The Israeli Tax Authority, Israel’s Falafel Industry and the Canada Revenue Agency’s Powers to Investigate Unreported Cash Sales: A Canadian Tax Lawyer’s Analysis

Posted: August 29, 2023

Image of bowl of falafel beside sauce

Introduction – The Israeli Government Conducts Wide-Reaching Audits of Falafel Vendors for Suspected Unreported Cash Sales

The Israeli Tax Authority has begun raising red flags over non-compliance issues related to the Israeli falafel industry and Israel’s tax laws. The falafel is ubiquitous with Middle Eastern cuisine, and is particularly popular throughout Israel. Falafel is one of Israel’s most common and widely available street foods and is considered to be Israel’s national dish. And like most of the food service industry globally, the Israeli falafel industry is driven by low-cost, high-volume transactions to individual customers. These transactions often occur on a cash basis. Vendors are responsible for collecting value-added tax (“VAT”) on sales of falafels, similar to food vendors in Canada subject to collecting and remitting GST/HST on sales. High-volume cash transactions for any business present concerns with respect to disguised sales because transactions are not recorded by a third-party entity like a bank.

The Israeli government has taken broad steps in recent years to curb tax evasion, money laundering and terrorist financing through regulating the use of cash for transactions. Israel’s Minimizing Use of Cash Bill, 5778-2018, which came into effect in 2019, imposed a ceiling of ILS 11,000 on the amount of cash that can be given or received as part of any transaction. That ceiling has been reduced as of August 1, 2022, to ILS 6,000, or approximately CAD $2,300, and further reductions are anticipated going forward. This unilateral push toward promoting electronic means of payment and supressing the use of “black money” as part of Israel’s underground economy has come with increased aggression in auditing cash-based businesses by the Israeli Tax Authority.

In December of 2022, the Israeli Tax Authority mounted a wide-sweeping investigation into suspected tax evasion within the Israeli falafel industry by auditing thousands of falafel vendors. As a result of that investigation, Israeli tax authorities were able to recover nearly ILS 120 million in unreported taxes from the 1,661 falafel businesses that were investigated. Although the subject matter of that investigation was unquestionably Israeli, the conduct of the Israeli Tax Authority and Israel Police reveals a fair bit about the kinds of powers that tax authorities have to investigate tax evasion and suspected unreported cash sales. This article will briefly discuss some of the journalistic comments made on that investigation, and what parallel powers the Canada Revenue Agency (the “CRA”) has within Canada to audit and investigate Canadian taxpayers for suspected non-compliance with Canadian tax law.

CRA Investigatory Powers when Auditing Canadian Taxpayers

As part of the Israeli Tax Authority’s investigation into unreported cash sales by falafel vendors, police conducted physical searches of businesses to review the books and records of falafel vendors and to identify whether those vendors had failed to accurately record their daily cash sales.

The ability to attend unannounced, a place of business and examine books and records is not unique to the Israeli Tax Authority. The CRA possesses similar powers to investigate the tax affairs of Canadian taxpayers. Those powers may be exercised by CRA tax auditors or special investigators appointed by the CRA to investigate suspected cases of tax evasion. These powers are afforded to the CRA as a function of Canada’s self-reporting tax system, which requires that the CRA have some authority to verify that the self-assessments undertaken by Canadian taxpayers correspond with Canadian tax laws. While these powers are incontrovertible in the context of a tax audit, issues arise when the purpose of CRA’s investigation turns toward criminal or quasi-criminal considerations.

Section 231.1 of the Canadian Income Tax Act affords CRA auditors and investigators the power to enter a taxpayer’s place of business without a warrant to inspect that taxpayer’s books and records. This tax audit power also extends to examining a taxpayer’s inventory and property to evaluate the accuracy of the taxpayer’s books and records. A warrant will still be required where an auditor or inspector for the purpose of searching a taxpayer’s home for books and records, but the conditions to obtain a warrant for this administrative purpose are exceptionally low. A judge of the Tax Court of Canada may also compel a taxpayer to grant reasonable access to books and records kept in that home where the CRA does not have sufficient grounds to obtain a search warrant.

CRA auditors and investigators are further empowered under section 231.2 of the Canadian Income Tax Act to compel any person to provide any documents or information required as part of a tax investigation. This power is exceptionally broad and allows the CRA to compel production of documents by third parties such as banks for purposes of investigating a taxpayer. Section 231.3 provides the CRA the means to obtain a search warrant to seize documents that are not voluntarily provided by a taxpayer or third party, or for any other documents or records that may assist in a tax investigation. Section 231.4 provides a further power for the CRA to establish an inquiry, supervised by a hearing coordinator appointed by the Tax Court of Canada. That inquiry can compel persons to provide testimony under oath concerning a taxpayer. The penalties for non-compliance are steep, and an individual who fails to comply with a request for information under any of the above laws may be held liable on summary conviction for a fine of up to $25,000 and may face up to 12 months’ imprisonment.

