Mr. X must have earned $11,000 in income. His net
worth increased by $7,000 over the year and he spent $6,000 on personal living expenses. This
would indicate that he had $13,000 in income to fund those changes in his financial
situation. However, $2,000 of those changes were paid for using the gift from his
grandmother. Because gifts are non-taxable, his taxable income must be reduced to only
$11,000. The net worth calculation is set out below:

The following example demonstrates how a net worth assessment works over a number of years.
Example #2:
Facts: Same as Example #1 but, at the end of the second tax year under audit, Mr. X had $40,000
in the bank, had reduced his student loan to $15,000 and had spent $7,000 on personal
expenditures.
Analysis: Applying a net worth calculation, Mr. X must have earned $20,000 in income in the
second tax year. His net worth increased by $13,000 between the first year and the second
year and he spent $7,000 on personal expenditures in his second year. This | would indicate
that Mr. X had $20,000 of income to fund those changes. There were no Tax Related
Adjustments in the second audit year. The net worth calculation is set out below: |
When Are Net Worth Assessments Used?
The CRA's authority to use net worth assessments comes from section 125(7) of the Income Tax
Act (Canada) (the "ITA"). That section reads:
"The Minister is not bound by a return or information supplied by or on behalf of a taxpayer
and, in making an assessment, may, notwithstanding a return or information so supplied or
if no return has been filed, assess the tax payable under this Part."
The CRA generally uses net worth assessments in 4 situations:
(i) Inadequate Books and Records: A net worth assessment is often used out of necessity
when a taxpayer either has no books and records 6, refuses to provide her books and records
7
or has books and records that are so poor that it is not possible to use them to audit her
income adequately. 8|
(ii) Lifestyle Audit: A net worth assessment is also often used when external evidence of the
taxpayer's lifestyle indicates a level of income that is much greater than that which could
be supported by the amount of income shown on the taxpayer's tax return 9. For example,
if a taxpayer is living in an expensive neighbourhood and driving a luxury vehicle but is
reporting only $10,000 of income per year, it may indicate that he has unreported
income. While there may be a reasonable explanation for this apparent discrepancy, at first
blush, this is the type of situation in which the CRA would consider a net worth assessment.
(iii) Unreported Sources of Income: If the CRA believes that a taxpayer has a specific source
of income other than those reported on her tax return, they may use a net worth assessment
10
. This is particularly true if the suspected source is a cash business. For this reason, net
worth assessments are commonly used where the CRA knows or suspects that the taxpayer
is involved in illegal activities (e.g. drug dealing).
(iv) Under Reported Source of Income: If the CRA believes that a taxpayer is only reporting
part of his income from a specific source, they may use a net worth assessment to catch the
unreported income 11.
Elements Of A Net Worth Calculation
There are 4 essential elements to a net worth calculation:
(i) assets;
(ii) liabilities;
(iii) personal expenditures; and
(iv) tax related adjustments.
Each of those elements is discussed in detail below. |

Assets
The first step in performing a net worth calculation is to determine the taxpayer's assets at the
beginning of the audit period and at the end of each year during the audit period.
There are 3 issues that need to be considered when compiling a taxpayer's assets for a net worth
calculation:
(i) how should the assets be valued;
(ii) how should improvements to the assets be reflected; and
(iii) how should specific types of assets be handled.

Valuation:
Under the ITA, taxpayers are generally not taxed on changes in the value of their assets until they
dispose of them. Because of this, assets are shown in a net worth calculation at their adjusted cost
base ("ACB"), not their fair market value ("FMV").
The following example illustrates why FMV should not be used.

Example #3:
Facts: At the beginning of the audit period, Ms. Y owned a building with a fair market value
("FMV") of $600,000. At the end of the first year of the audit, the FMV was $700,000. At the
end of the second year of the audit, the FMV was $1,000,000. Ms. Y had a $75,000 mortgage
on the building. She spent $12,000 on personal expenditures each year.
Analysis: If Ms. Y's net worth calculation were prepared using FMV, she would have substantial
income in each tax year. This is because the fluctuation in the FMV of the building from year
to year would cause Ms. Y's net worth to fluctuate which would indicate that she had
income. The net worth calculation is set out below: |
 Clearly, this would not be a reasonable method of determining Ms. Y's income. She would
be being taxed on gains on property that she has not disposed of.
The following example illustrates why it is appropriate to reflect assets at their ACB instead of
their FMV.
Example #4:
Facts: Same as Example #3. Ms. Y purchased the building for $100,000 five years ago.
Analysis: If Ms. Y's net worth calculation were prepared using ACB instead of FMV, it would
accurately determine her taxable income to be the $12,000 she spent on personal expenditures
each year. The net worth calculation is set out below: |

Example #4 illustrates the fact that assets should be included in a net worth calculation at their
ACB. It also illustrates that it is actually irrelevant what value is used for an asset that is owned
throughout the entire audit period, so long as the amount included remains the same throughout
the audit period. For this reason, many auditors will simply reflect assets that are owned
throughout the audit period as being worth $1.00. In the following calculation, we can see that
using a value of $1.00 for the building in Example #4 instead of the $100,000 ACB has no effect
on Ms. Y's taxable income.
Although it may be convenient to carry an asset at a value of $1.00, if the asset is disposed of
during the audit period, it will be correctly taxed only if it is carried in the net worth calculation at
its ACB. The following example illustrates a disposition of an asset.

Example #5:
Facts: Same as Example #4 except that Ms. Y sold the building in the second audit year for
$1,000,000. She repaid the mortgage and deposited the remaining $950,000 of net proceeds in
her bank account.
Analysis: We know that Ms. Y bought the building for $100,000 and sold it for $1,000,000.
Therefore, the net worth calculation should show her as having earned $900,000 in income
plus her living expenses. That is exactly what the net worth calculation shows by carrying the
building at its ACB. The net worth calculation is set out below:

prior year end year end

year end audit year 1 audit year 2
assets
building (ACB) $100,000 $100,000 —
bank account — — $950,000
liabilities
mortgage ($75,000) ($75,000) —
net worth $25,000 $25,000 $925,000
change in net worth — $900,000
personal expenditures $12,000 $12,000
tax related adjustments — — 12
income $12,000 $912,000 |

Improvements:
Improvements to assets should be shown in a net worth calculation as an increase in the carrying
value (i.e. ACB) of the asset.

Types of Assets:
In conducting a net worth assessment, the CRA should consider all of the taxpayer's business and
personal assets. It is particularly important for a taxpayer to ensure that the CRA has included all
of the taxpayer's assets in the opening net worth calculation.
Most assets are relatively easy to deal with. The following is a discussion of some of the more
difficult types of assets:
(i) Cash-On-Hand: Auditors generally ignore cash-on-hand as an asset unless there is a
notable difference in the amount of cash held by a taxpayer at the beginning and end of the
audit period. If a taxpayer had a significant amount of cash-on-hand at the beginning of the
audit period and that cash did not exist at the end of the audit period, that difference may
have a significant effect on her net worth and, thus, on her income. Unfortunately,
taxpayers are generally unable to substantiate the amount of cash that they had on hand at
any given time 13. Some taxpayers are also reluctant to tell the CRA about their cash-on-
hand, so the asset simply gets excluded from the net worth assessment. Taxpayers who are
able to prove that they had a large amount of cash-on-hand at the beginning of the period
may need to account for what happened to it if they want the CRA to believe that they did
not continue to have a large amount of cash-on-hand at the end of the audit period.
(ii) Brokerage Accounts: Brokerage accounts are a complex type of asset. The entire account
cannot simply be included in a net worth calculation based on the value of the account at
year end. This is in part because the year end value represents FMV rather | than ACB. It
is also because a brokerage account generally contains a number of different assets (e.g.
stocks, bonds and cash) and liabilities (e.g. margin) as well as gains and losses from trades
that need to be taxed at the capital gains inclusion rate. In my view, the appropriate way
to deal with a brokerage account in a net worth assessment is to treat each investment in
the account, the cash in the account and any margin in the account as a separate asset or
liability, as the case may be, and to adjust for the capital gains inclusion rate as necessary
in the Tax Related Adjustments portion of the net worth calculation. A detailed example
showing how a net worth calculation involving a brokerage account works is attached as
Schedule "A" to this paper.
(iii) RSPs: RSPs are a unique asset since income earned within the RSP is not taxable and,
thus, does not need to be tracked. The only thing that needs to be tracked in the net worth
calculation is contributions to and withdrawals from the RSP. The RSP should be shown
on the net worth assessment as an asset with an opening value of nil 14. Contributions to the
RSP should be shown as increases in the value of that asset 15. Withdrawals from the RSP
should be shown as reductions in the value of that asset 16. Withdrawals from the RSP and
the related withholding tax should be added to the taxpayer's income in the Tax Related
Adjustments.
(iv) Loans Receivable: Taxpayers should remember to include debts owed to them by friends
and family in the opening assets of a net worth calculation. Otherwise, when these debts
are repaid, they will appear to be income.
(v) Depreciable Business Assets: Depreciable business assets should be reflected at their
UCC each year. This approach has the effect of indirectly allowing the taxpayer a |
deduction for CCA. This is because, if the assets in the pool remain the same each year,
the UCC would decrease as CCA is claimed. The decrease in the UCC would be a decrease
in an asset. A decreasing asset would result in a lower net worth which, in turn, would
 result in lower income. Thus, carrying depreciable business assets at their UCC would
have the same result as carrying them at cost and allowing a separate deduction for CCA
17
. A detailed example of a net worth calculation involving a depreciable business asset is
attached as Schedule "B" to this paper.
(vi) Accounts Receivable: It is important to remember to include accounts receivable in a
taxpayer's opening business assets. Net worth assessments are calculated on a cash basis,
not an accrual basis. Therefore accounts receivable should be included in the taxpayer's
opening assets as they represent income that was presumably reported in a period prior to
the audit period. If the accounts receivable were not listed as an opening asset and they
were collected, the taxpayer would appear to have received income rather than simply
having changed one asset (i.e. the accounts receivable) to another, such as cash. Of course,
in the same way that a taxpayer would want to include accounts receivable in his opening
business assets, the CRA would want to include accounts receivable in the taxpayer's
closing business assets.
(vii)Uncashed Cheques: Uncashed cheques representing business income reported in a prior
period should be included in a taxpayer's opening business assets 18. Similarly, the CRA
would want to include uncashed cheques at the end of the audit period in closing business
assets.
(viii)Inventory: Taxpayers sometimes forget to include inventory in their opening business
assets. The expenditures associated with the inventory would have been deducted in the
previous reporting period. Therefore, if the inventory were not listed as an opening asset,
and it were sold, the taxpayer would appear to have received income rather than simply
having changed from one asset (i.e. the inventory) to another, such as cash. Of | course,
taxpayers should expect the CRA to want to include inventory in their closing assets in
order to reflect the fact that the expenditures the taxpayer claimed to have made to purchase
the inventory were, in fact, used to acquire an asset. All that said, in practice, unless there
were reason to believe that there was a substantial difference between opening inventory
and closing inventory, the CRA would often simply assume that the year end inventory
was the same in all years and ignore it as an asset.

