Audit Red Flags - Mistakes to Avoid in Your Business
Nobody wants to be audited, especially if you’re running a business. Audits can be stressful, time-consuming, and expensive if mistakes are found. But the good news is that most audits happen because of avoidable red flags.
In this post, we’ll break down what you need to know about CRA audits, the mistakes that businesses commonly make, and how to avoid costly errors. Staying compliant and audit-ready is key to running a successful business. Let’s dive in!
What to Know About CRA Audits
Did you know the CRA conducts audits to ensure businesses are following tax laws and paying their fair share?
Let’s break down why audits happen, how they work, and what to expect if your business is selected for one.
Purpose of CRA Audits
The CRA conducts audits for three main reasons:
- To make sure businesses comply with Canadian tax laws.
- To promote fairness in the tax system, ensuring everyone is paying their share.
- To verify that businesses receive the appropriate benefits or refunds they’re entitled to.
Ultimately, audits are about maintaining trust and integrity in the tax system.
How Audits Are Triggered
The CRA doesn’t just select files randomly, they use a risk assessment process. Here’s what they look for:
- The likelihood of errors in your tax return.
- Signs that your business might not be complying with tax obligations.
- How your business compares to others in similar industries.
- Findings from other audits or investigations.
If something in your tax return looks unusual or inconsistent, that could trigger an audit.
Audit Process Basics
If your business is selected for an audit, here’s what happens:
- A CRA auditor will contact you by phone or mail to schedule the audit.
- Audits can happen on-site at your business, at your accountant’s office, or remotely.
During the audit, the CRA will review your records, which could include:
- Business documents like ledgers, invoices, receipts, and bank statements.
- Personal financial records, such as credit card or bank statements.
- Records from related parties, like family members or business partners, if they’re relevant.
Outcomes of an Audit
At the end of an audit, there are three possible outcomes:
- No adjustments: Everything checks out, and your tax return is accurate.
- Reassessment: The CRA finds discrepancies, meaning you might owe more tax or be entitled to a refund.
- Dispute: You have 30 days to agree or disagree with the findings. If you disagree, you can provide more information or escalate the issue to an appeal.
Understanding these basics can help you stay prepared and avoid surprises.
Top Audit Red Flags for Businesses
Even small mistakes can trigger an audit. Let’s break down some of the most common red flags the CRA looks for in businesses.
Discrepancies in Income Reporting
One of the biggest red flags for the CRA is when your income numbers don’t match up. For example, if your tax filings show different income than what’s in your financial records, it can raise questions. Mismatches with CRA data or third-party reports, like T4 or T5018 slips, or inconsistencies with your bank records are common triggers.
The key is to ensure that all your income is reported accurately and consistently.
Excessive Business Expense Claims
Claiming too many expenses, or the wrong kind, can also catch the CRA’s attention.
Meals and Entertainment (M&E)
Meals and entertainment are one area the CRA watches closely. They only allow you to claim 50% of these expenses, so overclaiming more than that is a red flag. Plus, if you don’t keep proper receipts or can’t prove the business purpose of those expenses, you could be in trouble.
For more details, check out our guide on properly deducting meals and entertainment expenses.
Travel Expenses
Travel expenses are another hot spot. The CRA often sees claims for personal vacations disguised as business trips. Without itineraries, agendas, or travel logs to back up your claims, you’re at risk of an audit. Make sure your travel expenses are clearly documented and directly tied to your business.
Large or Frequent Cash Transactions
Cash transactions can also draw attention, especially in industries like retail or hospitality. If your business deals with high volumes of cash deposits or withdrawals, it’s essential to keep detailed records.
Failing to document or properly report these transactions can make your business look suspicious to the CRA.
Misclassification of Workers
The CRA is cracking down on businesses that misclassify workers. If you treat employees as independent contractors to avoid payroll taxes, you could face back payroll taxes, penalties, and interest.
It’s important to follow CRA guidelines to ensure your worker classifications are correct. To learn more, check out our guide on the differences between employees and contractors.
GST/HST Filing Errors
Errors in GST/HST filings are a common reason for audits. Not remitting the GST/HST you collect from customers is a serious issue, and so is overstating your input tax credits by including ineligible expenses.
If you use business assets for personal purposes, make sure you’re adjusting your filings accordingly.
Chronic Losses or Unusual Profit Margins
The CRA expects businesses to operate with a reasonable expectation of profit. If you report losses year after year, the CRA might question whether your business is legitimate or just a hobby.
Similarly, profit margins that don’t align with industry standards can raise eyebrows. To avoid this, make sure your financials reflect a clear and sustainable business model.
Home Office and Vehicle Expense Overclaims
Home office and vehicle expenses are often overclaimed, which can flag your business for an audit. Overestimating the percentage of personal space or vehicles used for business purposes is a common mistake.
Without mileage logs, receipts, or proper calculations, your claims might not hold up. Be diligent in tracking and calculating these expenses.
Other Common Areas Reviewed by CRA
Owner Drawings and Personal Benefits
If you’re misclassifying personal drawings as business expenses or including personal items like gym memberships as deductions, the CRA will take notice. Make sure these expenses are clearly separated from your business finances.
Shareholder Loans
Shareholder loans are another area of scrutiny for the CRA.
If you take a loan from your company and don’t repay it within the required timeframe, it could be treated as a taxable benefit. To avoid this, follow CRA rules carefully and keep detailed records of any loans.
For a deeper understanding, check out our comprehensive guide to shareholder loans.
How to Avoid Audit Red Flags
Now that we’ve covered the common mistakes that can trigger an audit, let’s talk about how to avoid them. With a few proactive steps, you can keep your business compliant and reduce your audit risk.
Use Reliable Accounting Systems
Using reliable accounting software like Xero or QuickBooks can help you stay organized and automate the tracking of income and expenses.
These systems also make it easier to generate accurate financial reports, which are essential for your tax filings. When your records are clear and consistent, it’s much harder for errors—or red flags—to slip through.
Maintain Proper Documentation
Documentation is your best friend in the event of an audit. Keep receipts, contracts, and mileage logs for all your business expenses.
Organize your records so they’re easy to access and well-categorized. Clear documentation can back up every claim you make, reducing the chances of disputes with the CRA.
Hire Professional Support
Even the most diligent business owners can benefit from professional advice. Working with an experienced accountant can help you review your financials and ensure your tax filings comply with CRA rules.
A professional can also catch errors you might miss and provide guidance on complex areas like GST/HST filings or employee classifications.
If you’re looking for expert guidance, Avalon Accounting is here to help reduce your stress and ensure your compliance.
Stay Proactive with the CRA
If you receive a notice or request from the CRA, don’t ignore it. Responding promptly shows that you’re cooperative and organized. Address any errors or discrepancies as soon as possible to prevent small issues from escalating.
The sooner you engage with the CRA, the easier it is to resolve concerns and avoid penalties.
Final Thoughts
We’ve covered a lot about CRA audits: what they are, the common red flags to watch out for, and how to avoid them. Understanding how CRA audits work can help you steer clear of mistakes that could trigger one.
Prevention starts with reliable systems, proper documentation, and professional advice to keep your business compliant and audit-ready.
If you’re looking for expert help, Avalon Accounting is here to support your business every step of the way.
