How To Avoid A CRA Tax Audit (And What To Expect)
January 12, 2022 Andrew AdolphAudits
A CRA tax audit is the last thing you want to deal with when running a business. A tax professional can do the hard work for you while advocating on your behalf. But until you make that call, you’ll have to do the work yourself.
What Happens During A CRA Tax Audit?
When the CRA performs a tax audit, it checks taxpayers’ books and records to see if they’re paying their taxes, abiding by the laws, and receiving eligible benefits. As you can imagine, this process can be extremely tedious for everyone involved.
Although most taxpayers follow Canadian tax laws, a CRA tax audit can happen to anyone. And if the CRA selects you for a random audit, it can feel quite out of the blue.
This post breaks down what to do during a CRA tax audit and some helpful information on what to expect.
8 Things That Trigger A CRA Tax Audit
After filing an income tax return, a CRA auditor (and computer software) assess it. The CRA reviews tax returns randomly, but certain things can prompt auditors to scrutinize your taxes closer.
Below are eight situations that could raise your risk of an audit.
1. Unreasonable Expense Claims
An excessive amount of expenses is a sure-fire way to attract the attention of a CRA auditor. So make sure all categories of your expenses can be itemized and explained, especially when compared to revenues generated or similar businesses with similar costs.
For example, the CRA might find it suspicious if you claimed $15,000 in transportation expenses alongside $75,000 sales. To ensure no wrongdoing, they would examine your books to verify the accuracy of this claim.
2. “Rounded” Figures
Naturally, the CRA expects exact amounts reported up to the cent. Rounding your figures upward leads to inaccurate record-keeping and makes it look like you provided estimates. Plus, a CRA auditor might think you don’t have receipts for your reported expenses.
In short, make sure to put precise amounts for everything. Accurate numbers will most likely look like $3,981.01 and $8,700.23.
3. Missing T-Slips
You’d be surprised at how many people forget to include their T-slips when they file their tax returns. However, the CRA has a program that alerts auditors about missing slips. As a result, you could get charged a 10% penalty for the first offence and up to 20% for the next.
Plus, multiple offences increase the likelihood of a CRA tax audit because it begins to look less like a slip of the memory and more like a deliberate way to avoid reporting your income.
Pro tip: Benchmark your current year’s tax return to the previous year’s T1. Doing so guarantees that you don’t forget anything crucial.
4. Operating Within Particular Sectors
An audit is likely to happen if you’re part of a “cash economy” sector such as:
These industries are prone to tax fraud, so the CRA is more diligent about audits.
5. You’re An Independent Contractor Or Self-Employed
You also could trigger an audit if you file as self-employed, a business owner, or an independent contractor. The CRA conducts these assessments to confirm your identity as an independent contractor and that your declared income is accurate since some workers may look for illegal loopholes.
6. Excessive Salaries For Spouse & Children
If your spouse or child works in the family business, they should receive payment. But you can expect a CRA tax audit to happen if an auditor suspects overpayment for services and lack of documentation for the said work.
7. Consecutive Annual Losses
Reporting losses every year is one way to get the CRA’s attention. Because why would anyone pursue an unprofitable business even after many years?
8. Unusual Income Discrepancies For Your Industry & Location
The CRA compares your reported income tax return to your industry and location average. That means certain expenses could compel the CRA to wonder how you’re able to keep up a lifestyle beyond your supposed income.
For example, suppose you declare a $60,000 annual income, but you live in a community where the average income is $120,000. In this case, that stark difference will alert the CRA.
The CRA’s risk-assessment programs help spot tax returns categorized as high risk for non-compliance. Whenever an auditor marks a tax return as high-risk, the CRA will examine the information from multiple sources to see if an audit is necessary given the possible risks.
What Does The CRA Tax Audit Process Look Like?
1. A CRA Auditor Will Notify You
The CRA will contact you by phone if it selects your tax return for audit. You’ll also receive a letter with details about the process.
Suppose you’re uncomfortable talking to the auditor and want to verify that it’s the CRA contacting you. In that case, you should wait for the tax audit confirmation letter before giving any additional information. You can also contact the agency directly and reach out to the auditor or team leader through the CRA’s hotline.
Once you confirm the auditor’s identity, you should answer their questions as best as possible. Cooperating with the auditor will help and ensure a smoother process for everyone. So if needed, provide access to your office (or place of business) and any records or books.
2. The CRA Auditor Will Visit Your Business
The auditor will usually conduct this at your place of business or office. For example, they could perform the audit in your accountant’s office or request to borrow documents to finish the audit at their CRA office. Make sure to keep yourself available if they would like to ask any questions during the audit.
How Long Does A CRA Tax Audit Last?
The time it takes to finish a tax audit may depend on the business’s ability to provide accurate records and data requested by the auditor. For example, delays may happen if a company cannot provide the required documents.
