The Canadian tax system relies on self-assessment by taxpayers. This means that each taxpayer is responsible for reporting their total income and determining their total tax owing. As a result, CRA has established broad powers to review, audit and investigate tax returns. The purpose being to ensure that the taxpayer has paid the correct amount of tax.

Canada Revenue Agency (CRA) may choose to audit an individual or business even if there is no apparent reason to do so. Generally, CRA can only audit someone up to four years after a tax return has been filed, although, in some cases, such as cases of suspected fraud or misrepresentation, CRA can go farther back and there is no time-limit for the re-assessment. Generally, it is recommended that people keep their records for at least six or seven years.

Most audits are done to determine whether the taxpayer paid enough tax. In extreme cases, if the CRA suspects a taxpayer of fraud or wilfully trying to evade paying taxes, the CRA’s Criminal Investigations Program (CIP) may conduct a criminal investigation.

Tax audits can have serious ramifications and are usually scary. To get help, ask a lawyer now.

Audit “Red Flags”

In some cases, the CRA audits people based on a lottery. This means that CRA randomly selected your file.

However, the CRA also relies on auditing taxpayers based on a number of established criteria and red flags, where it is more likely that it can collect additional taxes. For example, auditing low-income seniors who rely solely on their CPP payments likely would not result in additional taxes owing and would not be worth the time and money spent by the CRA to conduct the audit.

The CRA uses computer programs that zero-in on tax returns and can identify those that are incomplete, or, in some way are outliers to most of the tax returns submitted and do not conform to what CRA expects.

Businesses get audited the most:

1. Self-employed Individuals

Individuals who are self-employed are, perhaps, the most audited. The CRA may review income declarations, expenses, deductions etc. In particular, individuals claiming large or unusual deductions have a higher chance of an audit.

2. Small and medium sized businesses

Smaller businesses often face audits focussing on GST/HST compliance, reported income and deductions. Businesses that deal with a lot of cash (restaurants, construction etc.) may be more likely to be audited.

3. Large Corporations

Large corporations with complex and/or international tax obligations often face audits related to international dealings and cross-border transactions.

4. Charities and Non-profit organizations

Charities and non-profits may be audited in order to ensure compliance for their tax-exempt status, the issuance of donation receipts and other tax rules relating to their operations and activates.

5. Tax Credit and Benefit Claimants

Individuals or business who claim credits or benefits may be subject to an audit. More specifically, GST/HST credit claimants, Personal Tax Credit Claimants, and Scientific Research and Experimental Development Claimants are among the most frequently audited claimants.

The CRA may choose to conduct an audit based on a number of factors, such as:

1. Individuals or businesses that fail to report or provide information when required.­­
2. The frequency or likelihood of errors in tax returns. For example, if the amount an employee reported on their tax return is not the same as that reported by their employer.
3. Unusually high credits or deductions and recurring losses. For example, taxpayers who have a rental property that keeps incurring losses, or have excessively high home office expenses, or claim 100% of their vehicle expenses.
4. If the individual or business was previously audited and CRA was successful in collecting additional taxes. Even if the amount in question was small, or the error as determined by CRA was questionable (i.e., not clearly an error or omission, but rather CRA’s interpretation) your file may be flagged for future audits.
5. Amended returns to claim refunds or other amounts. For example, although you are permitted to carry business losses back three years, if you amend a previous return to do so, you have an increased chance of having your returns audited.
6. Businesses with an electronic point of sale system which may have electronic sales suppression software. Commonly called zappers, this software has the ability to modify or delete transactions, thus reducing the total gross sales amounts.
7. Businesses that hire independent contractors. CRA may question their independent contractor status. If CRA determines that the contractor should be categorized as an employee, CRA can collect more taxes from the business owner, as well as from the contractor who will not be able to claim business deductions.
8. Businesses that are cash intensive, such as massage parlours, restaurants or construction companies.
9. Businesses that CRA considers high risk for fraud, such as GST/HST missing trader scheme, also known as carousel scheme, usually dealing in intangible property such as film rights or intangible computer chips.
10. If you run a business and have related party transactions, such as having a spouse or child on the payroll.
11. Non-compliance with paying taxes owed.
12. CRA may also target a group of businesses or individuals to audit as part of an initiative to raise levels of compliance within the group.
13. Audit someone who is financially linked to someone who is already being audited, for example business partners and spouses.

Get help

For advice and assistance with tax planning, a CRA tax dispute, or other tax issues, contact KPK Law.

Personal and business tax issues are vast and complicated. To get help, ask a lawyer now.

								
You now have 3 options:
								

									
More answers about Tax Law
									
Master List: 2,500 Legal Answers
																													
																		
Government Links