In March, we told you what to do to make sure you don’t get audited this tax season. Maybe you listened, maybe not. Either way, here’s what happens when you actually get audited.
What exactly is a tax audit?
During an audit, the Canada Revenue Agency (CRA) closely examines books and records of small and medium-sized businesses to make sure they’ve filled out their returns correctly and applied the law appropriately. Under the Income Tax Act, you can be audited at any time in cases of fraud or misrepresentation, or at any time up to four years after the date of mailing the original assessment.
But it’s not how it looks in movies. An auditor from Canada Revenue Agency isn’t going to come to your house. In the extremely unlikely event that he or she does, you don’t have to talk to them.
“I have never seen an auditor just appear out of the blue. They can’t show up at a dwelling … and enter without a person’s consent,” says John Sorensen, a partner at law firm Gowling WLG. “If someone came knocking on your door, and said ‘Hi, I’m from the CRA. Can I come in and look around?’ you can actually say, ‘No you can’t — go get a search warrant.'”
Are there different types of audits?
According to Sorensen, there are two kinds of audits. There are times when an auditor might really be just looking to confirm certain expenses and it’s not uncommon for individuals to be double-checked.
“We call that process a desk audit,” he explains. “Someone sitting at a CRA office might just flag a taxpayer’s moving expenses, that’s something they tend to look at along with the deduction of legal fees. It’s not very scary and if the taxpayer has good records that shouldn’t be a challenging exercise.”
It seems simple enough; the CRA wants to double-check a claim you made, so you show them the receipts you’ve meticulously filed away over the last year. But what happens when you can’t find the paperwork or appropriate support to back a claim? Well, things get tricky. Sorensen says that for the most part, CRA auditors know what they’re doing and are professional.
“They don’t tend to be abusive of their powers,” he says. “But if a taxpayer cannot justify expenses, there’s a pretty high likelihood that the auditor would deny the expense and have a notice of reassessment issued, which increases the taxpayers tax exposure.”
In a nutshell, this puts you on their radar, which is not a good place to be. If the CRA starts looking into your return closely and discovers that there are deliberate omissions, it may assess a substantial gross negligence penalty. This penalty is the greater of $100 or 50 per cent of the understated tax and/or the overstated credits related to the false statement or omission, which can work out to a substantial amount.
Aside from the matter of the CRA asking factual questions about expenses, the other main thing Sorensen deals with is varying interpretations of the Income Tax Act.
“It’s virtually impossible to draft a tax law that would be deadly accurate in every conceivable circumstance,” he explains. “The statute uses some broad wording and we get into debates about what exactly the wording means. The goal isn’t to “cheat the tax man” — it’s to make sure the right result is achieved in accordance with what Parliament intended.”
How will the CRA contact me?
In all cases, you will receive an initial letter in the mail. In some instances, the taxpayer may receive a phone call and then a follow-up letter with a lengthy request for documents and information. Depending on the circumstances, CRA auditors are entitled to attend at a place of business and review records that are kept there or examine inventory.
But be careful when dealing with CRA agents on the phone, cautions CRA Communications Manager Paul-Noel Murphy. Watch out for their language and insist on written communication.
“We’ve got these people pretending to be collectors and auditors and they’re calling and saying that they’re CRA,” he says. “They use really aggressive language and they threaten to put you in jail if you don’t pay your tax bills. That’s not the way that CRA communicates with the public.”
Another telephone scam goes a step further and asks for payment immediately. Murphy says the CRA has received several reports from the RCMP’s Canadian Anti-Fraud Centre that more and more people are falling for these stings.
“There’s scams where they’ll call and ask you for payment immediately,” Murphy cautions. “They want [to be] paid by prepaid credit or by gift cards. It’s things like people going out to a corner store and buying iTunes gift cards and then being required to hand over the authorization codes over the telephone. These are not legitimate ways that the CRA would ever ask you to pay your tax bills. That’s a really prominent scam out there.”
What should you do if you the CRA declares its intention to audit you?
Assuming that you’re dealing with real CRA auditor and not a con artist, Sorensen’s general advice to clients is to be compliant and play nice.
“Auditors do have broad powers under the income tax act,” he says. “Failing to answer proper questions can be an offence that can lead to fines and even prosecution. On a less drastic note, if a taxpayer is obstinate or difficult, they will almost certainly get flagged as being not transparent and they’ll increase their risk profile for future audits. They’ll flag you and keep coming back year after year. It’ll drive you up the wall.”
Sorensen also stresses the importance of getting a lawyer involved. Accountants and other professionals are useful, but there’s one thing they can’t do.
“Your communications with your lawyer are subject to solicitor-client privilege whereas an accountant could be forced to disclose them,” he says. “If you tell your accountant, ‘Hey I’ve been hiding money offshore for years because I just didn’t feel like paying taxes and I feel like it might be tax evasion,’ you’ve just confessed to a crime to someone who could be compelled to testify against you.”
How long does all this take?
An audit can certainly be drawn out, Sorensen says. If a taxpayer isn’t happy with the result of the audit, there’s an appeal process with the CRA.
“We’ll file what we call a notice of objection and pursue the dispute at a higher level,” he says. “If we don’t get a result at that stage, there’s a dedicated Canadian court — the Tax Court of Canada — that sits in about 70 different cities in Canada. There’s around 24 judges that travel and sit in cities and towns all over Canada to hear tax disputes. This is not a branch of CRA, it’s a completely independent superior court at the federal level to hear tax disputes. There are internal appeal processes, you can end up going as far as the Supreme Court of Canada on a tax dispute.
What’s the worst that can happen?
The worst possible outcome is that the CRA could take the position that your filing reflects gross negligence. You may be subject to high civil penalties and could be prosecuted for tax evasion if the circumstances support that conclusion, or even criminal fraud.
“Worst possible outcome is extremely bad,” Sorensen says.
Can I pay these CRA penalties in The Keg/iTunes/Staples gift cards?
Again, no. Legal tender only.