“CRA tells us that there’s no such thing as a random audit," says Paul Lynch, KPMG’s National Leader for Tax Dispute Resolution and Controversy Services. He’d know: Lynch spent 18 years with the Canada Revenue Agency (CRA) and now sees the practical application of CRA’s audit procedures, including taxpayers being picked up for certain filing positions, for items found on websites and news articles. “Everyone is picked for a reason,” he says. “CRA has identified something which is considered a risk.”
And the fact that the CRA has been forced to shed hundreds of auditors over the past few years, thanks to budget cuts, hasn’t made it any less diligent. Instead, says Lynch, “it has forced them to get smarter. They do a lot of risk-based selection, because they want to get the best bang for their buck.” These days, there is a shift from larger, less risky enterprises to many first-time audits of smaller enterprises.
So what will cause the CRA to turn its eyes toward your company? The obvious red flags, says Lynch, are filing tax returns and other documents late, making changes to prior filings and making late payments. Industries that deal in cash — think retail, restaurants and construction — get a lot of attention, and the CRA periodically does deep dives on random industries, looking for companies that stand out. "People who have strange parameters compared to their peer group as a whole will raise flags," says Lynch. That could mean reorganizing your business, moving around assets or creating a new company. “In the CRA’s world, it’s not necessarily that something’s wrong,” says Lynch, “but it’s more of an opportunity for tax planning” — i.e. getting a little too aggressive with how you lower your tax owing — “or a higher probability that you’ve made a mistake, since those transactions are complex.”
If you’ve been flagged for an audit, here are the top seven items CRA will check out — and how to be prepared when they do:
Personal versus business use of shareholder benefits and employee taxable benefits
“I call these first two the comingling of corporate and personal assets,” says Lynch. Though there is legally a divide between business and personal, many smaller shops end up using the company car for running errands or bring a spouse along on a business trip. “It’s just human nature,” says Lynch “The key is to document everything.” Keep a detailed diary or log (or download an app) to keep track of your time, expenses and use of assets like vehicles, smartphones, computers and property. Picking up the tab at a business lunch? Document who was there and what you discussed. Write down when you used the company car and what for. “It’s all about evidence,” says Lynch. “They just need something that makes it seem legitimate.”
Employed versus self-employed staff
It’s pretty common for smaller businesses to hire contractors instead of full-time staff, since there are major implications to bringing people on board permanently — including Canada Pension Plan and Employment Insurance contributions and health benefits. “But if you’re the only company a person is working for, it’s hard not to count them as an employee,” says Lynch, which means the CRA could come after you for unpaid CPP and EI contributions. "Historically, 30 percent of tax cases in court have been about this issue," he adds.
The CRA will want to ensure that any legal, accounting and consulting fees are truly business-related, not personal, and that they’re not actually capital costs — which would mean they’re not currently deductible. They’ll also use them to find out how much tax planning you’ve done and whether it’s all above-board. “The whole issue is, what is really behind the expense?” says Lynch. “They’ll start to dig into that, and it will lead to other things.” Again, keep a meticulous breakdown of what each bill is for.
It’s quite common for a business owner to set up two entities: a company that handles the day-to-day operations and a holding company that owns all the assets and provides management services to the operating company. “It’s basically risk-management — so all the assets are separated from where all the risks are,” says Lynch. “But for CRA purposes, every company is a separate, legal entity, and you have to transact with each other like you would with any other third party.” That means you need to have a detailed contract that defines each company’s roles and responsibilities and what management services the top company is providing to the bottom one. You also must charge and keep track of GST and HST. “If you don’t have evidence,” says Lynch, “you can get into difficulty.”
GST and HST
“CRA is really focused on this right now,” says Lynch, since the cash-strapped provinces want to make sure they’re getting their fair share of these transaction-based taxes. Because there’s a mountain of paperwork and bookkeeping involved with tracking GST and HST, mistakes are common. “Most business owners don’t give it a lot of attention, because they know GST and HST doesn’t stick to them—they’re just pure tax collectors,” says Lynch.
Reorganizations or restructurings
Doing what’s called a Section 85 rollover — transferring property from one company to another or spreading assets to a family member — is perfectly legitimate, but it’s bound to draw the attention of the CRA. “It’s just a trigger for activity,” says Lynch. Make sure you cross every “t” and dot every “i.”
Lynch’s final advice: pay attention to the details. To help you do that, put in place a good accounting and tracking system — preferably electronic — or outsource it to someone who can give it their full attention. And if the CRA comes calling, says Lynch, respond to them quickly. “Keep on top of it and, if something goes off the rails, just suck it up and deal with it.”