Are you afraid of being selected for a CRA audit?

To maintain the integrity of Canada’s tax system, the Canada Revenue Agency (CRA) typically sends out about 30,000 audit letters each year and it can be a headache to many Canadian taxpayers.

In 2018, the CRA identified over $1.1 billion which includes both tax and penalties from audits of small and medium-sized enterprises.

Moreover, the CRA applied gross negligence penalties in 28% of small business audit cases and in 8% of medium-sized business cases.

Red Flags that Can Lead to an Audit

A CRA audit is a daunting task for most Canadian taxpayers as it is generally time-consuming and stressful and can stretch through several months or even years.

The CRA usually starts the process with a tax review notice which is not an audit letter. If a taxpayer has all the records and receipts that support his claims for all the expenses, the matter will be over.

However, if a taxpayer fails to respond or cannot prove certain claims, then he is out of luck.

The CRA generally chooses a file for an audit based on a risk assessment which takes a number of factors into consideration such as the likelihood or frequency of errors in tax returns or whether there are indications of non-compliance with tax obligations.

However, there are certain red flags that are more likely to trigger an audit.

Discrepancies between your income and HST/GST

The CRA will make a comparison between your sales revenue and HST/GST for the same reported period. If there is a discrepancy, the CRA will likely assume either your sale or HST/GST is underreported.

In addition, the CRA may even go a step further to verify whether the HST/GST collected matches what you owe.

Being self-employed can increase the chance of being selected for a CRA Audit

Self-employed taxpayers will not receive a T4 so the employer is not required to withhold taxes and remit them to the CRA. Therefore, the CRA generally wants to make sure they get their fair share and deems self-employed taxpayers as high risk.

Living an extravagant life

The CRA has conducted a “lifestyle audit” in recent years. The Global and Mail reported in 2016 that the CRA planned lifestyle audits in Vancouver as part of a real estate probe.

As a result, the CRA will come after taxpayers who live extravagant lives but whose incomes don’t support the lifestyle. Still, the CRA will often start the process by asking for clarifications.

If a taxpayer can provide a legitimate answer and the CRA is satisfied, an audit will likely not ensue.

Running a cash business

Since a cash business involves a lot of cash transactions, the CRA generally assumes it’s easier for business owners to under-report their sales because it’s harder to trace.

Therefore, it is important for business owners to develop a good practice of keeping detailed and accurate

records in case of a future audit. In addition, the CRA may also compare your business with others in the same industry. For example, if your cash transactions are lower than others in the same neighbourhood, the CRA is highly likely to pick your business for an audit.

Home office expenses

A taxpayer can only claim a dedicated space as a home office if he uses it more than 50% of the time for business. However, taxpayers tend to overclaim and since more people are working from home nowadays due to the covid pandemic, the CRA will no doubt pay close attention to this kind of claim.

Selected for a CRA Audit because of Car expenses

Driving to work from home is considered personal use which is not deductible. Therefore, if you claimed 100% of your vehicle use is for business purposes, the CRA will generally be very suspicious.

Participating in aggressive tax planning

The CRA has dedicated resources for identifying potential compliance issues such as artificial capital losses; surplus stripping; loss trading transactions; offshore investment accountants; RRSP contributions and TFSA.

Therefore, if you participate in any of these high-risk tax activities that are already under the CRA’s radar, you will likely set off the alarm.

Selected for a CRA Audit due to Family business

If you own a family business and one of the family members on the payroll is getting audited, it is likely that all other family members will get audited too. This is often the case when one of the family members is a contractor, which is a strategy for a family business to help certain members reduce tax liabilities.

Large charitable donations

Charitable donations are generally tax-deductible. However, if your donation is abnormally high compared with your income, then that is a red flag to the CRA.

The CRA has been cracking down on donation scams so you should always make sure your donation is made to a registered charitable organization.

Repeated business losses

Running a business can be tough and it is understandable for a new start-up to incur losses in its early years. However, the CRA will be skeptical if a business owner claimed business loss continuously.

After all, the purpose of opening a business is to make profits and it doesn’t make sense for anybody to continue to lose money when something has been proven to be a failure.

