So…can you take care of this for me? I don’t even know where to start.”
My good friend Joey, a generally confident and funny guy, walked into my office one day with a grande double double, a letter in his hand and this bewildered look on his face that almost made me laugh. I controlled my amusement and kept a straight face, as I knew he was in some kind of trouble. He put the coffee down in front of me, slumped in the chair and slammed the paper onto my desk: “Look at this. How can this be?” – He asked with a mix of disbelief and disappointment in his voice, as if a close friend of a tax consultant can’t possibly get a tax Audit notice. Following an old advice of not mixing friendship and business he had his taxes done by his brother-in-law the past seven years, paid his taxes on time and never had a problem.
Audits can pop up unexpectedly and make your life really miserable, mainly because of the stress associated with them, and the lack of understanding of the process and the reason behind them. So here are a few important facts worth knowing, that may help you avoid an audit, or if you are selected for one, debunk the mystery of the process behind it.
Every year an average of three million taxpayers in Canada will receive a notice of review or audit, requesting documentation supporting the claims in their tax returns. Dealing with taxes once a year is stressful enough, but receiving the dreaded notice will set off panic in some disorganized households or businesses. As always, one must fall back on carefully saved and organized documentation of every transaction – if applicable. In the absence of clear record-keeping, all hell breaks loose.
Can you avoid audits? Well, while there is no 100% guarantee for that, there are a few tips which if followed, may greatly reduce your chances of being reviewed or audited.
Before we go into what exactly sets off the CRA audit alarm, let’s distinguish between a review and an audit.
Reviews
Every year roughly 3 million taxpayers in Canada will receive a letter that their file is being reviewed and a request to provide supporting documentation for some of the claims they made in their returns. This is not necessarily reason for concern, unless of course the tax return involves some fraudulent transactions that will likely get discovered in the review.
The taxpayer usually has to respond within 30 days, and an extension can be requested if more time is needed to gather the requested information. The best course of action is to respond promptly, honestly and on a timely basis. The worst case scenario is the CRA reassessing the return, disallowing some claims and maybe adding some interest and penalties. Dealing with a review letter can be stressful but we handle it for our clients with ease.
To avoid issues in case a review or audit it is recommended that taxpayers keep a box or a large envelope with receipts and any printed documentation so that the CRA has something to chew through.
Reviews can be done on any category of taxpayer and any scenarios really. They can be done by random selection, or a file might be flagged in case of previous compliance issues. A very simple rule of thumb in order to avoid raising flags is to make any deductions reasonable, and to make sure your claims match the third parties involved ie expenses and invoices from suppliers, contractors, financial institutions etc.
The CRA has a scoring system to detect potential for inaccuracy and while this system is not disclosed, what we do know is that spousal support payments, large cash transactions and charitable donations- and even medical or childcare expenses – will often get reviewed
Audits
While reviews are shorter and easier to resolve, audits are basically in-depth reviews involving a close look at transactions and records.
One taxpayer category that is often subject to audits is a self-employed individual where their income tax reporting doesn’t match their HST return. Some other high risk categories are homeowners’ capital gains exemption on their principal residence, where generally a lot of fraudulent claims are found every year
. Frequent real estate transactions when one is not in the real estate business could easily trigger an audit.
Other audit triggers are continuous losses from rental income, or lifestyle inconsistencies where taxpayers claim low or no income but own high value real estate, luxury vehicles or travel frequently.
At times the audit is triggered by a report made by someone against you, an ex-spouse, an unhappy employee or an annoyed neighbour.
Joey suspected his neighbour, because of a fall-out they had over a tree in front of their houses, that both of their dogs seemed to mark as theirs – which started an irreconcilable dog feud. It turned out that it was a small accounting error in his latest HST return. It happens. We took care of it and the audit went smoothly.
Next time Joey showed up at my office with the biggest bottle of Scotch I’ve ever seen and a huge grin on his face. “What is going on?” I asked. “My neighbour is moving!” he said victoriously.
Written by: Christa Lazar