Top 10 things that may trigger an audit of your business

Tax time may have come and gone, but now it’s the Canada Revenue Agency’s turn to scrutinize millions of tax returns. As the numbers of small and medium-sized businesses (SMBs) continue to grow, the agency is paying particular attention to these returns to ensure tax rules are followed. 

Hobby, startup, self-employed, professional services and consultancy businesses are not immune. If you’re open for business, the CRA is watching.

Complaining about this is a waste of time. It is the CRA’s job to enforce tax laws and apply penalties on those they believe are not in compliance, and to seek out fraud. It is also imperative that SMBs understand the rules, and what may trigger an audit. The net sum: take tax filing seriously and be prepared.

1. Keep business and personal expenses separate. Although wider-ranging CRA audit guidelines mean auditors can look into both personal and business operations when conducting an audit, clear and separate business and personal records can score you major points.

2. The CRA sees you as an employee of your company. The habit of taking monies out of the business regularly to pay living expenses needs to stop. You now need to prepare a T4 slip for yourself, and deduct CPP and income taxes. Penalties are levied for late T4 filing and payroll remittance.

3. The CRA sees payments from the business to family members as employment.  You need to make payroll deductions, and keep records. If mom fails to declare this income on her tax return, the CRA may come asking for proof. Now that would be awkward.

4. High income earners are the CRA’s favorite audit targets. Professionals such as doctors, consultants and dentists are profitable audit targets.

5. Having multiple businesses receives more attention. Buying or selling products or services in regions with different tax rates? The price paid or sales received from the related businesses can become a CRA target.

6. Cross border tax co-operation means both the CRA and the U.S. Internal Revenue Service (IRS) are watching to make sure each country receives tax owed.

7. Estimating sales should only be done if there are no records. However, rounding up or down of expenses suggests the amounts were made up. The government provides a “benchmarking by industry” site where businesses can see their expense to sales ratio. This should give you a good idea whether you stand out from your peers and risk becoming an audit target.

8. Mortgage interest deduction in home office expenses is tricky. Only include the interest portion of the mortgage and not the principal.

9. Don’t overload the “Other Expenses” category on the T2125 “Statement of Business or Personal Activities” form. Large dollar amounts will draw attention.

10. Invoicing more than $30,000 a year makes it mandatory to register for and file HST/GST/PST.  Failing to do so may cause an audit in your future.

The CRA permits a business that has failed to declare income or one that made a mistake with GST/HST filing to correct the mistake through an adjustment or Voluntary Disclosure Program (VDP). If the CRA discovers the mistake before you take action, then prepare to face an audit. If your mistake is small and straightforward, deal with the auditor on your own. Good records are the key.

If the mistake is significant, consider contacting a tax expert for damage control. Once an audit is started, nine times out of 10, you will end up with much larger tax bills.

—Kristin Li is CEO of Tax 911 Now, which routinely works with the CRA to help SMBs be better informed and prepared for tax audits.