Where the CRA obtains evidence over the course of an investigation that justifies bringing criminal charges against that taxpayer, the taxpayer’s case is referred to the Department of Justice for prosecution under the Canadian Criminal Code. The broad powers afforded to the CRA to investigate a taxpayer’s tax affairs seemingly run face-first into the various constitutional and common law protections afforded to Canadians against state intrusion, but these issues are rarely settled in favour of the Canadian taxpayer. Section 8 of the Canadian Charter affords every person the right to be protected against unreasonable search and seizure by the state. Further, section 7 of the Canadian Charter provides the constitutionally entrenched right to protection against self-incrimination. The right of an accused to remain silent in the face of a criminal investigation is settled law in Canada.

As a result, the CRA’s investigative powers for a civil tax audit under the Canadian Income Tax Act cannot be used in a criminal investigation. Those Charter protections will only become applicable though once the predominant purpose of the CRA’s investigation becomes criminal or quasi-criminal. As well, there is no immunity from the CRA’s tax auditors sharing information gathered as part of a civil tax audit with criminal investigators. It becomes the taxpayer’s onus to demonstrate that the CRA’s predominant purpose when gathering information was for its use in a criminal investigation as opposed to a tax audit, which presents a substantial hurdle for the taxpayer to overcome. The CRA is generally obligated to advise a taxpayer under investigation of the right to remain silent when that investigation risks touching on criminal liability.

Techniques Used by the CRA to Indirectly Verify Compliance with Canadian Tax Laws

Where agents of the Israeli Tax Authority had uncovered questionable business behaviors or gaps in reported income and cash held on premises, further investigations were launched by the Israeli Audit and Assessment Department to reassess those businesses for unreported VAT. While we do not have details on what the results of those reassessments were, or how they were completed, the failure to maintain adequate books and records has never been treated by the CRA as a barrier to assess or reassess Canadian taxpayers. In truth, the CRA is afforded broad powers to investigate and make assumptions concerning a Canadian taxpayer’s income and tax liabilities, with or without supporting documentation. Under subsection 152(7) of the Canadian Income Tax Act, the CRA is not bound by the information provided by a taxpayer when issuing an assessment or reassessment of that taxpayer’s income. The CRA is entitled to consider sources other than the taxpayer’s books and records when assessing a taxpayer, including external and third-party sources of information and its own assumptions.

The CRA has developed various indirect verification of income (“IVI”) tests in order to assess a Canadian taxpayer where books and records are unreliable or non-existent. In conjunction with the CRA’s ability to compel third parties to produce documents, the CRA may conduct a bank deposit analysis. A bank deposit analysis involves a review of third-party records like bank statements and credit card statements as provided by the taxpayer’s respective bank to evaluate whether the inflow and outflow from those accounts. The CRA may employ a withdrawal analysis to determine the sources of those inflows and outflows, and whether the taxpayer’s various expenses and income sources are accurately reflected on those statements. Where there is a serious discrepancy between a taxpayer’s financial affairs and spending habits when compared with reported income, the CRA may employ a net worth analysis to assess a taxpayer unreported income. Under the net worth tax audit methodology, where any increase in wealth over that period cannot be explained by the income reported by the taxpayer, the CRA will assume that the difference is unreported income of the taxpayer.

The net worth audit methodology is a particularly blunt and inaccurate tax method of assessing a taxpayer’s income and has been recognized by Canadian courts as a method of “last resort” to audit a taxpayer where no other available method will fulfill CRA’s mandate. Once the CRA issues an assessment or a reassessment of a taxpayer, under subsection 152(8) of the Canadian Income Tax Act, that assessment remains valid until it is successfully vacated or varied on objection by the taxpayer. Challenging a net worth tax assessment can be an extremely time-consuming and expensive process because of the blunt nature of the methodology. A taxpayer is typically left to challenge the assumptions and calculations of the CRA on a line-by-line and item-by-item basis, and to perform an assessment of their own assets and liabilities over the tax audit period to refute the CRA’s assumptions. The decision to use the net worth audit methodology should never be one that the CRA takes lightly.

In some cases, the CRA cannot directly test any records to verify a taxpayer’s suspected unreported income. This may be the case where income was never deposited into a bank account, and it is impossible to quantify a taxpayer’s undeposited income through a net worth analysis or bank deposit analysis. In such cases, the CRA may use the assessing projections audit method. Under the assessing projections tax audit method, the CRA will analyze industry averages and trends in the taxpayer’s business, and other evidence gathered during the taxpayer’s audit concerning inventory turnover and cost of goods sold for the taxpayer’s business. The CRA will then compare what the taxpayer reported as income and what the CRA deducted through its own projections what the CRA believes the taxpayer should have earned during that period. The discrepancy between the taxpayer’s reported income and CRA’s projections will be treated as unreported income.

