Tax Check, please

It’s been said the only two certainties in life are death and taxes. While there’s little technology can do to prevent the latter, Canadian restaurants are coming under increasing scrutiny for using it to duck the taxman.

Last November, the Canada Revenue Agency announced that a two-year probe, which concludes next March, had so far uncovered about $40 million in so-called “phantom” cash sales in Canadian restaurants—sales that went unreported and for which taxes weren’t remitted to the government. Experts say that’s little more than a tiny fraction of the cash that restaurant owners pocket without paying any taxes. With so much cash changing hands, and employees regularly being paid under the table, tax evasion has become the crime du jour of the restaurant business. And the methods are considerably more sophisticated than even the construction industry’s notorious aversion to receipts.

The CRA landed its most high-profile catch to date late last year, charging 11 people in B.C. in what it alleges was a large-scale tax fraud scheme at four Vancouver-area sushi restaurants. The restaurants were accused of using electronic sales-suppression software, more commonly known as a “zapper,” to systematically delete cash-sales records from electronic cash registers. The software, though illegal, is often sold by the same companies that make point-of-sale systems for cash registers. (Two manufacturers in Quebec and another in B.C. have been accused of making and distributing zappers.) The programs cost about $500 and are usually distributed on CDs or USB keys so they can be removed to avoid detection by auditors inspecting the registers themselves. With a few simple commands, a zapper can completely reconstruct a restaurant’s sales reports after making cash sales disappear, rendering the manipulation nearly impossible to uncover.

Boston University law professor Richard Ainsworth has written extensively about the use of zappers. He suggests some five per cent of the restaurant industry’s sales are “zapped” from financial records. Using estimates prepared by the Canadian Restaurant and Foodservices Association, those “phantom” cash sales could add up to nearly $2.4 billion for 2009 alone—or 60 times what the CRA has found over the first 18 months of its investigation. While the federal agency wouldn’t speculate just how much in cash sales is being pocketed by unscrupulous restaurant owners and managers, CRA spokesperson Caitlin Workman says she “wouldn’t be surprised” if it climbed into the billions.

Very few cases involving zappers have been prosecuted in the U.S.—there are only two known cases on the books. “There’s $20 billion we’re losing in the restaurant business and we’re doing nothing about it,” says Ainsworth. In Quebec, however, clamping down on the devices is old hat. Since 1997, zappers have figured in some 250 investigations. In late 1999, officials found zappers in 33 restaurants belonging to a chain co-founded by Céline Dion. The company pleaded guilty to 74 counts of tax evasion and was fined $2.3 million. More recently, tax officials descended upon some of the swankiest addresses in Montreal. Four popular eateries ended up paying nearly $1 million in fines.

Despite the crackdown, Revenue Quebec estimates it lost $417 million in 2007-08 to tax evasion in restaurants, up from about $300 million in 2002. So, beginning last month, the provincial tax agency started rolling out black-box recorders to document every sale punched in at 46 restaurants and cafés. They plan to make the recorders mandatory on every cash register in the province by September 2010.

Some in the industry say tax agencies’ focus on restaurants cuts too narrow a swath. “Any cash business would be susceptible to zappers or any form of skimming off the sales,” says Paul Hewitt, a Toronto-based accountant who works with more than a dozen restaurants. One of the biggest zapper cases prosecuted by the CRA didn’t involve a restaurant at all, but the Metro supermarket chain, which was fined $62,000 in 2000 for hiding $340,000 in sales. Besides, according to Hewitt, restaurateurs who skim cash off the top are easy to catch using methods already in place, like indirect audits in which tax authorities project what a restaurant’s revenues should have been given their supply purchases.

In an email to Maclean’s, the CRA insists its investigations aren’t focused solely on the food service industry. “Stamping out [zappers] is just one aspect of the CRA’s much broader work to tackle all aspects of the underground economy,” the agency wrote. Quebec, by contrast, has made no bones about targeting restaurateurs. Its studies show the restaurant sector has the second-highest rate of tax evasion after the construction industry.

Ainsworth suggests Quebec’s more direct approach reflects just how widespread the phantom cash sales problem has become in restaurants: “Why shoot off the top of the iceberg when the rest of the iceberg is huge? Because it’s the only part of the iceberg we can see, for goodness sake.”