Because the Canada Revenue Agency (CRA) audits businesses for compliance, there’s actually no way to completely audit-proof your business. You may follow all the best accounting practices and still have your business selected to be audited because the CRA is auditing x number of returns of your type of business that particular tax year.
But the CRA also audits returns that raise red flags when reviewed and that kind of audit can be avoided by following these “rules”:
1) Keep a clear audit trail.
An audit trail is a clearly visible record of transactions that allows the path that money has travelled to be traced. The very first step in creating an audit trail is to ensure that there can never be any confusion as to what money belongs to the business and what money belongs to you – which means that the first thing you need(ed) to do with your new business is set up a separate business bank account and get a separate credit card for your business as well.
Then you need to be religious about paying your business expenses from the right account or on the right card and putting your business income into the right account, so you’ll always have a trail that will prove what money belongs where.
2) Don’t claim dodgy or unusual expenses.
Things such as claiming 90% of your house as home business expenses or claiming a large amount of miscellaneous expenses are surefire ways of getting the CRA to take a much closer look at your business’s tax return.
Unusual expenses are expenses that look out of line in terms of your industry, your income or your tax history. For instance, if you are operating a retail business and have a large amount of meals and entertainment expenses, the CRA will want to know why.
3) Avoid revenue discrepancies.
Your revenue, being what your business takes in, is a fixed number, not a variable one. So make sure that it’s the same number no matter where you report it. The CRA will compare the revenue you report on your tax return with the revenue declared on your GST tax return, your spouse’s tax return and with “information on tax returns with information provided by employers, financial institutions, and other third parties”. If they don’t match, it’s audit time.
4) Don’t claim a loss unless you can prove reasonable expectation of profit.
The CRA is always on the hunt for people who claim they’re running businesses when they’re actually not. To be running a business, you have to be conducting an activity for profit or with a reasonable expectation of profit. Claiming a business loss will automatically trigger the question of whether or not there was any reasonable expectation of profit in what you were doing.
5) Declare all your income.
Taking cash under the table, “forgetting” to record particular transactions that produce revenue, fudging the numbers – trying to hide income from the CRA is not only stupid, it’s self-destructive. Suspiciously low income or income that doesn’t match with other tax and financial documents will certainly trigger an audit. Plus falsifying a tax return is a crime and you could end up going to jail as well as paying fines.
Scrupulous record-keeping and honesty are the keys to keeping the auditors away from your business. They make doing business easier too!