What Prompts a Tax Audit?

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:

Random Change
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:

Errors on tax returns; an occasional error is normal, multiple errors and repeated errors will get you an audit.
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?

Major Changes in Income or Expenses; CRA likes things to be predictable, when things change dramatically, they will ask questions.
Repeated Losses; really? For how many years do you think your business can sustain losses before CRA will question it?
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.
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.
Large Charitable Donations; Your business is not doing well, but you donate $10,000 to charity? They will question it.
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.
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.
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.
Errors and Missing Information; If you get dividends, investment income, or rental income, CRA knows this. If you neglect to report it on your tax returns, they will call.
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 additional taxes, interest and penalties.

Contact a Ledgers Professional, we offer Accounting and Bookkeeping Services!