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CRA Income Tax Audit – Toronto Tax Attorney Introduction

As Toronto tax attorneys, we handle the CRA audits and 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 adequately 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 self-assessment income tax system continues to function properly. While most Canadians are truthful on their tax returns, there are some who are not. The CRA looks for errors or controversial positions or willful 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 correctly reported and are supported by accounting records and receipts. The CRA tax auditor will ask you to see individual or corporate books and records and bank account and expense receipts. A corporation will normally have to provide its minute book to back up any dividends or bonuses. Questionnaires may need to be completed. Any information that is incorrect, even if it is 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 Excise Tax Act for GST / HST.

Canadian Tax Audit Procedures

CRA auditors will often search the Internet for relevant information, and a taxpayer’s website or other sources located on Google may contradict information the taxpayer provides to the auditor. This information will be used for other inquiries possibly including requests for information from third parties. Additionally, open social media accounts are publicly accessible, and CRA auditors will collect this information from taxpayers’ social media accounts to build a case against a taxpayer. CRA officials have publicly discussed the use of taxpayers’ social media accounts in this manner. If the taxpayer’s lifestyle and reported income do not match, the CRA’s 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 conduct a GST (and HST) compliance review; If problems 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 performed during GST / HST audits. Combined income tax and GST / HST audits were discontinued in July 2010. These compliance reviews are not always carried out and sometimes income tax audits can miss big GST / issues. HST and vice versa.

CRA Audit Statistics

The CRA issues an annual report to Parliament. The latest was published in January 2016. The audit statistics from the CRA Annual Report 2014-2015 provide less detailed information than the previous year.

For small and medium-sized 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 $ 1.4 billion in tax impact. For large business and international files, the CRA audited 6,540 GST / HST income tax and shadow files and identified more than $ 448 million in tax impact. In all cases there were fewer audits in 2014/15 than in the previous year. Presumably this reflects the results of the budget changes.

Reasons for the tax audit

The CRA may choose to audit a taxpayer for a number of 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-shaped slips are reported

Since 2011 CRA has been auditing high net worth individuals and families, sending questionnaires requesting information on all companies, trusts, etc. that they control.

The CRA has also been concentrating additional audit resources on the black economy in an attempt to deter undeclared cash sales.

What is the tax auditor looking for?

The focus of the tax audit is to find errors in the tax returns. Here are some examples of typical problems that can arise in a tax audit that would cause a taxpayer to receive a tax assessment at the end of the tax audit and which could result in penalties or a referral for a tax evasion investigation:

  • Overhead expenses

  • Exaggerated deductions

  • More than income tax credits claimed

  • Income below reported or not reported

  • Unreported cash sales

  • Unreported Internet Income

  • Unreported extraterritorial income

  • Unreported offshore assets

  • Credits, such as for charitable donations, that are not backed by receipts

  • Personal expenses deducted for business

  • Shareholder loans not repaid within the final 2 corporate years

CRA Right to Audit and CRA Audit Policies

Section 231.1 of the Income Tax Act gives the CRA the legal capacity to conduct audits. In particular, it entitles auditors to request and examine documents, including computer records. Section 231.2 is a more formal provision by which a “demand” or “requirement” is issued, but it is not necessary for a tax auditor to use it in the normal course when section 231.1 is sufficient.

The CRA may choose to audit anyone, but case law has held that such discretion does not allow for a vexatious 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, that is, the most recent year for which it has been submitted and evaluated one return, plus one year ago, with limited exceptions. This policy may be singled 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 assessment that has been issued. Of course, this one plus one rule does not apply in the event that the CRA suspects undeclared income. They will usually be seen in three years, and in some cases even more than three 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 is properly assessed; A Tax Appeals Officer or a Tax Court judge will not have the power to cancel it for reasons 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 stated in Law 15 of the Taxpayer’s Bill of Rights which says “You may choose a person to represent you and obtain advice on your tax and benefits matters. Once you authorize us to deal with this person, we may 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 it is due to an error, will be used against the taxpayer. The auditor will also take notes and may misinterpret what the taxpayer has said or may incorrectly record responses. An Ontario tax attorney will have his or her own notes to contradict any error by the auditor. Contact our Toronto tax law firm for tax help as soon as you are contacted by a CRA tax auditor.

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