If two of the nastier inevitabilities in life are death and taxes, then tax audits would certainly rank as one of the more unpleasant possibilities.
More so when you consider that Canada Revenue Agency’s ability to monitor tax filings for inconsistencies and to detect patterns of potential error or fraud are only becoming more sophisticated as Ottawa implements increasingly complex algorithms and automated systems to police Canadian entrepreneurs’ tax-paying (or non-paying) activities. The odds of being audited are still relatively low, but are increasing given the prevalence of these new high-tech tools.
So, what’s an individual or business owner to do?
Because some audits are conducted completely randomly, literally anyone could have their name pulled for an audit. But there are proactive strategies that entrepreneurs like you can use to avoid piquing CRA’s interest, giving them reason to order an audit of your personal or business finances and potentially exposing your organization to costly penalties, back-interest payments and even criminal prosecution.
Here are five of the most important:
Beware when reporting large swings in income—if one year you report $150,000 in income, then $20,000 the next, you could set off alarm bells for CRA auditors who are looking for individuals or businesses that underreport income. The agency’s algorithms look for relative consistency in income, as well as annual business deductions such as entertainment or transportation expenses. Having said that, major swings can happen, such as the loss of a major customer or the timing of revenue one year to the next. If this is the case and CRA comes knocking, make sure your expenses are reasonable, and you have an explanation for a significant reduction in gross revenue.
Be reasonable about expenses—Claiming your entire personal residence as a place of business is a “no-no.” Attempting to deduct 100 per cent of your vehicle use as a business expense will certainly catch the ire of CRA. These are just two examples of major red flags for CRA auditors on the lookout for individuals who stretch the truth of their expense claims. Always limit expense claims to those that truly relate to your business, and be reasonable. If you’re claiming loan interest expense, as an example, make sure you can show the flow of funds from your line of credit directly into your investment account.
Be forthcoming—When the CRA requests further information about an expense claim, be sure to send them the necessary receipts in a timely manner. CRA is fairly reasonable and will more often than not grant you extra time if you need it, but don’t wait for the last day—contact them early with your request for an extension. Assuming the deduction has been properly claimed in your personal or business tax return, providing the necessary receipts and accepted proof of payment will usually settle the matter. Failing to submit the requested documentation, however, could trigger escalated inquiries and may even lead to a full-blown audit.
Assume you will be audited—Sound record-keeping is a must, particularly when it comes to logging business-related vehicle mileage, entertainment receipts and other deductions that tend to be common audit focal points. If you assume that an audit could occur at any time, you’ll be prepared if that scenario plays out. At worst, that strategy will prompt you to maintain the sound tax and financial records that every well-organized individual taxpayer and business owner should be keeping in the first place.
Be careful about taking a DIY approach—Preparing tax returns can be a complex task, particularly for incorporated businesses or individuals with business and rental income. Experienced accountants do this work every single day, understand tax law and know how to help to minimize the potential for a tax audit. If, however, you feel you may have made errors in one or more previous personal or corporate tax filing, there are remedies available before the auditor comes calling, which will avoid serious penalties or even criminal prosecution.
Spend the money and use the services of a qualified accountant. The same rule applies if you face a CRA audit. Let a professional handle all communications and filings with CRA to avoid potentially incriminating yourself or your business, or making additional errors that could result in steeper penalties, interest payments and, in a rare worst-case scenario, criminal charges.
Hartley Cohen, Partner