Joe Havas, CPA, CA
Hachem W. Halabi, D. FISC, CPA, CA
Tax Manager

In 2004, the Canada Revenue Agency (CRA) launched a pilot project to examine the compliance with tax rules of Canada’s high net worth individuals (HNWI) and their related entities. The project arose from evidence gathered by tax agencies in other parts of the world that indicated that high net worth individuals may not be in full compliance of their countries’ tax laws through the use of multiple business entities and complex structures located in one or many jurisdictions.

The tax audit process in Canada generally focuses on a business entity rather than on the owners of that business entity. Although “net worth audits” are a common tool used by the tax department, it is usually restricted to situations where the tax authorities feel that there is a substantial discrepancy between a taxpayer’s apparent living standard and their reported income.

In the CRA’s parlance, the return on the substantial investment of audit expertise in this pilot project makes it well worth continuing. Thus, in 2009, CRA formalized the Related Party Initiative (RPI) and integrated it into the operations of the International and Large Business Directorate, Compliance Program Branch.

CRA’s defines high net worth individuals, who will undoubtedly be contacted by the RPI, as taxpayers and their families whose net worth is $50 million or higher, or who control or exercise significant influence over more than 30 related entities. Identification of such taxpayers is a significant challenge to CRA since taxpayers file information about their income rather than their net worth. CRA conducts constant research into the identification of taxpayers who might be subject to audit under the RPI.

Under the RPI, the tax authorities are interested in information about the HNWI’s holdings in private corporations, trusts, partnerships, joint ventures, foundations, foreign entities, and investment holdings (both domestic and foreign), etc. Investments and transactions conducted through registered accounts, e.g., RRSPs, RRIFs, TFSAs, RCAs, RPPs are also within the purview of the CRA’s audit.

What happens if you are part of the population that the CRA is interested in as a result of the RPI? First of all, congratulations for having entered a relatively exclusive club. According to the CRA’s estimates, their target audience comprises a very small percentage of all Canadian taxpayers. Therefore, if you have not been selected for an audit yet, the likelihood is very good that you will be in the future. The first step should be a “health diagnostic” of your tax structure. Reviewing your organizational structure, identifying the risk areas, documenting the business reasons for the existence of various business entities should be done with your professional advisors.

If you are selected for an audit under the RPI, you will receive a lengthy (currently at 21 pages) questionnaire asking for the identification of all the various entities that are controlled by you or over which you or your family exercise significant influence. CRA requests documentation that may relate to transactions undertaken years, sometimes decades ago. Companies that have been wound up, liquidated or been the subject of bankruptcy proceedings may also be included in the documentation requested. Although CRA provides a delay of thirty days to produce the requested documentation, it will agree to reasonable extensions of the deadline. However, it generally does not agree to reduce the scope of its questioning. We strongly suggest that you work closely with professional advisors, who are experienced in dealing with RPI, every step of the way in complying with the requests of the tax auditors.