Red flags that could get your small business a CRA tax audit

Credit to Author: Shalini Dharna| Date: Tue, 13 Jun 2023 21:28:05 +0000

You went into business to offer your product or service; what you didn’t know was that you also went into a partnership with the Canada Revenue Agency (CRA). “Big Brother is always watching” as they say, and this causes entrepreneurs to experience such anxiety – the fear of doing something wrong, getting in trouble with CRA and being thrown into the famous CRA jail.

The reality is, being sent to CRA jail requires malicious intent to deceive CRA. However, CRA can – and does – frequently audit small businesses. When this happens one of two things will happen:

  1. They will disallow any iffy expenses and recalculate the tax return. Odds are you will now owe CRA money back; there will be interest on this balance owing.
  2. If you truly believe the expense is justifiable you can appeal any CRA decisions and take it all the way to court (depending on how aggressive you want to be).

So, what are some of the red flags that can lead to attention from the CRA? Before we get into that I want to also emphasize that there is always an element of random selection for CRA audits; but certain things on your tax return can certainly be a trigger.

Inconsistent reporting across forms

In the day and age of electronic submissions, it’s easy for CRA to compare information being reported across different platforms. For example, the total sales reported on your HST remittance should probably match the total sales on your tax returns!

To avoid this, proper bookkeeping is critical. Keeping detailed records of all your transactions in a proper accounting software ensures the financial statements you prepare are accurate and consistent when you file your various forms and reports.

Cash intensive businesses

Businesses that tend to work a lot with cash (for instance, gas stations, convenience stores, restaurants) are often audited for obvious reasons – cash is harder to track and therefore CRA wants to ensure all the numbers being reported are truly accurate. The part that entrepreneurs trying to hide cash tend to forget is…. numbers don’t lie!

For example, if you’re expensing $10,000 worth of inventory, but only reporting $3,000 worth of sales and don’t have inventory sitting on the shelf – that doesn’t add up! Or if you’re paying your employees tips in cash and not reporting it on the books – your point-of-sale systems won’t reconcile.  Numbers don’t lie!

Large and excessive expenses

You’re a business owner, that means you can write off whatever you want right? Wrong.  CRA has a very clear definition of a business expense – it is an expense necessary and reasonable to help you earn income. This means that if the business ceases to exist the expenses usually cease to exist. There are some expenses that mix business and personal (business use of home and business use of vehicle) and CRA has some up with specific formulas and criteria on how to calculate these expenses. CRA tends to audit these expenses often to ensure you’re complying with the formula.

A pro tip is to document why the expense is necessary and how it helped your business. Especially for those large one-off expenses. For example, if you travelled to the Bahamas for a business trip document who you met with, what was discussed and outcomes. You are allowed to add in an extra few days for personal – but those personal days are not write offs!

Running a business comes with a big learning curve for entrepreneurs. As long as you are open and honest, and not doing anything intentionally wrong, an audit is nothing to be scared of! Your accountant should be educating you on the CRA guidelines and helping you make informed decisions for anything you’re putting through your books/taxes that may be scrutinized.

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