Disproving Audit Assumptions

During a typical audit, the tax auditor interviews the taxpayer about the business operations and various factors that influence sales, such as portion standards, selling prices, theft, spillage, own-use and over-pouring.  If the auditor exercises sound judgment, the taxpayer’s assertions will be considered prima facie evidence that the assumptions are reasonable in the circumstances.  These assumptions form the basis for most audit assessments of restaurants and bars.  What if they’re just plain wrong?

Once the auditor makes a judgment about the assumptions to be used, the onus shifts onto the taxpayer to prove the auditor’s assumptions are incorrect.  While there is a degree of subjectivity attached to these assumptions, it is not enough to simply come up with other, more favourable, assumptions as a means of disproving the auditor’s judgment.  Too often, I see taxpayers (and their advisors) simply plugging different assumptions into sales projection spreadsheets and arguing that these assumptions are “more reasonable” than the auditor’s.  A complete waste of time.  This approach will not work.  Failure to grasp this point will cost you a great deal of money and, most likely, prevent you from effectively arguing your case on appeal.

One way is to prove that the auditor did not take a reasonable degree of care in exercising his or her judgment in setting the assumptions.  For example, the auditor may have interviewed the wrong individual in the restaurant or bar, acquiring incorrect information.  The auditor may not have exercised sound judgment in determining the appropriate questions to ask the taxpayer, or may not have investigated apparent inconsistencies, in order to properly set assumptions.  While they may try, at times, auditors cannot arbitrarily choose assumptions.  Failure to gather enough information to set a “reasonable” assumption can be used to show that the auditor used an arbitrary assumption.  The key to refuting the auditor’s assumptions is sufficient evidence.  A good tax advisor will be able to help gather and present proper evidence to refute the auditor’s assumptions.

In other cases, the auditor makes a number of factual errors in the analyses, casting doubt on their accuracy and reliability.  Perhaps the auditor failed to use menus that were in effect during the audit period, or to take into account price changes, in setting average prices for the analyses.  The greater the number of errors the auditor makes, especially if almost all of them are against the taxpayer, the more likely the auditor’s credibility and judgment will be seen to have been impaired.

Conclusions

Much of the auditor’s prima facie support for assumptions comes from the initial interview with the taxpayer.  Do not go this alone.  Seek professional representation prior to the initial interview.  It is much more difficult to disprove the auditor’s assumptions than it is to help the auditor better understand your business and select the most appropriate, and accurate, assumptions.

If you are faced with inaccurate assumptions, you must gather and present evidence to counter the auditor’s judgement.  Simply offering your or your accountant’s opinion that the assumptions are not reasonable (ludicrous, even) will get you nowhere.

The sooner in the audit process you get professional advice the better.

5 Replies to “Disproving Audit Assumptions”

  1. How often are restaurants in Quebec successful in disproving assumptions? What about going to court to fight penalties?

    1. It’s not really possible to give a percentage success rate. Sometimes you can reduce the tax, but not eliminate it completely. If you have to go to court to fight the issue, the burden is on the taxpayer to prove that the minister’s assumptions were incorrect. The key word, here, is prove. It is not enough to say that, had the auditor used a “more reasonable” assumption, there would not have been any “unreported sales”. Every case is different, and the documents and/or testimony required to refute the Minister’s assumptions will vary for each restaurant/bar.

      There are a variety of penalties that may have been imposed as a result of such an audit. In my experience, CRA tends to use the harsher penalties as a “club” to beat you into submission. CRA has the burden of proving that the penalty is justified. In most cases, they are unable to do so (and they know it). It usually isn’t necessary to go to court to have such penalties removed. Filing a Notice of Objection is usually sufficient.

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