All businesses dread getting a letter notifying them that they are subject to a CRA audit. Business returns are especially scrutinized by the CRA and it is impossible to avoid an audit. However, here are 10 red flags you should pay attention to which will increase your risk for an audit.
- Revenue Discrepancies – your revenue will be compared across all tax forms. The revenue declared on your GST forms will be compared to that on your income tax form, your spouse’s return, and information on tax returns provided by employers, financial institutions, and other third parties. If they don’t match, then it’s a sure-fire way to attract a CRA audit.
- Declaring Income That is Far Below or Above the Norm for Your Industry Will Draw Attention. The CRA knows what the income and profit margin for your industry should be and will compare your return to what is the norm.
- Deducting Large Business Expenses – being able to deduct business expenses is a big tax advantage of running a small business. However, expenses for advertising, promotions, meals and entertainment, travel, miscellaneous, and interest expenses will be scrutinized by the CRA. Claiming large deductions in any of these areas can attract attention.
- Claiming the Home Office Deduction – if you qualify for the home office deduction it is a great deal as you can deduct a percentage of your rent, real estate taxes, utilities, phone, insurance etc. However, you must only use this work space in your home to earn income and to meet with clients regularly. If you are not doing so then you should not claim this deduction.
- Claiming 100% Business Use of a Vehicle – this is a big red flag for the CRA as they know that it is very rare for an individual to use their vehicle 100% of the time for business. It is also a very easy expense for auditors to disallow as few people keep the required logbook to actually record their mileage.
- Changes in Shareholder Loans and Large Balances – changes in shareholder loans or balances are red flags to the CRA. They look for personal expenses recorded as business expenses and loans taken from the company.
- Running a Cash-intensive business – businesses that deal in a lot of cash such restaurants, hair salons, bars or other retail have the opportunity to take cash and not report all of their taxable income so you should expect extra scrutiny from the CRA.
- Reporting Several Years of Business Losses in a Row – is likely to earn you an audit especially when those losses are used to offset other incomes. The CRA expects all businesses to have a reasonable expectation of profit and the CRA’s idea of that may differ from yours.
- Making Large Charitable Donations – the CRA knows what taxpayers at your income level usually give to charity so if your donation exceeds that amount it can cause a red flag to pop up.
- Not Following the Rules for Employing Your Spouse or Child in Your Business – this type of income splitting is legitimate, but businesses not following the rules may become a target for the CRA.
In addition to these red flag triggers individuals who claim self-employment status are also liable to scrutiny from the CRA especially if you do not follow the self-employment rules. Although the CRA does conduct a certain number of audits each year just to check compliance, you can somewhat control your chances of being chosen if you pay attention to these red flags. In any case it is prudent to keep meticulous bookkeeping so that you have all the information to support your tax claims.
For more information see: The Tax Advantages of Self-Employment and Independent Contractor vs Employee: Which One Are You?
From an article by Susan Ward