How to Reduce the Probability of CRA Audit

No business owner would ever want to face the Canadian Revenue Agency (CRA) audit, as it is time-consuming and stressful for the one being audited. There is no foolproof method to avoid an audit, but there are ways to reduce the probability of being audited. Once you file your tax returns, the CRA’s risk-assessment system flags certain types of returns based on a particular demographic, industry, inconsistency with past returns, and discrepancies with your profile.

Instances Where Businesses Cannot Avoid a CRA Audit

The CRA risk assessment system uses data analytics to shortlist returns that might need human review. And that is where the probability of an audit increases. Some things are under your control, and some things are not in your control. For instance, four types of taxpayers are most likely to be audited as the number of misreporting cases has been high in their demographic:

• Self-employed individuals
• Taxpayers with offshore assets
• Businesses with a high volume of cash-based transactions, like restaurants, contractors, and barbers
• A connected party (your supplier, customer or any party you do business with) is getting audited.

In such scenarios, you may face an audit just for the CRA to ensure you follow all tax laws. Other than this, the best way to avoid a CRA audit is to be transparent and truthful in your income tax returns and file and pay taxes on time.

Instances Where Businesses Can Avoid a CRA Audit

Apart from the above instances, the CRA’s risk assessment system could look for trends in the numbers to identify discrepancies and inconsistencies. It might see the trend from past returns and match it with the numbers within the industry.

Significant Discrepancies in Income

The CRA gets tax returns from everyone working in your industry and neighbourhood. They know the standard income of a dentist, lawyer, manufacturer, automotive dealer or any other business. They also see the income level and living expenses of a particular neighbourhood.

Suppose you live in a neighbourhood with an average income of $120,000 and you report your income as $60,000, the system could flag your profile and raise suspicion that you are underreporting your income. Similarly, if you are in a profession where the average income is $100,000, and you are reporting an income of $45,000, it could raise suspicion.

Note that the income gap is significant and not minor.

Solution: Your income in a particular year may be three times your average, maybe because you sold a property. Your returns should be able to justify the one-off gains or losses.

Unreasonable Business Expense Deductions

Just as a windfall gain surge could turn the CRA’s eyes to your returns, unreasonable business expenses could do the same. The CRA allows small businesses to deduct costs, such as salaries, vehicle expenses, office utility and maintenance bills, from their sales and only pay tax on the profits.

The CRA critically reviews vehicle expenses and salaries paid to family members as they are the most common areas where inconsistencies occur.

• It looks unreasonable if you are a doctor and claim $20,000 as a car expense on $60,000 income. The suspicion will rise if your average car expense is around $3,000 in the last few years.
• Suppose you have hired your spouse as a store manager and are paying them $200,000 per year as a salary, way above industry standards. That could also raise suspicion and call for an audit.
• Also, unusual charitable donations that do not match your income could catch the CRA’s attention.

Solution: Only report expenses you have undertaken and have supporting payment receipts to prove that. Also, have a record or a vehicle log detailing the business use and personal use. Once you prepare the financial statements, critically review your expenses and watch for inconsistencies. If you find one, ensure you have the supporting documents and expect a probe from the CRA. The issue will escalate to audit only if such discrepancies continue for multiple years.

Other scenarios

Beyond the obvious, some common scenarios could make the CRA curious about your income tax returns if these trends continue for multiple years.

1. Reporting business losses for multiple years: While it is understandable that the initial few years might see losses, these numbers should be improved. Either losses should reduced, or the business should, at some point, make profits, especially when your peers in the same industry are reporting high profits. However, if your losses are genuine and you have documents to prove it without any exaggerated expenses, you are ready to answer CRA’s probe.
2. Inconsistencies in GST/HST: If you file Goods and Service Tax (GST) returns, ensure the income reported in GST and that in your income tax tally. Also, ensure you pay your GST regularly.
3. Rounding-off numbers: It might look small, but they create suspicion. If you round off the amounts of your expenses to say $5,000 or $2,500, it creates an impression that these figures are estimated and not accurate. The taxpayer may not have documents to support these claims. Hence, ensure you report the same amount as in the payment receipts with decimals, like $2,584.2.
4. Failing to report all income or attach a T-slip: It is common to forget to add certain non-regular income types. For instance, you sold your stocks, got dividends, started a pension, or did a pilot project and got a small one-time payment. You get a T-slip for all types of income, and a copy of this slip is sent to the CRA by the other party in their tax filings. If you fail to attach a T-slip or report an income, it is better to rectify the error voluntarily before the CRA finds it.

If you have been audited before, the CRA will watch you, especially if it finds any discrepancies. Hence, try your level best to avoid an audit. One effective way to reduce the chances of an audit is to seek professional help in tax filing.

Contact KSSP Partners LLP in Markham to Help You File Your Taxes

Talk to a professional accountant to help you prepare your financial statements, record documents, and file taxes promptly. At KSSP Partners LLP, our accountants and bookkeepers can provide services such as tax filing, record keeping, and audit assistance. To learn more about how KSSP Partners LLP can provide you with the best accounting and bookkeeping expertise, contact us online or by telephone at 289-554-5997.