Charities Audits: Dealing With The CRA

CHARITIES AUDITS: DEALING WITH THE CRA

Any taxpayer can be audited. With certain taxpayers or certain types of taxpayers it happens often. For large businesses or high net worth individuals it is a fact of life. Registered charities are also a type of taxpayer that is disproportionately audited, but a charity audit usually feels very different from a business audit.

For other taxpayers, the fight is usually about income or expenses. Maybe an item is income or capital. Maybe an expense is deductible or not. In most cases, a significant amount of tax is being paid and disputes are typically on the margins. With registered charities, which do not pay Part I tax, the dispute is more typically about compliance and principles, rather than counting and methodology. Instead of numbers on the margins, the stakes are often existential for the charity.

The Canada Revenue Agency (the "CRA") certainly sees charities primarily as beneficiaries of tax benefits, and not as contributors to the fisc in the same way that taxable enterprises are. This is the fundamental point to remember when dealing with the CRA on an audit. The CRA views their work in this area (i.e. enforcing the strict requirements necessary for a charity to receive favourable tax treatment) as important, and it is the Act's requirements, and not the social importance of the charity's mission, that should be focussed on in order to achieve the best success when dealing with the CRA on an audit.

In other words, the CRA is generally indifferent to the importance of the work of the charity if that work cannot be accomplished or is not being accomplished in a way that meets the requirements of the Act. They are an administrative police force aimed at ensuring that the "registered charity" (or other "qualified donee")1 stays within the boundaries set by the Income Tax Act of Canada (the "Act") and case law. And they are a busy police force. In 2012/2013 alone, the CRA's Directorate's Compliance Division completed 799 audits of charities.2

On a more practical note, the audit can be a major disruption. The process of preparing for the possibility of an audit and responding in a manner acceptable to the CRA can be a significant hassle, and will often involve extra work for the most important people in an organization, and extra spending on professional fees. Also, it is not the sort of business that a charity is usually involved in. The focus of the charity is its mission. That work (the relief of poverty, advancement of education, advancement of religion or certain other purposes beneficial to the community3) is what everyone wants to be doing. Spending time on detailed record keeping can sometimes take a backseat to the compelling work of a charity, but when the CRA begins asking questions, how well such records and documentation are kept and how careful a charity has been about scrupulous compliance with the Act requirements may mean the difference between sanction (including revocation) and being left alone by the CRA.

Room to resist the demands of the CRA is limited. Charities and other taxpayers who have asserted privacy over their documentation have been told by the courts that their expectations should be set low.4 In the end, in the event the CRA does choose to audit a charity, it is important to be responsive and helpful to the extent possible, while at the same time taking steps to ensure that the CRA follows the rules set out for it in the Act and otherwise.

This paper seeks to provide guidance on this subject by offering a general overview of documentation requirements for charities and CRA powers to audit, in addition to presenting some advice both on how to prepare for audits and how to properly respond (including comment with regard to privacy and solicitor-client privilege).

AUDIT POWERS

The Act sets out both the requirements for charities with regard to keeping records and the powers of the CRA to examine these records and to audit the charity or other taxpayer. This section focuses on the requirements for charities specific to audits.

The majority of taxpayers selected by the CRA for audit are done randomly, based on recommendations made by its audit software. The CRA also, at times, undertakes audit projects on particular groups of taxpayers if certain "results indicate that there is a significant noncompliance within [a] group" or targets particular taxpayers based on leads from other files or their connection to other problematic taxpayers.5

In general terms, the purpose of auditing a charity is to enable to CRA to:

verify revenues, including all charitable donations received; verify that resources are spent on charitable programs; and verify that the charity's purposes and activities continue to be charitable. The CRA's power to audit is found in subsection 231.1(1) of the Act. The CRA is explicitly permitted to inspect, audit or examine the books and records of a taxpayer and any document of the taxpayer or of any other person that relates or may relate to the information that is or should be in the books or records of the taxpayer. It is also granted certain investigation rights, such as the authority to enter into the premises of the taxpayer and the ability to require the management of the taxpayer to give it "all reasonable assistance and to answer all proper questions relating to the administration or enforcement of [the Act]".

The powers to audit are clearly very broad, essentially allowing the CRA to demand anything that contains information6 relevant to whatever is or should be in the books or records of the taxpayer. The auditor is also permitted to obtain information on unnamed persons during the audit of the taxpayer without seeking judicial authorization. In the context of charities, the identification of unnamed donors is relevant in determining the legitimacy of the donations and issued receipts and thus the validity of the taxpayer's charitable status.

Information from third parties may also be sought when the taxpayer cannot or will not provide the information the CRA is authorized to demand. Thus, in addition to the working papers prepared by the taxpayer's internal accountants, the CRA is also empowered to demand the working papers of third-party accountants and auditors where it is needed in accordance with the scope of the CRA's review.

Under subsection 238(1) of the Act, a failure to comply with a demand for information or documents is an offence which can result in fines or imprisonment.

Subsection 230(2) of the Act sets out the requirements for charities, among others, to keep records and books of account, for a period of two to six years (depending on the type of document),7 containing the following:

all information in such form as will enable the Minister to determine whether there are any grounds for the revocation of the charity's registration under the Act; a duplicate of each donation receipt for a donation received by it; and information in such form as will enable the Minister to verify the donations to it for which a deduction or tax credit is available under the Act. These records may be kept in electronic format, but if so, they must be "retained in electronically readable format" for the entire required retention period referred to above.8

In cases where an audit reveals non-compliance, the CRA has a number of corrective tools for enforcement purposes including:

Education letters: An education letter does not adversely affect a charity's registration. The letter identifies where the charity has not complied with the Act or CRA policy. The letter provides guidance to the charity so that it can take the required steps to become fully compliant. Compliance agreements: In more serious cases of non-compliance, the CRA may enter into a compliance agreement with the charity which outlines the noncompliance issues and the remedial actions that the charity has agreed (perhaps reluctantly) to undertake, sets out timelines for the changes, and outlines the consequences if the charity fails to abide by the agreement. Sanctions: In even more serious cases of non-compliance, sanctions may be imposed. Sanctions may include a temporary suspension of a...