We all know about them, but for the most part, they’re shrouded in mystery. CRA audits. Why do tax audits exist? What does it mean if you get audited by the CRA? And what should you do next?
In this article, you’ll find the answers to the most common questions about audits. By the end, you’ll have a better understanding of why they’re a necessary part of our tax system and the first steps you should take if you get advised of one.
Here’s what you need to know about CRA audits:
What You Need To Know About Audits
We all benefit from paying taxes, which build the roads we drive on and fund the health care system we rely upon. The Canada Revenue Agency, a revenue service of the Government of Canada, performs audits every year to ensure individuals and business owners pay their fair share of taxes.
Audits prevent tax evasion and maintain the integrity of the tax system. The system only works if everyone pays the amount they owe. Audits are a way to make sure that happens.
An audit is when a CRA tax specialist looks at a taxpayer’s books and records. They check that the individual or business owner is paying the tax they owe and abiding by tax laws. They’ll also check that the taxpayer is receiving any credits or benefits they’re entitled to.
How the CRA Selects Files To Audit
The CRA isn’t always transparent about why tax returns are chosen for audits. Part of it might have to do with your risk assessment level. The CRA uses an algorithm to determine whether an entity should be audited.
However, in our experience as Chartered Professional Accountants, we’ve learned what tends to trigger an audit. Here’s what we know:
Reasons specific to individuals
For individual tax audits, it’s more likely that you’ll receive a desk audit—this is a request about a specific deduction you’ve claimed rather than a complete CRA audit. If you make claims for any of these deductions, you may receive a desk audit:
- A business investment loss (did you hold shares inside a bankrupt private Canadian business?)
- Significant interest costs
- Tuition paid to a university outside of Canada
- Child care claims related to nannies
When you receive an audit for these deductions, you typically need to provide backup documents to support your claims.
If you’re self-employed or you make commission income, and you claim costs against your income, you may be more likely to get audited. Specifically, CRA tax specialists are concerned with car cost claims or ad/promotional costs that may be for personal endeavours.
In previous years, taxpayers who purchased tax shelter on anything other than oil, gas, or mineral flow through were more likely to get audited. The CRA typically audits the tax shelter itself; individuals who invested in it will get personally reassessed.
Reasons specific to businesses
What about corporations? If you run a business, you may get audited for an entirely different set of reasons than what we’ve detailed above.
Certain industries are more likely to get audited than others, specifically ones where people pay primarily in cash. Examples of high-risk industries from previous years include pharmacies, contractors, the restaurant industry, and real estate.
Another reason is that the GIFI your company filed (your annual summary of expenses and income) is compared with other companies in your industry. If your return falls outside of the standard ratios in similar files, your business may be selected for an audit.
And in some cases, it’s just the luck of the draw! Every year, a certain number of audits are randomly selected. You may be audited for no reason other than that you drew the short straw.
The Auditing Process
After you’re selected for a tax audit, what happens next? Maybe you aren’t paying enough tax; maybe you’re paying too much. Or maybe there’s no issue with your tax return at all. All of this will be determined during the tax audit.
Here are the steps that take place after an individual’s file is selected for an audit:
1. An auditor will contact you
The CRA will notify you of the audit through a letter or phone call.
It’s very important to confirm that you’re speaking with a CRA employee. Scammers often pretend to be CRA employees to steal your personal information.
If you receive a phone call from someone claiming to be part of the CRA, ask the individual for their name and phone number so you can check their identity. Be sure to confirm that the phone call is legitimate before giving out any of your information.
2. A location to conduct the audit will be established
Next, the CRA will share with you the date, time, and location of the audit. You may be given an on-site audit that will take place at your home, your business, or your tax representative’s office.
When you attend an on-site audit, the CRA auditor will present their identification card to you before they begin.
Alternatively, you may be required to travel to a CRA office, which may be located outside of your region. You’ll be asked to bring your records and supporting documents along with you to the audit.
3. Your records will be examined
Your records (also known as your books, documents, tax returns, and other financial information) are all subject to examination in an audit. Depending on the type of audit you receive, you may be required to provide the following:
- Mortgage documents
- Credit card statements
- Bank statements
- Bank statements
- Rental records
In addition, you may be asked to provide documents from other partners in your business or members of your household.
At this stage, CRA auditors will bring up any issues they’ve found with your documents. You can also voice any concerns you have about the process.
4. The audit will conclude
When the audit comes to a close, one of a few things can happen:
- Nothing. The auditor may find that your assessment was entirely correct. You won’t need to pay any extra tax, and you won’t receive a refund, either. The audit will be closed and you’ll be sent a completion letter.
- You’ll need to pay taxes. If the auditor determines that you owe taxes, you’ll be sent an adjustment in the mail and will need to pay the balance owing on the reassessment.
- You’ll receive a refund. In some cases, the auditor may determine that you’re entitled to a tax benefit. You’ll be given a notice of reassessment that proves you’re entitled to a refund on your tax return.
What happens if you disagree with the adjustment? You can contact the CRA auditor to explain your position and provide supporting documents. They may consult with other CRA tax specialists about your case.
If you do owe taxes, try to pay them right away to avoid interest charges. You can ask your auditor for the estimated amount of your taxes owed so that you can pay it sooner; that way, you won’t have to wait for the notice to come in the mail.
How You Can Prepare for a CRA Audit
There’s no doubt about it: Getting audited by the CRA is a stressful experience. It’s one you want to avoid whenever possible. So, what can you do to prepare yourself? Make note of the following:
1. Always be prepared
Do everything you can to ensure you’re keeping accurate books and records of your income streams and expenses. Keep physical and digital copies of your most important tax documents. Hold on to any receipts that may be important come tax time. And when you’re filing tax returns, work with a professional bookkeeper.
If you do get audited, you’ll thank yourself for all the diligent recordkeeping you did ahead of time.
2. Organize your tax documents
There are two kinds of people in the world. The kind of person that keeps every tax document and receipt in a manila folder in a filing cabinet, and the kind that leaves those papers all over the place.
Guess which person is more likely to get stressed out if they receive an audit?
That’s why it pays to stay organized—so you’ll have no trouble tracking down any of the documents your auditor requests. Put the time in to organize now, and you’ll have less to do later.
CRA audits can go as far back as six years, so hang onto your returns and receipts after they’re filed!
3. Hire a tax accountant
Here’s the thing about CRA audits: You don’t have to figure them out on your own. It’s a better idea to have a tax professional by your side who can help you through each step of the process.
At Compass Accounting, we’ve assisted countless Canadians file their taxes and go through audits. We’ll help you expedite the audit, track down the documents the auditor is looking for, and determine why you’re being audited in the first place.
Our Winnipeg tax accountants are here to help. Get in touch with Compass Accounting today!