Handling disputes with the Canada Revenue Agency: The audit phase

By Adam Aptowitzer, Drache LLP - Tax, Estates & Charity Law, Ottawa
June 26, 2006

Since June 2005, the Canada Revenue Agency (CRA) has had the power to impose
penalties on charities for breaking certain rules which stop short of revoking the charity's
registered status. These intermediate penalties range from a $500 penalty for not filing a
charitable information return, to paying 110% of an undue benefit bestowed upon a third
party. (I have outlined these intermediate sanctions in a previous article). In addition to
new penalties, there is also a new way of appealing such a penalty. This new system of
dispute resolution is the same system used by individuals and corporations when the
agency reassesses them for tax and/or penalties. The new system first requires an appeal
to the CRA's internal Appeals Division, and if unsatisfied with the Appeals Officer's
decision, it is open to the taxpayer to appeal to the Tax Court of Canada.

As charities are generally unfamiliar with this new process, it is critical for them to
become aware of every step that might be taken by the CRA, and what their rights and
responsibilities are in fighting a possible intermediate penalty. In order to fully explore
the charities options, this will be the first of a three part series of articles dedicated to
informing charities of their rights and responsibilities under the new system.

Choosing which charity to audit

The process generally begins with a CRA audit of a charity. The agency has several
factors that go into choosing which charities to audit. If the system regarding individuals
and corporations is any indication, the CRA will use news reports, snitch-lines, sector
specific sweeps and random statistical means to choose which charities to audit. It is also
likely the CRA will red-flag the charitable information return - the T-3010 - to audit
charities that report extraordinary items. Once a charity is chosen to be audited, the CRA
may begin by collecting information without informing the charity. This may include a
review of the different information returns that have been submitted by the charity. It
may also include a collection of the donation tax receipts that have been included in the
income tax returns of donors, or reviews of related charities either in Canada or overseas.
Obviously, there is little charities can do to stop the CRA from collecting whatever
information it wants, especially if that information has already been submitted to the
CRA by both the charity and the donors.

After the collection of information from outside sources, the CRA may contact the
charity. This contact may come by way of an informal call from a CRA auditor or it may
be an official request for information that would require the charity to produce all of its
books and records within a specific time, usually within 30 days. The charity does not
have to comply with an informal request but if the auditor does not get the required
information by informal means then he or she may issue a formal legal request. The
decision to cooperate with an informal request should not be coloured with the idea that if
one is cooperative with the CRA then they will "go easy" on the charity. CRA auditors
have a job to do and past experience has shown that they will apply the Income Tax Act
regardless of whether or not the charity has helped make their job easier. Thus, the
appropriate response to an informal request is to ask for a formal request for information,
this will outline exactly what the CRA needs and can be provided for them within the
time period allotted.

Your rights and how to enforce them

A formal request may state that the items are to be brought to the CRA offices; this is not
necessarily a requirement under the Income Tax Act. You may wish to have the auditor
review the documents on your premises. Indeed, in fulfillment of Parkinson's Law that
work expands to fill the time allotted to it, when the CRA has unlimited access to a
taxpayer's documents it takes far longer to resolve an issue. Moreover, experience has
shown that the CRA is not above losing documents. However, if the charity does provide
documents so the CRA can review them at their offices, the CRA should provide an
inventory of documents that are in their possession. Inventory lists should be as detailed
as possible to avoid disputes as to which documents are actually in the CRA's possession.

During the course of the audit, the auditor may have additional questions that must be
answered in order for the audit to be completed. Depending on the issue, it may be wise
to ask the auditor to record their questions on paper for a full documented response. It
must be remembered that the absence of information or the collection of inaccurate
information may find its way into an audit and result in more difficulty resolving issues
later. So, to ensure that information is as complete and accurate as possible, and at the
earliest possible stage, questions and answers should be recorded in documentary form.
Moreover, answers should be provided by knowledgeable personnel (or the charity's
lawyer), not by individuals who may simply be guessing and providing inaccurate
information.

What happens after the audit?

Once the auditor has completed his/her audit he/she will produce a letter outlining the
proposed assessment of penalties. The purpose of this letter is to provide the charity with
a chance to correct any misconceptions or inaccurate information or to argue on the basis
of principle that the auditor has made a mistake of law and the penalty should not be
levied. It is critical at this stage not to admit guilt (unless you want to accept the
consequences); the reason for this is that all documents may become evidence against the
charity in court.

Another option for a charity may simply be to remain unresponsive to the auditor's
position. The audit stage is fluid and if the auditor can be convinced their position is
wrong they may try to find another way to attack the charity. If that is the case, then it
might be best letting a weak or false argument by the auditor through to the Appeals
Officer. At this stage, the mandate of the officer is simply to determine the merit of the
assessment, not necessarily to find a justification for it. (The next article in this series
deals with the appeals stage in more depth). Hence, it might be easier to fight off an audit
at the appeals stage. This strategy must only be undertaken with experienced professional
advice. It is a dangerous game to play chicken with a CRA auditor in the hopes that the
arguments will be dismissed at the appeals stage.

If the charity does decide to respond to the auditor's letter, it can request an extension of
time to do so. Often an auditor states a response is required within 30 days but the charity
should not fear asking for an extension. The letter should only deal with the issues raised
by the auditor and even then must be a persuasive letter written with reference to the
appropriate sections of the Income Tax Act and case law. The letter can and should be
written to the attention of the auditor. However, if the charity and the auditor are going to
go back and forth on a particular issue and the charity is finding that the auditor is less
then responsive (or outright hostile), the charity has the option of requesting a meeting
with the auditor's supervisor or simply providing the auditor's supervisor with a copy of
the correspondence and the letter illustrating the problems. The obvious hope is that the
auditor's supervisor will recognize the charity's concerns and either overrule the auditor
or simply appoint a new one. When the auditor has finished the audit, he or she will
provide the charity with a letter stating its position. The charity will then receive a Notice
of Assessment or Reassessment formalizing the CRA's decision on the matter. At this
point the process enters the Appeals stage. This will be dealt with in more detail in my
next article.

