How the CRA uses 'nudge letters' with online sellers to increase uptake of Canada's VDP

What is a Nudge Letter?

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm.

A nudge letter is a non-formal communication from a tax authority, such as Canada Revenue Agency, designed to prompt taxpayers to review their tax affairs and ensure compliance.

Nudge letters are not accusatory but serve as a gentle reminder that the tax authority has data suggesting potential unreported income. These letters often target specific groups, such as online sellers or crypto investors, and encourage voluntary disclosure of undeclared income to avoid penalties or interest.

Nudge letters are cost-effective for tax authorities, shifting the responsibility to taxpayers to confirm their tax status. They are crafted to leverage behavioural psychology, creating a sense of urgency without escalating to legal action. However, ignoring them can lead to formal inquiries, making prompt responses critical.

CRA uses Nudge Letters to Discourage Tax Evasion

The CRA has used nudge letters as a low-cost, behavioural economics strategy to encourage tax compliance. Specific examples include the CRA having sent nudge letters to Canadians who received benefits such as the Canada Emergency Response Benefit (CERB) or Canada Recovery Benefit (CRB).

These letters reminded recipients of eligibility criteria and requested supporting documentation to verify claims, aiming to ensure compliance without immediate escalation to tax audits or repayment demands. Other nudge techniques included letters and phone reminders to encourage small business tax compliance.

Meanwhile, in the U.K., His Majesty's Revenue & Customs (HMRC) also issues nudge letters, although their use and context are different from that of CRA.

How to Report Undisclosed Income in Canada Under the Voluntary Disclosures Program

In Canada, the CRA operates the Voluntary Disclosures Program (VDP) to encourage taxpayers, including online sellers, to correct unreported income or inaccurate tax filings.

The VDP allows individuals to disclose previously unreported income, such as earnings from platforms like Amazon, Kijiji, or Shopify, without facing prosecution or full penalties, provided the disclosure is voluntary, complete, and made before the CRA initiates a tax audit or investigation.

This last point is crucial, as receiving a nudge letter might mean that CRA already has information that indicates tax non-compliance. In other words, the CRA suspects tax evasion.

While a simple nudge letter may not disqualify one from VDP eligibility, if the CRA initiates a full tax audit or investigation into the taxpayer's affairs, this has a greater chance of disqualifying the taxpayer from VDP eligibility. Thus, it is crucial to act before the CRA does.

The CRA is increasingly obtaining data from digital platforms and international tax agreements to identify non-compliance, meaning it could just be a matter of time until one's non-compliance is discovered.

HMRC in the U.K. sent Nudge Letters to Online Sellers

HMRC has launched a fresh wave of nudge letters targeting U.K. online marketplace sellers suspected of not declaring income from platforms such as eBay, Vinted, Etsy, and others. These letters, sent in early 2025, cover income earned up to the tax year ending 5 April 2023 and are based on data HMRC received from online marketplaces.

The nudge letters state: "We have information that shows you've earned income from online marketplace sales up to the tax year ending 5 April 2023. You need to tell us about this income." Recipients have 30 days to declare their income or contact HMRC.

This crackdown follows new rules effective January 2024, requiring digital platforms to report user income to HMRC, with the first reports delivered by 31 January 2025. HMRC's access to this data makes it easier to identify sellers who exceed the £1,000 trading allowance, beyond which income must be declared and taxed. Sellers classified as "traders" (those regularly selling for profit) are particularly at risk. HMRC's "Help for Hustles" campaign and online tools assist sellers in understanding their obligations.

The CRA's VDP offers significant tax relief to encourage taxpayers to correct unreported income or inaccurate filings, provided the disclosure is voluntary, complete, and made before CRA enforcement actions that would otherwise uncover the non-compliance.

Accepted VDP applications result in a variety of benefits that apply to the most recent 10 tax years, including waiver of criminal prosecution for tax evasion, relief from gross negligence penalties (up to 50% of additional tax owed), and 50% reduction of interest for tax years prior to the three most recent years, though the principle taxes owed must still be paid in full.

Ignoring a nudge letter risks escalating to a formal tax investigation, which could result in potential back taxes owing and resulting penalties (based on non-compliance severity) and late payment interest.

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm and is a Certified Specialist in Taxation Law who has completed the CICA in-depth tax planning course. He appears regularly in print, radio and TV and blogs extensively.  

With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation. Visit www.Taxpage.com and email David at david@taxpage.com.

Read the original article in full on Mondaq. Author photo courtesy Rotfleisch & Samulovitch P.C. Top image: iStock ID 1709784890.