When many of us or businesses get the notice from Canada Revenue Agency (CRA) that they've been selected for audit, the resulting feelings are characterized by fear and worry. Tax returns related to businesses are particularly examined and there is no way to evade a CRA audit. However, you can save yourself and your business from the audit radar by taking the measures mentioned below. First, we step into the process of selection of files by CRA.

The procedure: How CRA selects files for audits

The CRA risk assessment system chooses files for audit grounded on these potential conditions

  • There are some major errors in tax return
  • Non-compliance indications with tax duties
  • Comparison with similar category businesses' tax returns shows something suspicious

While auditing any selected business CRA thoroughly scrutinizes the books and other documents maintained for the purpose of proof. They ensure the laws and standards that are already established are properly applied fulfilling the law’s requirements correctly.

Which Business Types are Most Likely on the Audit Radar?

The following information is collected from the Canada Revenue Agency (CRA) Annual Report to Parliament 2014-2015. According to CRA in the sector of Small Medium Enterprise (SME) “we send on average more than 30,000 letters per year to taxpayers within groups at risk of non-compliance. The letters provide taxpayers with more information regarding certain claims they made on one or more of their recent income tax and benefit returns. We send the letters for educational purposes or to notify taxpayers of a potential audit in their sector.”

1) Business Income Outlier

CRA collected a number of files from same-category businesses if you declared your income very low or above as compared to the average income of a similar industry declaring in Canada Revenue Agency. They have wide information about the profit brackets of the various and similar industries for comparison.

2) Income Declaration Inconsistencies

You must be cognizant of your financial declarations in various places like the banking sector and other institutions. They must match wherever you declare because these financials are compared by the Canada Revenue Agency. If your financials don’t match you've made a blunder, therefore, you come into the radar of audit. Also, your declaration of income on the income tax return must be as you declare on GST/HST Tax Return.

3) Home Office Expenses

If you work from home to earn business income, you are eligible to get deductions for utilities, rent, insurance, phone bills, real estate taxes and other expenses that CRA allows. Note: home space must be used like an office on routine basis i.e. meeting with your clients. If you use your home space off and on for the purpose of earning business income, you must not take these deductions because Canada Revenue Agency is aware of this.

4) Tax Advantage via Deduction of Expenses

While trying to get the tax advantage don’t be irrational. The expenses you deduct on the income tax return it’s in certain concerns of CRA. For expenses such as interest expenses, meals & entertainment and promotion & advertising, don’t come overboard to claim these expenses. If you claim expenses outside the industry norms then you are increasing the chances of your audit. Normally, to avoid an audit the only expenses claimed are those incurred for the purpose of earning business income.

5) Documentation in Support of Books

Make sure you maintain a record in support of transactions. Poor bookkeeping and record maintenance lead to an audit. As discussed above the figures must match, declaring in the tax returns and financials.

6) Vehicle expenses claim

The CRA tax auditor can easily disapprove your claim in relation to vehicle expense because most people don't maintain the record that's required by CRA. Also, one of the reasons for disapproval of claim by CRA is if you write off 100 percent vehicle expense which means that the vehicle is used solely for business purpose. In case you don’t acquire any other vehicle it could lead to concerns. You must maintain a proper logbook as required by CRA.

7) Income Splits in the Family

A general way to reduce the tax load is by splitting it between family members or spouse who fall in the lower bracket of tax as compared to business holders. CRA has different ways to determine the facts if you misrepresented the figures. E.g. if you split income in terms of salary to your spouse but the spouse didn’t deliver any duty or services in the respective business. To avoid this type of blunder your family member can own shares in a business whose tax on dividends lowers the tax.

8) Donations & Charity Deductions

If you are claiming more charity deductions than your business income reported, the CRA could become suspicious about it and this will lead to an audit because you are outlying prevailing standards of the industry. CRA is more likely to review when the capital assets/property involved in the donations matter.

9) Filling dates

It is recommended that you file your return (HST, Income Tax) in compliance with their notices served, on time. It will be very helpful to avoid an audit.

10) Losses in Business

You must be careful while claiming the loss in the return, over the years as well, and settle the other sources of income with business losses. As a business, you project reasonable profit when registering. And also, the industry norm will affect your claims. For instance, if industry projections are having reasonable profits and you are not it will place you on the CRA audit list.