In April we introduced you to Audit Shield – a program that covers the cost of defending an audit from the CRA. Accountancy Insurance is the company that sponsors our Audit Shield program and they also do so for other accounting firms across the country. This month they released some interesting statistics on the most common CRA audit activity areas in Canada.
In this blog post we share some highlights from their report, along with some comments on what we have seen in recent years at Reach.
Processing Reviews of Personal Tax Returns
According to the AuditShield report, reviews of personal tax returns make up almost a third of CRA audit activities. The most common areas being scrutinized are medical expenses, charitable donations/government gifts, non-business foreign taxes paid and eligible tuition fees. Below, we discuss these commonly audited areas from our clients’ perspective.
Medical expenses
Our experience: We see about 5% of the returns we prepare be randomly selected for a review of medical expenses. It jumps to over 80% if the medical claim is for $15,000 or more (not so random anymore). For all the returns audited, substantially all the medical expenses were approved by the CRA.
Charitable donations/government gifts
Our experience: We see close to 1% of the returns we prepare be selected for a review of donations/gifts, and they all have been for relatively large amounts ($5,000 or more). In our experience, all returns have been fully accepted by CRA.
Non-business foreign taxes paid
Our experience: Like with medical expenses, we see around 5% of the returns we prepare be randomly selected for a review of foreign tax credits. These returns are often related to standard investment income information that CRA should already have.
Unlike the other two categories above, we see CRA reviews for some petty amounts. And, unlike the above, we have seen some foreign tax credits denied because we were not able to provide a copy of the US (or other country) tax return – a high demand when it pertains to publicly traded partnerships or trust.
Eligible tuition fees
Our experience: We see approximately 1% of the returns we prepare be randomly selected for a review of tuition fees. All tuition fees have been legitimate and have been accepted by CRA.
Audits of Specific Areas of Corporate Tax Returns
Over a third of CRA’s audit activities focused on specific areas of corporate tax returns. Two areas that are getting a lot of CRA attention in the last little while are outlined below:
Professional fees
Our experience: We see about 5% of the corporations we work with be randomly selected for a review of their professional fees. A few are still pending CRA’s conclusion, but the audits that have been wrapped up by CRA were resolved satisfactorily.
Vehicle over $30,000
Our experience: We see close to 3% of the corporations we serve be randomly selected for an audit of vehicles purchased for a cost of more than $30,000. With these specific audits, CRA is looking to make sure those vehicles are correctly classified for Capital Cost Allowance (‘CCA’) purpose. Again, all those resolved to date have been accepted by CRA.
Sales taxes: GST/HST and PST
Across the country, approximately 20% of the tax audit activities are focused on GST/HST and PST.
Our experience: We see roughly 2% of the businesses we work with be randomly selected for a sales tax audit. In most cases, the focus was narrowed, such as only providing the 10 largest sales and purchase invoices. The results here have depended on the quality of the bookkeeping, which varies depending on who prepares the books.
Other
According to Accountancy Insurance, the remaining 15% or so of audit activities are spread across payroll, full tax return audits (as opposed to specific items), employer compliance audit (such as WorkSafeBC) and other miscellaneous, narrow areas.
Our experience: We are a bit surprised that payroll-related audits are included in this remaining 15%. We have been asked to assist with a fair number of payroll-related audits for our clients and expected this to be higher.
The pie chart below shows the current distribution of AuditShield claims activity in Canada*.
Key Takeaways
Our tax system is one based on willing compliance with the law. CRA does not select individuals or corporations for audit based on the tax return having a mistake or being fraudulent; they cannot know that until they audit the return. So, they do their selection randomly to encourage people to file accurate and complete tax returns.
Under this system, you are “guilty until proven innocent”. This means that for 9 out of 10 audits we may assist you with, CRA will conclude that the tax return was accurate all along. That’s right. All that effort, stress and costs to prove that you were right in the first place!
The other 1 out of 10 will fall into four categories:
We could not provide the documents or information CRA requested. One of the biggest culprits we see here is a mileage log request for claiming a business or employment use of a personal vehicle. Without it, or some other persuasive evidence, mileage deductions are often fully denied by the CRA.
The cost of providing the information outweighs the tax-saving, even though the tax return filed was accurate. We are talking about a $30 foreign tax credit for which CRA wants you to provide them a copy of the impossible-to-get tax return for some publicly traded investment you hold.
Some tax rules can be subjective, and it is not always 100% clear what should be reported on a tax return – there is a range of positions, from ultra conservative to super aggressive. In such case, a CRA audit may result in a challenge of the position taken. A common and simple example that comes to mind are transactions with a related party or oneself that are required to be at fair market value.
Lastly, the audit may uncover some genuine errors. Accurate bookkeeping and record keeping is the first line of defense here. And when you are not sure about something, you can always ask us.
Should you sign up for our Audit Shield program?
It depends!
First, we suggest that you consider your chances of being randomly selected for an audit, taking the factors below into consideration:
How many of the general areas could you be audited for? This includes corporate tax, personal tax, GST/HST, PST, payroll, and WCB. Each have a roughly 3-5% chance of being randomly selected, so the more you have, the higher your chance of winning the audit roulette.
Do you report some items on your return that are highly susceptible to audit due to their nature or size? Employment expenses, moving expenses, scientific research & experimental development, large deductions such as foreign fax credit, medical and donations would fall into this category. The chance of one of these categories being “randomly” selected for audit is roughly between 20% and close to 100% in some cases. Those of you at the higher end already know the routine.
Then we suggest looking at the complexity of responding to an audit for any of the above scenarios. The more complex issues generally incur a higher cost of professional fees to assist you. Here is a rough rule of thumb:
Scanning and sending a few well-organized receipts to the CRA. You would be looking at $50-$75 per hour and under an hour.
Sort out bookkeeping errors and/or poorly organized receipts before sending to the CRA. This would cost you around $50-$100 per hour for a few hours of our time.
This would involve building support from scratch because no records were kept. You can expect to be changed $100-$250 per hour for 3 or more hours of our time.
Requires assistance from valuator/appraisers, or tax lawyers in addition to what has been outlined above. This can cost you anywhere from $250 to $700 per hour and would be a full-blown project.
Lastly, combine the estimated response cost spread and how often, if at all, you might be audited based on the above. Then compare that to the annual cost of participating in our Audit Shield program.
We have gone over this exercise (more or less formally) with some of you already: sometimes it made sense to sign up for AuditShield, and other times it has not. If we have not discussed this together already and the above exercise does not leave you with a clear answer, well, you know where to find us.
Accountancy Insurance. (2018). Claims activity across Canada [PDF file]. Retrieved from: https://www.accountancyinsurance.ca/images/Claims-activity-across-Canada-June-2018.pdf