Consequences of Unreported Income

Unreported income is a problem that the CRA is dedicating itself to fighting. Sometimes unreported income is intentional as defined in an underground economy and sometimes taxpayers do not realize what is included in income for tax purposes.

What is “Income”

Many Canadians do not realize what should be included in their income for tax purposes and therefore can inadvertently have unreported income. According to CRA and various judicial rulings, sources of income include:

  • Income from employment earnings such as:
    • salary, wages and bonuses;
    • RRSP, pension withdrawals and stock option benefits;
    • major fringe benefits, such as use of a company car;
    • a low or interest-free loan from the employer; and
    • employee allowances, set sums which are used to compensate the employee for various expenses they incur, but which may not be equivalent to the expenses incurred, and severance payments;
  • Income from business earnings such as:
    • profit and interest income on investments;
  • Income from property such as:
    • rental income (this would include rental income from rooms in homes)
    • income earned on the sale of real property (excepting the primary residence); and
    • income earned on the sale of shares in a corporation (this is taxed as a capital gain at a preferential rate); and
  • Income from property such as: dividends from shares or other investments.

All Canadian residents are required to report income earned no matter where the income is derived. Therefore, if a Canadian resident has income derived from another country or on the internet, it must be reported in Canada. For example, a Canadian resident who invests in a business in India, will have to disclose the amount of the dividends received and declare it as income in Canada or a Canadian resident who owns and rents a house in Dubai must declare the rental income here in Canada to comply with the Income Tax Act. However, if the taxpayer is earning income in a jurisdiction which taxes the income or is a participant in a Canadian Tax treaty, it may be credited or be taxed at a special rate. This should be confirmed with a tax specialist.

Not included in income are the following:

  • most gifts inheritances and lottery winnings;
  • GST or Canada Child Benefit Tax Credits;
  • compensation derived from being a victim of a criminal act or motor vehicle accident;
  • amounts provided by Canada or an allied nation for disability or death due to war;
  • strike pay;
  • amounts received from a life insurance policy upon death of the insured; and
  • an employer’s input into RRSPs, pension plans or drug, health or accident insurance are not included in income, but RRSPs and pension plans are taxed upon the withdrawal of funds.

However, in each of these cases the interest earned from investing monies from these sources of income is taxable, even though the initial amount is not.

The sources of income are diverse and are not restricted by the physical borders of Canada. As such, taxpayers are required to self assess the sources of their income and disclose all income from each source.

Methods of Disclosing Unreported Income

If you were unaware that all these sources of income were taxed or did not report this receipt of income, the CRA offers two distinct methods of disclosing unreported income. The method chosen is dependant on when the unreported income was obtained.

If the unreported income is for the preceding year, the taxpayer can file a T1ADJ to correct the discrepancy. The interest and penalties will accrue as of the date that the filing was due. If the unreported income is older than one year, the taxpayer can submit a Voluntary Disclosure. The CRA will not prosecute nor register a penalty against the taxpayer. The interest will still be due, but may be mitigated.

The taxpayer can file an additional Taxpayer Relief Application to reduce the amount of interest. This application takes approximately six months for the CRA to process, and may lead to some or all of the interest arrears being erased. The CRA may decide to not erase any of the interest and the taxpayer will owe an increased amount of interest for the interim period, if not already paid.

Once the CRA has begun an investigation into the taxpayer’s affairs, it becomes too late for voluntary disclosure, therefore disclosing before the CRA commences its investigation or issues a request to file, is important. The longer one waits to use these methods of disclosure, the harder it becomes to avail one’s self of them as the documents are less accessible, and other supports may not available. Also once penalties and interest begin to accrue, it becomes increasingly onerous to pay the tax liability.

Consequences for Unreported Income

The CRA can pursue investigations and prosecutions in circumstances where a person’s lifestyle is inconsistent with the income they have reported or where they have audited a third party and feel the need to audit the taxpayer. For instance, an audit of an employer may provide information that the taxpayer was paid a significant bonus. By following this course, the CRA may find that the taxpayer did not disclose this amount in its tax filing. There are several consequences for not disclosing income or disclosing income late.

1. Interest Accrual

Unreported income is subject to interest, from the date it should have been disclosed or filed. The rate of interest is based on the Treasury Bill rate for the previous three month period and fluctuates over time. As interest begins to accrue on the filing due date and is compounded, meaning that it is added to the balance owing and the next application of interest is applied to the entire sum, it is difficult to repay. The backdating of the start of the interest accrual also makes repayment difficult.

2. Penalty Imposition

If a taxpayer has not filed its taxes, it will be subject to a late filing penalty. For a first time offence, the penalty is equivalent to 5% of the balance owing in addition to 1% of the balance owing for every month it is late to a maximum of 12 months. If it is not the first offence, the penalty is equivalent to 10% of the balance owing in addition to 2% of the balance owing for every month it is overdue to a maximum of 20 months. Interest is charged on the penalty owing and this interest is compounded.

3. Fine Imposition

The CRA can charge the taxpayer for tax evasion. This litigation can result in fines ranging from $1,000.00 to $25,000.00.

4. Imprisonment

In some cases the CRA can charge the taxpayer and the result can be one year of imprisonment per conviction.

5. Loss of Personal Property

Finally, the CRA has the ability to place liens on homes and personal property, forcing a sale of the asset. These liens precede any other liens or mortgages (in the case of real property) and must be paid first out of the proceeds of any sale.

Most of the consequences imposed by the CRA involve loss of wealth, but imprisonment for tax evasion can also occur and any of these consequences can be posted on the CRA website or publicized and all of these usually cause the taxpayer emotional distress and anxiety.

The CRA is aggressively pursuing taxpayers who have unreported income. They have also made available methods of disclosing unreported income which are not onerous and provide adequate protection to the taxpayer. These options should be taken advantage of by the taxpayer, as once the CRA discovers the unreported income and chooses to prosecute, the result could lead to financial disaster due to the compounding interest, penalties and emotional distress

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