Preparing for a CRA Audit
What is an Audit?
Whether you prepare your own tax returns or pay for a professional to prepare them for you, there is always a risk that the CRA will select your return for further verification, review, or even audit. Independent review of your income tax, GST/HST, or payroll returns by the CRA is a part of every business owner’s life, and as a business owner, you are responsible for keeping good records and supporting documentation to support your business transactions. Even if you pay a bookkeeper or accountant to help you keep track of everything, the responsibility for keeping good records is the obligation of the taxpayer. Because the Canadian tax system is a self-reporting system, where taxpayers are expected to prepare & file their own tax returns, the CRA undertakes several types of independent review activities throughout the year to ensure taxpayers are following the laws and regulations set out in the Canadian Income Tax Act. During any type of CRA review activity, your financial records, transactions, and tax filings will be reviewed to verify their accuracy and compliance with Canadian tax rules.
This blog will tell you everything you need to know about CRA verifications, reviews, and audits - what the CRA is looking for, how to prepare, next steps, and tips moving forward.
Types of CRA Reviews
Most people are familiar with the concept of an audit, but that is only one level of review that the CRA undertakes throughout the year. There are actual multiple levels of CRA review that have differing scopes & requirements, which can be roughly broken down into three categories:
Verification
These are typically automated letters sent to taxpayers requesting additional information on a very specific deduction/credit. For example, they may ask to see donation receipts for charitable donations, or they may ask to see receipts/prescriptions to support medical expenses claimed. These letters have a very narrow focus and typically do not result in any additional review activity if the supporting documentation provided is sufficient.
Review (or desk audit)
These reviews typically have a broader scope than a verification letter. For example, instead of looking at a specific type of deduction or credit, they may look at a full return and request information about various elements of the return. One of the most common examples of these reviews is for GST/HST returns filed – CRA will request sales invoices & supplier receipts/invoices to support the top 10 revenue amounts & top 10 expense amounts claimed on a GST/HST return. These reviews can often lead to follow-up questions or additional review procedures.
Audit
This is the most intense review procedure that CRA can undertake. They generally do not open an audit unless they suspect fraud or non-compliance, as audits have a very broad scope and include a detailed review of almost all supporting documentation used in the preparation of returns (including other documents that may lead to evidence of non-compliance). An audit is typically the result of insufficient/suspicious information provided during verifications or reviews.
While most of the information below is still pertinent to CRA verifications & reviews, the focus of this article will be on dealing with CRA audits.
Preparing for an Audit
Once you have been notified by the CRA that an audit is being conducted, it is best practice to get organized as soon as possible. Delays can cause stress when deadlines are approaching and sometimes even result in fines, penalties, or interest charges. CRA can even make sweeping assessments & deny all deductions/credits on a return if they do not receive the information requested by the deadline indicated in the audit letter, which could result in a huge amount of additional tax, penalties, and interest owing. If you receive an audit letter from the CRA, you should contact the auditor right away and let them know that you will be gathering the documentation requested ASAP. Here are some best practices on getting organized for an audit:
Organize your financial records
Having convenient access to all relevant accounting records & supporting documentation can save so much stress and time. These include receipts, invoices, bank statements, accounting ledgers, and more. For Bright Line clients, we achieve this using Dext/QBO for all clients.
Keep deduction documents
Gather evidence for any deductions or credits claimed. These include business expenses, charitable donations, or other special deductions/credits claimed on your return.
Maintain clear communication
Be prepared to provide clear, transparent explanations for any discrepancies or unusual transactions if asked by the auditor. You should never lie to a CRA auditor or try to withhold information from them.
Consult a professional
Working with a tax accountant or tax lawyer (depending on the scope & severity of the audit) can remove the burden and uncertainty associated with audits. If you are working with a professional during the audit, be sure to contact the auditor and provide them with the contact information for whoever will be assisting you.
What Happens During an Audit
If you or your business are selected for an audit by the CRA they can request & examine the following information:
Information already available to the CRA such as filed tax returns, credit history, and special elections filed.
Your business records such as accounting ledgers & journals, sales invoices, supplier receipts/invoices, legal contracts & other documents, and bank/credit card statements.
Your personal records such as personal bank statements, mortgage documents, personal investment account statements, and personal credit card statements.
The personal or business records of other individuals or entities not being audited for example, a spouse or common-law partner, family members, associated corporations, partnerships, or a related trust (settlor, beneficiary, and trustee).
While the CRA may contact you over the phone to let you know you have been selected for audit, they are required to send a written audit contact letter. If the CRA tries to ask questions or asks for information in their initial phone call, ask them to send a letter outlining the scope of the audit and the requested information so you can review it with your tax professional.