Liabilities

Categories of Acceptable Liabilities:

Only the following 4 categories of liabilities should be included in a net worth calculation:
(i) liabilities that existed at the beginning of the audit period (e.g. an outstanding mortgage
from prior years);
(ii) liabilities that arose from the acquisition of assets during the audit period (e.g. a car loan);
(iii) liabilities that arose from paying other liabilities during the audit period (e.g. a line of
credit taken out to pay a credit card debt); and
(iv) liabilities that arose from personal expenditures during the audit period (e.g. a credit card
debt).
Very few liabilities do not fall into one of these 4 categories. Two examples of liabilities that do
not fall into these categories are fines and judgments that arose during the audit period. The reason
for excluding those types of liabilities can best be seen through some examples. The first example
simply sets a basis for comparison. It covers a liability that existed before the audit period.

Example #6:
Facts: At the end of the previous tax year, Ms. Y had $20,000 in the bank and her only liability
was a $10,000 fine payable. At the end of the tax year under audit she still had $20,000 in the
bank but she had paid $2,000 of her fine. Ms. Y had personal | expenditures of $5,000 in the
tax year under audit. Ms. Y's only source of income was $7,000 in T4 income.
Analysis:A net worth calculation confirms that Ms. Y's income was $7,000: $2,000 that she used
to reduce the fine payable and $5,000 that she used to cover her personal expenditures. The
fine payable was included in the net worth calculation because it fell into the first category of
acceptable liabilities: liabilities outstanding at the beginning of the audit period. The net worth
calculation is set out below. |

By changing the example, we can see why liabilities that fall outside the 4 categories should not
be included in a net worth calculation.

Example #7:
Facts: Same as Example #6 but, during the tax year under audit, Ms. Y cut down her neighbour's
tree. Her neighbour successfully sued Ms. Y for $3,000 in damages such that, at the end of the
tax year under audit, Ms. Y had a judgment payable of $3,000.
Analysis: If we included this new liability in Ms. Y's net worth calculation, Ms. Y's income would
be reduced to $4,000 because the increased liability would have decreased her net worth. The
net worth calculation is set out below. |
 This outcome is illogical. The fact that Ms. Y owed her neighbour $3,000 had nothing to
do with her income. The $3,000 judgment does not fit into any of the 4 categories: it did
not exist at the beginning of the audit period; and it did not arise from an asset that Ms. Y
acquired, from another liability that she reduced or from money she borrowed to pay her
personal expenditures. It is a liability that arose out of nothing. Accordingly, it should be
excluded from Ms. Y's net worth calculation.
Liabilities such as Ms. Y's $3,000 judgment in the above example should be reflected as personal
expenditures in a net worth calculation when they are paid. This is illustrated by the following
example.

Example #8:
Facts: Same as Example #6 but, Ms. Y pays the $3,000 judgment in the tax year under audit
using money from her bank account.
Analysis: Ms. Y's income is still the $7,000 that we know to be her T4 income. The payment of
the judgment is reflected in the determination of that income by showing a lower bank balance
and increased personal expenditures. The net worth calculation is set out below. |

prior year end audit year end

assets
bank account $20,000 $17,000
liabilities
fine payable ($10,000) ($8,000)
net worth $10,000 $9,,000
change in net worth ($1,000)
personal expenditures $8,000 19
income $7,000

Based on Example #8, we can see that liabilities that were paid during the audit period but that
were not caught by the 4 categories of acceptable liabilities should not be treated as liabilities in a
net worth calculation. They should be treated as personal expenditures in the year in which they
were paid.

Types of Liabilities:
In the same way that a taxpayer should ensure that her opening net worth calculation reflects all
of her assets, she should also ensure that her closing net worth calculation reflects all of her
liabilities.
Once you determine whether a liability falls into one of the 4 categories of acceptable liabilities,
most liabilities are relatively easy to deal with. The following is a discussion of some of the
common issues that arise with liabilities:
(i) Loans: Loans should only be adjusted in a net worth calculation to show advances, unpaid
interest and repayments of principal. Interest payments should be reflected under personal
expenditures. Taxpayers should not forget to include loans from friends and family in their
closing liabilities although they should expect to have to provide evidence from those
individuals that the loans were made. |
(ii) Credit Card Debts: It is important to show unpaid credit card debts in the closing
liabilities of a net worth calculation. Unpaid credit card debts generally represent amounts
owing for personal expenditures. If the personal expenditures from the credit card have
been included in the net worth calculation, but they have not actually been paid yet, they
must be shown as a liability in the net worth calculation or the taxpayer's income would be
too high.
(iii) Contingent Liabilities: Contingent liabilities should not be reflected in a net worth
calculation 20.
(iv) Business Accounts Payable: A taxpayer's business accounts payable should be included
in his net worth calculations. The net worth calculation would have indirectly accounted
for the related business expenses and would have assumed that they were paid using a
source of funds 21. Failing to reflect the fact that they were not paid would indirectly cause
the taxpayer to be taxed on income he or she did not have.
(v) Income Tax Debts: Income tax debts should be ignored as liabilities. This is true even if
they existed at the beginning of the audit period 22. The reason for this exclusion is that the
CRA chooses to treat income tax payments as personal expenditures in the year in which
they are paid so also treating them as a liability would result in double counting when the
liability was reduced. 23|
(vi) Payroll Tax Debts: Payroll withholding tax debts should always be included in a net
worth calculation as a liability as they are essentially business accounts payable.
(vi) GST Debts: The impact of GST related debts is discussed detail in Part of this paper.

Personal expenditures
The third element of the net worth calculation is the taxpayer's personal expenditures. Personal
expenditures may have been funded by disposing of assets, by incurring liabilities or by using
income earned during the year. Thus, to get a complete picture of the year-over-year changes in
the taxpayer's financial situation, personal expenditures must be included in the net worth
calculation.
The following discussion describes the 3 most common methods the CRA uses to determine a
taxpayer's personal expenditures. Following that discussion is an explanation of why only
personal expenditures are included, while business expenditures are not.
During an audit, the auditor will generally ask a taxpayer to estimate his or her personal
expenditures for each year. Taxpayers should be careful to think through their estimates as it may
be difficult to adjust them later without having their credibility questioned.
If the auditor does not accept the taxpayer's estimated personal expenditures, the auditor will
generally use one of the following 3 methods to estimate the taxpayer's personal expenditures:
(i) Statistics Canada averages;
(ii) a withdrawal analysis; and
(iii) a combination of the above techniques. |

Statistics Canada Averages:

The CRA will often determine a taxpayer's personal expenditures using average expenditures made
by people the taxpayer's age living in the same family situation. The CRA obtains these average
expenditures from Statistics Canada. This approach has been accepted by the Tax Court 24
although, not necessarily always without reservations 25. These average figures are broken down
into specific categories of expenses (e.g. groceries; books and magazines; hygiene). The CRA will
generally use Statistics Canada averages if there is no other information available to determine a
taxpayer's personal expenditures, if the available information is inadequate or if the estimates of
personal expenditures supplied by the taxpayer lack credibility.
The Statistics Canada approach could either hurt or help a taxpayer depending on his or her
circumstances. A taxpayer who spends lavishly would be taxed less than he or she should be,
whereas a taxpayer who scrimps and saves would be taxed more heavily.
Taxpayers should consider a number of factors in dealing with an assessment of their personal
expenditures based on Statistics Canada averages:
(i) Correct Category: It is important for practitioners to determine whether a taxpayer has
been placed in the correct statistical category. 26
(ii) Difference From the Norm: It is also important to determine whether the taxpayer differs
from the norm in any of the categories. For example, a single taxpayer who lives with 4
friends, would most likely pay less rent than the statistical average for a single person.
Similarly, a taxpayer who neither smokes nor drinks should not be taxed as if she does. The
Statistics Canada averages are national averages. A taxpayer should consider whether costs
are different in her local region. |
(iii) Reimbursement: It is also important for a taxpayer to consider whether any of her
expenses were paid by someone else. For example, if the taxpayer's boyfriend picks up the
bill whenever they eat out, the taxpayer should not be assessed based on the average
entertainment expense.

