Internal Audit – The Agency’s Strategy for the Underground Economy

Final Report

Audit, Evaluation, and Risk Branch

January 2020

Notice to the reader

Please note that in the spirit of the Access to Information Act, some information within this document cannot be disclosed for reasons related to Confidences of the Queen's Privy Council.

Table of contents

Executive summary

The Canada Revenue Agency’s (CRA) has identified maintaining fairness in Canada’s tax administration as one of its priorities used to guide the delivery of its core responsibilities: tax and benefits. PROTECTED.

The Strategy for the Underground Economy 2018-2021 builds on the 2014 strategy and now includes the emergence of digital, global platforms and crypto currencies, which all transcend traditional bordersFootnote 1. The current strategy also continues the effort to develop a social unacceptability around the underground economy and leverage third party data and information.

The objective of this audit was to provide the Commissioner, CRA management, and the Board with assurance that controls, including horizontal governance, are in place and working as intended to implement and monitor the Agency’s Strategy for the Underground Economy.

The examination phase of the audit was from November 2018 to May 2019, during which the audit team examined current policies, processes, and procedures that record, monitor, and report on the execution of the Agency’s Strategy for the Underground Economy. The audit involved the branches and programs, that the strategy documents identified as contributors to the CRA’s efforts to address the underground economy.

While the efforts related to this strategy appear to have resulted in identifying significant amounts of unreported income, the internal audit revealed that there is a lack of cohesive agency-wide measures to assess the effectiveness of the Agency’s strategy. The team found that there are limited documented roles, responsibilities, accountabilities, or performance expectations in the development and implementation of the Agency’s Strategy for the Underground Economy.

Summary of recommendations

The Compliance Programs Branch should collaborate with the Collections and Verification Branch, the Public Affairs Branch, and the regional Business Intelligence Quality Assurance programs to develop, implement, and strengthen controls that support:

Management response

The Compliance Programs Branch agrees with the recommendations in this report and has developed related action plans. The Audit, Evaluation, and Risk Branch has determined that they appear reasonable to address the recommendations.

1. Introduction

The Canada Revenue Agency (CRA) has identified maintaining fairness in Canada’s tax administration as one of the priorities used to guide the delivery of its core responsibilities: tax and benefits. The CRA’s core responsibilities in relation to tax is to ensure that taxpayers are provided the support and information that they need to understand and fulfill their tax obligations, and to take compliance and enforcement action when necessary, offering avenues for redress whenever taxpayers disagree with an assessment/decisionFootnote 2. Maintaining fairness in Canada’s tax and benefit administration is a CRA priority that aligns. PROTECTED.

The underground economy is defined, according to the Strategy, as economic activities or transactions in goods or services that are deliberately hidden, partially or entirely, from the government in order to evade paying taxes or other government reporting obligations.Footnote 3 Participants in the underground economy include both those that do not report and those that under-report sales or income. The CRA maintains its focus to prevent, detect, and address unreported and under-reported revenue by:

The Strategy builds on the 2014 strategyFootnote 4, which was the CRA’s first formal Strategy for the Underground Economy. The primary goal of the initial strategy was to reduce the social acceptability of, and participation in, the underground economy in order to protect the fairness and integrity of the tax and benefit system as well as the revenue base overall.

The initial strategy was based on the following 3 strategic themes:

The Strategy now includes the emergence of digital, global platforms and crypto currencies, which transcend traditional borders. Improving the effectiveness of business intelligence through increasing the use of third party data would assist in identifying opportunities for compliance actions in the validation of tax returns. Concurrently, the CRA will develop new communication products through consultation with key stakeholders to raise awareness about how participating in the underground economy affects government funded programs and services available to CanadiansFootnote 5.

The current Strategy also reflects some of the lessons learned from compliance activities related to the underground economy. One significant lesson is that changing social acceptability of participation in the underground economy is more challenging than initially anticipated. Another lesson learned is that some of the current compliances approaches are highly effective. One such compliance approach is pursuing taxpayer information through third party sources using court orders and information-sharing agreements.

The CRA’s current Strategy provides a new prioritization of efforts. It focuses on the following 3 themes:

  1. social acceptability and engaged citizenship
  2. leveraging third party data and information
  3. new business models and transacting in the digital age

The Canada Revenue Agency Mining the Underground Economy: Tactical Plan 2018-2021 outlines the short and long-term objectives for each underground economy strategic theme.

One significant difference between the initial and current Strategy is in the governance structure. The documents of the previous strategy included a clear governance structure (see Appendix A), to build on previous efforts and ensure the effective implementation and regular renewal of the strategy. The current Strategy does not document the governance structure in place to support its development and implementation.

