Tax audit letters from the Canada Revenue Agency (CRA) may not be welcome news to taxpayers, but even though a tax audit can seem daunting, it can be effectively managed if taxpayers are aware of their rights and informed on audit processes. A tool available to help taxpayers in the audit process is the audit agreement.
Recently, the CRA released updated guidelines on the use of audit agreements and the corresponding waiver of objection rights during tax audits. The current guidelines replace the previous communique AD-05-02B by clarifying criteria needed for audit agreements to be binding and provides information regarding the Audit File Resolution Committee. The communique also expands on the criteria for applying the use of audit agreements.
What is an audit agreement?
When a tax issue arises, the CRA and the taxpayer being audited may enter into an agreement known as the audit agreement. The audit agreement allows the taxpayer and the CRA to set out terms of the audit such as the facts of the case, the specific tax issues to be assessed, as well as how the audit may be resolved.
While the audit agreement does not preclude the CRA from auditing the same taxpayer for other taxation years or issues, it does provide a clear method and resolution for the tax issues addressed in that particular audit agreement. The use of audit agreements therefore provides taxpayers with greater certainty, less litigation and helps to provide the public with predictability when it comes to tax enforcement. Discussions aimed at resolving an issue through an audit agreement may take place at any stage once the facts are understood and the potential assessing positions and quantum have been identified. Procedurally, the opportunity for an audit agreement arises when a taxpayer challenges an auditor's adjustment proposal.
Binding nature of audit agreements
There are several requirements that must be fulfilled for an audit agreement to be binding on the taxpayer. These include (a) disclosing all material facts, (b) agreeing to pay the possible taxes and penalties owing depending on the results of the audit, and (c) providing a signed copy of the Waiver of Objection Rights to the CRA. As long as the facts of the case do not change, both the CRA and the taxpayer must comply with the results of the audit.
Waiver of objection rights
In order for the audit agreement to be binding, the taxpayer must waive the right to appeal an assessment. The waiver is voluntary and in signing it, the taxpayer gives up the right to object and appeal the results of the audit.
Audit agreements normally relate to subjective audit issues which could not be resolved easily with straightforward calculations. Examples of such issues include valuation of benefits, residency issues, reasonableness of expenses and others.
Given the subjective nature of these issues and the concern over the coercive power of the CRA, auditors are held to a high professional standard when entering into audit agreements. As a general rule, the law takes waivers of rights seriously. The CRA therefore strongly encourages taxpayers to make sure they understand the consequences of the audit agreement before signing a waiver of their rights.
To this end the CRA has established an Audit File Resolution Committee which is responsible for evaluating audit agreement proposals to ensure fairness and to promote the efficient resolution of audits.
Audit agreement process guidelines
It is paramount that the taxpayer agrees to their waiver of rights without any coercion from the CRA. In order to help guard against coercion allegations and to ensure that the taxpayer understands the agreement, the CRA requires auditors to document all correspondences and meetings with the taxpayer. This includes requirements such as informing the taxpayer of their right to seek independent legal advice, what the financial impacts of the audits will be, as well as what it means for a taxpayer to waive their right to object.
The content of the waiver of rights to object must be clearly set out to include the taxation periods at issue, the issues at stake in the audit and the potential for a finding of taxes or penalties owing related to the audit issue. The taxpayer will be liable to pay the assessments. Audit agreements must be completed on a principled basis according to the law (i.e. based on the applicable rules) because the agreement cannot be negotiated in an unprincipled manner. The auditors must be able to show that the above terms were agreed to voluntarily and provide documentation proving as such.
Takeaways for middle market businesses
While the process and parameters of audit agreements can be detailed and exacting, audit agreements can nevertheless be beneficial to both taxpayers and the CRA because they can improve the predictability and timeliness of the audits.