An internal report for the Canada Revenue Agency said a program to catch tax cheats in the construction industry is a good beginning, but the agency needs to do more.

The construction sector is a big headache for tax collectors because activity can be conducted without a paper trail, allowing firms and their customers to avoid paying taxes.

Since 1999, the federal government has required contractors to report all the payments they make to sub-contractors, in an effort to expose underground operators.

The report says that as a direct result of the program, Ottawa has identified $650 million in taxes owed in the last four years.

The study, written in June, said about 95 per cent of that money came from sub-contractors who had not filed tax returns. It stated: "The program has had a significant impact on identifying the non-filing population, and achieving enforced tax compliance."

But the report found numerous gaps in the program, which inundates the agency with 83,000 contractor information slips each year.

It said the agency:

• Rarely imposes financial penalties for a contractor's failure to notify the government of payments to subcontractors.
• Lacks the resources to verify information in 32,000 information slips each year.
• Allows too many contractors to escape scrutiny because of a rule that excludes companies for which construction is less than 50 per cent of their business. This category includes large retailers that offer home renovations, such as Home Depot and Sears.

The study noted that the program has had no impact on companies that deliberately operate on a cash-only basis to escape paying tax and other legal obligations.

A spokeswoman for the Canada Revenue Agency said program officials will consider the report's recommendation to assess more penalties. Beatrice Fenelon said: "We're trying to be more consistent and more diligent in the application of those penalties for people who didn't file and for late filers."

The agency is examining whether to broaden the scope of the program to include firms in which construction and renovation represents less than half their business.

Proposed changes to the program are to be ready by March 31, 2006.

A separate focus group carried out for the agency suggests the underground economy is accepted as a common and growing practice in the home-renovation sector.

The March 2005 report by Corporate Research Associates said: "Homeowners associate little or no risks with the underground economy, particularly for less expensive or more cosmetic projects. Interestingly, most do not perceive that they are doing anything illegal when paying a contractor cash."

Canada has 266,000 construction businesses with total annual revenues of $135 billion. Most have fewer than 10 workers.