Facing a CRA audit can be daunting. In this guide, we’ll break down common audit triggers, define non-compliance, and provide actionable advice to help you protect your business from unwanted scrutiny.
This guide is part of our series: Navigating a CRA Audit: A Guide for Small Businesses.
Check out the rest of the series here:
- CRA Audit Survival Guide: Understanding Non-Compliance and Audit Triggers
- What to Do After a CRA Audit: Recovery, Compliance, and Rebuilding Trust
- How to Survive a CRA Audit: Steps and Best Practices
Key Takeaways
- Every Entrepreneur Should Learn CRA Audit Triggers. Understanding what actions or mistakes typically lead to a CRA audit, including underreporting income, overstating expenses, and non-compliance with payroll taxes, can empower you to reduce your audit risk and deal with audits efficiently.
- Accurate Record-Keeping is Your Best Defense in An Audit. Proper bookkeeping and organized records are your best defence against audits and non-compliance notices.
- Understanding Your Obligations Can Minimize Audit Risk. Learn proactive steps to avoid non-compliance, including understanding tax laws, filing on time, and consulting with tax professionals.
- You Can’t Fully Avoid a CRA Audit. While good practices reduce audit risk, no business is completely immune to being audited. The CRA uses random selection and risk-based assessments, meaning even compliant businesses may be audited as part of their routine oversight.
What is Non-Compliance?
Non-compliance refers to a failure to adhere to tax laws, regulations, and reporting requirements set forth by the CRA. It can range from unintentional errors to deliberate attempts to evade taxes. Understanding what constitutes non-compliance is crucial for small businesses to avoid potential audits and penalties.
Types of non-compliance include:
- Failure to file tax returns on time
- Underreporting income
- Overstating expenses or deductions
- Failing to remit payroll deductions
- Improper GST/HST reporting
- Misclassification of employees as contractors
Avoid these common non-compliance issues by working with a CPA and using Enkel’s outsourced services for accurate bookkeeping, reporting, payroll management, and more.
Common Mistakes and Inaccuracies Leading to Non-Compliance
Small businesses often fall into non-compliance due to various mistakes and inaccuracies, including:
- Incomplete or inaccurate record-keeping
- Misunderstanding of tax laws and deductions
- Cash transactions not properly recorded
- Mixing personal and business expenses
- Incorrectly calculating GST/HST
- Failing to keep receipts for claimed expenses
CRA Actions for Different Types of Non-Compliance
The CRA's response to non-compliance varies depending on the severity and perceived intent of the issue. The actions generally fall into one of the five following buckets:
- Educational approach: For minor or first-time errors, the CRA may provide information and guidance to help the business correct its practices.
- Warning letters: The CRA may issue warning letters for more significant issues, outlining the problem and requesting corrective action.
- Penalties and interest: For more severe cases, the CRA can impose financial penalties and charge interest on unpaid taxes.
- Audits: When non-compliance is suspected to be extensive or deliberate, the CRA may initiate a comprehensive audit.
- Legal action: In cases of severe non-compliance or suspected fraud, the CRA may pursue legal action, including criminal charges.
Material Misrepresentation and Fraud
While most non-compliance issues are due to errors or misunderstandings, some cases cross the line into fraud. The CRA considers a tax return fraudulent when there is clear intent to deceive or evade taxes.
- Factors that may indicate fraud include:
- Consistent and significant underreporting of income
- Fabrication of expenses or deductions
- Maintaining two sets of books
- Deliberately destroying or altering financial records
- Complex schemes to hide income or assets
It's important to note that the burden of proof for fraud is high, and the CRA must demonstrate clear intent to deceive. However, the consequences of being found guilty of tax fraud are severe, including substantial fines and potential imprisonment.