Withdrawal Analysis:
A withdrawal analysis is another method that the CRA uses to determine a taxpayer's personal
expenditures. Its use is becoming increasingly common. A withdrawal analysis is based on the
theory that a taxpayer's personal expenditures may best be tracked by examining his or her bank
records and credit card bills.
In a withdrawal analysis, the auditor review the bank statements for any cheques or debit card
payments that can be identified as having been expended to purchase services, consumables or
smaller assets that have not already been included in the taxpayer's net worth calculation. The
auditor conducts a similar review of the taxpayer's credit card statements. The expenses are totaled
and are assumed to be the taxpayer's personal expenditures.
The following example illustrates that, when properly performed, a withdrawal analysis can
provide a realistic picture of a taxpayer's income.

Example #9:
Facts: Ms. M starts the year with $1,000 in her bank account. Her only source of income is
$10,000 in T4 income. She deposits that income into her bank account. During the year, she
uses her debit card to purchase $1,000 of groceries and her credit card to rent $500 of
movies. She pays her credit card debt from her bank account. At the end of the year, Ms. M's
bank account balance is $9,500.
Analysis: Ms. M's income should be equal to her $10,000 in T4 income. That is exactly the figure
that is calculated using a withdrawal analysis as part of the net worth assessment. The
calculations are set out below. |

Practitioners need to be aware of a number of risks associated with a withdrawal analysis:

(i) Business Expenses: It is important to remove expenses from the withdrawal analysis that
are business expenses. This assertion is true regardless of whether the taxpayer has claimed
those expenses in filing his tax return or not. In general, business expenses are ignored in
a net worth assessment because they would have no net effect on taxable income. The
reason for ignoring business expenses is discussed in more detail under Business Expenses
below.
(ii) Reimbursements: Taxpayers should consider whether they might have been reimbursed
for various expenditures that they incurred for others. For example, a taxpayer may have
purchased $10,000 of flights and accommodation for a family reunion in Florida but may
have then been reimbursed for $8,000 of that cost by his siblings. In those circumstances,
the taxpayer's personal expenditures should only be increased by $2,000.
 (iii) Liability Reductions: Practitioners should determine whether expenditures made near the
beginning of the audit period were paid to reduce liabilities that were outstanding at the
beginning of the audit period. For example, assume the taxpayer had a $1,500 phone bill
outstanding at the beginning of the audit period and that bill were shown as an opening
liability on the taxpayer's net worth calculation. If the payment of that bill | were captured
as a living expense, the taxpayer would be taxed twice on the same amount: once for the
reduction in the liability and once for the living expense.
(iv) Returns: If a taxpayer purchases an item using a debit card and then later returns that
item, the taxpayer's bank account will not reflect the fact that the personal expenditure was
not actually made. Accordingly, taxpayers should consider whether any larger items they
purchased during the audit period were returned.
(v) Cash Withdrawals: Cash withdrawals should not be included in a withdrawal
analysis. Unfortunately, the CRA does not always share this view. The CRA's approach is
often to include cash withdrawals as part of a withdrawal analysis unless the taxpayer can
explain where the money went. This approach can result in double counting. If a taxpayer
withdraws cash from his account, he could have spent it personal expenditures, but he could
also have spent it on any of the following:
• business expenses;
• acquiring assets that are already reflected in the net worth calculation;
• reducing liabilities that are already reflected in the net worth calculation; or
• transferring funds to another account 27.
If the cash withdrawal had been spent on any of the above, including it in the taxpayer's
personal expenditures would result in double taxing the same income.
This point was well articulated by Justice Archambault in Léger v. The Queen 28 :
"In my opinion, the unexplained withdrawals that the Minister used to make adjustments
must be excluded from the net worth calculation. It seems to me that those adjustments
are redundant, since I consider it possible that some of the assets acquired during the
relevant period were financed in part using those unexplained | withdrawals. One
example I can give is the purchase of a car: the contract of sale states that the price was
paid in cash.
Some of the withdrawals — amounts ranging from $150 to $500 — may have been used
to pay for groceries or meals in restaurants, but the Minister's calculations already
include an addition for 'personal expenses'. Some of the withdrawals may also have been
used to make the advances to the four subsidiaries. Part of the withdrawals may have
been financed using the line of credit. Moreover, the auditor was unable to determine to
what extent the withdrawals may have been used to repay the line of credit or included
in subsequent deposits.
Generally speaking, it strikes me as highly questionable to add unexplained withdrawals
in computing unreported income using the net worth method. The risk of some of a
taxpayer's assets being counted twice is too high." [emphasis added]
If an auditor believes that large amounts of cash have been withdrawn to cover personal
expenditures and that these personal expenditures have not been shown in the net worth
calculation, the auditor could always use a different audit technique such as a deposit
analysis that is designed to catch money flowing through a taxpayer's bank account. The
deposit analysis technique is described briefly in Part of this paper.
 (vi) Credit Card Payments: Some auditors will try to avoid reviewing each entry on the
taxpayer's credit card statements by simply assuming that any payments made from the
taxpayer's bank account to her credit card represent personal expenditures. However, if
the auditor does not review the credit card expenses individually, the taxpayer risks having
inappropriate amounts added to her income. There is a risk that business expenses paid for
by credit card could be included in personal expenditures. There is also a risk that there
could be double taxation of payments made against credit card debt | that was outstanding
at the beginning of the audit period 29. Finally, there is a risk that the taxpayer could be
taxed on cash advances. For this reason, each credit card entry should be reviewed
individually.

Combined Method:
Frequently, auditors may choose to combine the Statistic Canada averages and withdrawal analysis
methods to determine a taxpayer's personal expenditures. In this combined approach, the Statistics
Canada figures are used for each category of expenses unless the withdrawal analysis indicates
that expenditures in that category were greater than the average.
There are 2 risks to this approach:
(i) Combined Categories: Some stores offer products that cover a number of expense
categories. For example, most grocery stores sell not only food, but also medicine, flowers
and hygiene products. Some larger grocery stores also sell clothing and toys. Each of
these items is commonly shown as a separate living expense category in a Statistics Canada
calculation. If the withdrawal analysis shows a significant amount of money being spent at
one of these types of stores, the taxpayer needs to be careful that the cost is not simply all
lumped into the food category while leaving the Statistics Canada averages in the other
categories. A reasonable solution would be to pool the categories.
(ii) Personal Choice: The other risk associated with the combined Statistics Canada and
withdrawal analysis approaches is that it falsely assumes that the taxpayer is both just like
everyone else (the Statistics Canada figures) and an individual (the withdrawal analysis
figures). For example, assume the Statistics Canada's figures indicate that the average 22
year old single male spends $200 a month on alcohol and $50 on dining out. Now assume
that a particular 22 year old single male is audited and his withdrawal analysis indicates
that he spent $25 a month on alcohol and $300 a month dining out. If the combined method
is used, the taxpayer will be assessed on the basis that he had | $500 a month in
entertainment related personal expenditures: $200 in alcohol and $300 in dining out. This
result would be unfair. The Statistic Canada figures are averages. They are made up a
collection of the individual spending habits of a large number of people. In this particular
taxpayer's case, it would appear that he chooses to spend more time eating out with his
girlfriend than hanging out with the boys at the bar. This choice affects his spending
habits. It is unreasonable to tax him both on his choice (eating out) and his statistically
expected behaviour (drinking).

Business Expenses:
Generally, business expenses can be ignored in a net worth calculation. This is true whether the
business expenses have already been claimed on the taxpayer's tax return or not. There is no point
in trying to claim business expenses as there would be no net change to the taxpayer's income by
claiming them.
Two examples will help to illustrate why business expenses are generally irrelevant. The first
example deals with business expenses already claimed on the taxpayer's tax return. It illustrates
both paid and unpaid business expenses.

Example #10:
Facts: Ms. V had a painting business. At the beginning of the audit period she had $1,000 in her
bank account. In the year under audit, she had $10,000 in revenue and $3,000 in expenses. She
deposited all her revenue into her bank account. She paid $2,000 of her expenses from her
bank account during the year. At the end of the year, Ms. V still owed her suppliers $1,000
for the balance of her expenses. Ms. V had no other liabilities and no living expenses. She
filed a tax return reporting $10,000 in revenue and claimed $3,000 in expenses to arrive at
taxable income of $7,000.
Analysis: We know that Ms. V's income should be $7,000. A net worth calculation confirms that
number with no need to account for Ms. V's expenses. The net worth calculation is set out
below. |

prior year end audit year end

assets
bank account $1,000 $9,000 30
liabilities
accounts payable — ($1,000)
net worth $1,000 $8,000
change in net worth $7,000
personal expenditures —
income $7,000

The second example illustrates why there is no point in claiming unclaimed business expenses
when performing a net worth calculation.

