Entrepreneurs hoping that Canada Revenue Agency would eventually ease its audit-focused crackdown after a recent uptick in enforcement activity may be dismayed to learn that the exact opposite is playing out. In fact, the agency is becoming even more targeted and aggressive in its activities.
What we’re seeing now are a new range of enforcement initiatives, including a much closer examination of professional fees claimed by taxpayers. Now, more than ever before, CRA is requesting the submission of detailed invoices of all professional fees claimed. The agency may ask detailed questions to determine whether fees claimed were personal or corporate in nature, and whether they are incurred on income or capital accounts (the latter being non-deductible in the short term).
As well, the agency is scrutinizing investments in offshore funds more rigorously. As you may know, Canadian taxpayers are required to file form 1135 annually to declare offshore investments in excess of $100,000. We just recently faced an audit of one of those forms, a first for our firm.
Real estate audits continue to be another major focus area. CRA is analyzing transactions for evidence of practices such as ‘flipping’ a home for a profit before a sale closes. In some instances, individuals have attempted to avoid reporting the gains, have incorrectly claimed the gain as a capital gain, or have claimed a non-applicable principal residence exemption. These moves have GST implications, not to mention the obvious income tax implications. To make matters more complicated, CRA is particularly interested in examining intent when it comes to real estate transactions. If they determine that an individual is attempting to evade paying taxes, they could decide that person has met a threshold for the levy of penalties, back tax payments or, in extreme cases, even criminal prosecution
While the onus is on the tax authorities to prove gross negligence, the process and result can be challenging.
The difficult truth for entrepreneurs is that CRA is becoming far more aggressive and far less taxpayer friendly. While in the past they might conduct an audit, they’re now placing the onus on tax payers to do it for them. How? Let’s say they ask to see deposit records from an individual’s chequing account. The agency has the power to declare all income as unreported until proven otherwise. This places an enormous burden on business owners to prove that their tax claims are, indeed, legitimate. The change in approach has also increased legal, accounting and bookkeeping fees for entrepreneurs who are forced to gather necessary evidence to prove their position during an audit.
Worse, a relatively contained audit could spread to other areas of a business owner’s financial dealings should CRA find discrepancies or non-compliant practices in their primary investigation.
Because CRA can do most anything it wants to ensure that business owners are paying their fair share of taxes, the best approach is to assume that you could be audited at any moment. That means keeping comprehensive tax records and making sure that all invoices accurately describe the purpose for which they’re being issued or paid. And if you or your business are audited, defer to your accountant when it comes to liaising with CRA. That’s because the agency’s seemingly benign questions are often anything but. They could be fishing for potentially incriminating information.
A good accounting firm versed in tax precedent, accounting best practices and the finer points of client representation would be best equipped to help you manage the audit process. Because the last thing you need during an audit is to raise any further red flags with CRA.
Harris Kligman, Partner