I am often asked how the Canada Revenue Agency (“CRA”) selects its audit victims; oops, I meant to say taxpayers subject to audit. Through experience I know certain taxpayers, certain claims and certain industries seem to trigger audits. With that in mind, I will list below what I have seen and how I believe the CRA selects certain individuals and businesses for audit.
Reasons for Individuals and Corporations
I would suggest there is nothing worse than a scorned lover, a business partner you have had a falling out with or a dismissed employee to trigger a CRA audit. These individuals know your little secrets; a cash deal here, an offshore account there and a conference you expensed that was really a vacation. These people are also vindictive and in some cases, they make statements and claims that are not factual in nature; however, the claims are enough to bring the CRA to your door.
CRA also loves net worth audits. These are audits undertaken because you live in a 3,000 square foot home, have a Porsche and kids in private school, and yet show minimal income on your tax return. Typically CRA either stumbles upon these situations, or information from one of the individuals noted in the preceding paragraph provides a lead.
Reasons Specific to Individuals
We see far more desk audits (information requests in regard to certain deductions claimed) than full blown audits for individuals. You can expect an inquiry if you claim any of the following:
- a significant interest expense,
- an allowable business investment loss (usually if you held shares in a bankrupt private Canadian company),
- tuition from a university outside Canada (typically the child and parent are tied together as most children transfer $5,000 of their tuition claim to their parents),
- a child care claim for a nanny; even if you have filed a T4 for the nanny with CRA. Why CRA cannot crosscheck their records is baffling and befuddling.
In all the above cases you are just providing back-up information, these are not audits.
In past years individuals who purchased any tax shelter other than an oil & gas or mineral flow through have been audited. However, in most cases the CRA is auditing the tax shelter itself and the individual investors just get reassessed personally.
Full blown audits seem to occur with regularity in regard to individuals who earn commission income or self employment income and claim expenses against that income. In those cases, CRA gravitates to auto expense claims, requesting logs books they know one in 100 people actually keep, and advertising and promotion expenses they consider personal in nature.
Reasons Specific to Corporations
Corporations seem to be selected for three distinct reasons.
They carry on a business that is CRA’s flavour of the year; some prior flavours have been pharmacies, contractors and the real estate industry and any other industry CRA feels is a “cash is king” industry.
Corporations file General Indexed Financial Information known as GIFI. This information provides a comparative year to year summary of income and expenses. It is suspected by many accountants that CRA uses this information to review year to year expense and income variances of the filing corporation and to also compare corporations within a similar industry sector to identify those outside the standard ratios, but we don’t know that for certain.
The final reason is that it is just your turn. I have no knowledge of this, but it seems like CRA just runs down a list and if you don’t get caught in regard to #1 or #2, your turn just eventually comes up.
In all cases it is imperative you keep your source documents to provide to the auditor; CRA more then ever wants source documents. It is also vitally important if you and not your accountant are meeting with the auditor, that you try and keep your cool. In the end, the auditor is just doing his or her job and if you treat them badly, you are not doing yourself any favours.