If there’s one letter that entrepreneurs dread receiving in the mail, it’s the one from the Canada Revenue Agency informing them that their business or personal returns are the subject of a tax audit.
Audits can take weeks, months, even years to complete in extreme cases, and can be emotionally and financially draining for business owners who face more than their fair share of exhaustive situations simply running and growing their companies. The last thing they need is for the government to begin scrutinizing their personal or business tax filings.
The greatest challenge with an audit is that it forces you to collect and present detailed and often voluminous accounts of your revenue and expenses. This could include information that confirms everything from travel mileage to business-related entertainment costs—but often much more. If you have your documentation in order and can deliver the right information to the CRA, then you have nothing to fear. If not—or if there are errors in your tax filings—you face the threat of back taxes, interest charges and even penalties.
The bad news: the CRA will send out more than 30,000 audit letters to Canadians this year. The agency will often target self-employed individuals—particularly when their tax returns show filing inconsistencies such as sharp changes in expenses, profits or losses from one year to the next—those working in industries such as construction or hospitality (due to the prevalence of cash payments), and individuals whose lifestyle expenses might far exceed their reported annual income.
Being flagged by the CRA can be a routine occurrence, but any interaction with the tax man still needs to be managed with care. If you’re one of those who receives an audit letter this year, the first step is not to panic. Over-reacting can invite more problems than it solves. But it’s important to note that, as tempting as it may be, you must never ignore a CRA audit letter. Burying your head in the sand and hoping their auditors will go away won’t work. Doing so will likely risk additional penalties and interest payments.
Ensure that your tax lawyer or chartered professional accountant is the one managing CRA correspondence on your behalf. Taxpayers are obliged to respond to the CRA and provide requested information, but nothing more. We’ve seen some clients unwittingly provide incriminating evidence that only amplifies their problems. A trained and experienced tax professional will know how to manage these sensitive communications.
Next, ensure that your supporting documentation is ready to provide to the tax professional acting on your behalf, so they can effectively respond to the CRA’s questions. It goes without saying that these documents should have been properly organized even before filing your taxes, but if that wasn’t the case, now is the time to get your receipts and supporting documentation in order. Note that a tax review is not the same as an audit. The former is much less extensive and is typically a process where the CRA requests receipts to support a tax credit or expense claim. Taxpayers can, in theory, independently manage their interactions with the CRA once a review is initiated, but potential pitfalls abound. It is always advisable to consult with your tax professional before you respond. Also, be sure to provide only the exact information the CRA requests, and nothing more.
Once a tax review is complete, you’ll either receive a letter informing you that the matter is closed and you owe nothing more, or a notice of reassessment which levies extra taxes, and likely interest. In the case of a tax audit, if there are any proposed changes, the auditor will issue a letter describing them and giving you 30 days to respond. This is an opportunity to provide additional documentation or explanations to refute the proposals. Any adjustments that still remain will be reassessed similarly.
The unfortunate part is that once audited, your file could be flagged for a future review. But again, if your tax claims are legitimate, another audit should be nothing more than an inconvenience without having a significant impact on your business or personal bottom line.
Lastly, only work with qualified tax professionals and avoid any accountant who encourages you to make risky or questionable tax filing claims. They are few in number in our industry, but some individuals do play fast and the loose with the rules, and it’s their clients who lose in the end. The CRA’s highly advanced algorithms are designed to spot irregularities and will eventually catch up to any dubious claims.
Audits are always stressful, but when managed properly, they can be relatively easy to overcome. Seek the right professional help, answer the CRA’s questions and then get on with doing what you do best: operating and growing your business.
Adriano Romeo, Partner