My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, February 1, 2016

CRA Audit Update for Individuals and Corporations

There is probably no five letter word that strikes more fear into your heart and pocketbook than the word "AUDIT". We are anxious receiving any letter from the CRA, in case it is the dreaded "you have been selected for audit" letter. So today, I thought I would provide you with a mini update on some interesting wording the CRA is now using in audit adjustment proposal letters. For those of you that own small or mid-sized companies, I provide some information on audit selection criteria and what is happening in the small and medium-sized enterprises ("SME") audit area.

Audit Proposal Letters


Gross negligence penalties under subsection 163(2) of the Income Tax Act can be imposed when the CRA can show that a taxpayer knowingly, or under circumstances amounting to gross negligence, makes a false statement or omission in a tax return. The penalty for doing such is equal to the greater of $100 and 50% of the tax due to the false statement or omission.

This subsection has been applied sparingly by the CRA in the past. However, lately I have seen reference to this subsection in a number of audit adjustment proposal letters where the CRA states it is considering imposing penalties. It appears this wording may have become common or standard wording in audit proposal letters, likely to provide the CRA greater leeway to levy the penalty if the facts of the situation later lend themselves to a negligence penalty. This type of language can be scary to clients who receive the audit proposal letter, but have not done anything untoward, and would not be anywhere close to being subject to the gross negligence provision.

Thus, if you receive such a letter, do not "freak-out" if the letter has the gross negligence paragraph, it is not necessarily directed at you.

SME Audits


One of the audit initiatives the CRA has is the SME sector. No one knows for sure how a SME is selected for audit, but it is thought that the CRA uses a risk-assessment system to select businesses for an audit based on various factors. Some of these factors may include:

1. Random Selection - You hit the reverse jackpot and your company is just randomly selected.

2. Audit Tips - This is the worst possible way to be selected. This usually involves a disgruntled spouse, employee or ex-partner. They can be vindictive with knowledge they actually have or think they have that may not even be factual.

3. Past Errors or Non-compliance - This would include revised and amended returns, late filing of corporate and HST returns.

4. Comparative Information -Corporate tax returns must include 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 the 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.

5. Cash Transaction Industry - If your company is in an industry in which the CRA has seen other companies involved in cash transactions, you are at a high risk for an audit, even if you are compliant. In addition, even if your industry is not known as a "cash industry", if several companies in your space have had audit issues, the entire sector comes under scrutiny.

Record Keeping and Personal Records


The CRA perceives many SME's to have less than stellar record keeping. They also find that many small business owners tend to mix their personal and business expenses (so when your accountant tells you to get a separate credit card for your business, please listen to them).

As result of the above, the CRA may now request personal records such as your personal bank statements, mortgage documents and personal credit card statements to support the SME's expenses. This is something new and upsetting to clients. As per this CRA link to business audits, the CRA states:
  • Your personal records and the personal or business records of other individuals or entities are legally considered to be part of the items that relate, or may relate, to the business being audited.
  • An auditor can examine the records of family members.
  • An auditor may ask questions of the employees who do your accounting entries or know about the operations of your business.
You should speak to your accountant if you get such a request; however, the reality is the CRA feels they are legally entitled to these records and while some disagree, until there is a court case to  the contrary, you will probably be stuck having to provide these records.

Working Backwards


It appears that the CRA is now auditing parallel tracks (business and personal). They audit your actual corporation, while at the same time they are reviewing your net worth and sources of personal funds to support your corporate income and expenses. This new audit tack requires significant time and energy to provide such information (which is often not easily accessible), let alone significant stress. In addition, you may now need to document legitimate non-taxable sources of funds, such as gifts and inheritances, in order to support that they are not subject to tax.

I assume reading this post is not the way you wanted to start your Monday morning. But I figured you rather know what is happening on the audit front than not. Or maybe not :)

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

4 comments:

  1. I am confused, isn't income tax just a temporary measure to pay for WWI, or did we sign on permanently when we joined the Coalition of the Killing?

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    1. Hi Andrew

      Temporarily when measured against the history of the world:)

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  2. We just had a request by the CRA to document all expenses related to 'professional fees'.

    I suspect it was because our professional fees are likely way out of line with other similiar business. Would that make sense? (Our fees are high because we do a lot more software than most people in our industry).

    And can I now be hopeful that since we provided records that matched to the penny, that maybe next time they have a look they give us a pass?

    Either way, even though we had everything in order and documented, it still took many hours for my wife/bookkeeper to put this together. Finding individual receipts from years ago, matching them with bank records from years ago, having to find our software from years ago and install it, etc. And very high stress the whole time (and that's with a decent set of recordkeeping).

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    Replies
    1. Hi Glenn:

      Yes, any audit request is stressful and time consuming. There is no guarantee the CRA will give u a pass next time, but on the other hand, if you had messy bookkeeping they would probably automatically come back.

      Unless the CRA has accepted your receipts and finalized the audit request, u r still not necessarily out of the woods, as they could (not likely)argue some of the software expense should have been capitalized instead of expensed.

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