CRA Income Tax Audit – Introduction
As Toronto tax lawyers we deal with CRA audits and auditors on a daily basis. So what is a tax audit? This article will explain what you can expect to happen if you are audited for taxes.
The Canadian income tax system is based on self assessment. In other words it is up to every Canadian taxpayer to fully and properly report their total income from all sources on their annual T1 or T2 income tax return. The Canada Revenue Agency performs tax audits and issues income tax assessments to ensure that the self-assessment income tax system continues to work properly. While most Canadians are truthful on their tax returns, there are some who are not. CRA is looking for errors or disputable positions or deliberate misstatements on tax returns that have been filed.
What is a Tax Audit?
An income tax audit is an examination of a taxpayer’s returns and supporting records to make sure that income and expenses have been properly reported and are supported by accounting records and receipts. The CRA tax auditor will ask to see the individual or corporate books and records and bank account and receipts for expenses. A corporation will normally have to provide its minute book to support any dividends or bonuses. There may be questionnaires to be filled out. Any information that is wrong, even if due to an error, will be used against the taxpayer.
Most audits are done to ensure compliance with the Income Tax Act for income or payroll deductions or under the Excise Tax Act for GST/HST.
Canadian Tax Audit Procedures
CRA auditors will often search for relevant information on the Internet, and a taxpayer's web site or other sources located on Google might contradict information the taxpayer provides to the auditor. This information will then be used for further enquiries possibly including 3rd party requests for information. Furthermore open social media accounts are publicly accessible, and CRA auditors will gather this data from taxpayer social media accounts to build a case against a taxpayer. CRA officials have publicly discussed using taxpayer’s social media accounts in this way. If taxpayer lifestyle and reported income don’t match up the CRA tax auditor may decide to look into the taxpayer’s situation to see what’s actually going on.
CRA's practice on income tax audits is to do a GST (and HST) compliance review; if problems are found, the matter is normally forwarded to a GST/HST auditor for a full GST/HST audit. Similarly, an income tax compliance review is often done during GST/HST audits. Combined income tax and GST/HST audits were discontinued in July 2010. These compliance reviews are not always carried out and sometimes income tax audits may miss large GST/HST problems and vice versa.
CRA Audit Statistics
CRA issues an annual report to Parliament. The latest one was released in January 2016. The audit statistics from CRA Annual Report 2014-2015 provide less detailed information than for the previous year.
For small & medium enterprises no statistics were given. CRA reports that they reviewed 12,981 international and large business files and 9,440 aggressive tax planning files that resulted in identifying $1.4 billion in fiscal impact. For international and large business files CRA audited 6,540 income tax and GST/HST underground economy files and identified over $448 million in fiscal impact. In all cases there were fewer audits in 2014/15 that the previous year. Presumably this reflects the results of budget changes.
Reasons for Tax Audit
CRA may choose to audit a taxpayer for several reasons. Amongst them are:
- Industry audit projects
- Random selection
- Third party tips
- Past history of non-compliance
- Comparison of information on returns to information received from third-party sources – in other words are all T-slips reported
Since 2011 CRA has been auditing high net worth individuals and families, sending questionnaires asking for information about all companies, trusts, etc. that they control.
CRA has also been concentrating additional audit resources on the underground economy in an attempt to deter unreported cash sales.
What is the Tax Auditor Looking For?
The focus of the tax audit is to find errors in tax returns. Here are some examples of typical issues that may arise in a tax audit that would cause a taxpayer to receive a tax assessment at the end of the tax audit and that could result in penalties or a referral for a tax evasion investigation:
- Overstated Expenses
- Overstated Deductions
- Over claimed Income Tax Credits
- Underreported or unreported Earnings
- Unreported cash sales
- Unreported internet income
- Unreported offshore income
- Unreported offshore assets
- Credits, such as for charitable donations, that are not supported by receipts
- Personal expenses deducted for business
- Shareholder loans not repaid within 2 corporate year ends
Right of CRA to Audit and CRA Audit Policies
Section 231.1 of the Income Tax Act gives CRA the statutory ability to carry out audits. In particular it entitles auditors to request and examine documents including computer records. Section 231.2 is a more formal provision whereby a “demand” or “requirement” is issued, but it need not be used by a tax auditor in the normal course where s.231.1 suffices.
The CRA can choose to audit anyone, but case law has held that such discretion does not permit a vexatious audit made for capricious reasons.
The Canada Revenue Agency has an internal policy in CRA Audit Manual §9.12.3 that audits should normally be limited to “one plus one” years that is to say the most recent year for which a return has been filed and assessed, plus one year back, with limited exceptions. This policy can be pointed out to a tax auditor to try to limit the scope of audit requests, but it has no legal effect and cannot be used in court to challenge a tax assessment that has been issued. Of course this rule of one plus one years does not apply in the case where CRA suspects unreported income. They will typically look at three years, and in some cases even more than 3 years.
In theory, the CRA has no discretion in applying the Act and must “follow it absolutely” by issuing a tax assessment for all taxes owing. The reality is that in practice tax auditors have wide discretion not to assess an amount, however once it is correctly assessed; a Tax Appeals Officer or Tax Court judge will have no power to cancel it on grounds of equity, fairness or compassion.
Tax Audit Assistance from Toronto Tax Lawyer
Our top Toronto tax lawyers fight CRA tax auditors every day. A taxpayer has the right to professional representation at all times. This is specifically provided for in right 15 of the Taxpayer Bill of Rights which says “You can choose a person to represent you and to get advice about your tax and benefit affairs. Once you authorize us to deal with this person, we can discuss your situation with your representative.” A taxpayer should never meet with a CRA auditor without a professional Canadian tax lawyer present. Any information that is wrong, even if due to an error, will be used against the taxpayer. The auditor will also take notes and may misunderstand what the taxpayer has said or may wrongly record responses. An Ontario tax lawyer will have his or her own notes to contradict any auditor errors. Contact our Toronto tax law firm for tax help as soon as a CRA tax auditor contacts you.