Are you ready for a tax audit by the CRA?
Canada uses a self-reporting tax system and the Canada Revenue Agency (CRA) doesn’t have the resources or ability to audit every expense on taxpayer claims , this increases the risk of non compliance .The CRA likes to deploy its audit and penalties strategy to encourage tax compliance. That’s why, the taxpayers who play the “audit lottery” by hoping that they don’t ever get chosen for closer scrutiny by the CRA feel deep down in their hearts that, one day, the CRA will come to call at their homes or places of business. These taxpayers are rightful to be afraid because tax audit is never a good thing.
I have never seen the outcome of an audit assessment in the taxpayer’s favour-Former CRA Audit Review Supervisor
Majority of audits for individuals and small business are office audits where the CRA auditor reviews the taxpayer records at the CRA office. For the field audit, the CRA auditors will come to your office at a pre-arranged time to meet with you or your CPA(or both).
How does CRA select the file for Audit
Technically, everyone can be audited. CRA uses a risk-based audit model. It uses its most aggressive tactics on small and medium businesses as it perceives that these groups are most likely to have a high non -compliance risk due to their tendency of retaining poor records and having a lack of internal controls. As a result, the CRA has developed a reputation for treating small-business owners with a presumption of guilt.
Your compliance history
If the CRA finds that you were guilty of non-compliance once, there is a high probability that you might hear from them again. Alternatively, if they conduct a random review and you pass without red flags, they might not bother you again.
You did not file your tax return on time
As a non -filer for more than one year if the tax is due you will have to pay civil penalties and interest for late filing in addition to having to pay your taxes. Don’t wait until the Agency sends a request or demand to file.
You have errors on your tax return
A common and entirely preventable audit trigger is making mistakes on your tax return.
Remember, that your signature on the tax return is a legal declaration that your return is complete and truthful. Missing information such as Name, address, social insurance number, marital status, signatures etc. can increase the risk of an audit. If you find a mistake after filing the tax return, it is recommended that you should submit an adjustment rather than risking the CRA to uncover the error for you.
You did not provide information as requested by CRA
Tax reviews are the most usual type of interaction people will have with the CRA after submitting their return. In most cases, the CRA isn’t looking to do a full tax audit, what you got in the mail is likely a tax review notice, not an audit letter. For example, if you are claiming to be using your vehicle 94 per cent for business use, you can expect that CRA will want to see your log book. In other cases ,It may ask you for supporting receipts to substantiate childcare expenses or legal documents for the support payment you paid to your ex-spouse. Failure to provide this type of information can launch a CRA audit.
You under-reported your income
CRA generates comparison list for companies in the same industry to select those businesses whose tax filing deviates from the norm. Claiming higher than usual expenses can easily invite the attention of the CRA auditors.
For Example -If you own a company in the automobile industry and industry average for advertising is 5%, and yours is 30 %, then that might be enough to trigger an audit. Moreover, fluctuations in reported taxable income over the years due to aggressive tax planning can also trigger an audit.
If you are a salaried employee, the CRA has copies of all of your T4 slips and matches them with what you report. If they discover a discrepancy, they will eventually ask you to amend your return, and then levy a fine.
You work in construction, retail or the hospitality industry
The CRA has singled out these industries for special projects, where businesses are often heavily cash-based, for further inspection because of the high risk of tax evasion.
You frequently report rental and business losses
It would be best if you only claimed legitimate business expenses. Business expense deductions must be reasonable and legitimately incurred in the course of generating taxable income. Never claim personal expenses as business deductions or over-inflate your expenses as this will make you exceed the statistical norms of your industry and could trigger an audit red flag. For example – if you go from a $1,500 vehicle expense to an $8,000 vehicle expense you will need to show why. Be consistent. Keep a log book.
If you depict a trend of claiming losses year after year, you might have to face the questions from CRA tax auditor who might classify your business as a hobby
CRA often wants to review losses. Make sure to be prepared with all supporting documentation to substantiate your claim for an allowable business investment loss.If you lose money in a real estate rental, the CRA might wonder whether the property is given on rent at less than market-value rent to your friends or family members.The CRA may rely on interest and property tax information to adjust your reported rent income from your property.Claims of capital losses and gains also receive close attention from CRA because many taxpayers do not track them correctly.
Your income doesn’t match your postal code
If you are reporting considerably less income than your neighbours ,the CRA might start to wonder how you can afford to live where you do. The old saying that “cheaters never prosper “is true for those who take cash under the table for services rendered, or who conveniently forget to mention the extra weekend job.
You have a lavish lifestyle which is beyond your reported income level
If you drive a Mercedes and live in a mansion, but report $35,000 in annual income , you would be an ideal tax audit candidate. If a routine examination reveals the likelihood of unreported income, the CRA has the right to conduct an indirect determination of income(Net worth assessment) in which you will have to explain your personal and family expenses to determine how you lived on the income reported on your return. Of course, there may be unique reasons justifying the source of money such as inherited money and lottery income.
The primary protection against the net worth assessment is to keep a detailed record for any significant funds you receive, especially when the funds come from outside Canada.
If you have hidden money in a foreign country
Owning assets in foreign countries and parking your income in foreign jurisdictions might invite unwanted CRA audit as Canada has information -sharing arrangements with tax authorities in other countries. If the CRA asks, foreign governments and banks will provide records of your financial transactions.
You received EFT from abroad for $10,000 or more.
