Red Flags for your Canadian Business Audit by CRA and what to expect
If you recently filed your business income tax 2016, by hiring services of a Chartered Professional Accountant, you might be at ease, but otherwise you might wonder or somewhat be concerned about the likeliness of your business being audited by the Canada Revenue Agency(CRA), based on your filing. Here is what every business owner should know about the audit
Catching CRA’s eye
A variety of tax-return related items are likely to raise red flags with the CRA and may lead to an audit, although many business audits occur randomly. The following are some instances:
- The occurrences of significant inconsistencies between previous year’s filing and your most current filing.
- Gross profit margin or expenses markedly different from those of other business in your industry.
- Miscalculated or unusually high deductions.
- The occurrences of a marked difference in owner-employer salary being inexcusably higher or lower than those in similar companies in his or her location can be a red flag for the CRA, especially if the business is structured as a corporation.
- Deducting large business expenses: While being able to deduct business expenses from your income tax is one of the big tax advantages of operating a business, you need to be cautious about it. Advertising and promotion, meals and entertainment, travel, miscellaneous and interest expenses are most likely to catch CRA’s eye.
- Running a cash-intensive business: The CRA realizes that businesses that have lots of opportunity to take in cash also have lots of temptation not to report all of their taxable income. So if you operate a business such as a restaurant, hair salon, bar, or other retail business, operate or are a renovation or home improvement contractor, expect extra scrutiny from the CRA
- Having family on the payroll: There’s nothing wrong with having your spouse or child work as an employee in your business; this kind of income splitting is perfectly legitimate – as long as you follow the rules. The problem is that many small businesses don’t, making small businesses that put their spouse or child on the payroll an easy target.
- Making large charitable deductions. The Canada Revenue Agency knows exactly how much taxpayers at your income level usually give to charity, so a it is likely to trigger a red flag when your charitable donations exceed that number. Donations involving capital property are especially likely to be reviewed.
A CRA auditor will write to you or call you, or both, to begin the audit process and inform you where the audit will take place.
You can expect an audit to take place either “onsite” i.e. at your place of business, or, in rare situation, the audit may be conducted at a CRA office (office audit)
What does an auditor examine during a business audit?
The auditor will examine books and records, documents, and information (collectively referred to as records) such as:
- Information available to the CRA (such as tax returns previously filed, credit bureau searches, or property database information);
- Your business records (such as ledgers, journals, invoices, receipts, contracts, and bank statements);
- your personal records (such as bank statements, mortgage documents, and credit card statements);
- the personal or business records of other individuals or entities not being audited (for example, a spouse, family members, corporations, partnerships, or a trust [settlor, beneficiary, and trustee]); and
- adjustments made by your bookkeeper or accountant to arrive at income for tax purposes.
During an audit, the auditor will identify issues and discuss them with you. At any time, you can also raise your concerns with the auditor.
Once the auditor completes the examination of the records provided, the outcome will determine the next steps.
- Correct assessment: If the auditor finds that your previous assessment is correct, nothing more has to be done. You will receive a completion letter and the audit will be closed.
- More taxes owed or a refund: If the auditor finds that your return has to be reassessed (which means you will have to pay more taxes or you are entitled to a refund), you will receive a proposal letter explaining the reason for the reassessment. You will have 30 days to agree or disagree with the proposed reassessment. The auditor can further explain the reassessment if necessary.
If you disagree with the proposal, you are encouraged to contact the auditor to try and resolve factual disagreements. The auditor will carefully consider your explanations and respond to your questions about the proposal. If issues remain unresolved, you can contact the auditor’s team leader to discuss them further.
What to expect at the end of the audit?
At the end of the audit, a final letter will be sent to you and one of three things will occur:
- no adjustments will be made to your previous assessment;
- an adjustment resulting in more tax will be made (reassessment) and you will have to pay the balance owing; or
- an adjustment resulting in less tax will be made (reassessment) and you will be entitled to a refund.
If the adjustment results in more taxes being owed, the auditor can provide you with an estimate of the amount before the CRA issues a notice of assessment or notice of reassessment. This will give you the opportunity to prevent more interest charges from accruing by paying all or part of what you owe right away.
- Right to appeal- If you disagree with the reassessment, you have the right to appeal
- You should keep adequate books and records to determine you tax obligations and you entitlements for a minimum of six years
- It is your responsibilities to not only keep your books and records on paper but also in an electronically readable format.
You can seek advice and assistance of Raj Katlaria, Chartered Professional Accountant in Surrey, BC, who will not only ensure that your business does not get flagged by CRA, by using his expertise, but also advise you on how to avoid future business audits.
Our friendly, professional, dedicated and superior client service also provides accounting, taxation and auditing services, as well as bookkeeping, payroll, GST/HST and other related functions. We are committed to providing personal attention to our clients. We take pride and accountability in providing professional and quality services to both individuals and corporate clients in a wide range of industries. To consult Raj Katlaria, CPA for all your accounting needs, you can call at 778-926-9226 or email at email@example.com, or visit us at our Surrey, BC office for a personal consultation.
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