As a small business owner, getting audited by the CRA can be one of the most stressful ordeals you may encounter. In this post, you’ll learn what you can expect during an audit and how tax audit representation can help reduce your stress and save you thousands of dollars on a reassessment.
Behaviours That Can Get Your CRA Account Flagged For an Audit
Getting audited can be either the result of random selection, despite using corporate tax services, or it can be caused by behaviours that raise flags at the CRA and cause you to be audited. Some of those behaviours include:
- Sudden, drastic changes in reporting of revenues, expenses, credits, deductions, etc., especially a sudden rise in expenses, credits, deductions, or a sudden drop in revenues/earnings/income.
- Noncompliance/nonpayment of GST/HST.
- Unreported offshore income and/or assets on your small business income tax return.
- Continuous business losses. Startup businesses are expected to experience consistent losses in the first years of operation. If a business is in operation years later, however, and is still reporting losses every year, the CRA will want to know how it is still able to continue operating.
- Business expenses that are far above industry standards. The CRA has statistics and industry averages for almost every profession and can tell immediately if someone is overinflating their expenses.
- Underreporting profits based on your industry code. Like having industry stats on expenses, the industry code you enter provides the CRA with all kinds of historical averages and other data for standards under that industry code, including average profit margins.
- Disproportionate charitable donations when compared to net income/profit margin. If you are donating all or most of your earnings to charitable organizations, this is certain to raise a red flag.
- Not reporting T-slips. The CRA receives copies of T4, T4(OAS), T4(p), T5, T4A, etc., that you receive. If any are not reported in your return, the CRA must investigate to learn if it was an error on your end or your employer’s.
- Corporate loans to a shareholder that are not repaid within a year or that are repeated every year. The CRA will investigate to see if this is actually income and should be classified as such on the shareholder’s personal return.
- Unreasonable write-offs for home businesses. As with other industry statistics, if you are attempting to write off wildly large amounts as personal expenditures for a home business, expect an audit.
- Inconsistent information on tax and HST returns. For example, if your T1 or T2 sales numbers are different than your HST-reported sales, this is fairly easy to track and flag for the CRA.
- Information received from a third party also leads to audits.
Getting Audited – What Happens First?
If you are selected for an audit, you will receive notice from the CRA stating their intention to audit you. You will be advised of the following:
- Years that you are being audited for.
- Documents and records they want you to supply them with, such as:
- Previous returns
- Personal records
- Business records
- Financial records of family members
- Date, time and location of the audit
CRA audits can take place at your place of business or in a CRA office.
What to Do If You Receive Notice of an Audit
If you are put on notice of an upcoming audit, you should cooperate with the CRA by providing exactly, but only, what they ask for.
Gather all the documentation you have that supports the calculations you entered on your returns. Considering the potential consequences and the fact that the CRA auditor is looking specifically to prove that you made errors on your return, it is not advisable for you to represent yourself at an audit. Seek out tax audit representation services immediately.
What Not to Do If You Are Being Audited
Avoid these common mistakes many taxpayers make upon receiving notice of an audit:
- Ignore the CRA. They will not go away if you choose not to respond to their communications. In fact, ignoring the CRA’s letters will cause you to miss important dates and ultimately, the CRA will move ahead with their audit based on their biased and uncontradicted assumptions that usually result in an even worse outcome than simply responding to their requests.
- Provide the CRA with too much information. While you may think you are being helpful, the auditor is not your friend and is looking for ways to prove that they were justified in auditing you. Volunteering more information than what they ask for only opens the door to further scrutiny.
- Give up and accept the CRA’s audit findings. Because an audit is a long, drawn-out and stressful process, many taxpayers understandably accept the CRA’s reassessment, even knowing that it’s wrong, just to get the ordeal over with. Reassessments are commonly miscalculated, and many a certified business accountant will tell you that they have saved their clients thousands of dollars by disputing CRA reassessments.
During the Audit
During the audit, the CRA auditor will examine supporting documentation, including:
- Ledgers and journals
- Bank statements
- Sales invoices and expense receipts
- Car logs and any other relevant evidence you provide to support your tax filings
If the auditor has any issues with the documentation you provided, they will ask questions during the audit. This is why it’s crucial to have representation because, as mentioned above, your answers could result in requests for more documentation and further investigation.
You also have the right to ask questions or raise any concerns during the audit process.
How Long Does an Audit Take?
The length of the audit depends on how many years you are being audited for, the state of your financial records (including missing documents) and the consultation/corroboration required with other CRA tax specialists. It’s important to try and replace missing documents as soon as you receive notice of the audit, as this can speed up the process and help in proving your case.
Concluding the Audit
At the end of the audit, you will receive a reporting letter notifying you that either no adjustments need to be made, that a reassessment will result in you receiving a refund or that a reassessment requires you to pay more in taxes.
If you are reassessed to owe more in tax, the auditor will provide you with an estimate of the total owing so you can pay it back before interest begins to accrue.
If you do not agree with a reassessment, you and/or your representative have the right to appeal it.