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Paul S. Hewitt, CPA, CA

TAX │ ACCOUNTING │ ADVISORY

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Tax Audit Defense Case Study

I received a call from Jack, late on a Sunday night.  He had been reading my Canadian Restaurant Tax Advisor blog, trying to find some information that would help him deal with a CRA audit of his restaurant.  He had a bad feeling that he was about to get hit with a tax reassessment.  I agreed to meet with him a couple of days later.
 
During out meeting, I gathered appropriate information to prepare a defence to the expected reassessment proposal.  Sure enough, the proposal letter arrived one week later, and it alleged significant “unreported sales”, resulting in a $45,000 tax liability for a two-year audit.
 
Jack had been audited before, and it didn’t go so well, but he did learn to keep records of his staff drinks, customer comps and his own drinks.  I went to work assembling the proof that would be credible to the auditor.
 
I performed a thorough review of the tax auditor’s working papers and found numerous errors.  I assembled the proof, to ensure that the auditor would accept the corrections.
 
I found that the CRA auditor had failed to account for the difference between Imperial and US ounces, which significantly reduced the auditor’s calculation of “unreported sales”.
 
I discussed the menu with Jack and found that several popular items used alcohol in the recipes.  Using the recipes and sales data, I was able to credibly estimate the amount of alcohol used in cooking.
 
Finally, I reviewed all court cases that dealt with indirect audit methods used in restaurant tax audits.  I found that the allowances for shrinkage used by the auditor were significantly lower than those that had been set by case precedents.  The auditor wasn’t following the law!
 
We were ready to meet with the auditor.  She brought along her manager, perhaps knowing that she was in for a “fight”.  I presented my case to overturn the auditor’s proposed reassessment in its entirety.  I should note that, had the CRA not backed down, I had gathered sufficient evidence to attack the auditor’s use of the mark-up method to audit the restaurant.  I would have argued this on appeal.
 
It took about a month, but we finally received notice from the auditor that the CRA was abandoning their proposed reassessment of the restaurant and its shareholder. 
 
All told, it was about two months from the initial phone call.  While the result was excellent, Jack could have saved a lot of time and money by having me prepare for the audit before the auditor arrived.  He would have gone through an awful lot less stress too!
 
I should note that Jack kept better records of discounts and own-use than most restaurants, and that played a part in getting the proposed reassessment quashed.  All restaurateurs are strongly advised to keep similar records.  If in doubt, request my Proactive Tax Audit Check-up, which will ensure that your restaurant keeps credible evidence to support these amounts during upcoming audits.