While the 2012 Federal Budget announced cuts to the Federal Public service, the Canada Revenue Agency (CRA) is not cutting their audit staff. This is to continue to track down and plug leaks in the tax-collection system.
Electronic tax filing is becoming increasingly popular. The CRA also uses tremendously sophisticated computer systems to track variations or anomalies in year-over year filings of individual taxpayers.
CRA continues to bolster its audit and collection services. CRA’s audit activity and associated tax recovery have steadily increased in the past couple of years.
The message for taxpayers is simple: understand situations likely to bring your tax return to the attention of the auditors. Then be ready for their probing questions. Here's a short list of CRA hot buttons:
- CONSISTENT LACK OF BUSINESS PROFIT. CRA is quick to blame this condition on the absence of any reasonable expectation of profit in the first place. Then the agency disallows deduction of business or rental losses against other income. Fortunately, several recent court cases have found in favour of taxpayers, making this CRA tactic a little less likely to succeed.
- CONSISTENT FARMING LOSSES. Although the "reasonable expectation of profit" rule also applies here, CRA frequently contends that farming is not the chief source of income if taxpayers have significant employment or other off farm income. Since many farmers need additional off farm income just to make ends meet, this can be a problem. While the courts have periodically favoured taxpayers based on circumstances such as start up losses, many of these CRA decisions have been allowed to stand. If this happens, CRA will limit you to claiming restricted farm losses capped at $8,750 per year.
- PERSONAL USE OF CORPORATE PROPERTY. If you can prove that a withdrawal was a genuine loan repayment to you there should be no problem.
- Generally, funds withdrawn from a company in which you're a shareholder should be sorted out by your accountant in the books as salary or dividends which are taxable in your hands. Withdrawals can also be treated as short-term loans to you or relatives, but must be repaid within one year from the end of the corporation tax year in which they were made. Otherwise, with certain exceptions, CRA may rule them taxable benefits. Typically, personal use of corporate-owned property such as a car or house also constitutes a (taxable) shareholder benefit.
- ASSET TRANSFER TO CHILDREN. Assets transferred to family members (other than a spouse) are normally deemed to transfer at the asset's current market value (certain exceptions, for example qualified farm property, apply). This triggers capital gains for you if the value at time of transfer exceeds tax cost, and the asset transfers for zero or discounted consideration. Family cottages, rental property and shares of family and public corporations transferred to children for less than market consideration are common situations caught by CRA.
- PROPERTY SALES. CRA carefully reviews property sales for intentions behind the sale. If the real or even secondary intention in buying the property originally was for resale rather than to earn income from it, CRA might reclassify the gain as fully taxable business income rather than a capital gain. Now that capital gains are taxed at only 50% again, expect CRA auditors to focus more closely on the reporting method used for property sales.
- INADEQUATELY DETAILED GST RECORDS. If you claim GST input credits, auditors will ask to look at your receipts. If you don't have them, or if the receipts don't contain the required details (date, vendor's name and GST number, total paid or payable, and GST charged) your claim will, most likely, be denied for those particular receipts. Canceled cheques are inadequate support for GST input tax credits.
- MEAL AND ENTERTAINMENT DEDUCTIONS. As a general rule, a self-employed individual, partnership or corporation may deduct only 50% of these expenses. Claiming any more than that will result in an audit reassessment.
- AUTOMOBILE EXPENSE DEDUCTIONS. A detailed log supporting business kilometres driven on a vehicle is the key here. CRA auditors seem to enjoy reducing claims for automobile expenses (including fuel, car washes, repairs and insurance) on the presumption that a higher personal percentage applies if you either don't keep a logbook or do keep one but it's incomplete.
Even with these in mind, each year CRA conducts thousands of audits selected randomly from all Canadian taxpayers. This year it could be everyone who deducted an RRSP contribution, while next year it could be a totally different group.
So, how do you prepare for an audit? Remember that one of the key benefits of FBC membership is audit protection. So, we tell all our Members if they are ever audited to notify FBC right away. FBC will represent you during an audit at no extra cost.
If you're audited, follow these guidelines:
- Be honest - being straightforward will help more than hinder you. Being evasive will backfire.
- Be helpful - don't challenge and don't be antagonistic. The auditor is just trying to do his job. If there are mistakes or misunderstandings, FBC will be there for Members to represent your interests.
The quality and detail of FBC Member records are extremely good and will inevitably build confidence in your presentation.
All our Members receive audit protection. If you're ever audited or challenged on a tax return prepared by FBC, as a Member, we'll represent you - all the way to Tax Court if necessary. And, we'll cover the court costs and legal fees.