Furthermore, while the CRA reports the number of audits related to the underground economy and the associated unreported income as the Agency’s Strategy for the Underground Economy results in the annual Departmental Results Report, the current Strategy does not contain a detailed method for the measurement of the Strategy’s impact as it relates to the stated objectives.

The CRA commissioned Statistics Canada to estimate the extent of the underground economy in Canada. This study developed by Statistics Canada shows the underground economy as a percentage of Canada’s gross domestic product, and has been relatively stable around 2.5% since 1992Footnote 6. This measure, in addition to internal measures, may be used to speak to the effectiveness of the CRA’s efforts to combat the underground economy.

2. Focus of the audit

This internal audit was included in the Board of Management (Board) approved Risk-Based Audit and Evaluation Plan 2017-2020. The Assignment Planning Memorandum was approved by the Management Audit and Evaluation Committee in November 2018.

2.1. Objective

The audit objective was to provide the Commissioner, CRA management, and the Board with assurance that controls, including horizontal governance, are in place and working as intended to implement and monitor the Agency’s Strategy for the Underground Economy. The Agency’s Strategy for the Underground Economy is linked to the CRA corporate risks, namely business intelligence, digital commerce, and public image.

2.2. Scope

The audit examined current policies, processes, and procedures that record, monitor, and report on the execution of the Agency’s Strategy for the Underground Economy. The audit involved the branches and programs that the Strategy documents identify as contributors to the CRA’s efforts to address the underground economy. The audit included the Compliance Programs Branch and the regional Business Intelligence and Quality Assurance programs. The Public Affairs Branch and, the Collections and Verification Branch were also included as they are key contributors to the initiatives and overall results.

The planning phase included interviews in Headquarters, the Ontario Region, and the Atlantic Region. The examination phase included reviews and analyses of workload and audit results coding, as well as additional interviews in Headquarters, and the Quebec, Prairie, and Pacific Regions.

The audit covered the period from November 2014, which was the start of the CRA’s previous strategy for the underground economy, to May 2019, which includes the final reporting of the previous strategy and the development and implementation of the current iteration of the strategy.

2.3. Audit criteria and methodology

The audit criteria and methodology can be found in Appendix B.

The examination phase of the audit took place from November 2018 to May 2019.

The audit was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing, as supported by the results of the quality assurance and improvement program.

3. Findings, recommendations, and action plans

The first formal underground economy strategy was introduced in November 2014 and the CRA has been reporting the underground economy results as part of the Departmental Results Report since 1994. There have been a number of compliance initiatives developed and implemented in support of this priority. This continues to be the case as the Business Intelligence Division of the Compliance Programs Branch is consistently testing new methodologies to identify the highest risk taxpayers, including those in the identified underground economy sectors. The current Strategy has retained the compliance initiatives that are thought to have been effective in prior years.

The success of this iterative approach to the Agency’s Strategy for the Underground Economy will depend on the supporting governance structure, integrated operational planning, and clearly defined performance expectations and monitoring processes to assess the results.

The reality of key employee turnover and multiple branch stakeholders require strong controls to ensure continuity in the development and implementation of a comprehensive, horizontal Strategy. The ability of the programs to align compliance actions with compliance risks will largely depend on the existence of controls which can identify, assess and adapt the opportunities and challenges (both regionally and nationally) in a timely manner.

3.1. Governance

The governance line of enquiry focused on the existence of a collaborative, structured and documented development and implementation of the current Strategy. An important aspect of the Strategy’s implementation assessed as part of the internal audit are the controls in place to monitor and assess the progress and success of the Strategy. The findings related to this line of enquiry are outlined below.

3.1.1 While some key management roles have documented accountabilities, overall the roles, responsibilities, accountabilities, and performance expectations for the Agency’s Strategy for the Underground Economy are not documented in the stakeholder branches and regions.

The 2014 strategy document highlighted the need for a robust governance structure to build on the CRA’s efforts and ensure the effective implementation of the strategy. The 2014 strategy detailed a governance structure with a Director General steering committee supported by a multiple branch Director level committee. The Director General level steering was to develop an underground economy framework to implement the strategy, as well as clarify expectations, accountabilities, and the measurement of results. The cross - agency Director level committee was to be supported by four working groups: compliance approaches, communication, research, and measurements and reporting.

The internal audit found that, in support of the current Strategy, there are some documented performance expectations. In addition, there has been some activity in sub-working groups based on the themes of the current Strategy, the Minister’s Underground Economy Advisory Committee is in place, and updates were provided at the Operations and Policy Committee. However, documented roles, responsibilities, accountabilities, or performance expectations are lacking for either the development or implementation of the current Strategy for key stakeholders.

An established national governance structure would enable a holistic approach to the underground economy strategy’s development and implementation. It would also ensure a detailed strategy that is complete, measurable, timely, and relevant. The lack of such governance structure may lead to the absence of sufficient controls to address the issues that may hinder the success of the Strategy.

