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Business Law, Taxation law

The use of an indirect audit method: not in all cases!

Oct 18th, 2024

By Frédéric Delisle

In a recent case argued by the undersigned, Thibault v. Agence du revenu du Québec, 2024 QCCQ 5284, the Court, under the pen of the Honourable Louis Riverin, confirms once again that the use of an indirect audit method, in this case a “cash flow” audit, is not appropriate in all circumstances. On the contrary, a “barrier to entry” does exist for the recourse to such a method.

As is well established, an indirect audit method is to be used as a last resort when the information provided by a taxpayer is unreliable or non-existent. Inaccurate or unrealistic statements, unreliable or deficient records, or a lack of cooperation may justify the use of such a method.

However, it is up to the tax authorities to justify the use of an indirect audit method because a “traditional” audit should always be preferred. This is where a “barrier to entry” exists. The Agency cannot simply decide to use an indirect audit method without any justification.

As pointed out by the Court (our translation from the French):

50 The audit report does not relate any facts showing that Revenu Québec was unable, even relatively, to carry out a direct and traditional audit. The testimonial evidence reveals no more. From the very first communication with Revenu Québec, Mr. Thibault's representatives established an ongoing dialogue with Revenu Québec representatives, providing the requested information and supporting documents.

51 At no time in this case did Revenu Québec question the veracity of the information and amounts provided by the taxpayer and his representatives.

52 The mere mention in the audit report that Mr. Thibault's file had been selected by the specific “wealth index” program does not, in of itself, justify the use of an indirect cash flow method from the outset of the audit.

Adding, moreover, that the reductions obtained throughout the process of contesting the reassessments issued were significant, such that the results from the application of the method were unreliable, the Court rightly decides to cancel this part of the reassessments issued against the Taxpayer.