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moneysense.ca, 12/04/10
Cheating on taxes and Benford’s Law
Benford’s Law states that in many real-life sources of data, the leading digit is not distributed uniformly. Instead the digit 1 tends to occur with a probability of 30.1%, 2 with a probability of 17.6% but 9 has a probability of just 4.6%. In an uniform distribution, you would expect the digits to occur with a probability of 11.1% (1 out of 9). Physicist Frank Benford stumbled upon the phenomenon when he noticed that the first few pages of his logarithmic tables were more worn than the last few.
Media reports indicate that the Canada Revenue Agency employs Benford’s Law to flag tax cheats for further scrutiny. Unlike, made-up numbers that are picked to give the appearance of randomness (you can find an example here), real-life data in tax returns tend to follow Benford’s law. With so many Canadians choosing to file their taxes electronically, it must be a snap for the CRA to check for non-compliance in child-care receipts, charitable donations and medical expenses.
moneysense.ca, 12/04/10
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2008 was our first year where we had a full year’s worth of child care ($12,000) and could claim the full $7,000 and bang on CRA requested to see the receipt. Same thing for 2009 so we’ll see come the summer again if they request it.
The HRTC will also be another one will be interesting to see how they treat it. I had a roof and windows replaced so nearly reached the max with 2 receipts – but can you imagine someone sending in dozens of Home Depot receipts?
Very interesting – I’d never heard of Benford’s Law. Appears there are a lot of people in the US cheating on their charitable donations!
@Jon D: IIRC, CRA wanted to see the receipts for the first year our kids were in daycare but not the second. Perhaps, CRA surely checks the receipts for the first year and randomly thereafter? It is going to be impossible to check everyone’s receipts for the HRTC. I think CRA will probably just do random checks. I’m keeping my receipts around just in case.
@Ben: Charitable donations are gamed here as well through charitable tax shelters. Check the comments on this old post to see how surreal it can get:
http://www.canadiancapitalist.com/beware-of-tax-shelter-donation-arrangements/
Checked that post – good lord, what an epic discussion!
My opinion: Never cheat on the income side. On the expense side (if you’re self employed) and if you’re not sure of a deduction – claim it! Within reason, of course. If you’re a fashion model, claim your hair-do, noserings, etc but not if you’re a doctor. In which case claim your lab coat, stethoscope and tongue depressors, etc. Benford’s law be damned!
Very good read. Its apparent that I need to brush up on my tax law. Like Alex says, its prob the best idea to not cheat on the income side especially. Just don’t go out of control with the deductions because that still can raise red flags and result in some unwanted headaches, I watched a friend go through it and it pretty much scared me straight.
Want to stay out of trouble with CRA and still save money?
Learn the rules (most don’t), follow the rules (most don’t), but adjust your situation to fit within the rules (most don’t).
Easy.
I first heard about Benford’s law doing Sarbanes-Oxley pre-auditing. I’m not at all surprised the CRA are using it.
Cheaters beware!
And to Rob and Alex: you are absolutely right! Learn the rules and stay within reason!
Interesting… never heard of it being applied to tax audits. Nice.
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