Example #11:
Facts: Mr. W is a T4 employee. He reports all his T4 income on his tax return. He also runs a
drywalling business on the side. Mr. W does not report the income he earns in the drywalling
business on his tax return. He earns $20,000 in revenue from the business and has $5,000 in
expenses that he pays during the tax year. He deposits the $15,000 profit in his bank account.
Analysis: The net worth calculation will include the $15,000 in Mr. W's income as his net worth
will have increased by that amount.
Mr. W could claim the business expenses as a tax deduction. However, it would be a
pointless exercise. When Mr. W explained to the CRA that he had paid $5,000 in
expenses for the business, the CRA would simply increase Mr. W's income by $5,000
since he must have had income in order to pay those expenses. The result would be that
 Mr. W would still be reassessed to include $15,000 in his income ($15,000 from the net
worth calculation, less $5,000 in deductible expenses, plus $5,000 in additional income
to cover those expenses).
The exception to the above rule regarding business expenses occurs when there are expenses that
on the surface appear to be personal expenses but are actually business expenses. An example will
illustrate this point.

Example #12:
Facts: Ms. T is a T4 employee. She earns $40,000 in T4 income that she reports on her tax return.
She also rents out the basement suite in her house for $10,000 per year. She does not report the
rental income. Ms. T deposits all her earnings in her bank account. She has nothing in the bank
account at the beginning of the year and | $42,000 in the account at the end of the year. Ms. T
has $8,000 in personal expenditures.
Analysis: The net worth calculation will capture the $10,000 of unreported revenue from the
basement suite. The net worth calculation is set out below:

However, the above calculation does not lead to an accurate determination of Ms. T's
unreported income. The calculation has added $8,000 to Ms. T's income on account of her
personal expenditures. However, some of those personal expenditures were not personal
expenditures, but rather business expenses. For example, Ms. T would be entitled to deduct
a portion of her property taxes, utilities, insurance and interest payments on account of her
basement suite. Since the net worth calculation has already included these amounts in Ms.
T's income as personal expenditures, she must deduct them in order to put herself in the
neutral no-inclusion-no-claim position that would normally given to business expenses.

Tax Related Adjustments

Once the first 3 elements of a net worth assessment have been determined, the next step is to add
or subtract various Tax Related Adjustments. As discussed above, Tax Related Adjustments are
necessary because of the complexity of the ITA.
The most common adjustments are: |
 (i) deductions for non-taxable sources of income;
(ii) deductions for non-taxable government payments;
(iii) deductions or additions for types of income which receive special treatment under the
ITA;
(iv) additions for withdrawals from an RSP;
(v) additions for taxes withheld at source;
(vi) deductions for reported income; and
(vii) adjustments for GST.

Non-Taxable Sources
There are a number of sources of income or wealth that are not taxable under the ITA. If a taxpayer
receives income from one of those sources, that income is deducted as a Tax Related
Adjustment. The following are examples of non-taxable sources:
• gifts
• inheritances
• gambling winnings 31
• lottery winnings
• non-taxable insurance proceeds
One of the first things that an auditor will do in a net worth audit is to try to eliminate these non-
taxable sources of income by having the taxpayer verify whether she received any of these types
of payments during the audit period. If an auditor can do this successfully, he or she could be
confident that any unreported income arising from the net worth calculation would be from a
taxable source.
Taxpayers should carefully consider an auditor's questions about these non-taxable sources of
income before responding for 2 reasons.
(i) First, these are the types of sources that people often forget about. It is harder to get an
auditor to accept that a taxpayer received funds from these sources if the | taxpayer has
already denied it. Unfortunately some uneducated taxpayers instinctively deny having
received funds from these sources because they mistakenly believe that they are taxable on
those funds. These taxpayers later find themselves in a position where it is difficult to
retract their denial.
(ii) The second reason for thinking carefully before responding to an auditor's questions
about non-taxable sources is that if there is a possibility that the net worth audit may turn
into a criminal investigation for tax evasion, an admission by the taxpayer on these points
will significantly strengthen the Crown's case.

Non-Taxable Government Payments

Taxpayers often receive non-taxable funds directly from the government. These funds include:
• Child Tax Benefits
 • GST credits
• tax refunds
In a net worth assessment, the auditor will generally automatically determine the amount of these
funds using CRA's computers and will reduce the income determined under the net worth
calculation accordingly.

Special Treatment Under The ITA

Under the ITA, certain types of income are either not taxable or are subject to a reduced rate of
tax. Similarly, certain types of losses are not deductible. Adjustments should be made to decrease
a taxpayer's income in respect of those types of income and to increase his income in respect of
those types of losses. The following are examples of income and losses that must be adjusted:
• gains or losses from the sale of a principal residence
• gains from the sale of QSBC shares
• gains from the sale of a qualified farm property
• the non-taxable portion of other capital gains
• losses or non-taxable gains from the sale of personal use property
• capital dividends |
• dividends 32

RSP Withdrawals
As explained in the discussion of RSPs in Part of this paper, withdrawals from an RSP are an
addition to income.

Taxes Withheld At Source

If a taxpayer pays personal income taxes, EI or CPP relating to the audit period during the audit
period, he presumably used income to pay those taxes. CRA treats all taxes deducted at source as
Tax Related Adjustments. This includes tax withheld on RSP withdrawals. As discussed above,
any other taxes paid during the audit period are treated as personal expenditures. Both treatments
have the effect of increasing the taxpayer's income.

GST
Any additional GST to be assessed as part of the net worth assessment is a deduction from income
33
. This is because, as explained in Part of this paper, the GST portion of a net worth assessment is
calculated on the basis that the taxpayer's revenue was GST included.

Reported Income
If a taxpayer has already filed a tax return and reported income on that return, that income will be
deducted as part of the taxpayer's net worth calculation. Without this deduction, the net worth
calculation would result in double taxation. This is because the taxpayer's reported income would
undoubtedly have either been used to increase his net worth or to pay for personal expenditures
and, thus, would be caught by the previous elements of the net worth calculation. |

What Gets Missed

Net worth assessments are by no means a perfect audit tool. In certain circumstances, income will
not be detected.
For example, if a taxpayer earns unreported business income, a net worth assessment will not
detect that income if he is paid in cash and he either keeps the money under his mattress or uses it
to pay for untraceable personal expenditures (e.g. meals and entertainment). In these
circumstances, a net worth assessment would not catch the unreported income because the income
never touches anything by which it can be traced (e.g. a bank account or credit card) and is not
used to acquire any assets or pay any liabilities. So long as the taxpayer's reported income is
sufficient to support his personal expenditures within the Statistics Canada averages and any
excess personal expenditures which can be traced through a withdrawal analysis, a net worth
assessment will not detect his unreported income.
Luckily for the government, many taxpayers who might otherwise slip through the cracks lack the
self-restraint to avoid detection. It's hard to keep up with the Jones without buying assets!
Taxpayers who are audited and who have significant unreported income that was not caught by
the audit may wish to consider making a voluntary disclosure after the notice of reassessment is
issued. A voluntary disclosure would be particularly appropriate if there were a possibility that a
future audit could identify the unreported income as having been earned in the future audit years
and the unreported income would likely be subject to penalties in those future years.

Negative Net Worth Assessments

Occasionally, a taxpayer's net worth calculation may result in negative income in one or more of
the years under audit. Sometimes this is an indication that there is a serious flaw in the net worth
calculation. Other times, it is simply an indication of a timing error in the net worth assessment.
In other words, the net worth calculation has correctly identified the total income for the audit
period but has incorrectly allocated it among the relevant tax years.
If you have confirmed that the negative net worth figure is not an indication of a serious flaw in
the net worth calculation, there are a couple of potential solutions. One solution would be | to treat
the negative net worth figure as a non-capital loss and either apply it to reduce income already
reported in that year or carry it over to another year. Another solution would be to determine the
average net unreported income for the whole audit period and assess the taxpayer on that average
figure in each year. The solution that a taxpayer might prefer would depend on his marginal tax
rates in each year and the effect of interest on the unpaid taxes.
Net Worth Assessments Involving Couples
A marriage or common-law relationship adds further complexity to a net worth assessment as
couples often mix their finances. Where the taxpayer's partner has no real source of income, CRA
would generally issue a net worth assessment based on the assumption that the taxpayer paid all
personal expenditures for the couple.
Where each of the partners has his or her own sources of income, the CRA will generally conduct
a combined net worth calculation including the assets, liabilities and personal expenditures of both
partners, deduct the income reported by both partners and assess the resulting unreported income
to the partner whom the CRA believes earned the unreported income. As a result of this technique,
couples who are subject to a net worth audit should carefully consider who earned any unreported
income, as one partner may have a lower marginal tax rate than the other.

