Those of us who file our taxes on time and honestly and accurately report our income, deductions and credits to the tax man under Canada’s self-assessment system may be interested in a new study on individual income-tax compliance that attempts to measure Canada’s “tax gap.”
The “tax gap” represents the difference between the total amount of taxes that would be paid if each and every Canadian fully reported all their income properly (including income from the underground economy), took only appropriate expense deductions and properly claimed only the tax credits to which they were entitled, compared to the tax actually paid and collected by the Canada Revenue Agency. An estimate of the tax gap is a useful tool that helps gauge, in the government’s words, “the general health of the tax system and the levels of non-compliance with tax laws.”
Each year, the CRA processes about 27 million individual income tax returns and administers about $132 billion in individual income taxes, making up nearly 50 per cent of total federal government revenues. The study, released this past week, estimates Canada’s federal tax gap for individuals for 2014 (the year under review) to be approximately $8.7 billion or 6.4 per cent of total 2014 personal income tax revenues. This calculation was based on estimates of taxes that were assessed but not collected ($2.2 billion) and on taxes not paid on unreported income from the underground economy ($6.5 billion).
“The latest study will give the CRA more insight into the situation and will allow it to fight more effectively against tax evasion and tax avoidance,” said Diane Lebouthillier, Minister of National Revenue, in a press release announcing the results of the tax gap study. “We will therefore help to reinforce the confidence of Canadians in the country’s tax system.”
The CRA study comes in direct response to an October 2016 report of the House of Commons Standing Committee on Finance on tax avoidance and tax evasion which recommended that the CRA calculate Canada’s federal tax gap and provide information about the size of that gap and how it was calculated.
The study concludes that, for the most part, we can be pretty sure that the overwhelming majority of Canadians are at low risk of non-compliance despite minimal direct intervention by the CRA. This is largely attributable to some key features of our tax system, notably extensive third-party information reporting in combination with various other features. For the 2014 tax year, the report finds that 86 per cent of income assessed, 74 per cent of deductions reported and 83 per cent of credits claimed were “assured.”
The term “assured,” coined by the Organisation for Economic Co-operation and Development (OECD), is used to describe income, expenses or credits that can be independently verified by the CRA by matching information reported by taxpayers with information provided by arm’s-length third parties. A good example of assured income would be the income reported on T4 slips issued to employees by their employer. The CRA can easily match an employee’s reported employment income on their returns to the income reported on the T4 issued by their employer.
By contrast, the report noted that self-employment income is “a completely ‘non-assured’ income base, due to a near-complete lack of third-party reporting and a significantly more complex reporting process.” In addition, the analysis in the study suggests that self-employed individuals may contribute disproportionately to tax revenue loss resulting from the underground economy. To wit, have you ever paid a tradesperson or contractor in cash?
This is not to suggest that all self-employment income is necessarily inaccurately reported, but it’s certainly at higher risk of non-compliance. These findings support CRA’s risk-based compliance strategy which aims to minimize the compliance burden for the vast majority of us who report our income correctly and focus CRA resources to high-risk areas. This explains why an employee with only T4 and T5 income along with an RRSP deduction will never be randomly chosen for audit while an individual who is self-employed or who earns rental income could be a target for closer scrutiny.
The study cites the results of a CRA audit using a representative sample of 4,700 randomly selected individuals who reported self-employment income or substantial rental income in 2009. Results from the audit showed that if all 2.2 million self-employed individuals covered by the study had been audited, between $2.4 billion and $3.0 billion in additional federal tax revenues would have been assessed.
The audit results also indicated that just over 50 per cent of the filers sampled made reporting errors and more than 90 per cent of the files with errors had a change in federal tax payable, with the average amount of federal tax adjustment being just over $1,200. Notably, 12 per cent of files accounted for over 70 per cent of the adjustments.
In its last two federal budgets, the government has committed nearly a billion dollars to help the CRA crack down on tax evasion and avoidance. Preliminary results for the recent fiscal year ending March 31, 2017 show that the CRA has generated over $13 billion from these audit efforts.
While the just-released study did not estimate the international component of the tax gap, the CRA announced that the next study in its tax gap series will focus on international tax evasion and will draw on increasingly available international tax data to support the analysis. That study will be released some time in 2018.