Creating a small business from scratch and guiding it to success after years of hard work is one of the most fulfilling things a person can do with their life. Although the road to getting there is undeniably difficult—usually fraught with liberal doses of employee issues or supply chain problems or customer complaints along the way (sometimes all three)—the rewards are considerable: financial security, an overriding sense of accomplishment, and most importantly to many small business owners, autonomy.
As a professional tax accountant to many small businesses, as well as the proprietor of a boutique financial consulting firm, I can tell you that there’s no feeling quite like waking up in the morning knowing you’re the boss.
However, even once you attain this hard-to-reach goal and establish your small business as a profitable enterprise and a dependable fixture in your community, there are still some significant obstacles that can present themselves. Today, I want to talk about one of the scariest of them all: the government tax audit.
What is a Tax Audit?
A tax audit is when the Canada Revenue Agency (CRA) decides to review your financial records to ensure that the information you’ve reported on your tax return is accurate. Audits can be random or triggered by certain red flags, such as inconsistencies in your reported income or expenses that seem unusually high for your type of business.
While receiving notice of an audit can cause a high degree of anxiety in even the most rock-steady business owner, it’s important to remember that being selected doesn’t necessarily mean you’ve done something wrong. Sometimes it’s just a routine check. But, of course, as with anything else in the business world, it’s crucial to be prepared.
First Steps After Receiving an Audit Notice
If your small business is selected for an audit, the CRA will notify you in writing. The first thing to do is stay calm and read the letter carefully. The notice will outline what specific areas the CRA wants to review and what documents they need. Next, you’ll want to put your proverbial ducks in a row. Gather the relevant documents as quickly as possible, which may include financial statements, receipts and invoices, bank account records, payroll records (if you have employees), and tax returns from previous years.
Seek Help From Tax and Financial Pros
Even though audits are a standard part of doing business, they are without question stressful and time-consuming. If you’re unsure about anything taking place during the audit process, it’s a good idea to consult a tax professional like myself. Having a professional in your corner will help you make sure that everything is done properly, and they can also communicate with the CRA on your behalf.
The CRA allows you to have a representative, such as your accountant or financial advisor, to be present and act as your advocate during the audit. Retaining an expert who understands tax law helps to ensure that you won’t miss any critical details, and they will act to present your financial records in the best possible light.
Common Red Flags That Can Trigger an Audit
While audits can be random, certain things can increase your chances of being selected for one. Some common red flags include:
- Large or unusual deductions: Claiming expenses that are significantly higher than what is typical for your industry could catch the CRA’s attention.
- Unreported income: The CRA can cross-reference your tax return with information from other sources, like customer receipts or banking records. If there’s a mismatch, it could trigger an audit.
- Repeated losses: If your business consistently reports losses year after year, the CRA may want to take a closer look.
- Inconsistent payroll reporting: If your payroll records don’t line up with the deductions you’ve claimed, this could raise eyebrows in Ottawa.
Understanding what the CRA looks for can help you avoid unnecessary audits. The key is to make sure your financials are accurate, well-documented, and above all, honest just in case the government does decide to move forward with one.
What to Expect During the Audit
Once you’ve submitted your documents, the CRA will review them carefully. The audit process can happen in one of two ways: it can be a desk audit, meaning you send in your documents and the CRA reviews them remotely, or it can be a field audit, where a special CRA auditor visits your business to inspect your records on-site.
During the audit, the CRA may ask for additional documents or clarifications. It’s important to respond promptly and professionally. Once the CRA completes its review, it will provide you with its findings. If everything checks out, you’ll receive a notice that the audit is complete. On the flip side, if the CRA finds errors or discrepancies, you may have to pay additional taxes, along with possible interest or penalties.
Having your small business audited by government agents can be nerve-wracking, but with the right preparation and support, it doesn’t have to be a nightmare. Keep your records organized, report your income and expenses truthfully, and don’t hesitate to ask for help from the pros if needed.
Until next time, stay informed, stay prepared, and stay profitable!