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Do you want to avoid CRA Audits? These are the points to watch out

Do you want to avoid CRA Audits? These are the points to watch out

The power to tax is the power to destroy.
When you’re getting ready your tax returns, you want to make sure you prepare your tax returns in such a way that the Canadian Revenue Agency (CRA) doesn’t approach you for a tax audit. Entrepreneurs have described a CRA audit as an unpleasant, difficult situation and we believe it is best avoided. The CRA chooses a victim for an audit based on a risk assessment that looks at a number of factors, such as the likelihood or frequency of errors in tax returns or whether there are indications of non-compliance with tax obligations. The CRA also looks at the information it has on file for the taxpayer and may compare that information to similar files or consider information from other audits or investigations.

Here, we intend to explore what exactly triggers a CRA audit and how you as a small businesses owner or a self-employed person can avoid the prospect of a CRA audit.

How to Prepare for The CRA Audits, Do’s and Don’ts During the Audit

It should be kept in mind that the purpose of the audit is for CRA to verify that the correct taxable income has been reported.  Subsequent to initial phone contact, the CRA will send the taxpayer an audit commencement letter advising the taxpayer of the audit start date, scope of the audit, and the documentation to be reviewed by the auditor.  It is essential that all supporting documentation be in order, in case the auditor requests it.  This is especially true in the case of international issues. Tips to consider when an auditor:

  • Arrange adequate space for the auditor to do his work.
  • Do not have the auditor work in a “closet” but do not give him the “corner office”, either.
  • The auditor is merely doing his job to verify the completeness of the filed tax return, nothing more and nothing less.
  • Do not be defensive or aggressive in dealing with the auditor.

During the course of the audit, the auditor will usually issue query sheets which detail the information or supporting documentation requested for review.  The queries may range from being administrative in nature to daily transactions. It is best to answer the auditor’s queries on a timely basis, while providing no more information than is required.  The importance of having supporting documentation for deductions taken cannot be over-emphasized.  The bigger the deduction, the more complete the documentation should be provided.  After all, if substantial dollars are at stake, you need to be able to justify the amount of the deduction.  Provide any tax research that was done to support your filing position.  In tax matters, the onus is on the taxpayer to prove his filing position.  Do not put yourself in the awkward position where you need to find or reconstruct the supporting documents at the time the audit commences because they were missing, or never existed in the first place.

How to Prepare for The CRA Audits, Do’s and Don’ts During the Audit

The chart below show’s CRA dedicates more than half of its resources to Small to Medium sized businesses’ tax compliance.

There are some common triggers, which if you know them, may help you can reduce your risk of being audited.

tax graph
Unusual Tax Return Changes

The CRA searches for consistency in your expense forms from year to year, particularly in the event that you record as independently employed or an entrepreneur. In the event that you have enormous changes in deductions or income, the CRA may hail your arrival for a survey. Ensure that you can obviously record and bolster all changes.

Declaring income outside the norm

Business income that’s significantly higher or lower than the norm in your industry will also immediately draw interest. CRA also has information based on various industries in regards to their expected profit margins and incomes. Therefore, any significant variances from those benchmarks could include you into that lucky list for an audit.

Refusing to Provide More Information

If the CRA is interested in a certain aspect of your return, provide the receipts, logs, schedules or any other information requested. Who fails to provide this information can result in the CRA issuing a reassessment or auditing your return.

Ignoring a request for information does not make it go away. However, providing the requested information does not inoculate you from an audit either.

Unreasonable home office deductions

The CRA offers home office deductions to employees who have work space at home, and to self-employed individuals and small business owners who use their homes for business. To qualify for either of these deductions, the CRA sets requirements about how often you use the space and whether you use it for personal use.

If your claims seem excessive, the CRA may decide to audit your return. For example, a home office that takes up 10 percent of your home’s floor space likely seems reasonable. In contrast, a home office that takes up half of your six-bedroom home seems unrealistic and may trigger an audit.

Writing Off All of Your Vehicle

The CRA allows you to write off expenses related to using your car for your job or your business. However, the CRA knows that most people do not have vehicles used exclusively for work. If you attempt to write off 100 percent of your vehicle expenses as work or business expenses, that claim may trigger an audit.

Hiding Cash Income

The CRA requires you to report all income, including any cash or trade that you receive in exchange for services. The CRA has a number of techniques to determine the likelihood that you are collecting cash but failing to report it.

In the midst of an audit, the CRA may look at your lifestyle and property and compare those elements to the amount of income you declare on your tax return. Additionally, the agency may collect information from informants.

When simply looking at your tax return, the CRA may compare your income and your neighbor’s incomes. For example, if you live in an area full of millionaires but you only report a few thousand dollars in income, the CRA may notice that and start to reassess your tax return.

Recurring Losses from a Rental Property

The CRA allows you to write off losses from a rental property. However, it also assumes you bought the property to earn money, and if you are repeatedly reporting losses, it may want to look at your records.

If you have legitimate losses, you need the records to support them. In particular, the agency wants to see that you have done your due diligence with regards to finding renters and charging market-rate rents.

If you rent your property to a relative for less than fair market value, you cannot claim a loss.

Making large deductions for charity.

If the CRA feels you are making big charitable deductions, that can trigger an audit. The CRA knows precisely how much more frequently than it does not provide for charity at your salary level, so a warning emerges when your beneficial gifts exceed that number. Especially, it is most important to review donations including capital assets.

Do you want to know more?

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