CRA Income Tax Audit – Toronto Tax Attorney Introduction
As Toronto tax attorneys, we deal with audits and CRA auditors on a daily basis. So what is a tax audit? This article will explain what you can expect to happen if you are audited for taxes.
The Canadian income tax system is based on self-assessment. In other words, it is up to each Canadian taxpayer to fully and correctly report their total income from all sources on their annual T1 or T2 income tax return. The Canada Revenue Agency conducts tax audits and issues income tax assessments to ensure that the income tax self-assessment system continues to function properly. While most Canadians are truthful in their tax returns, there are some who are not. The CRA is looking for errors or objectionable positions or deliberate misstatements in the tax returns that have been filed.
What is a Tax Audit?
An income tax audit is an examination of a taxpayer’s tax returns and supporting records to ensure that income and expenses have been reported correctly and are supported by receipts and accounting records. The CRA tax auditor will request to see individual or corporate books and records and bank account and expense receipts. A corporation will typically have to provide its minute book to support any dividends or bonuses. There may be questionnaires to complete. Any information that is incorrect, even if due to an error, will be used against the taxpayer.
Most audits are done to ensure compliance with the Income Tax Act for income or payroll deductions or under the Excise Act for GST/HST.
Canadian Tax Audit Procedures
CRA auditors often search for relevant information on the Internet, and the taxpayer’s website or other sources located on Google may contradict the information the taxpayer provides to the auditor. This information will be used for further inquiries possibly including requests for information from third parties. Additionally, open social media accounts are publicly accessible, and CRA auditors will collect this data from taxpayers’ social media accounts to build a case against a taxpayer. CRA officials have publicly discussed the use of taxpayer social media accounts in this way. If the taxpayer’s lifestyle and reported income do not match, the CRA tax auditor may decide to investigate the taxpayer’s situation to see what is really going on.
The CRA’s practice in income tax audits is to do a GST (and HST) compliance review; if issues are found, the matter is normally referred to a GST/HST auditor for a full GST/HST audit. Similarly, an income tax compliance review is often conducted during GST/HST audits. Combined income tax and GST/HST audits were discontinued in July 2010. These compliance reviews are not always conducted, and sometimes income tax audits can miss significant GST/HST issues. HST and vice versa.
CRA Audit Statistics
The CRA issues an annual report to Parliament. The latest was published in January 2016. The CRA’s 2014-2015 Annual Report audit statistics provide less detailed information than the previous year.
For small and medium enterprises no statistics were provided. The CRA reports that it reviewed 12,981 large and international company files and 9,440 aggressive tax planning files that resulted in the identification of a $1.4 billion tax impact. For international and large business files, the CRA audited 6,540 income tax and shadow economy GST/HST files and identified more than $448 million in tax impact. In all cases there were fewer audits in 2014/15 than the previous year. Presumably this reflects the results of the budget changes.
Reasons for tax audit
The CRA may choose to audit a taxpayer for various reasons. Among them are:
-
Industry audit projects
-
random selection
-
Third Party Tips
-
Past history of non-compliance
-
Comparison of information about returns with information received from third party sources; in other words, all T-slips are reported
Since 2011, the CRA has been auditing high net worth individuals and families, sending out questionnaires requesting information on all companies, trusts, etc. that they control
The CRA has also been focusing additional auditing resources on the underground economy in an attempt to determine unreported cash sales.
What does the Statutory Auditor look for?
The focus of the tax audit is to find errors in tax returns. Here are some examples of typical issues that may arise in a tax audit that would result in a taxpayer receiving a tax determination at the end of the tax audit and could result in fines or a referral for a tax evasion investigation:
-
Overhead expenses
-
Exaggerated deductions
-
Claimed income tax credits
-
Reported or unreported earnings
-
Unreported Cash Sales
-
Unreported internet income
-
Unreported Extraterritorial Income
-
Undeclared offshore assets
-
Credits, such as charitable donations, that are not supported by receipts
-
Personal expenses deducted for business
-
Shareholder loans not repaid within 2 corporate year-ends
CRA Right to Audit and CRA Audit Policies
Section 231.1 of the Income Tax Law gives the CRA the legal power to conduct audits. In particular, it authorizes auditors to request and examine documents, including computer records. Section 231.2 is a more formal provision whereby a “demand” or “request” is issued, but is not required to be used by a tax auditor in the normal course where section 231.1 is sufficient.
The CRA can choose to audit anyone, but case law has held that such discretion does not allow for a nuisance audit conducted for capricious reasons.
The Canada Revenue Agency has an internal policy in the CRA Audit Manual §9.12.3 that audits should normally be limited to “one plus one” years, i.e. the most recent year for which the audit was filed. and evaluated a statement, plus a year ago, with limited exceptions. This policy can be pointed out to a tax auditor to try to limit the scope of audit requests, but it has no legal effect and cannot be used in court to challenge a tax determination that has been issued. Of course, this one plus one year rule does not apply in the event the CRA suspects unreported income. They will usually consider three years and in some cases even more than 3 years.
In theory, the CRA has no discretion in applying the Act and must “absolutely follow” it by issuing a tax assessment for all taxes. The reality is that, in practice, tax auditors have wide discretion not to assess an amount, however, once it has been properly assessed; a Tax Appeals Officer or Tax Court judge will have no power to cancel it on grounds of fairness, justice or compassion.
Tax audit assistance from a Toronto tax attorney
Our top Toronto tax attorneys fight CRA tax auditors every day. A taxpayer has the right to professional representation at all times. This is specifically provided for in right 15 of the Taxpayer Bill of Rights which says: “You may choose a person to represent you and to obtain advice on your tax and benefit matters. Once you authorize us to deal with this person , we can discuss your situation with your representative.” A taxpayer should never meet with a CRA auditor without the presence of a professional Canadian tax attorney. Any information that is incorrect, even if due to an error, will be used against the taxpayer. The auditor will also take notes and may misunderstand what the taxpayer has said or may record responses incorrectly. An Ontario tax attorney will have their own notes to contradict any errors by the auditor. Contact our Toronto tax law firm for tax help as soon as you are contacted by a CRA tax auditor.
