What if due diligence shows the seller underreported income?

Sometimes the books show more sales than the filed returns do. Sometimes the seller says the “real” earnings include cash that never went on a return. Either way, do not assume the explanation. The gap may have an ordinary cause, and your accountant can test that. Nothing here says the seller has done anything wrong.

What the finding means for a buyer

The returns and the bank records are documents. A figure that appears in neither is a claim you cannot yet verify, and you should not rely on it. If you are buying shares, the corporation itself changes hands. The CRA says owner changes for a corporation must be updated and validated with the federal or provincial incorporating authorities before the CRA is contacted. See hidden liabilities in a share purchase.

The CRA’s Voluntary Disclosures Program

The CRA describes the program as a way for taxpayers to inform it about and correct errors or omissions in their tax obligations. Its circular IC00-1R7 lists conditions for relief, among them: the application must be voluntary, and it must include information for a tax year at least one year past its filing due date, and an error or omission with interest, penalties or both. It says an application is not voluntary if an audit or investigation has begun against the taxpayer or a related taxpayer on the information being disclosed. Where it applies, payment of the estimated tax owing, or a request for a payment arrangement, is also required. The CRA is not required to grant relief for every application. See the glossary entry.

What to ask next

• Ask the seller’s accountant to reconcile books to returns for each year, in writing.
• Ask whether the corporation has made, or plans, a disclosure to the CRA, and what the CRA decided.
• Ask your accountant which tax years could still be reviewed. The answer on which tax filings to review is the place to start.

Your lawyer can say how any finding belongs in the purchase agreement. BDC notes that an accountant can help analyze a company’s financial records.