Estimating unreported income in tort personal injury claims
This article originally appeared on The Lawyer’s Daily website published by LexisNexis Canada Inc.
Underground economic activity totalled $45.6 billion in Canada in 2013, or about 2.4 per cent of GDP, according to Statistics Canada. Residential construction, retail trade, accommodation and food services accounted for more than half of the total underground economy, mostly in the form of unreported income through cash payments.
Prevalent in small, service-oriented enterprises, many business owners — such as mechanics, estheticians, hairdressers, tradespersons and restaurateurs — find cash transactions appealing, since businesses can avoid collecting sales tax, remitting sales tax and reporting a portion of their income, thereby avoiding paying income tax.
Failure to collect and remit sales tax and pay income tax constitutes tax evasion, which is illegal, posing particular challenges when calculating income losses in personal injury claims.
In assessing personal injury income loss claims, damages are awarded based on the projected earnings of the plaintiff but for the incident, minus the plaintiff’s actual earnings or anticipated future earnings. When quantifying damages for a plaintiff, projected earnings are often a function of historical earnings, as reported on their income tax returns. If there are claims of unreported cash, the plaintiff and counsel must be able to substantiate them, and the burden of proof falls on the plaintiff to:
- Convince the trier of fact that more income was earned than was historically reported for income tax purposes; and
- Convince the trier of fact of diminished earning capacity, resulting from the incident in question.
In admitting unreported income and proving the first point, the plaintiff’s credibility is inevitably questioned when trying to convince the trier of fact of diminished earning capacity, making it difficult to prove the second point.
So how do professional accountants, engaged to quantify economic damages relating to personal injury, estimate unreported income?
Documentation of cash sales
The most powerful method to substantiate cash sales is a paper trail. For example, the plaintiff may be able to produce handwritten ledgers, appointment books, cash register tapes or other records of unreported sales.
Economic loss experts can perform industry research to substantiate the likelihood of cash sales and use industry statistics to estimate the quantum of those sales.
If the plaintiff is unable to produce documentation, counsel can obtain testimony to corroborate work performed and the remuneration. For example, if the plaintiff is a contractor doing home renovations, counsel might be able to obtain sworn statements from various customers attesting to payment for work completed.
Income statistics might indicate cash sales if reported income is significantly lower than the relevant statistical average, based on the plaintiff’s job and demography. Statistics can be used to estimate pre-incident earning capacity, with Statistics Canada being a common source of data.
Earnings can be imputed by estimating the required annual expenditures of a plaintiff, which is a method sometimes used by the Canada Revenue Agency when auditing taxpayers.
For example, obtaining a summary of annual expenditures from the plaintiff — such as food, rent, clothing, utilities, etc. — can help with this assessment. If the plaintiff has not gone into debt to finance living expenses, one can assume he or she has earned sufficient income to pay for them. As well, an increase in assets (bank accounts, investments, car, etc.) could indicate income over and above the expenditures.
Whether an award is granted based on unreported income (i.e., an illegal act), ex turpi causa, is a legal determination. Generally, triers of fact have held that the inclusion of unreported income in an income loss claim is admissible.
In Bush v. Air Canada (NSCA)  N.S.J. No. 17, Justice David Chipman noted that “unlawful conduct which may embarrass a plaintiff in convincing the court of the true level of his or her income cannot be said to be the founding of a cause of action upon an immoral or illegal act."
Similarly, in Iannone v. Hoogenraad (B.C.C.A.)  B.C.J. No. 682, the British Columbia Court of Appeal decided that “the defendant contends that to take unreported income into account is to allow recovery which ought to be barred on the grounds of public policy. In my respectful opinion, that proposition confuses the concepts of a right to recover on a cause of action and the burden of proof upon a plaintiff whose right of recovery is not barred by a principle like ex turpi causa. ... It is not, in my opinion, open to the defendant to avoid compensating for that loss on the ground that unreported income was taken into account in computing it."
In the 1996 decision in Scheiwe Estate v. Skogan, the Alberta Court of Queen's Bench discounted the award by a 10 per cent contingency to account for the possibility that “at some future time, had the accident not occurred, it would have become taxed either due to change in corporate policy or as a result of the intervention of taxation officials."
Given relevant case law permitting the inclusion of unreported income, economic loss experts can interview the plaintiff and explore his or her circumstances to determine the most appropriate or reasonable approach in order to estimate unreported income.