Legalized Extortion?

I’m going to describe a real case study and let you decide if the title of today’s blog is true.  This situation occurred several years ago at a client’s restaurant in Ontario.

My client operated a small, reasonably successful, restaurant in a fashionable downtown neighbourhood.  She was the head chef, general manager and office administrator.  She did everything but wait on tables.  I found her to be scrupulously honest in every respect.  One day she received notice that her restaurant had been selected for a retail sales tax audit.  She wasn’t concerned, at all.  In fact, she relished the opportunity to show the auditor her impeccably accurate and organized accounting records.  She knew that she had always collected and remitted the correct tax from all of her sales transactions.  She recorded every single sales transaction, even the few that were settled with cash.  In short, she thought it would be an impossibility that the auditor could reassess her business for any unpaid taxes.  She was about to experience the the impossible!

The audit took about three days to complete, resulting in a proposed reassessment of about $7,000 (including penalties and interest) for the two-year period covered in the audit.  My client was speechless!  I was brought in to review the auditor’s working papers supporting the proposed reassessment.

I recreated the entire set of schedules in Excel worksheets, in order to examine the impact of small changes in the assumptions that the auditor used to identify the “unreported sales”.  I spent hours with my client identifying all of the factors that contributed to reduced margins on her alcoholic beverage sales, in order to support her position as being more reasonable than the auditor’s contention that she purposely failed to report all of her restaurant’s sales.  We determined that some of the alcohol and wine purchased for the restaurant was actually used in making sauces.  We could estimate a reasonable amount of customer comps during each year.  We could estimate the average amount of over-pouring of wine and alcohol.  By making reasonable estimates for each of these factors, we were able to show that the reported sales of alcoholic beverages was, in fact, quite accurate.  Was the auditor convinced?

No.  To each of our claims, the auditor’s response was “you can’t prove that”.  It didn’t seem to matter that the auditor could not “prove” the assumptions on which the reassessments were based.  My client was outraged by the reassessments.  I filed an objection to the reassessments, expecting the appeals officer to be reasonable in considering all of the factors that contributed to lower alcohol margins, rather than assuming there were unreported sales.  I expected that the appeals officer would realize that the taxpayer’s position was reasonable, shifting the onus of proof back to the auditor.  I was convinced that no reasonable person would find the auditor’s position to have been proven.

This time, I was outraged by the response from the appeals officer.  Knowing that our only remaining alternative was to go to court to appeal the reassessments, the appeals officer confirmed the auditor’s reassessments.  As the cost of going to court to appeal the reassessments would have been more than the amount of tax and penalties assessed, the case ended here.  My client was forced to pay the $7,000 in order to maintain her liquor licence.

Is this a case of legalized extortion?

One Reply to “Legalized Extortion?”

  1. Paul,

    I found your article extremely interesting. As the former partner is a restaurant/pub in Mississauga, we are currently faced with the exact same situation. We were audited for the period July 1, 2010 to September 30, 2012 and they originally came back and said that we owed $91,000 and disallowed ALL of our ITC’s. One of my partners and I re-created an entire 3 month HST reporting period in which we gave them all of our sales receipts, showed the bank statements with all of the deposits and payments, and provided all of the receipts. They have now come back with their “final” decision which is that we owe $46,000 plus another $9,000 in penalties. They tell us that they use their own “formula” to determine what are sales should be based on what the LCBO and Beer Store purchases were and came up with this number. They refuse to look at our independent inventory reports from Bevinco that show what the sales were, what the inventory was at the beginning of a given week, what the purchases were, and what the sales were to determine if we were short on sales , in other words, if there was “spillage.” They told us that they assume spillage of 2% when the AGCO allow 3% and our third party numbers show the actual number to be approaching 3%. When first contacted, one of my partners gave them a copy of what he though was out price list and even though they have been told 3 times that the numbers were wrong and that we were able to obtain the actual sales numbers from the point of sale system, they refuse to acknowledge that our “price list” is flawed. Further they refuse to acknowledge that they are skiing for HST for the period of August 1 to September 30, 2012 when we had sold the business and no longer operated. The last kick in the teeth is that they will not give us the back up of how they determined their numbers. All they say is that based on purchases, the sales should have been higher and as a result we owe the HST. There were 5 partners in this business.We put in $250,000 to buy the business and borrowed and did a vendor take back for $160,000 which was paid off within 2 years. Further we put in another $125,000 in cash to keep the business afloat during the 38 months that we owned the business and in the end sold it for $150,000 of which we paid about $80,000 for past due HST directly from our lawyer’s trust account. In the end, we lost lever $500,000 and I personally have gone through a horrible divorce in the interim and could not pay what they are demanding even if I wanted to. I am actually fortunate in that I resigned as the President and as a Director before the HST audit as I was subject to some litigation by the AGCO due to overcrowding on St Patrick’s Day 2010 and spent $25,000 in legal fees and fines and I was fed up with how mis-managed the business was and that at least 2 of the partners contributed nothing except occupying bar stools. For 3 of the partner, they have lost their life savings.To add insult to injury, the auditor is being completely evasive and when questioned when can we appeal he said that he doesn’t know and to just pay the tax…”it’s a good deal.” What can we do? We cannot afford the tax nor can we afford a legal battle with the CRA and how can they tell us what our sales should be based on purchases? Regulars are always given free pints and most get a “half pint” and pay that amount yet they are poured about 95% of a pint. The sales are real, the purchases are real and where in the IT Act does it allow the CRA to tell me what my sales should be? It’s the equivalent to the CRA saying to a car dealer that you owes us HST based on the MSRP eve though you actually sold it for less and the numbers can be proved. In their little fantasy world, no business would ever go bankrupt because based on purchases the sales should actually be higher than what was reported….this isn’t extortion, it’s theft.

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