Net Worth Assessments Involving Closely Held Companies

Net worth assessments of the owner—manager of a company add additional wrinkles to an already
complex form of assessment. Generally, when there is a company involved and there is no obvious
source of income for the individual taxpayer other than the company, the CRA will conduct a net
worth audit of the individual and assume that any unreported income shown by the net worth
calculation was appropriated from the company and is thus taxable in the individual's hands under
section 15(1) of the ITA. This, of course, results in double taxation as CRA will reassess both the
company and the individual taxpayer in respect of the same income. |
The following are some particular issues that practitioners should pay attention to when a company
is involved in a net worth assessment:
(i) Separate Business: The company and the individual can avoid double taxation if the
unreported income came, not from the company, but rather from a separate business carried
on by the individual taxpayer personally. Taxpayers are sometimes reluctant to admit to
having a different source of income. However, a taxpayer would be far better off admitting
that she had unreported personal rental income from her vacation property than accepting
CRA's assumption that she had appropriated unreported business income from her
company.
(ii) Corporate Assets: In cases where the individual taxpayer has clearly appropriated funds
from the company, practitioners should examine the company's books and records to
determine whether the appropriated funds were truly unreported income in the company's
hands. It may simply be that the individual taxpayer appropriated corporate assets rather
than corporate revenues. For example, the company may have started the audit period with
a large account receivable from a prior period which, once collected, was appropriated by
the individual taxpayer. In that case, while the individual taxpayer would be taxable on
the appropriation, the company would not be taxable as it would already have paid tax on
the account receivable in a prior year.
(iii) Shareholder Loan Repayment: The same arguments normally used by taxpayers to avoid
assessments for appropriating corporate assets also apply to net worth assessments. If the
individual taxpayer could show that the funds paid to her were a repayment of her
 shareholder loan, she would avoid taxation on the payment. For this reason, it is important
for taxpayers to determine the opening and closing balances of their shareholder loans
accurately as part of their personal net worth calculations. Unfortunately, as net worth
assessments often arise in situations where taxpayers have poor books and records,
establishing advances and repayments in the shareholder loan account may be difficult. |

GST And Net Worth Assessments

General
GST forms an important part of any net worth assessment. Just as section 152(7) of the ITA
gives the Minister the ability to reassess a taxpayer without regard to the taxpayer's filed tax
returns, section 299(1) of the Excise Tax Act (the "ETA") gives the Minister the ability to assess a
taxpayer for GST without regard to the taxpayer's filed GST returns.

GST Net Worth Calculations

There are 2 methods by which GST can be calculated in a net worth assessment: the quick and
dirty method and the detailed calculation method.

Quick and Dirty Method:

The quick and dirty method of calculating GST on unreported income is to treat the taxpayer's
unreported income as having been GST included. The auditor simply multiplies the unreported
income determined under the net worth calculation by 6/106 34 to determine the GST included in
the unreported revenue. The auditor then assesses the taxpayer for that GST and makes an
adjustment in the Tax Related Adjustments to reduce the income tax assessment by the amount of
the GST.
The quick and dirty method of GST calculation is based on a number of assumptions. Those
assumptions and their validity are discussed below:
(i) GST Included: The most obvious assumption is that the taxpayer's unreported sales were
made on a GST included basis. This assumption is a generous one for many taxpayers and
not one that a taxpayer would normally challenge.
(ii) Taxable Supplies: In using the quick and dirty method, the auditor has assumed that all
unreported income arose from taxable supplies. If some of the unreported income came
from exempt supplies or zero-rated supplies, the quick and dirty method would not produce
an accurate picture of the GST payable. Examples of common sales of | exempt supplies
that would be caught by a net worth analysis include the sale of used residential property
(other than a principal residence 35 ), residential rentals, the sale of investments (e.g. stocks)
36
, interest income and dividends 37.
2007 BCC p.11:39/40 Anatomy of a Net Worth Assessment (Graham, D.)
(iii) Revenue Equals Income: The auditor has also assumed that the unreported income was
equal to the unreported revenue. In other words, the auditor has essentially assumed that
 there were no variable expenses related to the unreported income. In most cases, this is a
reasonable assumption for two reasons:
(A) First, many taxpayers who fail to report all their income would, nonetheless, claim all
their expenses. For those taxpayers, their unreported income would be equal to their
unreported revenue.
(B) Second, to the extent that a taxpayer does have expenses related to the unreported income
and to the extent those expenses were not already claimed by the taxpayer, those expenses
were most likely subject to GST. This fact would entitle the taxpayer to input tax credits
("ITCs") in respect of those expenses. There is no point in the auditor calculating GST on
the full revenue only to have a deduction for ITCs reduce the net GST back to the amount
that would have been calculated on unreported income in the first place. Taxpayers with
unclaimed expenses generally benefit from the auditor's assumption that these expenses
were subject to GST. One reason that taxpayers benefit is because not all the taxpayer's
expenses related to the unreported income were necessarily subject to GST (e.g. labour,
services provided by small suppliers and services supplied under the table). The other
reason that taxpayers benefit | is that, even if all the expenses were subject to GST, the
taxpayer may not be in a situation to produce the necessary receipts to claim the ITCs.
(iv) Non-Revenue Related GST: The quick and dirty method also assumes that there was no
GST arising from situations where no income was generated. As a result, GST is missed
on things such as the self-supply of newly constructed rental housing 38 and the change of
property from commercial use to personal use 39. Taxpayers would generally not challenge
this assumption.
In summary, some of the assumptions underlying the quick and dirty method benefit taxpayers
while others do not. A taxpayer should carefully consider the net effect of these assumptions
before challenging the use of the quick and dirty method.

Detailed Calculation Method:

The alternative to the quick and dirty method of GST calculation is to perform a detailed GST
calculation. In the detailed calculation method, there is a separate calculation of Tax Related
Adjustments for GST purposes ("GST Related Adjustments"). This separate calculation is used
because the goal of a GST net worth calculation is to determine the total consideration that the
taxpayer received for taxable supplies as opposed to the taxpayer's unreported income.
In a GST Related Adjustments calculation, the auditor first makes adjustments to determine the
total consideration that the taxpayer received for taxable supplies, then calculates the GST
collectible on those supplies (on a GST included basis) and then subtracts the ITCs to which the
taxpayer is entitled 40 to arrive at the taxpayer's net tax. Finally, the auditor compares that amount
to the net tax actually reported by the taxpayer and assesses the taxpayer for any difference. That
assessed GST is then carried over to the taxpayer's Tax Related Adjustments as a deduction from
unreported income. |
Many of the adjustments on the GST Related Adjustments are the same as those found on the Tax
Related Adjustments. The following adjustments used to determine a taxpayer's revenues are only
found on GST Related Adjustments:
 (i) Expenses: The taxpayer's reported business expenses are added back. This is logical
because the intention of the GST Related Adjustments is to determine revenue, not
income. However, it can sometimes be difficult for the CRA to determine what the
taxpayer's expenses actually were. In these situations, the CRA will sometimes use
industry averages.
(ii) Non-Cash Deductions: Non-cash deductions such as CCA and the amortization of
cumulative eligible capital are also added back.
(iii) ACB of Disposed Assets: Income tax on capital assets is calculated based only on the
difference between the taxpayer's proceeds of disposition and his or her ACB. On the other
hand, GST would be payable on the entire proceeds of disposition. This difference is
corrected by adding back the ACB of capital assets disposed of in a taxable supply during
the audit period.
(iv) Non-Cash Transactions: Non-cash transactions such as self-supplies and changes in use
of capital property are added in.
(v) Exempt Supplies: The taxpayer's employment income, interest income and dividends are
specifically deducted. Any other known exempt supplies, such as the sale of investments
or used residential property, are also deducted. If the auditor was not able to determine
exactly which supplies made in the course of the taxpayer's unreported business were
exempt, the auditor would generally assume that the same ratio of exempt supplies to
taxable supplies in any supplies reported by the taxpayer for the business existed in the
unreported supplies.
(vi) Zero-Rated Supplies: Any known zero-rated supplies are deducted. If the auditor was
not able to determine exactly which supplies made in the course of the taxpayer's |
unreported business were zero-rated, the auditor would generally assume that the same
ratio of zero-rated supplies to taxable supplies in any supplies reported by the taxpayer for
the business existed in the unreported supplies.
(vii) Sale of a Business: Income related to the sale of substantially all of a business to which
section 167 of the ETA applies is deducted.
(viii) GST Collectible: GST that the taxpayer reported as collectible on his or her GST return
is added back. This addition is made because the taxpayer's GST will be calculated on a
GST included basis. Thus, it is necessary to add any GST collected to revenue to reach a
GST included number.

The Impact of GST on Income Tax Net Worth Calculations

Various aspects of a taxpayer's GST situation could also affect his income tax net worth
calculation.

