Although CRA does not expressly mention how they select taxpayers for tax audit purposes, it is based upon our experience that following may trigger, among many others, a tax audit. If you want to keep your small business stay out of such triggers here are some tips mentioned below against each trigger:
- Discrepancy in revenue: If you deal with only taxable property and supplies and you are GST/HST registrant you declare revenue in two separate reports to CRA. One is GST/HST return and the other one is the T1 return or T2 income tax return. CRA can easily detect any differences in revenue reporting between these two types of tax returns. However, if you deal with both taxable and exempt supplies, there is still a difference between GST/HST return and income tax return because you do not show revenue from exempt supplied in GST/HST return but the same is shown in the income tax return. CRA may cross-check your revenue across all tax reporting forms.
- Recurring business losses: There has to be a reasonable expectation of profit in order to be a business. If your business is showing recurring losses consecutively for many years, this could raise the flag for audit. CRA usually looks at the motivation behind such losses. If you create this loss every time to offset income from other sources CRA is serious about this. There must have an active and genuine effort to do business with a reasonable expectation of profit.
- Recurring rental losses: If you are a self-employed and renting part of your principal residence or investment property and create recurring losses and if CRA determines that such losses are used to reduces income from other sources, it is a flag for audit. It is expected that no one rents out at a lower-than-market rate unless it is a cost-sharing arrangement with your relatives.
- Claiming vehicle expenses as 100% business use: If the vehicle is owned by yourself or by business and you claimed 100% vehicle expense as for business use it is the flag for audit. Irrespective of the ownership usually there is personal use of vehicle. So you cannot claim a deduction for personal use if owned by yourself or you have to include taxable benefit in your personal tax return for personal use if the vehicle is owned by your corporation. Also, there is a requirement of maintaining records such as log book.
- Claiming business-use-of-home-office expenses: You can claim home office expenses if your home office is either your principal place of business (meaning that it is used more than 50% of the time for business purposes) or used exclusively for purpose of earning business income. You can deduct eligible expenses only for proportionate business use areas of your home. If you do not meet above criteria CRA may disallow such expenses.
- Claiming large or unusual business expenses: Any unusual or large expenses especially that are not consistent with the same industry may create flag for audit. For example, you operate one convenience store and you claimed travel expenses for the overseas trip, this is not a usual expense particularly for this type of business. Expenses such as advertising and promotion, travel, meals and entertainment, and those expenses that qualify for claiming input tax credit (ITC) in GST/HST return are of special interest for scrutiny by CRA.
- Use of tax shelters aggressively: When you make any charitable donation or tax-deferred investment in any instrument you are in fact using a tax shelter. Taxpayers are allowed to donate and invest in tax-deferred scheme such as RRSP; however if you do it excessively such as you make huge charitable donation compared to your earning or you make RRSP contribution in an investment vehicle that is now permitted or you make donation to any charity that issued you receipt for the amount more than you actually contributed, these may create flag for audit.
- Keep proper bookkeeping records and receipts, and make sure your revenue matches across all tax forms
- Maintain reasonability while claiming business expenses and do not claim expenses of personal nature even though they are similar to business expenses
- File your tax returns and forms on time to avoid review or audit due to non-compliances
- Cooperate CRA auditors and respond quickly within the prescribed timeline
- Never make things up even if you reported a wrong amount mistakenly
- It is always advisable to get help from appropriate professionals such as accountant, lawyer
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