Understanding Tax Audits

In Canada, the tax auditor is probably the most feared government official. With a tax system based on trusting the individual to report all income earned; take only the relevant deductions; and pay the correct taxes due: it is a system that some are tempted to cheat.  To help prevent this, the Canada Revenue Agency (CRA) sends out auditors to check on individual and business accounts on a regular basis.

There are four main reasons for being audited.

1. The Random Selection

The CRA’s computers will select a set number of income tax returns that share a common parameter. For example, any returns with interest expenses that increased from year one to year two by more than 10 per cent will be selected.  They will then be sent to an audit supervisor to check manually. At that point the returns will either be dismissed from audit or sent to an auditor who will investigate the issue further.

2. Tax Evasion

The government may choose to audit someone is if they have been tipped off that the person is evading taxes. It could be a disgruntled employee, a spiteful relative or a jealous friend. Anyone who informs the government of possible tax evasion or fraud will be taken seriously. If your business is implicated, an audit may be conducted no matter how “clean” your tax return and financial statements appear.

3. Appearing in Someone Else’s Audit

While auditing another corporation or individual that you are linked with, the auditor may notice something that should be investigated further, and a flag is put onto the file. For example, an audit of a restaurant indicates payments made to their bookkeeper totalling $6,000 per year, but the bookkeeper only reports income of $5,000. In this case, the next available auditor would flag the bookkeeper’s return for audit.

4. The Matching Program

The Canada Revenue Agency automatically conducts a matching program. If a bank sends you a T5 slip for interest income, your return will be reviewed to ensure that you reported the income. If the T5 was missed for any reason, an adjustment will be made.

So now that you know how you get selected, what happens if you did make a mistake?

1. The Honest Error

If the mistake is an honest error, you will have to pay the additional taxes due plus interest. For example, if you claimed 60 per cent of your car expenses as business expenses and it should only have been 50 per cent.

2. The Negligent Mistake

If, however, you made a negligent mistake and you should have known better, such as not reporting your tip income that you received as a waiter, then you will not only have to pay the additional taxes and interest, but you could also face some pretty hefty penalties.

3. The Fraudulent Mistake

Finally, if you were fraudulent in your “mistake” by creating false expenses, for example, on top of the taxes, interest and penalties you may also face a criminal conviction, jail time and deportation.

You work hard to make your small business a success and it is important to make sure you know and follow the CRA’s rules. If you are unsure of how a particular expense should be filed or what you should claim, seek the advice of a professional accountant.

For More Information

For more information on allowable deductions and your small business tax requirements, check out Gabrielle’s Tax Tips from an Accountant , run monthly in the Small Business BC Education Centre.

Alternatively why not attend one of our Ask the Accountant days , run monthly until November 2011. These 30 minute consultation sessions allow you to ask the specific tax questions you have about your business, with an accounting professional from Loren, Nancke &Company, CGAs.