The Compliance Programs Branch should consider collaborating with the stakeholder branches and regions to establish the appropriate governance structure for the development, implementation, and monitoring of the Agency’s Strategy for the Underground Economy.

3.1.2 The goals and objectives related to the Agency’s Strategy for the Underground Economy have not been fully detailed or defined in terms of the consistency and horizontality of the compliance activities of the stakeholder branches.

Although there is no documented governance structure, the Medium and Small Enterprises Directorate, the Collection and Verification Branch, and the Public Affairs Branch are relied upon to track the achievements for each specific initiative but have no defined performance measurements criteria, expectations, or agency-wide performance indicators. The Assistant Commissioner of Compliance Programs Branch, the Director General of the Small and Medium Enterprises Directorate and the Director General of the Individual Compliance Directorate in Collections and Verification Branch have specific underground economy performance expectations contained in their performance agreement. Having expectations and goals or objectives developed holistically, rather than independently, would ensure a better coordination and the maximization of efficiencies.

A good example of a horizontal compliance approach is in the Atlantic region where, there are policies and procedures in place for the Business Intelligence Quality Assurance program, the National Underground Economy Compliance Research Unit, and the Atlantic Compliance Research Unit to develop and leverage regional business intelligence resources to support the compliance activities of the Compliance Programs Branch, the Collections and Verification Branch, and the Appeals Branch. The coordination allowed for a more effective utilization of research and analytical resources in the identification of taxpayers and registrants with a higher risk of tax non-compliance.

Recommendation 1

The Compliance Programs Branch and the stakeholder branches should ensure the Agency’s Strategy for the Underground Economy is better communicated nationally and clearly identifies key branch and regional responsibilities and accountabilities.

Action Plan 1

The Compliance Program Branch agrees that it is important to better communicate the underground economy strategy nationally and that key branch and regional responsibilities and accountabilities are well documented and understood. We will leverage and build on current mechanisms to fulfill this action item, as follows:

3.2. Operational planning

The operational planning line of enquiry focused on the mechanisms or controls in place to identify, assess and adapt to data, information or challenges as they occur. For instance, the Ontario Business Intelligence Quality Assurance program has procedures in place to facilitate new methodologies for the usage of local open source data as part of its business intelligence process to identify potentially high-risk taxpayers. The Pacific regional Business Intelligence Quality Assurance program has developed processes and procedures that would enable the measurement of the effectiveness of their business intelligence process in the identification of high risk taxpayers using income adjustments as one indicator. Another good practice identified is that the Quebec regional Business Intelligence Quality Assurance program has leveraged the regional Criminal Investigations Division data as part of their business intelligence and program management processes. The internal audit reviewed various regional compliance activities that affect the reported underground economy results and the alignment of these activities at the national and regional levels. The findings resulting from the operational planning line of enquiry are outlined below.

3.2.1 There is currently no CRA policy regarding the use of open-source data as part of its compliance activities.

The national and regional Business Intelligence Quality Assurance programs, as well as their respective research and analytics teams, are continually researching different methodologies to identify potential high-risk taxpayers and registrants. A number of these methods might use open-source data or information that is publicly available on various digital platforms as the starting point for the business intelligence process.

The internal audit team found that there is no documented national CRA policy on the use of open source data as part of the CRA compliance activities. A documented policy on the use of open source data or information would encourage a more horizontal approach to the usage of the information by the Agency in support of its service and compliance activities. An agency-wide policy may also reduce the risk of inadvertent information or data incidences.

The CRA should considerer developing a policy on the use of open-source data and data accessibility at the organizational level, in support of service and compliance activities, beyond those specifically related to the underground economy.

3.2.2 There are inconsistencies in coding and reporting of underground economy compliance activities and results.

The Prairie region’s business intelligence and workload screening processes, for small business income tax files, allocated the most underground economy files as per the HQ suggested sector targets. However, it is difficult to determine and assess whether underground economy compliance approaches employed are in line with objectives without a common understanding across the CRA of what compliance activities should be coded as underground economy.

The current and previous strategy documents defined the underground economy as economic activity that is “partially or entirely hidden from the government in order to evade paying taxes and other government reporting obligations.Footnote 7” However, the internal audit found that each stakeholder branch is coding underground economy within the context of their own compliance activities and performance measures.

Internal audit recognizes the challenges associated with the development of a standard understanding of what constitutes activities related to the underground economy. The Strategy’s monitoring and reporting processes would benefit from having an agency-wide common understanding of the underground economy and its participants, which would enable consistent reporting and an accurate assessment of the effectiveness of the Strategy. The challenges in assessing the effectiveness of the Strategy hinder the stakeholders’ ability to conclude on the Agency’s compliance activities and its progress in combatting the underground economy.

The above finding is addressed in recommendation 2 below.