According to Globe and Mail reports, In 2017-18, the CRA had planned to review about 100,000 EFTs in four secret jurisdictions. If your bank accounts reflect many EFT deposits from abroad, you might invite CRAs attention.
Someone snitched on you
You might have never thought that someone snitched on you. Please be advised that any time your colleague, ex-spouse, the business competitor, neighbour, friend or anyone else thinks that you have done misrepresentations of income and deductions to the Canada Revenue Agency, he/she might pick up the phone and call the CRA’s unique and anonymous phone number to report you, thereby resulting in a CRA audit.
Strategies for best possible tax audit outcome
Hire a CPA
The first decision to make when you get an audit notice is whether to handle it yourself. The auditor may even ask for financial information from your family members. Seemingly easy audits can be full with “dangers and traps”, and as a small business owner, you might not be the right person to deal with the auditor under the stressful situation presented by a potential audit. Hence, you should hire a Certified Professional Accountant (CPA) who can help you review the tax returns and gather all requested documentation. However, if there are legal issues involved, or it’s a complex tax pattern, then it is also recommended to get a tax lawyer on board.
It is important to note that any representation fees paid to a tax professional are a tax-deductible expense.
If you are a risk taker and would like to chose to represent yourself, make sure you read the CRAs ” Taxpayer bill of rights guide ” which lists several rights that you are entitled to when dealing with CRA.
The CRA auditor will examine supporting documents including general ledger, bank statements, sales invoices, expense receipts and car logs etc. to ensure that your tax filings are legitimate. Having an accurate and complete general ledger substantiated with receipts is one of your best insurance against an audit as it establishes your credibility as a responsible taxpayer. You can use the modern cloud accounting technology to facilitate the process of organising receipts as you can quickly click pictures of receipts and upload them directly to the cloud is a seamless fashion.
If you discover an overstatement of income or understatement of expenses, your CPA should bring it to the attention of the tax auditor. If, however, you find out the reverse, discuss this with your CPA to decide the most favourable way to share this information with the CRA.
Your automatic response might be to panic, but while audits are often based on red flags, they might be a result of random selection.
If you attend the audit yourself, we recommend you to keep control of your anger and resentment.
If the auditor indicates that he or she wants to disallow a deduction, or otherwise increase the tax you owe, and you don’t agree with, state your disagreement calmly and only once. At all times, maintain a correct and courteous attitude. Sometimes it is very hard, especially if the auditor is aggressive and impolite. An auditor who is treated well may repay the kindness if they find small or trivial items.
Don’t Volunteer Information
It is also important to not feel intimidated -An Audit is a daunting experience, and sometimes it may feel like an inquisition, but don’t forget that the power of auditor is limited.
During the audit, be nice but yet on guard while dealing with the CRA auditor.
It would be best if you answered all questions honestly, but don’t offer anything that wasn’t asked for as you don’t want to complicate things. Casual conversations may uncover issues the auditor would not have otherwise found.
An Ex- CRA auditor mentioned in an interview
“My favourite thing was to put them(taxpayer under audit) at ease, ask them how their weekend was, ask them how their evening was, ask them about their hobbies, once you start getting into the hobbies , you start associating their hobbies with the expenses they are claiming , and you will see that some of these expenses are not legitimate ”
All the information uncovered in the course of the audit is admissible in court as evidence against you. Don’t let the CRA turn your audit into a fishing expedition to build a better case against you.
What happens after the audit
After finishing the audit, the CRA will either opt to keep the original assessment as is or reassess your tax filings. If they choose to reassess, you will receive a Proposal to Reassess letter demanding further information needed for the Reassessment, followed by a Notice of Reassessment, which will indicate the additional taxes and interest owing, plus penalties.
You can choose to file a notice of objection (within 90 days after the date of mailing of the notice of assessment ) using form T400A with the appeal division of the CRA, stating the reasons why you disagree with the (re)assessment . The CRA is required to reconsider the assessment and notify the taxpayer in writing of the results.
If you are still dissatisfied after the objection process, you may appeal to the Tax Court of Canada. This appeal must be made within 90 days of the mailing date of the CRA’s reply to the objection or, if the CRA has not responded, 90 days after the notice of objection was filed. Either party(you or CRA) may appeal the Tax Court’s decision to the Federal Court of Appeal. This appeal must be made within 30 days of the date on which the decision is made by the Tax Court.
If the deadline for filing a notice of objection is missed, an application may be made to the Tax Court of Canada for an extension of the time. The Court may grant an extension where it considers it “just and equitable” to do so.
An audit is the worst nightmare for most taxpayers. We at Cloudiverse CPAs believe that it is our professional responsibility to educate our clients to be proactive and prepare them to survive an audit by maintaining detailed tax records efficiently. Finally, we commit to being with them and helping them through the audit process.If you have more questions on how to be CRA audit ready , please call for free consultation at 1-8444-ONL9CA (1-844-466-5922).
White, Dan. “Interview with a CRA Auditor Part 2.” YouTube, YouTube, 1 May 2010, www.youtube.com/watch?v=MNaJ_HU8_F4.
CRA launches new strategy to crack down on tax havens. (2017, April 12). Retrieved from https://www.theglobeandmail.com/news/politics/cra-launches-new-strategy-to-crack-down-on-tax-havens/article33065307/
The information provided on this page is intended to contain general information. The data does not take into account your situation and is not designed to be used without consultation from accounting and financial professionals. Cloudiverse CPAs will not be held liable for any problems that arise from the usage of the information provided on this page.