"Help! I'm being audited," are dreaded words
uttered by Canadians. They are especially dreaded by business
owners because an audit means extra work and extra accounting
Have you wondered what triggers a tax audit by CRA in the first
Once an income tax return has been filed, it is subject to both
computer and human review. Some tax returns will be audited
on a random basis, but most audits are caused by what is in the tax
return: the information you supplied and the way you supplied
Here is a list of "red flags" that are likely to
trigger an audit by CRA.
1. Claim unreasonable expenses.
The best way to ensure an audit is to be greedy with expenses
claimed. The amount of any category of expense has to be reasonable
both compared to revenues and compared to other similar businesses.
Claiming $10,000 in car expenses against $50,000 in sales will
likely trigger an audit. Don't claim such a high percentage
unless you supply a mileage log and you're willing to be
Another basic CRA review technique is to compare expenses
claimed to the amount deducted in previous years. Any
discrepancy will be flagged for audit. So, if travel expenses
increased from $3,000 to $12,000 expect questions and very possibly
2. Use all "rounded-off" numbers in your tax
CRA likes to see exact amounts in both the dollars and cents
columns. Rounded-off numbers (for example, $2,500 or $10,000)
signal to CRA that you have likely not been keeping accurate
records and are estimating everything at the end of the year. It
also tells CRA that you are not likely to have receipts. Put in
exact amounts, such as $2,486.32 and $9,742.56, and you are less
likely to trigger an audit.
3. Forget to include a T-slip.
It’s easy to forget a T-slip, but CRA has a matching program that will pick up any missing slips and will charge you a 10% penalty for the first time, rising to 20% for subsequent occurrences. And you will increase your audit risk: was it inadvertent, or are you not reporting all your income?
A tax return preparation tip: compare everything on this year’s tax return to last year’s T1, to ensure that you haven’t missed anything.
4. Use of tax shelters.
Tax shelters may be a proper and legitimate way to reduce your income tax. They are also a sure ticket to a tax audit. CRA audits all tax shelters, and has been refusing to process tax returns with tax shelter claims, but has now lost that battle in court.
5. Certain sectors are on CRA’s watchlist.
Restaurants, construction, and small retail outlets have been identified as part of the
“cash economy” and stand a large chance of being audited.
6. Being self-employed or an independent contractor.
If you own a business or are an independent contractor, you increase the chance that CRA will audit either to make sure you are declaring all of your income or that you are, in fact, an independent contractor and not an employee looking for more tax breaks.
7. Over-paying salaries to spouse and children.
Paying spousal or child salaries is proper for services rendered and if the amount charged is market rate. But expect a CRA audit to check for services not rendered, overpaying for services that were provided and not documenting amounts paid. This is an especially tricky area because the audit reassessment will deny the expense (or part of it) for the taxpayer, but it remains taxable to the recipient resulting in double taxation.
8. Reporting business losses for years and years.
Small business owners can expect CRA to come knocking if they report losses for several consecutive years in a row—why would anyone continue to operate an unprofitable business?
9. Big discrepancies in income for your industry, neighbourhood.
CRA compares what you report on your income tax return to the statistics for your industry, your profession and your neighbourhood.
For example, if you’re declaring $50,000 a year in income and you live in a neighborhood where the average reported is $130,000, that is a noticeable difference. CRA is going to audit to see how you can continue living beyond your means.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).