As a business owner, the last words you want to hear are “CRA tax audit”. However, if a CRA auditor contacts you by phone with a follow-up letter confirming the details, the audit wheels are already in motion. Before you panic, use our tips on how to prepare for a CRA audit to avoid prolonging the process and help reduce the risk of paying cra audit penalties and additional taxes.
With so many scammers out there today, your first step is to confirm that this is a legitimate audit. Never share information with someone claiming to be a CRA auditor over the phone. For example, scammers often ask you to confirm your address, SIN, or financial information during the call. DO NOT answer these questions. Instead, politely let them know you will wait for the confirmation letter. You want to feel confident you are dealing with a real auditor before answering questions or turning over any records.
Once you receive the confirmation letter, your goal is to make it clear you are willing to collaborate. If an accountant handles your taxes, let them know you are being audited immediately. They will assemble the required documents and records to share with the auditor. Follow the instructions to reestablish contact with the CRA auditor right away and be prepared to answer their initial questions. If you don’t have the answers at that very moment, be honest, and avoid getting flustered. The auditor will have to arrange to come to your place of business to review your records, and you can provide the information at that time.
You or your accountant/bookkeeper will need to put together the following documents when preparing for a CRA audit:
- Your business records, including ledgers, journals, invoices, receipts, contracts, and bank statements
- Your personal records, including personal bank statements, mortgage documents, and credit card statements
- Personal or business records of other owners or entities, including your spouse, business partner, or a trust
You can also inform anyone involved with your company’s financial records of the audit, such as your bookkeeper or accountant. They should be prepared to assist should the auditor need to confirm information found in the records you provided.
In most cases, the auditor will ask for your records in advance. Unfortunately, the CRA does not receive documents via email for security reasons. However, they provide a secure online service to upload your audit documents. If you don’t have electronic records available, you can share your paper records in the following ways:
- Keep paper records at your place of business so the auditor can review them there,
- Allow the auditor to “borrow” your records for use at their office, or
- Mail the records to the CRA tax services office
We would not recommend mailing your documents, as this increases the risk of loss or damage. Anything the auditor takes for review requires a detailed receipt. You should copy any records taken from your office to provide evidence along with the auditor’s receipt should any paperwork be lost or damaged.
Here are some of the important things you should know if you are being audited:
Along with your records, the auditor might choose to confirm income reported via “indirect verification of income.” This confirmation is usually required if the auditor notices any of the following red flags or discrepancies:
- Lots of errors in your books and records
- You combined the use of your business and personal bank accounts
- Your lifestyle indicates you must earn far more than you reported on your tax returns, such as extravagant homes, pricey vehicles, expensive clothing, dining out at high-end restaurants, exotic travel, etc.
- Your business sector is considered high risk for unreported income
- Your income is far lower than other businesses in your sector
If an indirect verification of income is required, your auditor will consider all relevant information to help determine if the income reported is accurate. This usually involves what is called the “net worth method.” You, your spouse, and all contributing members of your household will have to provide the following information:
- Assets and liabilities
- Motor vehicle registration
- Land title information
- Personal spending receipts
- Records of non-taxable sources of income you receive, such as gifts, inheritances, lottery winnings, etc.
Your lifestyle is considered, and all your assets are calculated to determine your net worth. This number is then compared to the income you reported on your tax return.
The economic entity audit approach groups “related, associated, and/or otherwise connected” legal entities into a group to ensure the auditor has a clear picture of more complex business structures. Instead of focusing on you, the auditor considers the risks presented by the structure of your economic entity and how transactions among its members might impact your income.
Economic entity audits tend to occur if the auditor feels the group presents a higher risk of non-compliance. If this is the case, the auditor will contact each member of the group as they see fit. Preparing for an economic entity audit is the same as a standard business audit.
How long it takes to complete your audit depends on the state of your records, how quickly they are provided, and the level of suspicion your lifestyle presents. Also, if an economic entity audit is required, it can add to the time as different group members are involved. The more complicated your finances become, the deeper the auditor might have to dig, and the higher chance they might call for indirect verification of income or seek assistance from a CRA tax specialist.
Once the audit is complete, your auditor provides a written summary telling you whether all is well, changes are needed for your return, taxes are owed, or you are entitled to a tax refund. You have 30 days to respond if changes are required or to contact the auditor if you disagree with their findings. For changes made to taxes payable or your taxable income, you will also receive a Notice of Reassessment.
The CRA will also send you a Notice of Redetermination for changes made to a loss you claimed. You can contact your auditor to discuss how they arrived at their decision. Should you feel their conclusions are unfair or unfounded, you can speak to the auditor’s team leader.
If you are dissatisfied with the results after speaking with the team leader, you have a right to file an objection. Any money owed is suspended until the objection is resolved. However, if your objection is rejected, remember you must pay the balance owed along with penalties and interest. The interest continues to accumulate during the time your objection is reviewed, which can take some time depending on the complexity and number of cases being processed.
Therefore, consider paying the amount owed upfront to avoid further penalties and interest. The CRA will send you a cheque for any money owed to you should your objection be valid.
Understanding your tax obligations and being prepared for tax season is the best way to avoid a business tax audit. A bookkeeper or tax accountant can also streamline the process and ensure your records and claims are accurate and compliant.