3.2.3 There are limited documented or established underground economy specific feedback mechanisms in place between the stakeholder branches at the regional or national level to support the continued development and operational improvements of the Agency’s Strategy for the Underground Economy.

The quality of a decision-making process is dependent on the completeness, accuracy, timeliness, and relevance of the information available. An effective monitoring process of the current Strategy would enable the accountable individuals to have timely and accurate information as it relates to the Strategy’s specific deliverables and overall goals and objectives. For example, the Pacific Region’s Business Intelligence Quality Assurance program has implemented processes that would better enable the measurement of the effectiveness of its business intelligence process in the identification of high risk taxpayers. These processes have not be adopted nationally.

The internal audit found that there is limited inter-branch feedback and monitoring of the implementation of the 2018-2021 CRA’s Strategy for the Underground Economy, which would enable decision makers to evaluate the strategic initiatives for their overall compliance value to determine if they should be sustained, expanded, modified, or suspended.

Recommendation 2

The Compliance Programs Branch, in collaboration with the Collection and Verification Branch, should develop, document and communicate a plan, including a monitoring process, to ensure consistent coding and reporting of underground economy compliance activities and results.

Action Plan 2

To ensure consistent coding and reporting of underground economy compliance activities and results, the Compliance Programs Branch, in collaboration with the Collection and Verification Branch, will create a working group to develop a plan to ensure consistent coding and reporting of underground economy compliance results.

3.2.4 The Agency has completed initial research in cryptocurrency and analyses, and has delivered the planned foundational training on cryptocurrency. However, the attributes, characteristics, or indicators of tax non-compliance for new business models have not been identified, documented or communicated with key stakeholders

The internal audit found that initial research into understanding digital currencies has begun and select auditor training has been provided to increase the basic knowledge about block chain technology and cryptocurrency within the Compliance Programs Branch. The initial research and completed training align with the Strategy documents, which detail a phased approach to understanding and addressing the potential risks of new business models and transacting in the digital age. Phase 1 focused on research to understand digital currencies and the associated risks for non-compliance. Phase 2 will include the development of mitigation approaches against risks in cryptocurrency transactions and the creation of a centre of expertise. Phase 3 as outlined in the Strategy documents will focus on policies, strategies and potential legislation to improve risk assessment tools.

The internal audit team also found that the attributes or indicators of tax non-compliance related to new business models or the use of digital currencies have not been identified, documented, or communicated in order to improve the risk assessment process. Although the Compliance Programs Branch has identified tax compliance issues in their planned phases, the effectiveness of future compliance approaches that involve new business models or digital currencies will be dependent on the Branch’s ability to identify the attributes and indicators of tax non-compliance.

The Compliance Programs Branch should consider documenting new compliance approaches to identify the attributes and possible indicators of tax non-compliance in regards to new business models.

4. Conclusion

The focus of this audit was to provide assurance that the controls, including horizontal governance, are in place and working as intended to implement and monitor the Agency’s Strategy for the Underground Economy. The audit found that specific roles, responsibilities, accountabilities, as well as performance expectations for the development and implementation of the Strategy could be better documented and communicated. There was also an opportunity to better define the goals and objectives of the Strategy to ensure consistency and horizontality of the compliance activities across the stakeholder branches.

The internal audit also found that feedback mechanisms in place could be improved to better support the continued development, operational improvement and reporting of the Agency’s Strategy for the Underground Economy.

5. Acknowledgements

In closing, we would like to acknowledge, recognize, and thank the Small Medium Enterprises Directorate for the time dedicated and the information provided during the course of this engagement. Additionally, we would like to thank the Collections and Verification Branch, the Public Affairs Branch and the Regions for their assistance and cooperation in facilitating the successful completion of this internal audit.

6. Appendices

Appendix A – Reducing participation in the underground economy – Canada Revenue Agency, 2014-2015 to 2017-2018, Governance structure

UE Goverance Structure

Appendix B: Audit criteria and methodology

Audit Criteria

Based on the Audit, Evaluation and Risk Branch risk assessment, the following lines of enquiry have been identified:

 
Lines of enquiry Criteria
Governance Responsibilities and accountabilities of the stakeholder branches and the regions are documented, understood and communicated to all stakeholders.
An oversight structure is in place such that, performance measures have been developed and the ability to identify and address performance and control weaknesses exists, in order to assess the implementation of the Agency’s Strategy for the Underground Economy and its tactical plan.
Operational planning There are documented CRA policies and guidelines on the usage of open-source data and information.
The CRA has the capacity and access to the tools to identify and assess the compliance risks associated with new business models and transacting in the digital age.
There is an established feedback loop incorporating the Headquarter business intelligence processes, regional business intelligence and file selection processes, and compliance results.

Methodology

The methodology for examination included the following:

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