Entrepreneurs cringe when they read the word “audit” in any correspondence from the Canada Revenue Agency (CRA). That’s no surprise; facing a CRA tax audit can be a costly, time-consuming, nightmarish experience. Unfortunately, they seem to be happening with more frequency and more costly results.
Over the past year as a firm we’ve noticed a significant spike in CRA tax audits, as well as a sharp uptick in proactive penalizations covering a wide range of infractions. While there is no data to quantify this extra scrutiny, based on our own experience, and from what we’ve gleaned from extensive discussions with other accounting firms of various sizes, business owners are getting more unwelcome calls from the CRA.
MORE CRA NEWS: Small Business Give the CRA a C’ »
Anecdotally, we’ve also seen a major increase in letters from the CRA indicating the potential application of gross negligence penalties—a penalty essentially applied in the event of an assessment—alleging the taxpayer has intentionally misrepresented their financial disclosure to minimize taxes owed. Such assertions were extremely rare in the past, and in some cases are now being assessed even before accountants have had a chance to review the CRA’s claims and prepare a response. Penalties for gross negligence can be significant, up to 50% of taxes owed.
The CRA’s crackdown doesn’t end there. The agency has become increasingly aggressive and persistent in collecting HST, while also sending accounts receivables to debt collectors faster than in the past.
There’s still more. In January 2013 CRA opened a whistleblower line to report potential non-compliance. The CRA is particularly interested in tips about real estate transactions to determine whether individuals are reporting homes as principal residences or rental properties, when in reality they intended to flip the homes to turn a quick profit and at least try to avoid paying income tax. Because so many entrepreneurs view real estate as a worthwhile investment—particularly in red-hot markets such as Toronto and Vancouver—they’re being investigated by the CRA in disproportionate numbers.
MORE WHISTLEBLOWERS: The Business-Boosting Alternative to Snitch Lines »
This perceived spike isn’t due to some plague of improper filing practices on the part of accountants across Canada. On the contrary, it has more to do with a change in way the CRA is looking for infractions. To suss out offenders, the CRA is using increasingly sophisticated algorithms and data tracking systems, such as advanced business intelligence, to cross-reference tax returns, HST returns, T1s, T4s—virtually all of the documentation that is, or could be, required to operate a small business—and using it to audit entrepreneurs in search of potential infractions.
The key point here is that the CRA has become highly sophisticated in the tools it uses to track records and administer federal tax law. Add in the fact that the agency is currently engaging in a widespread enforcement blitz, and the message for entrepreneurs is clear: Now is the time to take CRA enforcement seriously and ensure your company’s accounting and bookkeeping practices can withstand an auditor’s intense scrutiny.
The good news is that if the CRA does audit your business, the process can be managed efficiently and effectively with the right proactive steps. Here are four to keep in mind.
Maintain proper documentation
Even in the face of an audit, having proper documentation to support your tax filing should allow you to defend your position with little or no financial impact. That means keeping accurate records for everything from automobile mileage to meals and entertainment expenses. These documents will provide you—or more likely your accountant or lawyer—with the evidence they need to substantiate your tax filing position in the event of a CRA investigation. Without it, your filing position will be weak and your case will be difficult to defend.
If you haven’t been approached by the CRA and do spot potential areas of non-compliance in your tax returns, you have the right to prepare a voluntary disclosure to the CRA proactively highlighting your oversight—an approach that can help minimize or eliminate any potential penalties you might otherwise have to pay.
Speak to your accountant before taking action
Entrepreneurs often take huge risks to start and grow their businesses, frequently making snap decisions when opportunities or challenges arise. Accountants, on the other hand, tend to be more conservative in nature. In the face of a CRA audit, you need to bury the former instincts and think like the latter. The best approach when facing a CRA audit is to seek help from a professional before making any moves, and that includes corresponding with the agency.
Engage a reputable accountant
Ask for referrals from other business owners, carrying out your own due diligence to determine if the accountant or accounting firm is the right fit for you, and then repeat the process to develop a short list of top candidates before eventually making a decision. Unfortunately, many entrepreneurs learn the importance of this approach when it’s too late, and find themselves on the hook for paying thousands of dollars in interest, penalties and back-taxes. Proactively seeking the advice of an informed, responsive and reputable accountant can help the entrepreneur mitigate risk and protect their bottom line.
Some of the key questions to ask during those meetings include: Will I be dealing with a senior accountant (or perhaps even a partner), or will I be assigned to a junior accountant? What size of company does your firm typically service? If the firms works mainly with multinationals or larger businesses, your SME will likely fall to the bottom of their priority list. Do they explain tactics and strategies in detail? Are they willing to defend their tax and accounting positions and explain how they arrived at those conclusions? Will they stand by that position if challenged during a CRA audit or in court? Can they provide examples of successful client outcomes? How much experience does the accountant have? Do they have the necessary resources to stay a step ahead of legislative and tax case-law developments? Unfortunately, many accountants are so out of touch with new accounting standards and tax law changes that they don’t realize they’re giving poor advice.
Do a cost-benefit analysis
With CRA on the lookout for any potential infraction, it pays to carefully consider any strategic financial move and its tax implications. There are far too many overly aggressive accountants who, despite being aware of heightened enforcement by the CRA, will still try to put through expenses that clearly stretch the limits of reasonable accounting practices under Canadian law. Some understand that what they’re doing is basically illegal, but will try to get away with their unscrupulous moves and hope that the CRA doesn’t notice. Sometimes it’s the entrepreneurs who ask their accountants to stretch the rules to save a few dollars. This has obviously never been an acceptable practice, but now the chances of getting caught are even higher. Hence the importance of performing a cost-benefit analysis before making any such move. Ask yourself: is trying to cheat on my taxes worth the stress, time and cost of an audit and potential fines? Hint: the answer should be a resounding “no!”
I recommend taking the same approach when it comes to hiring an accounting firm. Again, seeking the right accounting assistance can help avoid many of these issues and position your organization to respond favourably to a CRA challenge. That means spending more for a comprehensive level of service. Can you cut corners on accounting? Sure, but it could end up costing you most if the CRA comes knocking.
And as we’ve seen in recent months, the risk of receiving that letter from the taxman is more real than ever.
Armando Iannuzzi is a tax partner at Kestenberg Rabinowicz Partners LLP, a Markham, Ont.-based firm that provides strategic tax, accounting and finance services to entrepreneurs.
MORE WAYS TO AVOID AN AUDIT FROM MONEYSENSE:
- How to Reduce the Risk of a CRA Audit »
- The CRA TFSA Crackdown’ is No Cause for Alarm »
- How to Protect Yourself from CRA Phone Scams »
- 5 Things Your Accountant Isn’t Telling You »
- Tax Profit as Income or Capital Gains? »
Have you been targeted in the CRA’s enforcement blitz? Share your audit experiences and concerns using the comments section below.