What will be examined during an audit?

An auditor will examine books and records, documents, and information (collectively referred to as records).

These include information available to the CRA, your business records, your personal records, the person or business records of other individuals or entities not being audited and adjustments made by your bookkeeper or accountant for tax purposes.

During an audit, the auditor may find issues and discuss them with you. You can also raise concerns with the auditor at any time. After the auditor examines the records, he or she will either:

– correct assessment – if the auditor agrees with your previous assessment, you will receive a completion letter and the audit will be closed;

– more taxes owed or a refund: if the auditor decides to reassess your previous tax returns, you will receive a proposal letter.

Tax Tips – always seek professional help during an audit

An audit often takes a toll on a taxpayer financially and emotionally as audits are full of pitfalls and traps. Therefore, it is highly recommended to consult with a professional expert when a taxpayer receives an audit letter from the CRA.

Since most audits also involve legal issues, one of the advantages of hiring a tax lawyer is their legal expertise which guarantees any communication between you and the accountants are privileged so that the CRA cannot use that against you.

Another important thing is that the CRA cannot use its civil audit power to gather evidence when they are doing a criminal investigation. Instead, they must rely on a search warrant in order to seize books and records.

Picked for a Tax Compliance Check

When you are selected for a CRA audit, talk to a tax attorney.

At Barrett Tax Law, our experienced Canadian tax lawyers have helped countless individuals and business owners handle their audits, feel free to contact our office for a consultation to let us level the playing field for you against the CRA.

Jack Wang, Tax Lawyer at Barrett Tax Law, 416-907-8429

Why am I being selected for an audit?

The CRA is tasked with enforcing tax laws in Canada. As part of their efforts to ensure compliance with tax laws, the CRA conducts audits to scrutinize taxpayer records and ensure that they have correctly filed their taxes. However, for those who are selected, it can be a daunting and time-consuming process. In this article, we’ll explore the different factors that can lead to a CRA audit.

Random Selection

The CRA uses advanced computer algorithms to analyze tax returns, identify potential errors or omissions, and flag them for further review. This is one of the most common ways that taxpayers are selected for a CRA audit.

In the fiscal year 2020-2021, the CRA audited 0.9% of all individual tax returns and 3.6% of all corporate tax returns through random selection. While the chances of being chosen for a random audit are relatively low, it is still possible.

Industry and Occupation

Certain industries and occupations pose a higher risk of non-compliance with tax laws. For instance, those who are self-employed, have rental properties or have substantial investment income may have a greater likelihood of being audited by the CRA.

Similarly, businesses in particular industries such as construction, hospitality, and retail may be more prone to audits due to the high level of cash transactions and the potential for underreporting income. The CRA audited 9.4% of all construction businesses and 4.4% of all accommodation and food services businesses in the fiscal year 2020-2021.

Previous Non-Compliance

A history of non-compliance with tax laws can increase the chances of being selected for a CRA audit. This may include failing to file tax returns, underreporting income, or claiming deductions or credits that they are not entitled to.

In the fiscal year 2020-2021, the CRA audited 44% of all individuals and 77% of all corporations who had previously been non-compliant.

Third-Party Tips and Leads

The CRA receives tips and leads from third parties such as other taxpayers, former employees, or suppliers. These tips and leads can provide information that suggests non-compliance with tax laws, and the CRA may use this information to select taxpayers for audit.

In the fiscal year 2020-2021, the CRA audited 12.6% of all individuals and 10.3% of all corporations based on tips and leads.

High-Wealth Individuals

High-wealth individuals with a net worth of $50 million or more may also have an increased chance of being audited by the CRA. This is because these individuals have more complicated tax situations and may be more likely to use aggressive or even abusive tax planning strategies.

In the fiscal year 2020-2021, the CRA audited 14.3% of all high-wealth individuals.

While the probability of being audited is relatively low, it is still essential to file tax returns correctly and on time. By maintaining accurate records and seeking professional guidance when necessary, taxpayers can mitigate the risk of being selected for a CRA audit.