Pro Tax Tip – Solicitor-Client Privilege and At-Risk Industries for Voluntary Disclosures

One major exception to the powers of the CRA to investigate a taxpayer’s tax affairs is provided under paragraph 231.7(1)(b) of the Canadian Income Tax Act. Specifically, a taxpayer cannot be compelled to disclose information protected by solicitor-client privilege. Under common law, solicitor-client privilege applies to a particular communication where three elements are present:

  1. The communication is made between a lawyer and the client;
  2. The communication is made in confidence to the lawyer; and
  3. The communication is made in the course of providing legal advice.

Solicitor-client privilege is not exclusively limited to legal advice and can include instructions and advice on what a client should do in practical terms communicated with that legal advice. Solicitor-client privilege is unique to lawyers, and Canadian taxpayers receiving advice from tax accountants will not be afforded any level of protection from disclosure for those communications seeking advice. Solicitor-client privilege can be extended to an accountant, however, where a lawyer has retained an accountant to assist the lawyer in giving tax advice to a particular client. This relationship must be formed before any accountant begins performing work for a particular client.

It is extremely important when operating a cash-based business that legal counsel is retained as soon as any tax non-compliance issues are identified. Cash-based businesses are treated with increased scrutiny by the CRA during an audit because the evidence confirming a particular cash transaction will typically be created and maintained by the taxpayer and not by a third-party like a bank. It is crucial that any cash-based business be proactive in resolving any non-compliance matters, rather than waiting for the CRA to initiate an audit, and engaging an expert Toronto tax lawyer early in the process ensures that those efforts and actions to correct compliance issues will be protected by solicitor-client privilege.

Should your business qualify for relief under the CRA’s Voluntary Disclosures Program (“VDP”), the CRA is obligated to waive criminal prosecution for non-compliance, in addition to penalties and some interest on taxes owing. A voluntary disclosure application is a time sensitive application, however, and may be rejected if the CRA has contacted you or your businesses concerning the tax non-compliance you have sought to disclose. Engaging a top Canadian tax lawyer to prepare your voluntary disclosure application offers essential protection for any sensitive documents prepared by your accountant for filing a voluntary disclosure application, should the CRA otherwise investigate your tax affairs. Our experienced Canadian tax lawyers have assisted numerous Canadian taxpayers with the CRA’s VDP and can help you to carefully plan and promptly prepare your voluntary disclosure application. And should the CRA initiate an audit of your tax affairs or otherwise put you at risk for potential tax evasion charges, you should engage an expert Canadian tax lawyer immediately to ensure that your rights under the law are preserved.


What powers does the CRA have to compel a taxpayer to provide documents or information as part of an audit?

The CRA has extensive powers to compel production of documents and evidence. Under subsection 231.1 of the Canadian Income Tax Act, CRA tax auditors and investigators can enter a taxpayer’s place of business without a warrant to inspect that taxpayer’s books and records and inventory. Under subsection 231.2, the CRA can compel any person, including third parties who are not a taxpayer under audit, to provide documents and records as part of a tax audit.

Subsection 231.3 provides the CRA with the power to apply for a warrant to search a place for documents and evidence where an individual may not be cooperative with a CRA investigation. Subsection 231.4 provides an additional power whereby CRA can establish an inquiry, supervised by the Tax Court of Canada, to examine individuals under oath about the affairs of a taxpayer under audit.

Do the CRA’s powers to investigate and audit a taxpayer violate constitutional and common law rights?

The CRA’s extensive powers to investigate a taxpayer’s affairs do not necessarily violate a taxpayer’s constitutional and common law rights. So long as the CRA exercises its investigative powers as part of a civil audit, the CRA’s ability to compel production of documents and to interview individuals will not violate section 7 or section 8 of the Canadian Charter, or the individual’s right to remain silent. Where the predominant purpose of CRA’s investigation becomes criminal or quasi-criminal, Charter and common law rights may apply.

What methods does the CRA possess to audit and reassess a taxpayer for unreported cash sales?

Under subsection 152(7) of the Canadian Income Tax Act, the CRA is not limited to using what books and records a taxpayer has maintained when preparing a tax assessment. Given this liberty, the CRA has developed a number of indirect verification of income (“IVI”) tests where the books and records and financial activities of a taxpayer do not align with the CRA’s expectations concerning that taxpayer’s business.

The CRA may employ a net worth analysis to assess the taxpayer unreported income, based on the inflows and outflows of cash from bank accounts maintained by the taxpayer or related parties. The CRA may also use an assessing projections audit method, by comparing the taxpayer’s business with industry averages and trends to project what unreported income was earned by the taxpayer’s business in a given reporting period.

What are the conditions under common law for solicitor-client privilege to attach to a communication between a lawyer and a client?

Under Canadian common law, solicitor-client privilege applies to a particular communication where three elements are present:

  1. The communication is made between a lawyer and the client;
  2. The communication is made in confidence to the lawyer; and
  3. The communication is made in the course of providing legal advice.

The conditions that are required for solicitor-client privilege to attach to a communication may also differ between provinces, depending on provincial common law.


"These articles provide information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."

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