CRA Audit Triggers
While the CRA doesn't disclose all its criteria for selecting businesses for audit, several factors are known to increase the likelihood. These CRA audit triggers include:
- Significant changes in reported income or expenses from year to year
- Income inconsistent with the industry average or local economic conditions
- High ratio of expenses to income compared to similar businesses
- Large or frequent cash transactions
- Discrepancies between tax returns and other information slips (e.g., T4s, T5s)
- Operating in a high-risk industry (e.g., cash-based businesses, construction)
- History of non-compliance or late filings
- Tips from informants or public information suggesting potential non-compliance
- Random selection as part of the CRA's statistical sampling process
The Importance of Sound Bookkeeping Practices
Maintaining accurate and comprehensive financial records is crucial in mitigating non-compliance risk and reducing the likelihood of an audit. It’s also the key component to defending your claims in the event of an audit. Certain data is more valuable and essential on this page than other factors, however. As such, sound bookkeeping practices include:
- Keeping detailed records of all income and expenses
- Regularly reconciling bank statements with financial records
- Separating personal and business finances
- Using accounting software to track transactions and generate reports
- Retaining receipts and supporting documents for all claimed expenses
- Staying informed about tax law changes and deadlines
- Consulting with a professional accountant or tax specialist when needed
By implementing these practices, small businesses can:
- Ensure accuracy in tax reporting
- Quickly identify and correct errors
- Provide clear documentation in case of an audit
- Demonstrate good faith efforts to comply with tax laws
Challenges in Maintaining Compliance
Despite their best efforts, small businesses may face several challenges in maintaining compliance. But there are always workarounds, especially when partnering with tax and tech pros who have ample experience navigating CRA audits.
Challenge 1: Complexity of Tax Laws
Tax regulations are often complex and subject to change, making it difficult for business owners to stay informed. When you partner with tax pros who are, by default, keeping in lock-step with the latest amendments and modifications to the tax code they’ve already mastered, you can rest assured that complex language won’t throw your tax claims for a loop.
Challenge 2: Resource Constraints
Small businesses may lack the financial resources to hire dedicated accounting staff or invest in sophisticated accounting systems. Solutions like Boast offers services that allow teams to work smarter, saving significant time and resources that would otherwise go to tax claim preparation.
With resources freed up throughout the claim process—and higher returns, refunds and tax credits as a result—resource constraints loosen up—and opportunities to double down on investments come to light.
Challenge 3: Time Management
Business owners often wear many hats, making it challenging to dedicate sufficient time to bookkeeping and tax compliance. By working with partners who can take on the heavy lifting for key (but tangential) activities like R&D tax credits, key team members can focus on their day-to-day while projects can remain on track (and even enjoy more funding down the line).
Challenge 4: Industry-Specific Issues
Some industries have unique tax considerations that require specialized knowledge. Folks like the tax and tech experts at Boast are technologists in their own right, with unmatched expertise in building game-changing solutions and sourcing non-dilutive capital to drive even greater innovation.
Challenge 5: Growth-Related Challenges
As businesses grow, their tax obligations become more complex, potentially leading to compliance issues if not properly managed. By working with a continual partner for tax claim preparation who has key integrations to your primary workflows and sources of financial data, the claim and audit process becomes passive and seamless.
Conclusion
Understanding non-compliance and what triggers a CRA audit is crucial for small businesses in Canada. By recognizing common pitfalls, implementing sound bookkeeping practices, and staying informed about tax obligations, businesses can significantly reduce their risk of non-compliance and the associated consequences.
Remember, while the prospect of a CRA audit can be intimidating, maintaining accurate records and seeking professional advice when needed can help ensure your business stays on the right side of tax laws. In the event of an audit, well-maintained records and a history of good faith efforts to comply can make the process much smoother and less stressful.
By prioritizing tax compliance and maintaining transparent financial practices, small businesses can focus on what they do best – growing their operations and contributing to the Canadian economy.
About the Author
Boast works with hundreds of companies across North America to craft defensible R&D tax credit claims while also offering 100% audit defence guarantees in the event the CRA or provincial government contests a claim.
Talk to one of Boast’s SR&ED experts to learn more.
