Receiving a notification from the CRA (Canada Revenue Agency) that you have been selected for an audit can strike fear into the heart of anyone who owns a small business or is self-employed. That fear doesn’t usually stem from a concern about having done something dishonest since most entrepreneurs believe they are CRA compliant with their transactions and reporting. The worry comes from the possibility of an unintended error or oversight being discovered, the resulting ramifications that may ensue, and the stress that is inherent in dealing with an authority that has the power to impact you both financially and legally. Another major cause of stress is not understanding the audit process or how to properly prepare for it. This guide explains how CRA audits work.
In Canada, the onus is on the taxpayer to self-report. To maintain integrity in the system, the CRA conducts assessments and audits as a means of instilling confidence and fairness. The CRA’s risk-assessment systems flag tax returns that are considered at risk of non-compliance. A CRA officer will then review information from various sources to determine whether an audit is needed to address the risks identified. CRA may be alerted to a particular return for any number of reasons including abnormal expenses/deductions; a divergence from industry norms; sale/acquisition of assets; discrepancies with institutional reporting; and industry targeting. Returns are also automatically selected at random for review.
A CRA auditor will contact you to start the audit process by mail or phone, or both, and will inform you of the period(s) being audited. Due to the proliferation of scams, you may not be comfortable speaking to the auditor until you have verification that they are from the CRA. You may choose to end the call, look up the contact information independently and call back. You can also wait until you receive the audit confirmation letter before providing additional information.
Once you are satisfied regarding the identity of the auditor, you should answer the auditor’s questions to the best of your ability. Try to confine your answers only to the questions asked and refrain from adding surplus bits of commentary that may lead to tangent investigations. The auditor may request further access to your business and records.
Sometimes, audits are conducted over the telephone by means of an interview and an examination of follow up documentation. These are called desk audits. However, the auditor may decide to conduct an onsite audit and request access to your place of business.
Sometimes, auditors will complete the audit at a CRA office or your accountant’s office. They will request and remove relevant documentation and return it after the audit.
The auditor will want to discuss the information which you reported on your tax returns. Most business owners employ an accountant or bookkeeper to assist them in record keeping and reporting so the auditor may wish to speak with them as well. It is recommended that you have your accountant or small business tax advisor readily available and, in many instances, have them act as the principle contact for the auditor. They can provide clear, concise explanations for the auditor’s enquiries. For that reason, audits are often facilitated at the tax preparer’s place of business.
During the audit process, the auditor will look at various records and supporting documents. This includes all business records and small business expenses, related bank statements as well as the personal records of the business owner and associated entities. It is good practice to keep a record of each document requested and provided to the auditor, including electronic files. This is particularly true for any documents the CRA removes from the premises.
To determine the accuracy of reported income, CRA may employ additional processes. These indirect verifications of income are often used when:
An example of an indirect verification of income method used by the CRA is the Net Worth Review. The auditor considers any source of income, assets/liabilities, and spending habits that support your lifestyle. That net worth and income requirement is then compared to the actual information reported on the business owner’s tax return. Auditors will not just examine business records but also the personal finances, real estate holdings, vehicles, and other lifestyle indicators for the taxpayer and their spouse or partners.
After the audit has concluded, you will receive a report from the auditor about their findings and conclusions. The auditor may find that no further actions are required. Or the auditor may determine that adjustments are required to the tax return(s). You will have an opportunity to comply or contest the findings within 30 days and work with the auditor to find a resolution. If changes are made to your taxable income or taxes payable, you will receive a Notice of Reassessment.
You can file a notice of objection to dispute the assessment and include your rationale and supporting evidence. It is advisable to have a knowledgeable accountant or tax advisor assist you in making your claim.
Source: Canada Revenue Agency