GST and Assets:

GST refunds owing at the beginning of the audit period should be reflected in the taxpayer's
opening assets as an account receivable. If this were not done, the GST refund would appear to
be income. The corollary to this is that GST refunds that have not been paid at the end of the audit
period should also be reflected as a closing account receivable possibly resulting in an increase in
the taxpayer's income.
GST and Liabilities:
The treatment of GST debts in a net worth calculation depends on how and when they arose and
when they were paid:
(i) Owing at the Beginning of the Audit Period: GST debts owing at the beginning of the
audit period should be included in a net worth calculation as an opening account
payable. This would include net tax that was collected in a reporting period prior to the
audit period, but that has not yet been remitted. That said, it is not in a taxpayer's interest
to increase his opening liabilities and I have never seen CRA include this type of liability
in a net worth calculation. |
(ii) Old Debts: GST debts arising from assessments made during the audit period in respect
of a reporting period prior to the audit period should be treated as a personal expenditure
when paid and should otherwise be ignored as they do not fall into any of the 4 categories
of acceptable liabilities: they did not exist at the beginning of the audit period and they
were not used to acquire assets, reduce liabilities or pay living expenses during the audit
period.
(iii) New Debts: The treatment of GST assessed during the audit period in respect of a
reporting period during the audit period is very complex. It depends on what the
assessment relates to (e.g. unremitted net tax vs. uncollected GST vs. improperly claimed
ITCs vs. a failure to self-assess), when the assessment was paid, whether the quick and
dirty method or the detailed method of GST calculation was used and whether the auditor
even considered the fact that the assessment had been made. Practitioners should follow
how this GST debt has been treated by the auditor carefully before determining whether it
should be treated as a liability in the reporting period to which it relates, treated as a living
expense when it was paid or ignored.
(iv) Arising From the Net Worth Assessment: GST debts arising from the net worth
assessment itself are accounted for in Tax Related Adjustments. The GST owing is
deducted from income in the Tax Related Adjustments. Any penalties and interest are
ignored.

Attacking Net Worth Assessments

One of the reasons why net worth assessments are becoming more and more common is
presumably because, if properly done, they are very difficult for a taxpayer to challenge.

Assumptions and Onus

With one exception, the questions of onus and assumptions are no different in net worth
assessments than they are in regular tax assessments. The Minister makes the assumption that the
taxpayer's income was the amount determined by the net worth calculation. The Minister | must
disclose to the taxpayer the basis upon which the net worth assessment was calculated 41. It is then
up to the taxpayer to demolish the Minister's assumption.
The only difference between net worth assessments and normal assessments is that, in a net worth
assessment, the Minister is relieved from his ordinary burden of having to identify a taxable source
of income 42. Once the Minister demonstrates that there has been an increase in income, the onus
lies on the taxpayer to separate her taxable and non-taxable sources of income 43.

Options for Attacking a Net Worth Assessment

The taxpayer cannot demolish the Minister's assumption that the amount determined by the net
worth calculation represents additional income by simply stating that she reported different figures
on her tax return or by stating that the Minister should have used the figures in her books and
records 44.
Taxpayers have only 2 options available to try to challenge a net worth assessment:
(i) attack the individual elements of the net worth assessment piecemeal; or
(ii) present a better method of determining the taxpayer's income.
If successful, the piecemeal attack will not result in the net worth assessment being overturned,
but simply being reduced to the extent of the individual adjustments that the taxpayer was able to
prove. If a taxpayer wants to force the Minister to vacate a net worth assessment, she must
demolish the Minister's assumption that the net worth calculation is correct by providing a better
alternative.
Judge Bowman (as he then was) described the two approaches as follows 45: |
"It is almost impossible to challenge such assessments piecemeal. The only truly effective
way of disputing them is by means of a complete reconstruction of a taxpayer's income for
a year. A taxpayer whose business records and method of reporting income are in such a
state of disarray that a net worth assessment is required is frequently the author of his or
her own misfortunes."

Piecemeal Attack:
The most common approach employed by taxpayers is to attack individual elements of the net
worth assessment. A taxpayer often adopts this approach because the taxpayer has neither the
resources nor the books and records to present an alternative method of assessment. The following
is a list of potential methods of attacking individual portions of the net worth calculation:
(i) Check the Numbers: Net worth calculations are very complicated calculations. It is not
uncommon for the auditor to have made mistakes either in determining the underlying
numbers or in applying those numbers to the calculation.
(ii) Increase the Value of Opening Assets: Ensure that the taxpayer has remembered all the
assets that she held at the beginning of the audit period. The net worth calculation may
result in more income for the taxpayer than is warranted if her opening assets are
understated. Opening assets that are commonly overlooked are accounts receivable and
cash.
 (iii) Decrease the Value of Closing Assets: Ensure that the taxpayer's closing assets have
been correctly determined.
(iv) Decrease the Value of Opening Liabilities: Ensure that the taxpayer's opening liabilities
have been correctly stated and that any payments made prior to the audit period have been
reflected.
(v) Increase the Value of Closing Liabilities: Ensure that the taxpayer has remembered all
the liabilities that she owed at the end of the audit period. The net worth calculation | may
result in more income for the taxpayer than is warranted if her closing liabilities are
understated. Closing liabilities that are commonly overlooked include accounts payable
and loans from friends or family.
(vi) Decrease Personal expenditures: As set out in the discussion of personal expenditures
above, the taxpayer should ensure that whichever method of calculating personal
expenditures has been applied, its application was appropriate to her
circumstances. Taxpayers should be particularly diligent if a cash withdrawal analysis has
been used. Taxpayers should also be careful to ensure that business expenses are not
treated as personal expenditures.
(vii) Reduce Appropriations: As set out in Part of this paper, the taxpayer should consider
whether alleged corporate appropriations were truly appropriations and, thus, whether a
change can be made from double taxation to single taxation or no taxation at all.
(viii) Identify Non-Taxable Sources of Income: Ensure that the taxpayer has recalled all non-
taxable sources of income such as gambling, gifts and inheritances.
(ix) Deduct Business Personal Expenditures: Ensure that the business portion of any
expenses that has been added as personal expenditures is either deducted as business
expenses or removed from personal expenditures. Pay particular attention to cell phones,
home offices, internet costs and automobiles.
(x) GST: Identify exempt and zero-rated supplies. Claim ITCs on any business related
personal expenditures. Determine whether the taxpayer was a small supplier at any point
in the audit period.
(xi) Income Split: Consider whether the unreported income is more accurately characterized
as income belonging to the Taxpayer's spouse or common-law partner. |
(xii) Shift Income to a Different Year: If it is clear that a specific asset was acquired during the
audit period but it is unclear exactly when, consider the effect that the timing of the
acquisition will have on assessed income. Agreeing with the auditor that the acquisition
occurred in a certain year may move the income to a year with a lower marginal tax rate or
may avoid one or more year's interest.

Better Method of Determining Income:

A taxpayer's second option for challenging a net worth assessment is to argue that his income can
more accurately be determined using different method.
The most logical alternative method would be using the normal accrual method of accounting.
However, a taxpayer is most likely being assessed under the net worth method either because his
books and records were inadequate to determine his income or because there is good reason to
believe that those books and records do not reflect all his income. As a result, a taxpayer would
only likely succeed in overturning a net worth assessment using the normal accrual method of
accounting if he is able to reconstruct his books and records to either make them comprehensible
or to have them fully reflect previously unreported income.
The only other alternative available to a taxpayer is to argue that some other alternative method of
determining income is a more appropriate method of calculating his unreported income. Possible
alternative methods of determining income are set out in Part of this paper.

Gross Negligence Penalties

It is common for auditors to assess gross negligence penalties when they issue a net worth
assessment. This is presumably both because the amount of alleged unreported income is often
high, because that income generally either comes from an unreported source or from deliberate
underreporting of income from a reported source and because the taxpayer's records are often poor
or non-existent. |

Onus
As with all gross negligence penalties, the onus is on the Minister to prove that the penalties should
be applied 46. It is not enough for the Minister to simply rely on the fact that the taxpayer has failed
to disprove the net worth assessment. The Minister must prove that the taxpayer made a false
statement or omission in her tax return knowingly or under circumstances amounting to gross
negligence 47.
Not surprisingly, taxpayers' attempts to challenge gross negligence penalties on net worth
assessments have met with mixed results. Penalties have been reversed in a number of cases 48 and
upheld in others 49. Taxpayers are more likely to succeed in avoiding penalties when the CRA is
unable to identify the source of the unreported income. This is because it is harder for the CRA to
prove that there was a false statement made in the return if they cannot identify what statement
should have been made.

