As a small business owner in Canada, being audited by the Canada Revenue Agency (CRA) can be a most daunting experience. You have enough to do managing your business without undergoing a time-sucking and possibly expensive tax audit. The Canada Revenue Agency (CRA) audits companies some times on the basis of a random selection but most tax audits are caused by the content of the tax return. Certain red flags may draw the attention of CRA computers and auditors. Far from picking names out of a hat, the Canada Revenue Agency (CRA) has a sophisticated assessment system working behind the scenes. 

But how can you avoid getting audited in the first place?

Follow these 5 simple tips, and you can decrease your chances of getting audited by 90%:

1. Not reporting income

It’s very basic but very important, make sure you report 100% of your income. If one year your report $200,000 in income and next year you report only $20,000, you could set off alarm bells for CRA auditors. The agency’s algorithms look for relative consistency in income.

2. Claiming high business expenses

Claiming significantly higher amounts of tax deductions and credits than previous years. Claiming your entire personal residence as a place of business. Attempting to deduct 100% of your vehicle use as a business expenses. All of these are examples of red flags that CRA auditors look for. Always limit expense claims to those that truly relate to your business and be reasonable. 

Businesses need to be cautious about certain expenses such as advertising and promotion, meals and entertainment, travel, miscellaneous, and interest expenses. If not considered reasonable given the nature of the business, they will be scrutinized by the CRA. False deductions can lead to interest and penalties on your tax return.

3. Having family members on the payroll

There is nothing wrong with having your family members on payroll of your business as long as you follow the rules. As long as the compensation paid to your family member is commensurate with the salary or wage the business would pay to anyone else to do the same job, it is considered legitimate.

4. Recurring losses

Losses are part of every business but having losses over several years in a row will trigger a red flag. If you have a rental property, it is possible that your expenses may exceed your rental income in an year when you go through extensive repairs and renovations but if losses occur for consecutive years, CRA will likely take notice.

Be ready to justify your claim with a well-documented account of your expenses.

5. Making large charitable donations

The CRA has a record of how much taxpayers at each income level usually give to a charity, so a red flag pops up when your charitable donations exceed that number. Donations involving capital property are especially likely to be reviewed.

Final words

Preparing tax returns can be a daunting task, particularly for incorporated businesses or individuals with business and rental income. Experienced and qualified accountants do this work every single day, understand tax law and know how to help to minimize the potential for a tax audit. Let professional DM Tax accountants handle all communications and filings with CRA to avoid potentially incriminating yourself or your business, or making additional errors that could result in steeper penalties, interest payments and, in a rare worst-case scenario, criminal charges.