The CRA will also conduct interviews with you or key members of your team to answer overall questions about your business or to provide details that will help them in determining what information they should be requesting during the audit. These interviews can be over the phone, in person, or via video call. It is important that if you are planning to get the help of a tax professional that you ensure they are included in all interviews with the CRA audit team.
The audit process normally takes anywhere from a few months to a year to be completed, depending on the scope & complexity of the information under audit. Some audits with very complex subject matter can take multiple years to complete, so staying patient and following the process is key. Once the CRA auditors have completed their audit activity, they will send an audit conclusion letter that will outline:
Proposed audit adjustments – if the auditor believes that certain amounts on the return(s) under audit should be changed based on their review, they will detail the proposed changes in their audit letter. The auditor will typically provide a period of time within which you can provide additional supporting documentation to change any of their proposed adjustments.
Amounts of taxes, penalties, and interest owing – based on any proposed audit changes, the CRA will provide a breakdown of additional taxes, penalties, and interest that will be owing to them once they conclude the audit.
If you are providing additional information in response to the proposed audit adjustments, the CRA will likely send a final audit adjustment letter after reviewing the additional information. When they consider their adjustments to be final, they will indicate in their written communication that they will no longer be accepting additional information.
The generally accepted rule of thumb is to keep your books and records dating back 6 years, but it is always best to have access to your entire history of books and records digitally where possible
Avoiding an Audit
Audits can be a huge drain on time & resources for small businesses, so avoiding them in the first place is a good idea. There are a few common red flags that the CRA looks for which can often lead to an audit which include:
Claiming unusually high credits or deductions
Consistency is key; any large or unusual changes in income or deductions may result in a CRA audit.
Forgetting to report income
If you have income reported on T3/T4/T4A/T5 slips (or any other slips that are filed with the CRA), it is important to ensure that income is included on your return, as the CRA will often check income per filed returns vs income reported on slips they have on file.
Refusing or forgetting to provide more information
If you are contacted at any time by the CRA for information to support certain items on any of your tax filings, do your best to provide them with the information requested. Often refusing or forgetting to acknowledge a CRA request for information can often result in an audit.
Claiming personal expenses within your business
If you are claiming 100% of personal expenses such as cell phones, vehicles, your principal residence, or any other type of mostly personal expense, it could cause CRA to want to investigate further via an audit.
Overusing tax shelters
Especially when making charitable donations the CRA is looking for non-profits they’ve never heard of. Every year the CRA will conduct audits for this reason alone. Visit the CRA’s list of charities to see if your charity of choice has a good history with the CRA.
A business or rental property that keeps losing money
If you own a business or rental property that happens to be losing money the CRA may take notice. A year of particularly high expenses or particularly low income can often be acceptable, but continued losses over consecutive years (especially if they result in cash refunds from the CRA) might trigger an audit.
Most of the time it just comes down to being realistic and reasonable. Remember that the above are just a few common reasons that you may be audited, but CRA conducts several internal checks & balances throughout the year to determine who is a good candidate for audit. Above all, it is important to provide accurate & timely information to the CRA during an audit or any other type of review activity.
Next Steps
Ideally, the CRA auditor will complete their review of the information provided and issue a notice of assessment with no proposed audit adjustments. However, this is often not the case and there may be further action required to settle the audit in satisfactory manner.
Once a final audit adjustment is provided by the CRA, they will issue a notice of assessment which will formally report their adjustments on the tax returns under audit. If you do not agree with the notices of assessment once they have been received, there are a few ways that you can fight them including:
Filing a notice of objection
Filing an appeal to the Court (only if you’ve gone through the objection process)
Filing relief/remission provisions (only once all other options are exhausted)
Filing an appeal to the Court (only if you’ve gone through the objection process)
Filing relief/remission provisions (only once all other options are exhausted)
All of the above are complex legal processes that should not be undertaken without the help of an experienced tax accountant or, more appropriately, a tax lawyer. However, submitting any of the above objections to the CRA is your right as a taxpayer – if you are looking to understand these processes further, you can find more information on the CRA website.
Conclusion
The key takeaway from this article is that good organization is the key to making the audit process smooth and pain free, while minimizing negative tax consequence and hopefully avoiding audits in the first place. Being able to quickly locate and provide requested documents to the CRA will make this process much more manageable. Working with an experienced bookkeeping team can also prove to be extremely useful by always ensuring that your records are accurate and up to date. Ultimately, proactive preparation and attention to detail can help minimize the risk of errors, reduce stress during the audit, and ensure that your business remains compliant with Canadian tax regulations.