This article first appeared in Charity Law Insights, a law newsletter for charities and
not-for-profits. It is reprinted with permission.

Adam Aptowitzer distributes the above information on the understanding that it does not
constitute legal advice or establish the solicitor/client relationship by way of any
information contained herein. The contents are intended for general information
purposes only and under no circumstances can it be relied upon for legal decision-
making. This article is current only as of the date above and does not reflect any
subsequent changes in the law. Readers are advised to consult with a qualified lawyer
and obtain a written opinion concerning the specifics of their particular situation

Changes to Charity Rules

Adam Aptowitzer, January 30, 2006

The advent of 2006 will bring with it the fulfillment of several proposed changes that
affect charities and which have been promised or in the planning stages for some time.
Considering that the Charities Directorate is more determined and more capable than ever
to be an effective enforcer of the law it is important for charities to have a basic idea of
the changes in store for them. Here are the five changes charities should keep in mind as
we begin the New Year. 1) Changes to Receipts In addition to the information required
on charitable receipts prior to 2005, receipts issued after the beginning of 2005 are also
required to show The “Canada Revenue Agency” and “http://www.cra-
arc.gc.ca/charities”. The new development for 2006 is that while the CRA has stated they
will not penalize charities for not including the information for receipts issued in 2005,
they “expect” charities to conform to the new regulations by January 1, 2006. 2)
Intermediate Sanctions Before the passing of Bill C-33 last year, the CRA’s sole
punishment for a charity that broke the rules was deregistration. As the penalty was too
draconian for anything but the most severe infractions it was rarely imposed by the CRA.
Bill C-33 implemented a variety of lesser penalties for infractions (although
deregistration still remains an option of the CRA). This year will likely see the first
impositions of these penalties. Below is a chart of the new penalties. See Penalties
Chart in PDF format 3) New Tax Dispute Resolution Mechanism Starting in June
2005, (although practically speaking 2006 will likely see the first cases), the tax dispute
resolution mechanism for individuals and corporations will apply to charities. The
process of levying a penalty will likely begin with an audit of the charity. Where the
CRA sees fit to levy a penalty, the charity will receive an official Notice of Assessment.
If the charity objects, it will have 90 days to file a Notice of Objection with the CRA. In
the normal course, the CRA will assign the file to an internal ‘Appeals Officer’ who will
review the CRA’s position in light of any submissions made by the charity and included
with its Notice of Objection. If the charity disagrees with the Appeals Officer’s decision,
it will have 90 days to file a Notice of Appeal in the Tax Court of Canada. Appeals from
the Tax Court go to the Federal Court of Appeal. Questions of registration/deregistration
or annulment go straight to the Federal Court of Appeal. The imposition of a new
deadline schedule on charities, a group otherwise unaccustomed to dealing with this
dispute resolution mechanism, is bound to lead to confusion and missed deadlines.
Fortunately, there are mechanisms that allow a charity to file beyond the deadline under
certain circumstances. The imposition of these penalties is new for both the CRA and
charities and therefore it is critical for charities going through the process to have a
professional legal advisor from the audit stage through the Tax Court and Federal Court
of Appeal level. 4) Disbursement Quota Changes The disbursement quota is a
complicated calculation that stipulates how much each charity must spend on their
charitable objects in a year. In 2005, the government passed changes to the disbursement
quota that, among other things, further complicated the calculation and dealt with
donations of ten year gifts, the definition of ‘enduring property’, and transfers between
charities. As a charity's spending requirements for 2006 are based on amounts collected
in 2005, this year will see the first impact of the changes in 2005. Given that it still lies
with the CRA to deregister a charity that fails to disburse its quota, charities should speak
with a qualified professional advisor to ensure that they have properly calculated the
quota with the new changes. 5) Possible Implementation of Proposed Changes There
are a variety of changes that the Liberal governments tabled in 2005 and preceding years,
which are waiting official passage into law. Many of these relate to the use of tax shelters
as a way to provide increased donation credits for donated dollars. The CRA policy is to
begin enforcement of these provisions from the date of their announcement (when passed
they are usually passed retroactive to their date of announcement). However, with the
change in government it is possible that some of these provisions will not become law.
The more cynical among us may argue that as there is no real difference between the
Conservatives and Liberals on these issues, we will see the Conservatives pass the
majority if not all of the provisions. However, if this analysis is wrong, we may see the
entire sector thrown into disarray before the end of the year.
Infraction First Infraction Second Infraction
Failure to file Information Return $500
Issuing of receipts with incomplete 5% on the eligible amount of the 10% of the eligible amount on the
information receipt receipt

Knowingly issuing or participating in the issuance of a 125% of the amount listed on the receipt or possible
false receipt revocation

Transferring property to another charity to delay 110% of the fair market value of the property
expenditures on charitable activities

Knowingly accepting transferred property from a Revocation

charity attempting to delay expenditures on charitable
activities

Charitable organization carrying on 5% of business’ gross revenue 100% of gross revenue

an unrelated business 188.1(1)

Acquiring control of a corporation 5% of all dividends received 100% of all dividends received
by a foundation s.188.1(3)

Conferring an undue benefit on 105% of the benefit conferred 110% of the benefit conferred
another individual, corporation or
entity s.188.1(5)

Audit Exemption for Ontario Charities

Adam Aptowitzer, October 19, 2006

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