More small and medium businesses, including farms, are being audited these days. Some audits are done randomly. Others are in response to these common red flag issues.
A survey of the 100,000-plus small business members of the Canadian Federation of Business indicates that about 21% of those small businesses were audited in 2005, compared with only 16% in 2001.
Audits are nothing to fear if you comply with tax rules and regulations. Knowing how Canada Revenue Agency (CRA) selects taxpayers for audit, as well as what to expect during an audit, could make you better prepared if you're singled out.
CRA uses several processes for selecting taxpayers for audit. Many taxpayers are simply chosen at random from among all tax filers. However, in selecting taxpayers for audit, CRA will often pay closer attention to:
- Restaurants and other cash businesses
- Renovation and home improvement contractors, and other businesses where receipts may not be needed
- Businesses whose margins or incomes are not within the norm for that industry
- Taxpayers who claim rental or business losses
- People who were previously audited and found at fault
CRA's audit programs are supported by sophisticated automated tools like their Compliance Measurement Profiling and Assessment System (COMPASS) that looks at over 300 factors in evaluating the relative risk level of every self-employed individual and GST registrant.
Then there are CRA audit projects. At various times, CRA will target certain groups or industries that tend to have a high level of tax non-compliance, such as construction, real estate or hospitality industries.
In other cases, CRA may do what is known as a secondary review. That's when CRA audits a spouse, investor, supplier or subsidiary of an individual or company on which it is already doing a main audit. CRA also will choose audit targets based on leads from informers such as former spouses, ex-business partners, employees, competitors, and neighbours.
In addition, specific items on tax returns will draw particularly close CRA scrutiny. Knowing about these items, and then handling them correctly on your tax return, could help you reduce the chance of audit. Many of these items are specific types of expense claims. Several more are related to investment issues.
Tax Deductions for Extended and Crew-cab Pickups
One item on the list for CRA audits of farms and construction contractors is claims for extended- and crew-cab pickups. Be aware that you must use your extended cab or crew cab pickup 90% or more for the transportation of goods, equipment or passengers during the taxation year in which you acquired it. Otherwise, your GST ITC and capital cost allowance (CCA) will be limited to a capital cost of $30,000. Also, it's critical that you keep a detailed log of business and personal use of the vehicle. If CRA ever questions your claim and you don't have a log to support it, CRA will likely disallow it.
Eligibility to claim employment expenses is limited to very few people, so such claims are a flag to CRA to look more closely.
CRA also will request additional information to support many claims for either childcare expenses or tuition expenses.
Large charitable donations of cash over $25,000 and capital property are also often reviewed by CRA.
While carrying charges, such as interest and management fees related to investments, are usually deductible, CRA still will often request supporting documentation.
Several audit "flags" are related to investments. For example, CRA will check very closely any losses claimed on investments in small business corporations, mainly because the tax rules regarding allowable business investment losses are so complex. Be sure you retain all supporting documentation to substantiate your claim for an allowable business investment loss as it is guaranteed you will hear from CRA.
Claims of capital losses and gains also receive close scrutiny from CRA because many taxpayers do not track them correctly. You cannot always depend on the account statements provided by your financial institution. Often the cost base this statement provides is not accurate for tax purposes. Income trusts, which so many investors hold these days, erode their cost base over time due to returns of capital and are tricky to track. Investments in foreign currency also can be a problem because you need to account for the foreign exchange gain or loss in addition to your economic gain or loss.
Today, many Canadians earn income from foreign sources, either through investments or employment. Claiming foreign tax credits because you've paid tax in another country is another item that CRA often questions.
Failure to remit source deductions for employees, such as tax, CPP and EI, on a regular basis or failing to pay your GST and PST correctly and on time also could lead to an audit. CRA and provincial revenue departments may see these omissions as just one issue in a much larger tax problem.
Types of Audits
If CRA does decide to audit you, it could be one of 3 types.
- Desk audit - CRA will simply request documentation to support a claim you've made on your tax return, such as child care expenses, rental losses or automobile expenses.
- Field audit - CRA auditors will visit you to do a thorough review of your business records.
- Special investigations - CRA believes criminal prosecution may be necessary.
What to do if CRA flags you
Always remember that accurate, detailed records are your best tool in making any audit process easier for you. If CRA does come out to do a field audit, it need not be a totally traumatic experience if you keep a few points in mind.
As soon as CRA notifies you about an upcoming audit, contact your tax professional or accountant to arrange qualified representation during the audit. Then contact CRA for a written request listing all specific documents it wants to review. Be sure you ask for enough time to get ready for the audit. Having to postpone the appointment because you don't have the data together is not a good beginning.
Compile everything CRA asks for - no more and no less. During the audit, answer all questions honestly, but don't provide any extra information. Make it as easy as possible for the auditor to move quickly through your records by providing a quiet, comfortable workspace and having your documents well organized.
Once an audit is completed and if CRA decides tax adjustments are required, the agency will send you a proposed statement of adjustments for rebuttal, usually within 30 days, prior to issuing a notice of re-assessment detailing any additional taxes and interest owing, plus penalties. If you don't agree with the CRA assessment, you can always appeal.
FBC provides audit protection for all our Members. If you're ever audited or challenged on a tax return, we'll represent you - all the way to Tax Court if necessary. And, we'll cover the court costs and legal fees.
If you would like a free consultation to find out how FBC can help you with your small business tax needs, call 1-800-265-1002, or email today.