Managing increasing prescribed interest rates on tax reassessments

With rampant inflation and growing interest rates, Canadians everywhere are bracing for a looming recession. The interest rates applicable for tax planning in Canada have been increasing as well, leaving many tax decisions that once made sense to now being much tougher to manage economically. Interest rates applicable for tax planning refer to the prescribed interest rates, which are computed quarterly and published online by the Canada Revenue Agency (CRA).

The prescribed interest rates have been on a rapid trajectory upwards during the past year despite historical lows for the previous 10 years. In fact, starting April 1, 2023, it will be the fourth consecutive quarter of prescribed interest rate increases. Tax decision making that once relied on historically low prescribed interest rates should now be scrutinized in light of these inflationary times.

This series of two articles will explore two key considerations on how increasing prescribed interest rates can affect the middle market. This first article is going to dive into an example of how the prescribed interest rate increases can affect income tax reassessments. The second article will investigate the impact of increasing prescribed interest rates on certain loans. You can find the second article here.

Overdue taxes on reassessments

Within a certain limitation period, taxpayers can be subsequently reassessed on taxation years that have already been assessed. If not otherwise prompted by the taxpayer, this means that the CRA has made some sort of change to the taxpayer’s tax return for that year. This could be for a multitude of reasons and can either reduce or increase the taxes owing for that given taxation year. One common reason that tax returns are reassessed are due to tax audits where the CRA increases taxable income and resulting taxes owing, whether as a result of unreported income, the denial of a deduction, or many other reasons.

Interest rates are important for reassessments because an increase in taxes owing is oftentimes accompanied with interest charges. Interest is charged based on the prevailing prescribed interest rate for each quarter since the tax owing was due.

Assume an individual had an increase to their 2019 taxable income due to a CRA audit. The taxpayer engaged a dispute specialist to assist with negotiations. The taxpayer is confident in their tax position and opted not to pay the alleged outstanding amount, expecting it to be reversed in full on conclusion of the audit. The additional tax owing per the tax reassessment is $100,000.

This example shows that the risk (cost) of not promptly paying the taxes per the disputed reassessment has gone up considerably. Consideration should be given as to whether it now makes sense to pay any outstanding disputed reassessments to limit this interest risk going forward.

The take-away

Managing tax reassessments and interest therein is mostly a cost-benefit analysis. It is important to weigh expectations of a dispute result against any avoidable costs, such as interest.