If you run a farm or other small business, be prepared for a tax auditor's call.
Previous reviews of Canada Revenue Agency’s (CRA) practices by the Canadian Attorney General's office flagged "small and medium enterprises" (SMEs) for high levels of "non-compliance" with tax legislation. The report recommended more rigorous CRA audits for this taxpayer group.
Indirect Verification of Income
The report also suggested more frequent use of indirect verification of income (IVI) methods, and application of penalties to improve audit effectiveness. So if you fall into the SME tax category, be aware that you're a prime audit candidate.
CRA defines all self-employed individuals, small and medium-sized corporations, partnerships, and trusts as SMEs. Small corporations include those with annual reported revenues below $1 million. Medium corporations have annual reported revenues of no more than $250 million.
Non-compliance with tax legislation could involve failure to file a tax return or register to collect the GST/HST, incorrectly reporting income or tax deductions, or failing to remit taxes owing.
Reasons for Non-compliance
Such acts occur because taxpayers:
- Don't understand the income tax act and their tax obligations
- Intentionally choose to avoid paying tax
- Simply make mistakes on tax returns
Today, the agency continues to beef up its audit processes aimed at SMEs. Initiatives include hiring additional auditors and enhanced auditor training in the new IVI techniques.
Auditing SMEs requires special techniques because these enterprises often lack the sophisticated internal controls auditors normally use to evaluate the accuracy of amounts reported. This is particularly true in industries where cash transactions are common and total sales are under $1 million.
In conducting a thorough field audit of an SME, auditors put less reliance on sales records maintained by the taxpayer. Instead, they verify reported sales by using new IVI techniques such as:
- Net worth assessment
- Third-party information
- Sales projections based on key input costs
- Bank deposits (including a review of personal bank and credit card accounts for all family members)
- Household budget compared to Statistics Canada data
How to Prepare for an IVI Audit
To be prepared for a CRA IVI audit, keep copies of all personal bank, investment, RRSP and credit card statements for you and your family members together with your business records. This should expedite matters, and be a lot less costly if CRA does request them during an audit. Trying to reconstruct these records after the fact can be a nightmare.
It's also wise to document all transfers and deposits for all bank, investment and credit card accounts. Should you take cash out of one account and deposit it in another account without a paper trail like a cheque or electronic funds transfer record, an auditor will assume the cash deposit is an income receipt rather than just a transfer or perhaps a loan advance.
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 thorough field audit (as opposed to a desk audit in which you take your books into the CRA office), it need not be a totally traumatic experience if you keep a few points in mind.
- Notify your tax preparer/accountant to arrange qualified representation during the audit.
- You or your representative should contact CRA for a written request listing all specific documents CRA wants to review.
- Compile everything CRA asks for - no more and no less. Don't provide any more information than requested, because it just might raise new questions in an auditor's mind.
- Be sure you or your representative request enough time to get all of the information together before the audit.
If you haven't kept copies of various bank and credit card statements as noted above, it could take time to get them from your financial institutions. Postponing the audit appointment because you don't have the data together will annoy the auditor. That's not a good way to begin an audit.
Auditors have the right to tour your place of business, whether your home or a separate office, to assess the size, type, and existence of your business. When this happens, be aware that the auditor will also be looking and listening for obvious inconsistencies between your declared income and your apparent business success and/or lifestyle.
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. An audit will generally wind up a lot sooner if the records remain in your possession. Try to avoid letting auditors take them off your premises.
An auditor may ask you to authorize a check of your bank and loan records and safety deposit boxes. You should sign the authorization form, but scratch out the line indicating you will pay for any service charges. If CRA has to pick up these costs, the auditor will likely restrict his search somewhat.
You or your representative should answer all the auditor's questions honestly. But don't try to be helpful by providing additional information. That just might open up another can of worms and delay the proceedings.
Once an audit is completed and CRA decides tax adjustments are required, the agency will send you a proposed statement of adjustments for rebuttal 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, all is not lost. The standardized appeal process in place can go all the way to Tax Court if you wish.