If you don’t have specific forms, talk to the auditor or the auditor’s team leader to seek alternate methods to validate the amounts stated on the returns.
Delays may also come from the CRA’s end when, for example, the auditor needs to consult other CRA tax specialists or the auditor is absent for personal reasons. In addition, certain cases may require the CRA to assign a new auditor to the business tax audit.
3. You’ll Provide The Required Documents
While the audit is in progress, the auditor may take a look at the following documents:
- Business records (E.g. journals, ledgers, invoices, receipts, bank statements, and contracts.)
- Personal records of the business owners(s) (E.g. credit card statements, personal account bank statements, and mortgage documents)
- Personal or business records of other entities or individuals related to the business owner(s) (E.g. spouse, corporations, family members, a trust, or partnerships)
Besides these, the CRA may speak with your accountant, bookkeeper, or employees about the business, its books, and reported tax returns. If your company has digital or electronic copies of your books and records, the auditor may ask for them before meeting you to speed up the audit process.
If digital or electronic records are not available or physical copies are required, the auditor may either:
- Review the documents at your office, place of business, or representative’s office, OR
- Borrow the documents needed for further review.
If they need to borrow copies, the auditor will give you a receipt thoroughly indicating the borrowed data. You can also send your additional paperwork to a CRA tax office, mail them, or submit them online via the CRA’s secure online services. Unfortunately, auditors cannot receive files via email due to security purposes.
4. The Auditor Will Verify Your Income
For further verification, the CRA may use other references or alternative methods to validate the reported business income, which is called “indirect verification of income.” The CRA normally uses this method if:
- Your reported income doesn’t align with your lifestyle.
- You used your business and personal bank accounts interchangeably.
- Your business belongs to a sector with a high risk for unreported income.
- A single person does most of the accounting, or a small group mainly conducts the business.
- Your reported business income is lower than similar companies in the same sector.
When the need arises for indirect verification of income, the CRA will ask for the cooperation of the business, its owner(s), and any chosen representative of the company. This request ensures that the auditor has all critical information and resources when validating the reported income’s accuracy.
The most common method used by the CRA for indirect income verification is the net worth method. When an auditor conducts the net worth method:
- The auditor takes into account changes in assets and liabilities, personal expenditures, and other crucial information such as non-taxable sources of income (E.g. gifts, lottery winnings, inheritance)
- The auditor then compares income based on the calculated net worth with your tax return information.
- This method goes beyond your business books and records. It includes a thorough examination of your lifestyle using financial records and other verifiable information (such as land title information or vehicle registration).
- The CRA may also review the personal financial records of your spouse, family members, or other contributing household members. This provides a comprehensive financial picture of your household.
What Happens After A CRA Tax Audit?
Once the auditor finishes examining the records and books of the business, they will give you a written summary of the tax audit assessment. If the auditor doesn’t require further changes to the returns, the audit ends, and you don’t need to do anything else.
However, if the auditor finds the need for changes to be made to the tax returns, you will be given 30 days to respond to the written tax audit summary of the auditor. After that, you have the option to agree or dispute the auditor’s findings.
What Happens If You Object?
If you decide to dispute or disagree with the suggested adjustments of the auditor, you may contact the auditor to discuss resolving this. If you cannot address your issues during the discussion, you may contact the auditor’s team leader to discuss them further.
You will receive a Notice of Reassessment if your taxable income or taxes payable changes occur. In contrast, the CRA provides a Notice of Redetermination for modifications to a claimed loss.
If you still disagree after the CRA’s reassessment, you have the right to object. However, you won’t have to pay the additional taxes until the courts settle your objection during this period.
For more information on filing an objection, head to this link: CPP/EI appeal to the Minister.
You should understand your rights as a taxpayer and what to expect during an audit. Doing so will help avoid unnecessary issues and gain security knowing that your business complies with Canadian tax laws.
For more info on this, see RC17, Taxpayer Bill of Rights Guide: Understanding your rights as a taxpayer.
You also have the right to file a complaint against the CRA for subpar service, which you can do here: Complaints, objections, appeals, disputes, and relief measures.
If the CRA audits your business, a tax professional can help you prepare and assure that you provide accurate information. Call 604-240-6173 to book a free appointment with Andrew Adolph, CPA. As a sales tax expert and former CRA auditor, he can help you discuss current or potential issues and recommend a plan for your business.
- Canada Revenue Agency. (2021, March 10). Business audits. Canada.ca. Retrieved December 1, 2021, from https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/changes-your-business/business-audits.html
- Rotfleisch, D. J. (n.d.). Eight things that can trigger a tax audit by CRA. CFIB. Retrieved December 1, 2021, from https://www.cfib-fcei.ca/en/tools-resources/eight-things-can-trigger-tax-audit-cra
Andrew Adolph is a CPA and former CRA auditor with 25 Years of experience. He helps businesses to not par any more in sales taxs than the law says they must and acts as an advocate for you if you are being audited, so you can fous on your business.