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CRA Tax Audits and How to Avoid Having Your Canadian Small Business Audited
Being audited by the CRA is probably one of the all-time most frightening & daunting events you will experience in your lifetime.
The Canada Revenue Agency audits people or companies whose tax returns seem suspicious or abnormal. You are more likely to be audited if you are self-employed, a small business or are in an industry with a lot of cash transactions.
Keep in mind that your revenue will be compared across all tax forms. This means that the revenue you declare on your income tax form will be compared with the revenue declared on your GST tax return, your partner/spouse’s tax return, and "information on tax returns with information provided by employers, financial institutions, and other third parties". If there are discrepancies, hello Auditor.
Declaring business income that’s significantly higher or lower than the normal levels in your industry will also quickly draw attention. The CRA has all the information it needs to compare the profit margins and incomes for various industries and will compare your income to what’s “normal” for this type of business.
You are just inviting an audit if you claiming 100% business use of a vehicle. The CRA know that it’s a rarity for an individual to realistically use a vehicle 100% of the time for business. It’s also a relatively easy tax deduction for auditors to negate because not very many people out there keep the necessary records that are required by the.
The home office deduction is excellent because if you qualify for it, you can deduct a certain percentage of your rent, insurance, utilities, phone bills, etc. But be aware - to be able to claim this deduction you have to use the “work space” in your home specifically to earn business income and use it regularly to meet with customers/clients, most small businesses don’t qualify. And don’t be fooled - the CRA knows this. If you’re not using your home office space exclusively for business purposes, consider not utilizing this deduction.
The ability to deduct business expenses from your income tax is one of the big tax advantages of operating a small business, you still need to be careful about it. The CRA pays special attention to meals & entertainment, travel, advertising & promotions, “miscellaneous” and interest expenses.
Claiming large deductions in any of these areas is like waving a red flag.
If you are a corporate business owner, you need to be aware that any changes in debit balances or shareholder loans or seen as warning flags too. The CRA looks for loans taken from a company and personal expenses recorded as business expenses.
Canada Revenue realizes that businesses in a cash rich environment potentially have lots of temptation to not report all of their taxable income. If your business is one such as a restaurant, hair salon, bar, or other retail business, or are a renovation or home improvement contractor, expect extra scrutiny from the beginning.
It’s perfectly acceptable having your spouse or child work for your business - this kind of income splitting is absolutely valid – but you need to follow the rules. Therein lies the problem whereas a lot of small businesses do not follow these rules, making this issue a common red flag for auditors.
Losses occur in business - a single business loss in itself is not necessarily cause for an audit. BUT, having losses over several years in a row will throw up the red flags, particularly if those losses have been used to offset other income.
Keep in mind that to qualify as a legitimate business, there needs to be a realistic expectation of profit but know that the CRA’s understanding of what is considered ‘reasonable’ may be substantially different from your understanding.
This again can be an issue when falling outside the median. The CRA has all the data to know exactly how much is usually given to charity by taxpayers at your income level, so a warning is triggered when your charitable donations are over that number. You are more likely to be audited if there are donations involving capital property.
If your small business still comes under scrutiny by the CRA, following are some suggestions for how to handle an audit.
At Green Quarter Consulting - Accounting and Bookkeeping Services for White Rock, Surrey and Langley, we are here to help. We can assist with guiding you through some of the Triggers and Red Flags that can bring about a CRA Tax Audit.