The Taxman Cometh

More than ever before, we are experiencing a significant increase in the amount of CRA audit activity and it would seem there is no end in sight. Being audited by the CRA is never a pleasant experience; however, it does not have to feel like the end of the world. Understanding the audit process, being aware of various tips and traps and being audit ready will all aid in making being audited as pain free as possible.

The Audit Process

While every audit has its own unique issues, most follow a standard process that begins with that dreaded little brown envelope from the CRA. Inside will be a letter indicating that your personal or corporate or trust tax return or returns have been selected for review and a provided list of books and records is required. Typically, this letter will also indicate that the CRA auditor will be contacting you to finalize a time for them to come for a visit and audit your books and records. This is the start of the audit process and is the best time to make your tax preparer aware of what is coming.

The next step in the process is the actual visit from the auditor or field audit where they will review your books and records, request further documentation and ask additional questions. This visit can occur at your home or place of business, but can also be arranged to take place at the office of your tax preparer. Choosing a location other than your home or place of business avoids the unnecessary interruption of your day to day activities or business operation and also allows your tax preparer to field the auditor’s questions.

Once the auditor has completed their audit, they will finalize their findings and send a letter proposing adjustments to your taxable income. This letter basically identifies items in your tax return that the auditor has taken issue with and allows you an opportunity to provide additional supporting documentation for your tax filing position. Your response or responses to this letter is the next step in the process and is often referred to as making representations to the CRA.

Following representations, some items will be resolved and on others you and the auditor may have to agree to disagree. Shortly thereafter you will receive a notice of reassessment and it is at this point that you may owe additional taxes, interest on those taxes and potentially penalties.

If there are still items that you do not agree with you can file a notice of objection with CRA and be assigned an objections officer who will review the audit file and consider additional arguments or information with respect to those items. If the notice of objection stage doesn’t yield a result and you still want to fight certain items, an appeal to the Canadian court system is where you are headed.

Audit Tips & Traps

• Watch for deadlines on any communication you receive from CRA. Often these letters will give the taxpayer a set amount of time to respond. If you do not adhere to the deadline your audit may be processed more quickly and without an opportunity for you to respond.
• CRA does not communicate via email. If you receive an email “supposedly” from the CRA, it is likely a scam devised to obtain personal information. Do not respond.
• Be weary of waiver requests. The CRA has a three year window of opportunity that begins on the date of the notice of assessment for that particular taxation year. In order to extend that three year window to allow time to audit, the CRA may request that you sign a waiver. It is always advisable to contact your tax preparer prior to fully understanding and signing a waiver of this type.
• Be civil with the CRA auditor. They are people doing their job and the more miserable your make the audit the more likely they will return the gesture.
• Seek advice from a tax specialist, your tax preparer, your accountant or advisor at the beginning stage of the audit. Their experience will save time and possibly reduce the reassessment.
• Where possible, pay the amount reassessed and stop the “interest clock”. To avoid any further interest accrual on the balance owing, it is recommended that the balance be paid. This is in no way an acceptance of the reassessment or the auditor’s adjustments. If payment is not made and objections are unsuccessful, you will have paid interest unnecessarily.
• Resolve as many issues as possible during representations. The notice of objection stage of the audit causes the process to drag out considerably so work with the auditor as much as possible.

Audit Selection Process

A common question is “How does the CRA decide who gets audited?” and the answer, unfortunately, is not definitive. The CRA does engage in audit “projects” wherein a certain type of taxpayer, industry, transaction, organization structure, etc. is identified and flagged for a type of audit campaign. In the last year, the CRA has focused its efforts on the audit of family trusts, personal services businesses, large corporations, non-profit organizations and the characterization of pipeline easement income. Other audit triggering events may include the sale of a business to a new owner, the use of a beneficial tax exemption, the request to amend a tax return or a major transaction to identify a few.

Be Audit Ready

While we can’t always tell when an audit will occur, we can take steps to be ready in the event of an audit. The foundation of being audit ready is the state of your books and recording keeping process. Auditors will request supporting documentation for items reported in the tax return. Unsupported items in a tax return lead to audit adjustments that are extremely difficult to reverse. Also, poor record-keeping can be viewed as a general disregard for the accuracy of items reported for tax purposes and can lead to gross negligence penalties over and above the amount of tax owing.

The best way to avoid an upward tax reassessment is to seek the advice of a qualified tax preparer or specialist when preparing your tax return. The Income Tax Act is complex and difficult to navigate without the aid of a specialist. Most that have experienced a CRA audit learn this lesson the hard way. So put an MNP tax specialist in your corner and be ready for when that little brown envelope arrives.