Proof of Amount of Unreported Income

Some older case law indicates that the Minister not only has to prove gross negligence, but also
has to prove the amount of unreported income 50. If this were the case, the Minister would be in
the impossible position of having to prove that the income determined by the net worth calculation
was the taxpayer's actual unreported income 51. This line of thinking has been overturned in more
recent cases which have clarified that if the Minister can prove gross negligence, the penalty will
be applied to the quantum of unreported income determined by the net worth calculation without
the need for the Minister to prove that was the correct unreported income. 52|

Evasion
Tax evasion cases based on net worth assessments are not common. As with all tax evasion cases,
the Crown bears the burden of proving its case beyond a reasonable doubt. This can be particularly
difficult for the Crown in the case of a net worth assessment. A net worth statement can provide
sufficient evidence for the Crown to obtain a conviction for tax evasion 53. However, the Crown
is faced with some challenges that are particular to net worth assessments:
(i) Source of Income: As discussed above, in a civil net worth assessment, the Minister is
relieved from having to prove the source of the alleged unreported income. The same is
not true in a criminal prosecution. The Crown must prove beyond a reasonable doubt either
that the alleged unreported income came from a taxable source or disprove beyond a
reasonable doubt all non-taxable sources of income 54. The Crown may not disregard
explanations as to the reason for the alleged unreported income that are reasonably
susceptible to being checked. However, if the accused does not provide relevant leads to
the Crown, the Crown is not required to negate every possible source of non-taxable
income 55.
(ii) Accused's Assets: A net worth assessment is only evidence against the accused to the
extent that the Crown can prove beyond a reasonable doubt that the assets in the net worth
statement were the accused's assets 56.
(iii) Accused's Income: The Crown is faced with an extra challenge where a joint net worth
calculation has been done for a couple. The Crown cannot simply charge both individuals
and assert that one or both of them is guilty of tax evasion in the total amount of unreported
income shown by the net worth calculation. The Crown must prove which individual is
responsible for which income 57. This may be very difficult | in situations where both
individuals have potential alternative taxable sources of income.
It should be noted that if the Crown were able to prove the accused evaded the payment of tax but
not to prove that the evasion involved the entire amount charged, the accused could still be
convicted on the grounds that he evaded the lesser amount that the Crown was able to prove
58
. Therefore, in these circumstances, attacking a specific mistake in the net worth calculation
would reduce the penalty that the accused faces but would not result in an acquittal.

Alternative Arbitrary Assessment Techniques

The following is a brief summary of some other alternative arbitrary assessment techniques that
the CRA uses:

Deposit Analysis
In a deposit analysis, the auditor examines the taxpayer's bank accounts and treats all deposits to
those accounts as income. The auditor then deducts the income reported by the taxpayer on her
tax return from the total deposits to arrive at unreported income. Deposit analyses have been
accepted by the Tax Court as an appropriate alternative audit technique 59.
Generally, deposit analyses are not as accurate a method of calculating income as net worth
assessments. A deposit analysis may not adequately examine where the money that was deposited
into the bank accounts came from (which could result in over taxation) and, similarly, a deposit
analysis may omit money that never enters the bank account (which could result in under taxation).
Taxpayers who are faced with a deposit analysis, should be careful to ensure that transfers from
their other bank accounts have not been treated as deposits. |
While a rough deposit analysis is often used by an auditor to determine whether it is worthwhile
to go through the effort of preparing a full net worth assessment, the two techniques should not be
combined as they will result in double counting the same income.

Percentage Return On Cost of Goods Sold

This alternative audit technique involves taking a known amount of goods sold and applying an
industry average rate of return on those goods. It is a useful technique when there are reliable
records that show the number of goods that the taxpayer sold but the auditor suspects that the
revenues from those sales have been underreported. The technique has been accepted by the
Courts 60. It is more common as a method of assessing GST since its focus is on determining
revenue.

Percentage Return On Known Assets

This unusual alternative audit technique involves taking assets that the taxpayer was known to own
at the beginning of the audit period and assuming that the taxpayer earned a fixed rate of return on
those assets. The technique was accepted by the Tax Court in Hsu v. The Queen 61. In that case,
the CRA knew that the taxpayer had certain assets when he came to Canada but had been unable
to obtain any information from the taxpayer regarding his finances since that time. The Minister
assessed the taxpayer on the basis that he had received a 10% return on his assets each year.

Percentage Increase In Income

This is another unusual audit technique. It involves taking the taxpayer's income for a base year
and assuming that her income increased by a specific percentage in the following years. This
technique was accepted by the Tax Court in Natale v. The Queen 62. In that case, the taxpayer had
refused to file tax returns and claimed not to have any records. |

Constant Net Tax

Where taxpayers fail to file GST returns, the CRA will sometimes simply issue arbitrary
assessments based on the assumption that the taxpayer's net tax for the unfiled reporting periods
was the same as his net tax in prior reporting periods. While taxpayers should be sure to object to
these types of assessments within the time limit for doing so, they can usually manage to have the
reporting periods reassessed by simply filing returns.

Marijuana Yield
Taxpayers who have been involved with illegal marijuana grow-ops are commonly assessed on
the basis of an assumed yield. The auditor generally takes the number of plants that were known
to exist when the grow-op was discovered and assumes that that is an accurate indication of the
taxpayer's regular crop size. The auditor then assumes a specific yield per plant and multiplies
that yield by the price per pound that he or she believes the taxpayer would have received. The
resulting revenue is multiplied by the number of crops that the auditor assumes the taxpayer has
harvested during the audit period. The auditor is often able to obtain an indication of when the
grow-op began by reviewing hydro records. As the technique involves a number of different
assumptions by the auditor, there would generally be a variety of options for attacking these kinds
of assessments. |

Schedule "A"

Brokerage Account Net Worth Calculation

The following example illustrates the calculations involved when there is a brokerage account in
a net worth assessment.
Facts: At the beginning of the audit period, Mr. Z had $15,000 in his bank account and a
brokerage account containing the following assets:
• shares in ProfitCo with an ACB of $5,000;
• shares in LossCo with an ACB of $7,000;
• a bond with an ACB of $10,000 that produces $500 of interest per year; and
• $1,000 cash
During the first year of the audit Mr. Z:
• deposited $10,000 to the brokerage account from his bank account;
• sold the ProfitCo shares for $9,000; and
• received $500 interest on the bond.
During the second year of the audit, Mr. Z:
• withdrew $8,000 from the brokerage account and deposited it in his bank account;
• sold the LossCo shares for $6,000;
• bought shares in NewCo for $4,000 using $3,000 of margin;
• bought shares in QuickCo for $1,000 and sold them for $5,000; and
• received $500 interest on the bond.
Mr. Z had no other assets, liabilities or living expenses.
Analysis: If Mr. Z were reporting his income normally, we would expect to see $2,500 in taxable
income in the first audit year made up of:
• a $2,000 taxable capital gain in the first audit year relating to the sale of ProfitCo ($9,000
proceeds less $5,000 ACB multiplied by the 50% capital gains inclusion rate); and
• $500 interest income.
In the second audit year we would expect to see $2,000 in taxable income made up of:
• a $500 allowable capital loss relating to the sale of LossCo ($6,000 proceeds less $7,000
ACB multiplied by 50%); |
• a $2,000 taxable capital gain relating to the mid-year purchase and sale of QuickCo ($5,000
proceeds less $1,000 ACB multiplied by 50%); and
 • $500 of interest income.
These are the exact figures that we find using a net worth calculation and tracking each
asset and liability separately. The net worth calculation is set out below:

prior year end year end year end

audit year 1 audit year 2
assets
bank account $15,000 $5,000 $13,000
brokerage account
ProfitCo $5,000 — —
(ACB)
LossCo (ACB) $7,000 $7,000 —
NewCo (ACB) — — $4,000
QuickCo — — — 63
bond $10,000 $10,000 $10,000
cash $1,000 $20,500 64 $22,000 65
liabilities
brokerage account
margin — — ($3,000) 66
net worth $38,000 $42,500 $46,000
change in net worth $4,500 $3,500
personal expenditures — —
tax related adjustments ($2,000) 67 ($1,500) 68
income $2,500 $2,000 |

Schedule "B"

Depreciable Business Asset Net Worth Calculation

The following example illustrates the calculations involved when there is a depreciable business
asset in a net worth assessment.
Facts: At the beginning of the audit period, Ms. K had a piece of machinery that she used in her
business. The ACB of the equipment was $12,000. Its UCC at the beginning of the period was
$10,000. During the first audit year, Ms. K was entitled to claim $1,000 in CCA on the
equipment. Ms. K disposed of the equipment during the second audit year for $11,000 and
deposited the funds in her bank account. Ms. K had no liabilities or personal expenditures in
the audit period. She earned $20,000 of income from her business each year which she
deposited in her bank account.
Analysis: If Ms. K were reporting her income normally, we would expect to see income of $19,000
in the first audit year ($20,000 in regular income less $1,000 CCA) and $22,000 in the second
audit year ($20,000 in regular income plus $2,000 in recapture). These are exactly the figures
that the net worth calculation produces by carrying the equipment at its UCC each year. The
net worth calculation is set out below.

