While we have a self-assessment tax system in Canada, if the tax man suspects that your return doesn’t fully capture all of your income from all sources, there are methods the Canada Revenue Agency may employ to uncover unreported income. One such technique is the “bank deposits method.”
This method is an alternative way of determining income that is sometimes used by the CRA when it believes a taxpayer’s returns and other records are an inadequate means of verifying a taxpayer’s true income. A bank deposit analysis typically involves reviewing each deposit a taxpayer has made to their bank account (in excess of a certain amount), and then asking the taxpayer to explain the source of each of those deposits. To the extent that the taxpayer either can’t explain the source, or provides an explanation that the CRA doesn’t accept, the CRA proceeds to include the deposit in the taxpayer’s income. Of course, if the taxpayer is able to prove that a given deposit comes from a non-taxable source, such as a gift or transfer, or has already been reported in income, the CRA ignores that deposit.
The case
Over the past decade, there have been more than a dozen reported cases in which this method has been used by the CRA to detect undeclared income. The most recent case was decided last month in Tax Court and involved a retired used car dealer in Orillia, Ont., who reported relatively little income in his 2013 and 2014 returns. The CRA reviewed the taxpayer’s bank statements for these two taxation years and reassessed him on the basis that he had failed to report income of $21,392 for 2013 and $36,770 for 2014. These amounts consisted of nearly 20 separate cash deposits, ranging from $200 to $7,500, which the CRA deemed to be unreported income.
Gifts from his mother
The taxpayer testified that he had a history of keeping money at home “in order to show his parents how much he had saved.” After the taxpayer’s father passed away, his mother was left at home without any help, and faced a variety of medical issues that worsened over time. The taxpayer took his mother to medical appointments, did her shopping, as well as her banking and investing. He would update her bankbook and he had full access to her account.
The taxpayer testified that his mother gave him cash gifts every month “in appreciation for the assistance that he gave her.” He testified that she would give him at least $1,000 monthly. When his mother made a profit on a successful investment, she would give the entire profit to her son. When he withdrew $1,200 in cash from her bank account, she would keep $900 and give him $300 as a gift.
This arrangement continued until his mother passed away in 2010. According to the taxpayer’s testimony, his mother had given him total cash gifts of $70,000 during her lifetime. He claimed that he kept this bundle of cash in a freezer at home until 2014 when he testified that he began using a home safe. The taxpayer maintained that the source of all of the deposits at issue was the $70,000 in cash gifts that his mother had given him over the last 18 years of her life. He claimed that his former spouse “had taken a photograph of the $70,000 in cash at the matrimonial home earlier that year.”
The taxpayer offered several explanations as to why he kept the $70,000 in cash at home. These explanations included having sufficient funds on hand to, initially, take a vacation with his now ex-wife and then, to keep the $70,000 away from her.
He testified that once his divorce was settled in late 2012, and he had not been ordered by the court to give one-half of this cash to his former spouse, he began a process of depositing the $70,000 into his personal bank accounts.
Garage sales
In cross-examination, the taxpayer admitted that one of the unexplained deposits for $2,500 in May 2014 could have been the proceeds received from a garage sale that he conducted that year. Three of the unexplained deposits made in September and October 2013 ($4,000, $2,900 and $2,000) were also marked as “Cash from Garage Sale.”
When the taxpayer asked what exactly he sold at those garage sales, he stated that the goods consisted exclusively of “antique furniture, such as a couch, and other furnishings from his own home such as oil lamps, etc.” The taxpayer was then shown a copy of a letter he had written to the CRA auditor in which he said that he had purchased more than $1,000 worth of items at “Liquidation World” and more than $1,100 worth of items at “Goodwill” in 2013 and 2014 for his garage sales.
Judge’s ruling
The CRA described the taxpayer’s testimony on critical points as “implausible,” and the judge concurred, adding that it “was neither credible nor reliable.” The judge questioned why, if the taxpayer had received at least $1,000 in cash gifts from his mother each month for 18 years, the total amount of cash gifts received was merely $70,000, and not closer $216,000.
The judge also felt that the taxpayer’s various explanations as to why he kept the $70,000 at home “make no sense. Why keep it at home where it gathers no interest and is at risk of theft, fire and flood?” The taxpayer’s explanation that cash was kept at home to pay for an anticipated vacation with his wife “makes little sense. Few vacations, other than the most extravagant, would cost anywhere close to $70,000.”
In court, the taxpayer testified that his former spouse had taken a photograph of the $70,000 in cash, yet he failed to produce such a photograph nor did he call his former spouse as a witness. The judge quipped: “In any event, it is difficult to imagine what such a photograph would depict. Would it show the interior of a freezer with stacks of $100 bills spread across the shelves? It is unfortunate that the photographer was not in the courtroom to answer questions about the alleged photo of $70,000 in cold, hard cash.”
In the end, the taxpayer failed to prove, on a balance of probabilities, that the unexplained deposits in 2013 and 2014 came from a gift of $70,000 bestowed on him by his mother and thus the judge upheld the CRA’s reassessments.