When you own a business, taxes have a significant presence in your general operations. From GST/HST filing, payroll remittances and income taxes, paying, filing and planning for your business taxes is a necessary part of the job.
But if you’re being audited … that takes things to a whole new level.
The CRA’s Increased Commitment to Tax Compliance
In recent years, the Canada Revenue Agency (CRA) has increased their personnel budget by $1 billion dollars, and spent $160 million on electronic infrastructure with a focus on data mining and automation*. With this increase in resources, the CRA’s capacity for inquiries and investigations has been significantly enhanced. More than ever, the CRA is looking closely at expense categories that may contain payments that are not current deductions such as some professional fees, promotional costs and website development. The scrutiny takes the form of requesting detailed invoices, and inspecting the legitimacy of business expenses.
Who Gets Audited, and Why?
Taxpayers want to know: Are audits random or targeted? Jerry Paskowitz, a Partner at Sloan Partners LLP, says it’s difficult to tell. “I’ve been in practice for many years, and I don’t know how many audits are arbitrary versus targeted.”
“What I will say is that sometimes the CRA concentrates on certain segments of the economy where there is a tendency to misrepresent taxes,” he says. For instance, there was a CRA project where they scrutinised contractors, because some prefer cash payments. Another project focused on used car dealerships.
We also know that the CRA is spending more on data mining — they’re using the information filed in tax returns and doing ratio analyses on personal incomes,” Paskowitz says. “For instance, they will look at individual income and match that up with postal codes to figure out if you can afford to live there based on your tax return income. If they think you can’t, they may ask for more information. At the corporate level, they are comparing expenditure amounts and percentages with other entities in a similar industry classification.”
“The CRA also looks at inconsistencies in your tax return from year to year. Big swings in reported income or deducted expenses will raise some flags and may trigger a request for more information, if not an audit.”
So what do you do if you receive an audit letter from the CRA?
Four Steps to Take If You’re Audited
- Don’t panic. First, understand whether this is an actual audit or not. In many cases, it’s a tax review. Paskowitz explains, “A tax review is a request for information on one or two items. For instance, the CRA has been running a project for two years now, where they are only interested in documentation to support professional fees.” In the case of a tax review, once you provide the requested information the matter is generally over.
- Don’t ignore it. If you have received a notice that you will be audited or reviewed, you should acknowledge it. The best thing to do is to respond to the CRA within the specified time frame. You want to stay on their “good side”.
- Provide the information being requested. You want to make it as easy as possible for the CRA to review your response, so it’s important to provide everything clearly and with as much detail as is required. If you’re missing documents, explain why.
- Get an expert involved. An audit is a detailed, comprehensive process. An expert, typically an accountant, can organize the information in such a way that the auditor can understand what has been done and why.
The better presented the information is, the greater the likelihood that it will be processed quickly and the matter will be resolved in the tax payer’s favour. Paskowitz suggests, “Make everything really clear, provide cross-references, and leave no room for misinterpretation.”
Preparing for an Audit
While there isn’t a great deal you can do to avoid getting flagged for a tax review or audit, being organized and prepared may help you get through one without too much headache. Keep in mind, the burden is placed on you, the taxpayer, to prove you have declared all your income and that all your expenses are legitimate. Preparation is key.
Here are a few things you can do:
Save and organize your receipts. Using invoicing and accounting software that lets you take photos of your receipts and organize them into categories is a great way manage your deductible expenses. Should you need to provide them to the CRA to support your tax return, you’ll have them on hand.
Make sure your claimed deductions are reasonable and appropriate. Take a look at Understand Common Tax Deductions for a refresher on what’s reasonable for your business. Should the CRA find that your deductions are not relevant to your business operations, you will owe tax against the amount that was incorrectly deducted. What’s more, you might be flagged and investigated again in the future.
Look into Audit Insurance. Some accounting firms offer insurance to cover the fees needed to respond to an audit. Paskowitz explains, “When people get letters asking for information, they generally need professional assistance to respond. It takes time and costs money. Sometimes audits can take three years to get through — audit insurance protects you against a big bill.”
Always claim all your income, regardless of the source. Even if it’s received as cash or trade.
Nobody wants to get audited. But if you do, it’s not the end of the world. Follow these steps, enlist the help of an expert, and you will come out the other side.
*Source: Federal Budget 2016, 2017, 2019
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.