Finding out you are facing a tax audit can be intimidating and frightening. Whether it’s for your personal income taxes or business taxes, a CRA audit can be intrusive and there could be significant consequences involved. When you are being audited by the CRA, it’s important to work with a professional tax accountant to ensure you are providing required information so the audit process can finish as quickly and smoothly as possible.
Understanding the reasoning and processes surrounding CRA audits can provide insight into why you were selected and the actions you need to take next.
What is a CRA Audit?
When you receive an audit, the Canada Revenue Agency is trying to check the accuracy of the claims made on your tax return through receipts, invoices, pay stubs, or other records. Most audits are not criminal investigations and are done to simply determine whether or not an individual or business has paid enough tax.
Most taxpayers in Canada comply with tax laws. The CRA’s auditing process helps taxpayers better understand their tax obligations and helps to maintain the integrity of the federal and provincial tax systems.
The CRA will let you know what documents are needed for the audit as well as any relevant deadlines. Usually, the audits will be held at an individual’s residence or company, but sometimes may be held at a CRA office. When the audit is complete and an assessment is made, the decision can be appealed if the individual feels that they were overassessed.
Each CRA tax audit is slightly different depending on what triggered them, who the auditor is, and what the CRA is looking for. Usually, however, a standard set of rules and processes will apply.
How Does the CRA Decide Who To Audit?
The CRA chooses a file for audit based on a risk assessment. While the full criteria can seem unpredictable, the assessment looks at a number of factors, including the likelihood or frequency of errors in a tax return and whether there are indications of non-compliance in tax obligations. The CRA also looks at existing information on file for the taxpayer in question and can compare that to similar files or previous audits or investigations.
Sometimes, the CRA will perform random audits which are selected, naturally, at random from the tax paying population. This is a way to help maintain the integrity of the tax paying system and ensure that taxpayers are staying compliant.
What Happens When The CRA Audits
When the CRA decides to audit an individual or a business, the process is largely the same. In both cases, the auditor is looking for tax compliance by verifying a number of documents. The difference between an individual and business audit is in the materials requested. An individual may only have a T4 and T1 and claim some relevant tax credits, while a business may have dozens of claims, a significant list of expenses, donations, investments, payroll, GST / HST, and more.
When Does CRA Notify You of an Audit?
The CRA can notify you of an audit any time after your income taxes are filed. A CRA auditor will notify you by mail or phone (or both) that you are being audited, where the audit will take place, and what date it will occur. They will also inform you the documents that are needed. Sometimes, you will be required to submit documents to the auditor in advance of your meeting, while other times you can simply bring them to the meeting.
How Many Years Can CRA Go Back To Audit?
In most cases, the CRA can reassess (or review) your tax returns for the previous three years and audit them for the previous four years. It is always recommended to keep all relevant tax documents for six years from the end of the last tax year they relate to, including:
- All T-slips
- RRSP contribution slips
- Medical receipts
- Charitable donation receipts
- Self-employed revenue
- Business revenue
- Expense records
- Financial statements
- GST / HST records
- Payroll records
However, if the CRA suspects fraud or misrepresentation on the part of the taxpayer, there is no time limit and the CRA can go further back to audit.
What Does a CRA Auditor Review?
The auditor examines a number of documents during the audit process. Some documents will be requested from you and some will already be available to them from previous filings online. These can include business records, personal records, financial statements, and accountant records.
Some documents reviewed by a CRA auditor include:
- Filed tax returns
- Credit history
- Property details (such as mortgage documents or rental records)
- Business ledgers and journals
- Customer Invoices and expense receipts
- Business contracts
- Bank statements
- Credit card statements
- Personal or business records of other individuals not being audited (such as a spouse, corporation, or trust)
- Adjustments made by a bookkeeper or accountant for tax purposes
- Other records, documents, or information considered relative to the tax return being audited
The auditor will ask you questions during the audit, and you are free to ask them questions as well.
After the audit is complete, there are generally two outcomes:
- A correct assessment is determined and no further adjustments are made on your previous tax return
- It is determined that more taxes are owed or the individual/business is entitled to a refund. In this case, you have 30 days to agree or disagree with the proposal.
- If you do not agree with a final assessment, you have the option to appeal it
How Long Does CRA Audit Take?
This process can take anywhere from two weeks to several years and depends on a number of factors. An audit for a large corporation, for example, will usually take longer than a personal income tax audit of an individual with one T4. The scope of the audit, the state of the records, missing records, and required consultation with other CRA tax specialists can all influence how long a CRA audit will last.
CRA Audit Triggers
Tens of thousands of audits take place in Canada in any given year and while technically, any individual or business can be audited, there are several triggers that can make you more likely to fall into an audit.
Your revenue is declared across tax forms, so if your revenue declared on your income tax does not match the revenue declared on other forms, the CRA will audit you to find the discrepancy.
Being an outlier
The CRA knows the benchmarks for revenue in your industry. Declaring business income that is significantly higher or lower than similar businesses in your industry will draw attention.
Changes in shareholders and large balances
The CRA will look for personal expenses recorded as business expenses and loans taken from the company.
Deducting large business expenses or unusual business expenses
Expense deduction is a big part of many CRA audits. They look for inconsistencies or unusual spending in things like meals and entertainment, travel, and promotion. Any significant deduction in these areas will likely trigger an audit.
