There are about 80,800 restaurants in Canada (CRFA), and about half are audited every four years. That’s a lot of restaurants being audited, and you just know that the majority of them receive reassessments at the end of each audit.
Rather interestingly, there are only about 10 significant court cases involving restaurants that had been audited using the mark-up method. How can this be?
Most restaurant audits result in tax reassessments for sales and income taxes, and the owner is reassessed for personal income taxes on “unreported sales”. All reassessments include substantial penalties and interest charges, making for pretty hefty tax bills! If you disagree with the reassessments, you can appeal.
In Canada, the first avenue of appeal is to file a Notice of Objection, where you set out the facts and reasons why you believe the auditor incorrectly reassessed the restaurant (and you). Typically, this involves providing documents and arguments to prove your case. If you lose at the Objection stage, you may appeal to the Tax Court.
Unfortunately, this appeal process is notoriously slow, especially for restaurants. In particular, the Ontario government prolongs the appeal process as long as possible, because the taxpayer still has to pay amounts in dispute (not so for CRA income tax reassessments), and if the restaurant is unable to pay the reassessment, it is quite likely that the restaurant will end up closing anyway. It usually takes months (as many as 18!) for the Ontario appeals officer to contact you and acknowledge receipt of your Notice of Objection.
Update (July 2017).
Turns out the CRA appeals process is even slower than Ontario’s! I’ll be writing a separate post about the CRA’s dysfunctional appeals process. I have one client that has waited almost four years to get a decision from appeals regarding an HST reassessment. Other clients are finally getting their objections resolved after about two years. Still, this is far too long!
To make matters worse, when the disputes involve HST, the taxpayer is required to pay the full amount reassessed, including penalties and interest, even though the amount is being disputed. This makes it even more crucial that you be properly prepared to fight every tax audit before the auditor issues a reassessment. You can find out more about this on my website.
In many cases, the appeals officer simply reaffirms the tax auditor’s reassessments or offers to settle the case (with an agreement not to appeal to the courts) for some lesser amount. Technically, they’re not permitted to do this, but they get around it by “accepting” some of your appeal arguments and dismissing the rest. Usually, the “lesser amount” is still quite substantial, but low enough that it doesn’t make financial sense to appeal to the courts (a much more expensive proposition).
If you cannot provide credible evidence that proves you did not hide sales, you will lose. You can accept the Notice of Objection appeal decision, pay the taxes, penalties and interest, and get on with your life. OR, you can appeal to the courts. If the amounts are significant, you will require legal representation to prepare and present your case in front of a judge. Smaller cases may be argued without a lawyer.
At any rate, this is a very expensive, and time-consuming, process! Every taxpayer that gets into this position should carefully weigh the costs against the possible benefits of winning the case. Most taxpayers (restaurants) lose their cases (either at the Notice of Objection stage or at court). The number one reason they lose is a failure to provide credible evidence to support their margins.
In some cases, you may wish to appeal smaller reassessments, because you don’t want to be seen as a “tax cheat”, which will invite more audits in the future and a much higher level of scrutiny.
Most restaurants can afford to file a Notice of Objection to appeal their cases. Unfortunately, if they lose at that stage, many go out of business before they get their day in court, and even if they make it, few can afford keep up the fight!