How does the CRA make sure that Canadian businesses comply with current tax law? They audit. A CRA audit can come in one of three flavors: Income Tax Audit, HST/GST Audit, and Employer Compliance Audit.
The Income Tax Audit is the most basic (and least painful) type of CRA audit. Essentially, the CRA will examine the amount of money you spent and earned. This isn't to say that an Income Tax Audit won't impact your business. It will cost you time and money.
The HST/GST Audit verifies that you have been faithfully collecting and remitting GST/HST (Goods and Services tax/ Harmonized sales tax). This CRA audit is more involved than the Income Tax Audit.
The Employer Compliance Audit is used to ensure proper withholding and remittance. It's important to note that the CRA also examines taxable benefits in this audit.
You may feel a little better knowing that the CRA will not perform both the Income Tax Audit andthe HST/GST Audit on the same firm. That's small comfort, however, when you realize that a CRA audit is time-consuming, tedious, expensive, and intrusive. It's best to avoid an audit from the start, and the best way to do that is to avoid the following red flags:
1. Neglecting to pay CPP or EI.
One of your responsibilities as a Canadian employer is to withhold CPP contributions and EI premiums from your employees' pay cheques and then to send these funds along to the CRA. In addition to your employees' contributions and premiums, you must add your own contributions to these funds. If you don't, the CRA will require that you cover both your own portion and that of your employees.
2. Reporting Consecutive Losses.
Nobody likes to admit that their businesses are suffering – until tax time, that is. The government allows for losses by offering extra tax credits. This helps fledgling businesses to make it past those difficult first years. If you report four or more consecutive losses, however, the CRA will likely audit to see what's going on.
3. Failing to Hire an Accountant or Outsourced Payroll Processing Firm.
The CRA knows that when people handle their accounting themselves, they're more prone to making errors. In addition, when you handle your own accounting, there's more temptation to include income or expenses that shouldn't be included in your reports. For these reasons, the CRA is more likely to audit small businesses who handle their accounting themselves.
4. Reporting Excessive Business Expenses.
If you report business expenses that are much higher than you usually report, or if your business expenses are higher than other similar businesses in your area, the CRA may want to find out why. Sometimes businesses report higher-than-usual business expenses when they face a big expansion or remodeling project. You can avoid this red flag by spreading your business expenses out over several years instead of tackling everything at once.
5. Receiving Most of Your Income in Cash.
The CRA looks for unreported income, and cash deposits will be scrutinized. You should be able to explain each of your cash deposits, especially if they're not being reported as income. The CRA especially targets small businesses when it comes to analyzing cash income.
An outsourced payroll processing service can help to minimize your risk of a CRA audit by guaranteeing proper withholding and remittance, helping you to become 100% compliant, and structuring your payroll processes to avoid audit red flags. If you feel that you're currently on shaky ground when it comes to a CRA audit, take steps today to improve your situation and your peace of mind.