Benford’s Law – The ‘Number One’ Method of Finding Tax Audit Targets

Benford’s Law – The ‘Number One’ Method of Finding Tax Audit Targets
 
It is a fact that not all Canadians accurately report their income or deductions from their income when filing their tax returns. Sometimes on purpose but just as often it happens by accident.
 
And it is because of a few ‘number fudgers’ that the Canada Revenue Agency is forced to audit Canadian individuals and businesses. Trying to catch those who may not have properly reported their yearly income.
 
But how do they do this? How does the Canada Revenue Agency choose who to audit? With tens of millions of individuals and businesses filing tax returns they just can’t audit everybody. They don’t have the employees to accomplish such a mammoth feat. Or the time. So perhaps it’s your past history that will make you a candidate. Or the type of business you operate. Something unusual on your return. Or just blind chance. But these aren’t the only methods of finding audit targets – there’s also Benford’s Law.
 
Benford’s Law hints to the frequency distribution of digits. In a distribution, the number 1 occurs as the leading digit about thirty percent of the time, the number 2 eighteen percent of the time, the number 3 twelve point five percent of the time and so on. Larger numbers occur in the leading position less frequently – 9 as the first digit less than 5% of the time. Benford’s Law also concerns the expected distribution for digits following the first.
 
So what does this have to do with your tax return?
 
Well, people who ‘fudge’ numbers, tend to distribute the lead numbers randomly but equally i.e. one is as likely to be found as the first number as five or nine is. In short – the distribution of ‘fudged’ numbers tends not to be random.
 
So when your tax return is examined by a Canada Revenue Agency computer program looking for tax return anomalies, those tax returns that do not have random number distributions i.e. number 1 is the lead digit in a series as often as 3 or 5 or any other number, then the CRA may decide to audit your tax return.
 
It has been found that Benford’s Law is very effective at pinpointing what sort of tax information is most prone to error or fraud. Which tells the CRA how best to deploy their resources. The Tax Auditor.
 
 
If the Canada Revenue Agency has contacted you or you fear that you may be a candidate for a tax audit let National Tax Service assist you today.