How individuals and business owners can minimize the chance of a CRA audit

Being selected for an audit by the Canada Revenue Agency (CRA) doesn’t necessarily result in penalties or more taxes owed. But audits take time, and it’s safe to assume most taxpayers and business owners can come up with any number of activities they’d prefer to being audited.

While the CRA doesn’t publish detailed audit statistics, the good news is the chance of being audited is relatively small for employees who haven’t bought or sold property or claimed losses, says Anna Malazhavaya, founder and tax lawyer at Advotax Law Professional Corp. in Toronto.

The probabilities she’s heard discussed at Canadian Tax Foundation conferences rise to about 2 per cent for small businesses and 7 per cent for medium-sized companies.

“The best advice I can give to an individual or a business owner who wants to avoid being audited is to hire a very good accountant and share all the information with that professional. Just tell the truth,” Ms. Malazhavaya says.

That said, there are red flags individual taxpayers and business owners should avoid when possible:

Tips for individuals

Be careful with real estate transactions: The CRA’s real estate tax force was established in 2019 to focus on tax non-compliance in the Greater Toronto and Greater Vancouver real estate markets.

“Auditors analyze real estate transaction data, and they normally select people who sold a real estate property relatively soon after they purchased it or after construction work was done on the property and a permit was obtained from the city,” Ms. Malazhavaya says.

Watch for shifts from previous years’ tax returns: Inconsistencies in individual (or business) tax returns from one year to another may attract attention. Watch for new sources of income and large sales or purchases, says Natalie Worsfold, partner, tax litigation, with Counter Tax Litigators LLP in Toronto.

In addition, CRA systems often flag first-time declarations of offshore assets for a pre-assessment review that may precede an audit.

“If you respond to [that] with enough information, you can usually escape a full audit,” she says.

Don’t stray too far from the average: If the average income in the taxpayer’s neighbourhood is much higher than the taxpayer’s reported income, the discrepancy may be flagged, says Sabrina Fitzgerald, national tax leader with PwC Canada in Ottawa.

Echoing Ms. Worsfold, she adds that shifts from year-over-year averages may trigger an audit as well. For example, a sudden change in reported investment income, medical expenses or spousal support payments.

Tips for business owners

Avoid big changes in businesses: Ms. Fitzgerald says frequent changes in the structure of a business may raise suspicion. So can a significant increase in expenses or expenses that are either disproportionate to reported revenue or unusual for the industry. Making significant changes when amending a corporate tax return may also prompt an audit.

Keep business claims reasonable: Claims for large refundable credits may cause the CRA to take a closer look.

“The CRA may scrutinize these claims to ensure they’re legitimate and accurately reported,” Ms. Fitzgerald says.

Also, a long run of rental or business losses may raise questions about whether these ventures have a reasonable expectation of earning income or are merely a hobby.

Classify expenses appropriately: As anything outside the pattern of a business’s normal reporting could raise the CRA’s eyebrows, make sure there’s consistency in how business expenses are classified, Ms. Worsfold says.

It’s essential, for example, to ensure bookkeepers and accountants are on the same page when deciding how to categorize a contractor’s fees.

“Strengthen your documents,” she says. “Keep an eye on what’s in your journal entries [and] in your year-end adjusting entries, [which are] one of the first places CRA looks.”

Make sure all reporting matches: Mismatches in reporting for a business and related corporations can trigger an audit. In addition, corporate tax returns should be consistent with GST/HST reporting and T slips.

“The pattern recognition that the CRA is doing is essentially looking at all the information they have about you and people you do business with, and then looking to see where the inconsistencies are,” Ms. Worsfold says.

What to do if you’re audited

Increasingly, CRA audits are risk-based challenges to something that appeared on a taxpayer’s return, rather than geared toward education, Ms. Worsfold adds. That means back-and-forth communication can escalate quickly from friendly to “a conflict unfolding in front of your eyes.”

She recommends businesses, in particular, stay in touch with their accountant throughout the year and, if selected for an audit, remain involved in the process even if the accountant takes the lead.

“The audit volume and intensity are increasing so much, you want to make sure that everybody’s aware of what’s happening, what’s being passed to the CRA and where you are in that conflict escalation framework,” Ms. Worsfold says.