Wednesday, June 18, 2014

Undisclosed Income

It’s not often that we use this space to talk about developments in the Tax Court of Canada, but a recent case has brought forward an issue that we end up seeing time and again in personal injury and family law disputes: real versus declared income.

In Truong v. the Queen[1], the appellant reported annual earnings of around $40,000 from his work as a casting inspector. After receiving a tip that the appellant was living beyond his means, the CRA initiated an investigation and learned that he had been convicted of possession with the intent to traffic marijuana. Clearly, the appellant elected not to report income from these illegal activities.

Since income was not reported from these activities, the CRA had to determine the additional unreported income indirectly from a number of other sources – sadly, the appellant neglected to keep detailed financial records from his trafficking business. In determining an appropriate level of income to impute to the appellant, the CRA examined the income and expenses of his girlfriend – who could not have financed her personal expenditures without assistance – and real estate properties held in other individuals’ names, for which evidence existed that implied the appellant was using them in order to generate rental income.

Imputing Income in Personal Injury Matters


Calculating damages in personal injury cases is an exercise in weighing possibilities; we need to ask ourselves realistically, what could the injured have possibly earned in the absence of their accident? The answer to that question is largely based on the available evidence, including their background, education, economic conditions and what is often the most important piece of evidence, their earnings history.

Reported income is one of the bedrocks upon which a personal injury claim is based. In motor vehicle collisions, for example, the injured plaintiff is compensated by their insurer by way of benefits that are based on their income. If this bedrock is not solid, the injured party stands to lose both their income replacement benefits in the short-term, and any future damage awards further down the road. A plaintiff’s personal injury claim without sufficient evidence to establish their true income is akin to building the proverbial house on a bed of sand.

Individuals from all stripes will work to minimize their income for tax purposes, using a variety of strategies ranging over the entire spectrum of legitimacy. Because it is usually difficult for a salaried employee to minimize their income these individuals are usually business owners or contractors with the flexibility to deduct personal expenses and engage in unreported cash business. When we encounter a client whose income is in dispute prior to being injured, our first order of business is to develop a case that supports their true earned income.

How do we do this? It isn’t always possible to construct a purely evidentiary argument; detailed financial records may not exist. What we will usually end up with is a scenario based in part on the available financial information and using other, indirect evidence of additional unreported income. An example will help to illuminate this process.

Consider a client that had not reported income for at least five years prior to being injured in a motor vehicle accident. The client states that he had been working as a tradesman, but was paid in cash from an employer that also ran an entirely cash business. He also earned income from other cash sources: renovating houses in his spare time and purchasing, renovating and then selling homes for a profit.

Let’s start with the evidence: we would ask for copies of cheques issued by his employer in order to corroborate his employment income. In addition, bank statements, credit card statements or any copies of receipts from home improvement retailers like Home Depot and other home renovation supply stores would serve to provide some evidentiary basis for the income that he earned renovating houses. And finally, mortgage documents and agreements of purchase and sale would demonstrate a history of real estate income that wouldn’t necessarily need to be reported for income tax purposes.

Personal cheques may not be as reliable as a T4, but they are at least indicative of some level of employment income; receipts and invoices from Home Depot could suggest a little more than a passing fancy for hardwood floors and granite countertops, particularly if the expenses are substantial; and mortgage documents are not only evidence of gains made on buying and selling homes, but they can also be used to deduce some basic level of income because banks will not lend unless they can be assured that the borrower has the resources to pay them back.

So, we’ve managed to cobble together individual pieces of evidence from a number of sources in order to construct what looks like a picture of this person’s income. It’s an admittedly fuzzy picture, but the general form is there. The question we need to ask and answer is, “Is this reasonable?” Let’s say our analysis resulted in us attributing annual income to our client of about $40,000, a huge jump from the $0 they claimed for income tax purposes. In light of that fact, it’s important to take a step back from the details and examine this scenario we’ve created so that the Courts and we can judge whether or not our calculations bear any resemblance to reality.

Now, the words ‘reasonable’ and ‘reality’ are a little bit vague in this context, but let’s agree that it would be neither reasonable nor realistic to impute $100,000 of income to a single parent living in community housing. If we think about it this way, a nice way to test the reasonableness of our conclusions would be to compare our client to his neighbours using statistical data.

So if we were to summarize the process through which we would impute income to a client that had previously underreported their income for tax purposes, we could liken it to penning a novel. The first part – using bills, mortgages, and other pieces of evidence to construct our argument – is akin to writing the plot. We’re using little bits of information in order to develop a story about Mr. or Mrs. X and what they do for a living. The second part – evaluating how they compare to similar individuals around them – should establish for the reader (read: the Courts) that this is a work of non-fiction. Our case needs to look more like a biography than Alice in Wonderland, so it’s important and hopefully evident that the narrative needs to be consistent and that both parts are integral in making that happen.

This process need not be limited to personal injury matters; it can, for example, also be applied to self-employed spouses in a family law matter or in proving or defending criminal charges such as in Mr Troung’s case. The techniques described in this article are even used by Canada Revenue Agency in establishing a taxpayer’s undisclosed income. The key to using these methods successfully lies in obtaining quality evidence and employing experienced and knowledgeable financial experts.

Let the experts at Krofchick Valuations assist you in creating a case built on a solid foundation. We employ the skills of forensic economics, business valuations, investigative accounting, and actuarial science to assist in assessing and quantifying your clients’ economic position. Let the experts at Krofchick Valuations help you resolve your case in a timely, efficient, and professional fashion and see why We Make The Difference.




[1] Truong v. The Queen, 2011 TCC 72.

No comments:

Post a Comment