For some, it is their greatest fear, for others, a fact of life. The letter from CRA saying they want to review your tax returns.
There are only 2 ways that a taxpayer can be selected for an audit:
1. Random Change
2. Targeted Selection Process
We’ll ignore random chance and give you the details for the Targeted Selection Process (TSP).
The TSP is based upon risk factors; the CRA looks for those that are more likely to owe more taxes based upon some specific criteria and experience:
10% of randomly selected taxpayers face an additional tax bill of more than $5,000 while 35% of TSP taxpayers owe more than $5,000 in additional taxes.
Filing online vs. paper filing has absolutely no bearing on being selected for an audit, what does matter though are:
1. Errors on tax returns; an occasional error is normal, multiple errors and repeated errors will get you an audit.
2. Self-Employment; taxpayers that are employed and have T4’s, RRSP Receipts etc. have a very low risk of being audited – CRA gets their tax information directly from the employers; mistakes are highly unlikely.
Individuals that are self-employed however, pose a much better opportunity for the CRA, especially those that are in cash oriented businesses (home renovations, contractors, etc.).
Here are some interesting statistics from a CRA report to Parliament:
CRA conducted 366,260 audits in one year resulting in $2.5 Billion in additional taxes, interest and penalties. (small business audits)
CRA conducted about 63,000 GST/HST audits in this same period resulting in assessments of more than $600 million.
They conducted 20,635 audits on ‘underground economy’ businesses – resulting in addtional tax, interest and penalties of more than $284 million.
98% of tax evasion cases prosecuted by the CRA result in Convictions! And the rate of conviction has NEVER fallen below 94%
When it comes to your small business, what will trigger the CRA to consider an audit?
1. Major Changes in Income or Expenses; CRA likes things to be predictable, when things change dramatically, they will ask questions.
2. Repeated Losses; really? For how many years do you think your business can sustain losses before CRA will question it?
3. Expenses that are different than others in your industry; if you claim $10,000 in travel and all of your competitors don’t claim travel, CRA will question it.
4. Underreported Earnings; CRA conducts very detailed statistical analysis of businesses. If you are in a certain industry, they know what your margins should be; if you are way off, they will question it.
5. Large Charitable Donations; Your business is not doing well, but you donate $10,000 to charity? They will question it.
6. Home Office Deductions; There are very specific criteria required to claim home office expenses, if you don’t meet the criteria, they will come calling.
7. Discrepancies between GST Returns and Tax Returns; yes, they do check! If your revenues do not match or your expenses are not the same, they will question it.
8. Shareholder Loans; if the loans appear on your financial statements (as a receivable) for 2 consecutive years, expect a call! CRA does not like Shareholder loans that should be considered income and taxable.
9. Errors and Missing Information; If you get dividends, investment income, or rental income, CRA knows this. If you negelect to report it on your tax returns, they will call.
10. Divorce! – Yes, there is nothing worse than a disgruntled spouse. One call to CRA declaring that you have hidden income, over-reported expenses etc. will get you Audited!
There are a few other ways you can get yourself audited, but your best defence is a good accountant and accurate, detailed records!
Don’t skimp on a bookkeeper, it could end up costing you tens of thousands of dollars in addtional taxes, interest and penalties.
Next Month: What to do if you are audited.