How to Get Ready for a CRA Tax Audit
What is a CRA Audit?
The Canada Revenue Agency (CRA) administers tax laws and various benefit programs for the Government of Canada and several provinces and territories. Audits are an important part of the CRA’s range of activities aimed at making sure the tax system is fair for everyone. During an audit, the CRA closely examines the books and records of a taxpayer to confirm whether they are fulfilling their tax obligations, following tax laws correctly, and receiving the benefits and refunds to which they are entitled.
How does the CRA select files for a business audit?
The CRA chooses a file for an audit based on a risk level. The risk assessment 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 other similar files, audits, or investigations.
What can you expect during an audit?
An audit will start with a letter from the CRA, informing you that you are being audited. This letter will put you on notice and specifies the years that the CRA wants to audit as well as the documents and records it wants to see.
In most cases, the audit will take place on site at your business location, where the CRA auditor (“auditor”) will introduce themselves and will clarify the details of the audit, including the scope of the audit and document requirements.
It is important to ask questions for any further clarification. Also, obtain the contact details of the auditor’s supervisor should you need to involve them later.
You should provide only the documents that they need and not more. If during the audit the auditor asks for documents that weren’t originally requested, you should ask for clarification.
The auditor may need to make copies of your electronic records or borrow some of your documents. If so, the auditor will give you a detailed receipt for any borrowed documents and return them as soon as possible.
CRA Office Audit
In certain rare situations, the audit may be conducted at a CRA office. Office audits are usually limited to one or two items.
In some cases, these office audits can lead to a more comprehensive audit, depending on what the CRA finds. Therefore, it is important to take office audits seriously to prevent their scope from increasing.
What are your rights and responsibilities?
As a taxpayer, you should understand your rights and you should not be afraid to assert yourself where appropriate. Do not give the auditor free reign over your files. The Taxpayer Bill of Rights is available on the CRA website.
You are also entitled to file a complaint with the CRA complaint services should you feel your rights have not been respected.
Current trends in the audit of specific items
Employee vs self-employed contractor
The general approach to distinguishing between an employee and an independent contractor is the question of whether an employer/employee relationship exists. As there is no clear definition of employer/employee relationships, disputes between taxpayers and the CRA are very common.
It is extremely important for a business to be sure that any individual who is being treated as a self-employed contractor qualifies for that status. A failure to correctly determine whether a worker should be considered an employee or, alternatively, self-employed, could prove to be very costly to a business using the services of that individual. It is possible that, if the CRA judges the individual to be an employee, the business could be held liable for Canada Pension Plan (CPP) and Employment Insurance (EI) amounts that should have been withheld from the individual’s earnings, as well as the employer’s share of these amounts.
If you are self-employed and use your personal vehicle to earn business income, then the auditor considers this to be business use of a motor vehicle and will allow you to claim your motor vehicle expenses. This entitles you to deduct a portion of vehicle expenses such as fuel and maintenance costs based on your mileage. However, the CRA is very specific about what mileage may be used for business vs personal. Therefore, if you’re mixing personal and business mileage without keeping a proper mileage log, the auditor can reject all amount of your claims for this expense.
Similarly, if a vehicle is provided by your employer, then you can claim deductions as per CRA rules. If those rules are not followed, then the auditor can reject your claims for these expenses.
Shareholder loans can be a useful way to manage short-term personal cash needs. They also allow shareholders more flexibility in how and when cash is withdrawn from a company.
If you just need a short-term loan for less than a year, a shareholder loan could be an easy way to obtain the funds. To avoid having to include the amount in your personal income, the loan should be repaid within the year. In case repayment isn’t possible, a dividend could be issued, and you would pay personal tax on the amount at a reduced rate.
Improper use of shareholder loans can result in double taxation and audits from the CRA.
What is the CRA auditor allowed to examine?
In a nutshell, a lot and likely more than you would expect. For the audit of your business, the auditor may examine your personal records and even the personal or business records of your family members.
CRA regularly asks for:
- previously filed tax returns, credit bureau searches, or property database information
- business records (such as ledgers, journals, invoices, receipts, contracts, and bank statements). The CRA will usually ask for a copy of these records in a digital format
- personal records (such as bank statements, mortgage documents, and credit card statements)
- the personal or business records of other individuals or entities not being audited (a spouse, family members, corporations, partnerships, or a trust [settlor, beneficiary, and trustee]); and
- adjustments made to arrive at income for tax purposes.
The only documents the CRA may not access are those protected by solicitor-client privilege.
During the audit, you have the right to receive complete, accurate, clear, and timely information. We recommend that during the audit, you regularly communicate with the auditor to learn about any findings, which will allow you to respond more effectively.
Once all your explanations and responses have been addressed, and if the auditor concludes that your previous assessment is correct, you will receive a completion letter and the audit will be closed. Alternatively, if the auditor concludes that your return must be reassessed, you will receive a letter explaining the reason for the reassessment. In most cases, you will have 30 days to respond. For audits by Revenue Québec, you will only get 21 days to respond, subject to being granted an extension upon request.
An adjustment may result in an increase in the balance of tax that you owe. If you disagree with the reassessment, you can object to it by filing a “notice of objection” within 90 days of the notice of reassessment being sent. If you need an extension, you must submit the application within one year from the date on which the 90-day objection period ended, along with a letter explaining the reasons that prevented you from filing the objection within the 90-day period.
The filing of a notice of objection will suspend the collection of any income tax amount owing, but not of a GST/HST amount owing. However, larger corporations will have to pay 50% of the amount owing even if an objection is filed. In many cases, it is prudent to pay the amount owing to prevent interest from accumulating.
How can you be prepared for a CRA Audit?
Maintain good records: Have the receipts and documentation to support your claims ready in case your business is selected for review. You are required to keep your records, supporting documents, and financial information for at least six years. If you keep electronic records, you must retain them in an “electronically readable format”. Certain records, such as your general ledger or directors’ minutes for a corporation, must be kept longer. Well-kept records can reduce the time required to complete the audit.
Be knowledgeable and ask questions: Before the auditor begins the audit, confirm what taxation years are under review and what records will be required. This will help ensure you have everything ready when the auditor arrives.
Understand the information you are providing: Carefully review all information provided to the CRA and ensure that you are not providing any more information than has been requested. Make a copy of everything you give them, because if an issue arises later, you should know what they know.
Be courteous and professional: It is important to cooperate with the CRA and provide them with the information they request, if the request is legitimate. Creating a rapport and responding promptly and professionally may make the process smoother.
Put your responses in writing: If the auditor asks complicated questions that require judgment, give those responses to the CRA in writing to create a record of your response. If you do have sensitive records subject to solicitor-client privilege, assert privilege.
Hire an accountant: An accountant’s knowledge and experience can improve your tax planning strategies and help ensure your business is optimized for taxation, without breaking tax rules. They assist you during such demanding times by acting as liaison between you and the auditor. Also, an accountant can assist with the negotiation process, particularly if the audit becomes difficult. In the case you feel the audit came to an irrational conclusion, the accountant could also assist you with filing a notice of objection. When the CRA makes a request for an audit, it is better to be prepared. Plan accordingly, and have everything ready well in advance.
For help with Tax Audits or any other accounting matters, reach out to us at (+1 403-375-9955) for the Personalized Tax Consulting and CRA Audit Services.