Running a cash-intensive business
Businesses that operate with significant cash flow, like restaurants, bars, hair salons, and other retail businesses often get extra scrutiny to ensure all income is being declared.
If a business experiences losses year after year, especially when those losses offset other income, an audit is a possibility to ensure this is not being done in bad faith.
Filing taxes as a self-employed individual can be complex, and making the smallest of mistakes can trigger an audit, especially when it comes to expense reporting.
How Far Back Can CRA Audit an Individual?
The CRA can reassess or inspect an individual’s personal tax return for the previous three years, and audit them for the four years previous to that. This means your personal tax return could be subject to an audit up to six years from the end of the last tax year they relate to.
For example, if you receive a Notice of Assessment for your 2018 taxes in June 2019, the CRA can go back and audit this return until June 2022.
However, if the Canada Revenue Agency suspects fraud in your 2018 income tax, it is within their right to launch an audit at any date in the future not bound by these deadlines.
CRA Business Audit
A CRA business audit is very similar to a personal income tax audit in process. When auditing a corporation, the CRA may also request input from your accountants, bookkeepers, and/or employees to get a well-rounded picture of your business as it pertains to the audit.
For a business tax audit, the CRA will need to ensure that the earnings reported by the business are correct. This is done by what is known as “indirect verification of income”.
The CRA will use this indirect verification of income when there are indications of one or more of the following:
- The books and records are prone to error (such as if one person is solely responsible for all accounting or the main functions of a business are done by one person or one small group of people)
- The business and personal bank accounts may have been used interchangeably
- The taxpayer’s lifestyle does not seem the match the income reported to the CRA
- The business is in a sector that is considered to be at high risk for unreported income
- The business consistently reports a lower income than other similar businesses in the same sector
The net worth method is most commonly used by the CRA to indirectly verify the income a business. This method goes beyond the books and records of a business and involves a comprehensive review of the business owner’s lifestyle using personal financial records and other verifiable information. The auditor considers changes in assets and liabilities, personal spending, non-taxable sources of income, and other relevant information to determine the business owner’s “net worth”. This is then compared to the information reported on the tax return to ensure all calculations line up.
If you are a business owner being audited, it is recommended to work with an experienced tax accountant throughout the auditing process to ensure your business, income, assets, and expenses are represented correctly.
For more detailed information, visit Business Audits at the CRA.
How Far Back Can CRA Audit a Business?
There are limits on when the CRA can audit a corporation or business. For Canadian-controlled private corporations (CCPCs), there is usually a three year limit from the time of a Notice of Assessment. For example, if your business receives a Notice of Assessment in 2019 for corporate taxes filed for the 2018 year, the CRA can audit you until 2022.
However, for GST / HST purposes, the CRA can audit those returns for up to four years from the particular tax year.
Similar to individual income tax audits, if the CRA suspects fraud, they are not subject to these limits and can extend the audit period indefinitely.
CRA GST / HST Audit
Small businesses, SMEs, and corporations that have revenue over $30 000 per year need to remit GST / HST when they file corporate taxes. This opens firms up to the potential for GST / HST audits by the CRA.
You will be notified by the CRA if they are starting a GST / HST audit for your company specifically. This type of audit can be triggered by any number of factors, including reporting significant sales or ITCs (input tax credits) in your initial years and revenue discrepancies between your T2 and GST / HST return.
An auditor will be particularly interested in your banking records, GST / HST collected, input tax credits claimed, and sales and purchase invoices. This will allow them to verify any discrepancies in your GST / HST reporting on your corporate tax return.
CRA Payroll Audit
The CRA can start a payroll audit for your company if they see inconsistencies between employees, salaries, wages, T4s, or issues with remittances and deductions. A company with a large staff and complex payroll can trigger an audit when there are compliance issues affecting even a small portion of the staff.
Your company will be notified by the CRA if they are specifically carrying out a payroll audit. In these audits, the CRA will particularly want to examine business records relating to the company payroll. This can include bank accounts, ledgers, journals, sales invoices, expense accounts, payroll deduction remittances, employee pay stubs, and T4s. The employees of a corporation may also be questioned or be requested to submit documents to the CRA to provide a comprehensive picture of a business’ payroll processes.
CRA Random Audit
Though not as common as it once was, you or your company could be chosen for audit by the CRA randomly. If this occurs, the process and how far back the CRA can audit do not change, even though they do not have specific compliance issues in mind.
When selected for a random audit, it can be helpful to work with a tax accountant to ensure the process is as smooth as possible and concluded quickly.
The best way to handle a random audit is with prevention. If you are tax compliant and filing your taxes accurately and on time, an audit will not uncover any further tax owing or refundable, and the entire process will be simplified!
Get CRA Audit Help
When you are notified of a CRA tax audit, it is important that you contact a tax accountant. A CPA (Chartered Professional Accountant) with experience in tax accounting is an asset when navigating the complicated rules of an audit and ensuring you have the right documents, accurate information, and meet deadlines.
Whatever stage of the audit process you are in, Accountor CPA can help. Tax audits can be an intimidating and drawn-out process, especially if they are for a small business or large corporation. Our tax accountants have experience with audits for individuals and businesses across Canada. Let us put our experience to use and minimize the time you need to spend on a CRA audit.
Contact us today for a free consultation.