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Small Business and Freelancer Tax Audits: What You Need to Know

Yes, the CRA often audits small business owners and freelancers. But the first thing to know: don't panic

According to the CRA, audits are required in order to ensure that Canadian tax legislation is followed. And it is not just very wealthy individuals or big businesses that can be subject to them. Small business owners and freelancers may find themselves subject to them as well.

If your business is selected for review, it may merely be a review or preliminary audit of a specific aspect of your business, such as a HST filing; in many situations, you can reply to these reviews by providing documents online using the CRA My Business Account. In rare situations, however, your account may be selected for audit after the risk assessment on your company return.

At this point, lots of people panic. But there is rarely a need to, especially if you remain calm, try to understand the process better and get some expet advice.

How a CRA Audit Begins

If the CRA decides to audit you, you will be contacted by an auditor, who will phone or write to schedule a meeting. It could happen on-site at your company or off-site at a different location.

The auditor will submit a pretty thorough, yet broad, list of items that they want made available to them during or before the audit. We understand that getting audited can be a frightening experience for many small businesses, but it shouldn’t be.

The CRA is usually only looking to make sure things match what you’ve claimed. If you’ve kept all your documents that you’ve claimed being audited. If you work with a tax accountant, we will have advised you to do that (and can even hold onto such things for you as an extra safeguard.)

The auditor may request to inspect your business and personal documents, ledgers, accounting records, invoices, credit card statements, bank statements, bills, and contracts, among other things. If you have business partners, the auditor may need to see similar personal financial documents from them as well.

The auditor’s only job is to double-check that your records match the numbers on your tax return. The procedure is complete if everything matches and no further action is needed or will be taken. The process will have been annoying and even upsetting, and you may wonder why you were ‘targeted’ but it will end at that point.

If the auditor finds erroneous or missing information on your tax return, they will ask for an explanation, and if they aren’t satisfied or convinced, they will propose that your claims be refused and the account reassessed.

What if You Disagree With an Auditor’s Assessment?

If you disagree with the auditors’ conclusions, you have a limited time to object to the findings from the date the Notice of Assessment was issued. If you object, you must offer additional information to the CRA so that they can review the previous assessment and the reasons for it again. You have 90 days to object, and you can do so either online using the Register My Formal Dispute Option in your CRA My Account, or by filling out form T400A and mailing it to your local tax office.

If the CRA agrees with your findings, a Notice of Reassessment will be issued, and the assessment will be reversed.

You can pay the tax owed if the CRA disagrees or you find that their assessment was correct. You are not required to wait for the CRA to issue a reassessment. Instead, you might get an estimate from the auditor and pay in advance. This aids in the reduction of interest and penalties — and every little bit helps.

You can object again if you disagree with the CRA’s review of your objection, but this time to the Tax Court of Canada.

What Triggers an Audit of a Small Business?

Most small business owners and freelancers who are selected for audit often want to know why they were targeted, especially if, as far as they know, they did everything right.

The CRA chooses which returns to audit based on a variety of factors, including the risk of problems with particular credits or deductions you’ve claimed. According to your industry (SIC) code, the agency also analyzes results to past years or to similar organizations or lines of business. They also check people at random, so you could end yourself in that pile.

If you file a tax return and claim significantly more or less deductions or credits than in previous years, you may be subject to an audit.

Excessive home office claims, writing off 100 percent of your company car expenses, reporting much less income than your neighbors, or claiming repeated losses from rental or self-employment may also provoke an audit.

Being self-employed raises the chances of your return being audited. However, if you have a good record-keeping system in place, such as working with a seasoned tax accountant, you shouldn’t have to worry about being audited. And you’ll have a very valuable expert on your side in the event that you are.