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Last updated: Jul. 31, 2023
As a small business owner, you know the importance of staying on the right side of the Canada Revenue Agency (CRA) when it comes to tax preparation and filing. If the CRA audits you, it can cost you a substantial amount of time and money, not to mention the headaches and stress that come with it.
Knowing how CRA selects taxpayers for audit, as well as what to expect during an audit, could make you better prepared if you’re selected.
Here’s what you should know about CRA audits
Canada’s tax system is essentially based on self-assessment. What this means is that taxpayers will register their business, calculate their income, deductions, credits, and taxes owing at the end of their applicable reporting period. Their returns are submitted to the CRA on or before the required reporting deadline along with payments or instalments of taxes owing
The CRA selects files for auditing to ensure businesses calculate taxes correctly. Audits ensure that taxpayers not only meet their tax obligations but also receive refunds or benefits they are entitled to.
When the CRA receives a tax return, it runs through an “initial processing” phase to check basic information and calculations. From there, your notice of assessment is created.
Tax audits, which are more detailed reviews of your books and records, are performed after you receive your notice of assessment.
The CRA will review your reported income and expenses to confirm that you are following applicable tax laws and that your calculations are accurate.
They will check that you have reported all of your income from all sources. In addition, they will verify that the credits or deductions you claim are valid and supported by proper receipts or documentation.
In the case of goods and services tax or harmonized sales tax (GST/HST) audits, they will verify that you have collected and reported GST/HST on all taxable supplies. They will also verify that the input tax credits you claimed are eligible and supported by receipts.
At the end of the audit, one of three things will occur:
- The original assessment was correct and there is nothing more to be done.
- You must pay additional taxes to CRA (this is the most common result).
- You are entitled to a refund.
What triggers a CRA Audit?
Many taxpayers are simply chosen at random from among all tax filers.
In selecting taxpayers for audit, CRA will often pay closer attention to cash businesses such as trades businesses, where a small job may be paid in cash, or businesses where receipts may not be needed. They will also review businesses whose margins or incomes are not within the norm for that industry. CRA will also look more closely at taxpayers who claim rental or business losses.
Then there are CRA audit projects. At various times, CRA will target certain groups or industries that tend to have a high level of tax non-compliance, such as the construction, real estate, or hospitality industries.
In other cases, CRA may do what is known as a secondary review. That’s when CRA audits a spouse, investor, supplier, or subsidiary of an individual or company on which it is already doing a main audit.
Being aware of these and the following audit triggers, could help you reduce the chance of audit.
- Unreported Income: Discrepancies between reported income and various sources of income, such as employment, self-employment, rental income, investments, etc., can lead to audits.
- Significant Fluctuations or High Expenses: Drastic changes in income or unusually high expense claims compared to previous years or industry standards may raise red flags.
- Large Business Losses: Consistent business losses or losses that seem disproportionate to the industry’s norms might attract attention.
- Claiming Business Expenses for Personal Use: Trying to deduct personal expenses as business expenses is a common audit trigger.
- Home Office Expenses: Claiming home office expenses that are not legitimate or are exaggerated can be a trigger for an audit.
- Foreign Income and Assets: Failing to report income earned abroad or not declaring foreign assets can lead to scrutiny.
- Non-Compliance with Tax Laws: Consistent failure to comply with tax laws, late filings, or non-payment of taxes may increase the likelihood of an audit. Failure to remit source deductions for employees, such as tax, Canada Pension Plan, and employment insurance, on a regular basis or failing to pay your GST/HST or provincial level sales tax correctly and on time also could lead to an audit.
- Inconsistent Information: Inaccurate or conflicting information across different tax-related documents, such as T4s, T5s, and T4As, could attract attention.
- Unusual Tax Deductions or Credits: Claiming tax deductions or credits that are uncommon for the taxpayer’s situation or not supported by proper documentation can lead to audits.
A note about claiming losses: The CRA will check very closely any losses claimed on investments in small business corporations, mainly because the tax rules regarding allowable business investment losses are so complex.
Claims of capital losses and gains also receive close scrutiny from CRA because many taxpayers do not track them correctly. Be sure you retain all supporting documentation to substantiate your claim for an allowable business investment loss.
You can lower your chances of triggering an audit by the CRA by staying compliant with tax deadlines and instalment payments, claiming reasonable expenses, and reporting all your income, including payments received in cash.
What happens if the CRA audits you?
Accurate, detailed records are your best tool in making any audit process easier for you.
As soon as the CRA notifies you about an upcoming audit, contact your tax specialist to arrange qualified representation during the audit. Then contact CRA for a written request listing all of the specific documents it wants to review.
If you are audited, comply with all requests for information. This is much easier to do if you ensure your records are kept in order.
During the audit, answer all of your CRA auditor’s questions honestly, but don’t offer anything that wasn’t asked for. You don’t want to complicate things.
Once an audit is completed, if the CRA decides tax adjustments are required, the agency will send you a proposed statement of adjustments for rebuttal, usually within 30 days. After receiving the statement, CRA will issue a notice of re-assessment detailing any additional taxes and interest owing, plus penalties. If you don’t agree with the CRA assessment, all is not lost. You can always appeal through the normal appeal process.
Following the tips above can help reduce the likelihood that your business will be audited by CRA. But, in the event that you do receive an audit notice, being prepared and knowing what to expect can help make the process much less stressful.
[Free Download] You’ve done the work, you’ve filed your taxes, so what happens now?
Download our free 23-page guide to learn how to read your personal or corporate Notice of Assessment, the most common audit triggers for Canadian farmers and business owners, the CRA audit selection process, how to survive an audit if you happen to be chosen for one. We’ve also included some bonus information for our incorporated business readers on the Corporation Assessing Review Program (CARP).
Choose a representative that understands how to work with the CRA
Filing a business return is hard enough. But creating a tax strategy that flips the rules in your favour? That takes an expert. For more than 70 years, we’ve helped farms and small businesses optimize their returns to save money today and for the long run. And if you are chosen for an audit, we’ll represent you fully and handle the paperwork and communication involved with the CRA and their auditors, at no extra cost. You’re in good hands.
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