The CRA regularly sends out letters advising taxpayers that they are being audited. Some taxpayers are more likely to be audited for reasons that cannot be avoided. For example, if you have had previous tax audits and the CRA found a number of errors or omissions, it is likely that you will be audited again. Also, if you are self-employed and do not receive a T4, its more likely that you will be audited as you do not have an employer that has been withholding taxes, so the CRA deems that you are a higher risk.
Apart from these unavoidable factors, there are other certain things to watch for if you would like to be less likely to attract the CRA’s attention. In any event, it is important to keep detailed and accurate records so that you are able to provide clarification to the CRA in the event you are asked questions or go through an audit.
1. Vehicle Expenses
If you claim 100% of your vehicle as a business expense, this is a red flag for the CRA as it is unlikely that you never use your car for personal use (especially since driving from home to your workplace is considered personal use). You should keep records of your business kilometres driven each year, to support the percentage of your vehicle that you are claiming as a business expense.
2. Home Office Expenses
If you claim 50% or more of your house costs as a business expense, this is a red flag for the CRA as it is unlikely that you use 50% or more of your home for your business. To claim the home office deduction, the space must be used exclusively and regularly to earn business income.
3. Revenue and HST Differences
The CRA will compare the sales reported on your corporate or personal income tax return to the total reported on Line 101 of the HST return filed for the same period. If there is a difference in the amounts reported, the CRA will question if the sales have been under reported for either income tax or HST. You can run this comparison yourself before filing, to ensure that any discrepancy can be supported.
4. Claiming Losses
The CRA may investigate if you are perpetually reporting losses. While businesses often may have bad years and lose money, the CRA expects that individuals who are running a business have an expectation of generating a profit, and perpetually reporting losses can be a red flag.
5. Cash
Certain businesses, like restaurants, hair salons, or contractors, earn many of their sales in cash. The CRA knows that there is a temptation not to report all income when so much of it is received in cash, so they may perform net worth assessments for the owners of the business. You should keep accurate records to support your personal and business income. The CRA will compare the percentage of your cash sales with others in your industry, and if you are reporting significantly less, you may be flagged.
6. Family Connections
The CRA may flag you if you have family members on your payroll, and if your family members have been audited. Taxpayers may sometimes employ family members as a way to favour certain members and reduce their income tax liability. Therefore, it is important that you keep detailed and accurate records.
7. Large or questionable charitable donations
It will attract attention from the CRA if your charitable donations are abnormally high compared to your income is abnormally high compared to your income, and if you donate to organizations that the CRA suspects may be involved in tax schemes. You should have tax receipts for any charity donations that you are claiming on your tax return.
8. Standard of Living
If your standard of living appears to be out of line with what you are earning, this will attract attention from the CRA. While this may just be as a result of the fact that you are good at budgeting and spending your money, the CRA may ask for clarification if they think it is questionable.
This article is a general discussion of certain tax and accounting matters and should not be relied upon as tax or accounting advice. If you require tax or accounting advice, we would be pleased to discuss the issues in this article with you.
