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.
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.
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.
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:
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.
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.
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.