prior year year end year end

end audit year 1 audit year 2
assets
bank account — $20,000 $51,000 69
equipment (UCC) $10,000 $9,000 —
liabilities — — —
net worth $10,000 $29,000 $51,000
 change in net worth $19,000 $22,000
personal expenditures — —
tax related adjustments — —
income $19,000 $22,000
1
I would like to thank Werner H.G. Heinrich and David Pedlow of Koffman Kalef for their assistance in
reviewing this paper.
2
Hsu v. The Queen 2001 DTC 5459 (FCA) leave to appeal refused (2002 CarswellNat 500) at para 30
3
Bigayan v. The Queen 2000 DTC 1619 (TCC)
4
The goal is to determine the income that would appear on line 150 of the taxpayer's return.
5
Hsu, supra at para 29
6
See for example: Coulombe v. The Queen 2004 DTC 3470 (TCC)
7
See for example: Hsu, supra
8
See for example: Morrow v. The Queen 92 DTC 6380 (FCA); Michaud v. The Queen (2002) [2004] 2 CTC
3079; and Duncanson v. The Queen 2002 DTC 3828 (TCC)
9
See for example: Kerr v. The Queen 89 DTC 5348 (FCTD)
10
See for example: Mohammadi v. The Queen 2005 DTC 1340 (TCC)
11
See for example: Bigayan, supra; and Malone v. The Queen 2006 DTC 3130 (TCC)
12
For simplicity, I have assumed that the sale of the building was taxable on income account. Had it been
taxable on capital account, a Tax Related Adjustment would have been made here to reduce Ms. Y's income by
$450,000.
13
In Léger v. The Queen 2000 CarswellNat 3703 (TCC), the Court found the taxpayer lacked credibility when
he claimed to have had substantial cash on hand at the beginning of the audit period at the same time that he had
a significant line of credit balance, although the taxpayer's credibility was also affected by his prior conviction
for conspiracy to traffic in narcotics. The Court also concluded that if a taxpayer has a lot of cash on hand at the
beginning of the audit period, there is good reason to believe that he would have the same amount of cash on hand
at the end of the audit period.
14
Auditors will sometimes show the RSP with an opening value equal to its fair market value at the beginning
of the audit period and then carry that value through the audit period making adjustments for contributions and
withdrawals. This alternative method of reflecting the opening value should have no impact on the net worth
calculation.
15
Because net worth calculations are determining income per line 150 of the taxpayer's tax return, there is no
deduction made for RSP contributions as part of a net worth calculation. If the taxpayer has not already claimed
the deduction when filing his tax return, he should be given the deduction on any reassessment arising from the
net worth assessment.
16
If there were withdrawals in excess of contributions, the RSP would show as a negative asset (i.e. effectively
a liability). That is acceptable and should not affect the net worth calculation.
17
Carrying depreciable business assets at UCC is the method commonly used by the CRA. Alternatively, assets
can be carried at cost and CCA allowed separately as was done in Coulombe, supra at para 63 to 69
18
Moody v. MNR 57 DTC 1050 (Exch Ct)
19
This is the $5,000 personal expenditures from the previous example plus the $3,000 paid on the judgment.
20
An example of this type of improper liability can be found in Léger, supra at para 38. The taxpayer's audit
period was from 1988 to 1991. During or shortly after the audit period the taxpayer was charged with conspiracy
to traffic in narcotics. In 1993, the taxpayer pled guilty to the charge and was fined $100,000. The taxpayer
attempted to have the $100,000 included as a liability in the audit period. The Court rejected the taxpayer's claim
for what was essentially a contingent liability.
21
See discussion on business expenses in the discussion of Tax Related Adjustments below
22
Income tax debts arising from the net worth assessment itself do not fall into any of the 4 categories of
acceptable liabilities and thus should be ignored.
23
The CRA most likely treats income tax payments as personal expenditures because, in the normal course, an
income tax debt would be determined, become due and be paid all within the same tax year as thus is better suited
to being reflected as a personal expenditure.
24
Malone, supra at para 14 and Lacasse v. The Queen 2006 DTC 2618 (TCC)
25
Bigayan, supra at para 17
26
see Lacasse, supra where the Tax Court held that the taxpayer's son was essentially supporting himself and
thus that the taxpayer's personal expenses should be determined using the Statistics Canada figures for a couple
rather than a family of three.
27
In my experience, some financial institutions reflect transfers from one account to more than one other account
as a withdrawal followed by 2 deposits. The same is sometimes true of transfers between accounts with different
currencies.
28
Léger, supra at para 41 to 43
29
If this debt has already been listed as an opening liability in the net worth calculation, the taxpayer would be
taxed once for reducing the liability and once as a personal expenditure for making the withdrawal to do so.
30
This is made up of the $1,000 opening balance + $10,000 revenue - $2,000 expenses paid during the r
31
If a taxpayer is too successful at gambling, they are sometimes met with the argument that his profits were
business income (see: Dowling v. The Queen 96 DTC 1250 (TCC))
32
Because a net worth assessment is trying to determine income per line 150 of the taxpayer's tax return, there
is a Tax Related Adjustment to add the dividend gross up to the taxpayer's income. The dividend tax credit, occurs
below line 150 so it is not included in the net worth assessment. That said, the taxpayer should make sure that the
credit is included as part of any reassessment if it has not already been claimed in his return.
33
This includes GST only, not penalties or interest.
34
Use 7/107 for periods where GST was calculated at 7%
35
The sale of a principal residence should have been entirely excluded from the net worth calculation in the Tax
Related Adjustments so no GST should have been applied to it under the quick and dirty method.
36
Under the quick and dirty method, GST would only have been applied to the taxable 50% of capital gains
since the exempt 50% should be excluded from the net worth calculation in the Tax Related Adjustments.
37
The dividend gross-up that appears in Tax Related Adjustments should not appear in GST Related
Adjustments so it should only be necessary to deduct the amount of the dividend itself.
38
ETA section 191
39
ETA section 200
40
This would be ITCs already claimed by the taxpayer, less ITCs denied by audit, plus additional ITCs allowed
by audit.
41
Hsu, supra at para 22
42
Hsu, supra at para 29
43
Molenaar v. The Queen 2005 GTC 1451 (FCA) at para 4 and Gentile v. The Queen 88 DTC 6130 (FCTD) at
6132 (cited with approval in Hsu, supra at para 29)
44
Dezura v. The Queen 1947 CTC 375 (Exch. Ct.) at 378; cited with approval in Morrow, supra
45
Ramey v. The Queen 93 DTC 791 (TCC) at 793
46
section 163(3) ITA
47
Dowling at 1261; Boileau v. MNR 1989 CarswellNat 311 (TCC) at 24
48
See for example: Bigayan, supra; Malone, supra; Dowling, supra; Boileau, supra; and Wajsfeld v. The Queen
2005 DTC 1171
49
See for example: Michaud, supra; Lacasse, supra; Lai v. The Queen 2005 DTC 1823 (TCC); Kerr, supra; and
Leger, supra
50
Fortis v. MNR 86 DTC 1795 (TCC) at 1800 to 1802
51
Kerr, supra at 5354
52
See Kerr (rejects Fortis); Pompa v. AG (Canada) 1994 CarswellNat 1143 (FCA) at para 16-17 (rejects Fortier
and cites Kerr with approval); Dowling, supra at 1261 to 1263 (rejects Fortier and follows Kerr); Leger, supra
(follows Dowling)
53
R. v. Ross 1998 CarswellNS 115 (NSSC) at para 15
54
R. v. Zuk 2005 DTC 5628 (Ont. Court of Justice) at 5646 and R. v. Derose 2001 CarswellAlta 1163 (Alta
Prov. Ct)
55
Zuk, supra at 5629 and Derose, supra at para 113 to 117 both citing with approval the US Supreme Court in
Holland v. United States [1954] 348 US 121 and United States v. Massei [1958] 355 US 595
 56
Ross, supra at para 16
57
Ross, supra at para 17 to 22
58
Zuk, supra at 5635; Derose, supra at para 81 and R. v. Cormier 1986 CarswellBC 662 (BCCA)
59
Khullar Au Gourmet International Ltd. v. The Queen 2003 GTC 809 (TCC) (note: the Court refers to the audit
technique as a "modified net worth", but the facts of the case indicate that it is a deposit analysis); and 2868-2656
Québec Inc. v. The Queen 2003 CarswellNat 5228 (TCC) affirmed 2004 CarswellNat 5871 (FCA)
60
See for example, Dezura, supra; 9001-9159 Québec Inc. v. The Queen 2002 CarswellNat 4437 (TCC); Modes
Crossfire Inc. v. The Queen 2003 DTC 899-112 (TCC). But also see Panda Marketing (1997) Ltd. v. The Queen
2002 GTC 201 (TCC) where the approach was rejected in the circumstances.
61
Hsu, supra
62
86 DTC 1493 (TCC)
63
The QuickCo shares do not show up on the net worth calculation because they were not held at either the
beginning or the end of the second audit year.
64
The cash in the account is simply carried at its year end value. The deposits and withdrawals do not need to
be tracked nor do individual changes in the cash account. However, for the purposes of this example, the following
describes where the year end cash balance came from: $1,000 opening balance + $10,000 deposit + $9,000
proceeds from the sale of ProfitCo + $500 interest income
65
The cash in the account is simply carried at its year end value. However, for the purposes of this example, the
following describes where the year end cash balance came from: $20,500 opening balance - $8,000 withdrawal +
$6,000 proceeds from the sale of LossCo - $1,000 used to buy NewCo - $1,000 used to buy QuickCo + $5,000
from the sale of QuickCo + $500 interest income
66
The margin is recorded as the difference between the ACB of the shares when purchased and the cash paid at
purchase, not the actual margin at year end. This is consistent with using cost rather than FMV.
67
This is the non-taxable portion of the $4,000 capital gain.
68
This is the non-taxable portion of the $3,000 net capital gain ($4,000 capital gain - $1,000 capital loss)
69
The bank account balance is made up of the $20,000 opening balance + $20,000 in regular business income
in the second audit year + $11,000 in proceeds from the sale of the equipment

Author Information
Of Koffman Kalef LLP, Vancouver, BC.

Bibliography Information
David E. Graham, "Anatomy of a Net Worth Assessment," in 2007 British Columbia Tax
Conference (Toronto: Canadian Tax Foundation, 2007), 11:1-55.