Cross-Border Audits: What the CRA and IRS Share, How They Match It, and What Triggers a Letter

The CRA and the IRS have exchanged taxpayer information for decades under Article XXVII of the treaty, and since 2014 they have done it automatically for financial accounts under the FATCA intergovernmental agreement. A cross-border taxpayer should assume that what one agency knows, the other can learn: the Canadian bank account a US citizen never put on an FBAR, the US rental income a Canadian never reported on a T776, the departure date on a final T1 that does not match the arrival date on a first 1040. Most cross-border audits start with a mismatch between two documents that were never meant to be read together.

Key takeaways

• Treaty exchange (Article XXVII): either agency can request information from the other about a specific taxpayer, and both exchange information spontaneously when an audit turns up something relevant to the other country.
• FATCA: Canadian financial institutions identify accounts held by US persons and report them to the CRA, which forwards them to the IRS annually. The reverse flow (US institutions reporting Canadian-resident accounts) is narrower but exists.
• Slip matching: Canada's NR4 slips (amounts paid to non-residents) and the US's Forms 1042-S (amounts paid to foreign persons) are matched against the recipient's return in the other country.
• Mutual collection assistance (Article XXVI A): each country will collect the other's finally determined tax debts, with an exception for taxes that arose while the taxpayer was a citizen of the collecting country.
• Common triggers: an FBAR with no matching foreign income on the 1040; a T1135 with no foreign income on the T1; a 1042-S for rent with no 1040-NR; a departure date that does not match the substantial presence test; a FATCA report on an account never disclosed.

What flows automatically

FATCA. Every Canadian bank, brokerage, and insurer screens accounts for US indicia (US citizenship, US address, US phone number, US place of birth) and reports the account holder's name, TIN, balance, and income to the CRA, which transmits it to the IRS each September. RRSPs, RRIFs, TFSAs, and RESPs are exempt from Canadian reporting under the intergovernmental agreement, but non-registered accounts are reported. A US citizen in Canada whose bank has flagged them and who has never filed an FBAR should expect the IRS to know about the account.

Slips. Canadian payers issue NR4 slips for pensions, RRSP withdrawals, dividends, interest, and rent paid to non-residents, filed with the CRA. The CRA can share NR4 data with the IRS on request or spontaneously. US payers issue Forms 1042-S for the same categories paid to foreign persons, filed with the IRS, and the IRS can share them with the CRA. A Canadian resident who receives a 1042-S for US rental income and does not report it on the T1 is exposed to a spontaneous exchange.

What flows on request

Under Article XXVII, an examiner in either country auditing a cross-border taxpayer can request the other country's returns, slips, and bank records for that taxpayer. The request goes through the competent authorities and is answered from the other agency's files. An IRS examiner reviewing a US citizen's foreign tax credit can obtain the Canadian T1 and notices of assessment; a CRA examiner reviewing a departure return can obtain the US 1040 to confirm the residency start date.

What gets matched

The documents that produce cross-border audit letters are the ones that describe the same fact from two sides:

• The departure date on the final T1 and the residency start on the first 1040 (or the substantial presence test). A gap means income in the gap was taxed by neither country; an overlap means the tie-breaker was never applied.
• The foreign tax credit claimed on one return and the tax actually assessed on the other. A CRA reassessment that reduces Canadian tax leaves the US credit overclaimed under section 905(c).
• The T1135 listing US accounts and the T1 reporting the income from them.
• The FBAR listing Canadian accounts and the 1040 reporting the income from them, and the Form 8938 that should match the FBAR.
• Form 5471 for a Canadian corporation and the T2 the corporation filed.

Collection

Article XXVI A allows each country to collect the other's tax debts once they are finally determined, using its own collection powers. The CRA will collect an IRS assessment against a Canadian resident, and the IRS will collect a CRA assessment against a US resident, with one exception: neither country will collect a claim against a person who was its own citizen when the tax liability arose. A Canadian citizen living in Canada with an old IRS debt is protected; a US citizen living in Canada with a CRA debt is not.

Worked example

A US citizen living in Toronto has a $400,000 Canadian brokerage account, reported on his Canadian T1 for years, and has never filed a US return or FBAR.

• FATCA. The brokerage flagged his US place of birth in 2015 and has reported the account to the CRA, and through it to the IRS, every year since.
• Exposure. The IRS has ten years of account balances and income with no matching 1040 or FBAR. The FBAR penalty for non-willful failure is up to $16,536 per year per report (the statutory $10,000, adjusted for inflation); the IRS can go back six years on the FBAR and, with no return filed, without limit on the income tax.
• Fix. The Streamlined Foreign Offshore Procedures: three years of returns, six years of FBARs, a non-willfulness certification, no penalty. Available only before the IRS opens an examination.

Official sources

"Any information received by a Contracting State shall be treated as secret in the same manner as information obtained under the taxation laws of that State and shall be disclosed only to persons or authorities (including courts and administrative bodies) involved in the assessment or collection of, the administration and enforcement in respect of, or the determination of appeals in relation to the taxes to which the Convention applies." — Canada-United States Tax Convention, Article XXVII, https://www.canada.ca/en/department-finance/programs/tax-policy/tax-treaties/country/united-states-america-convention-consolidated-1980-1983-1984-1995-1997.html

"Accounts identified as belonging to a non-resident or a U.S. person must be reported to the CRA by Canadian financial institutions. [...] The automatic exchange of financial account information with the United States (U.S.) is governed by an Intergovernmental Agreement (IGA) signed in 2014." — Canada Revenue Agency, Enhanced financial account information reporting, https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/enhanced-financial-account-information-reporting.html

Practitioner note

The cross-border audit letter almost never comes from a random selection. It comes from a slip, a FATCA report, or a date that does not match its counterpart. We reconcile the two returns against each other before filing either, and we tell every US-person client with Canadian accounts that the bank has already told the IRS.

See also: Planning a move? Start with the Canada-to-US tax checklist and browse every corridor by city, province, and state.

Next step

Fairlight prepares the cross-border reconciliation of both returns, the response to CRA or IRS information requests, and the streamlined catch-up where the exposure already exists. See cross-border pricing or book a call.