If you have been selected for a CRA audit, you may be wondering what kind of tests they will perform.
While this largely depends on whether the CRA auditor believes your records are accurate and reliable, they are also required to perform a number of indirect tests to verify that what you have earned has actually been reported. These tests typically apply to owner-managed, small and medium sized businesses, where there are fewer internal controls in place.
There are two types of Indirect Verification of Income (IVI) techniques used in a CRA audit– supporting and assessing. Supporting IVI tests cannot be used to calculate a tax reassessment. These are merely used as an estimate to help the auditor determine whether there are amounts that have not been reported.
Supporting IVI techniques
Bank Deposit Analysis
- The auditor will ask for your business and personal bank statements.
- The CRA audit will analyze all bank deposits and withdrawals to determine whether the gross revenue reported and related expenses are reasonable.
Rough Net Worth
- This method looks at whether an individual or business has generated enough money to support their personal expenses and any increase in net worth.
- The CRA audit will look at external factors including whether you have enough money to support a certain lifestyle or live in a certain area. They use estimates, information from your bank account, as well as information from Statistics Canada to conduct this analysis.
- The auditor will ask for all personal bank, investment and credit card statements. They may also ask to see mortgage and loan documents, insurance policies, property tax and utility bills.
Source and Application of Funds
- This test is primarily used for self-employed individuals.
- The CRA audit will look at where your income comes from and compares it to the income that has been reported.
- Under this method, the CRA audit will analyze the company’s balance sheet and income statement, and compare the financial ratios to industry averages. Some of the main ratios they look at are gross profit and working capital.
- If a GST audit is being conducted, they will compare revenue and expenses on the GST returns filed to any income tax returns filed during the period.
Note that for all small and medium businesses undergoing a CRA audit, the auditor must perform a bank deposit analysis, and either a rough net worth or source and application of funds test. Don’t be surprised if you are asked for any of the additional records noted above.
Assessing IVI techniques
These are used when an auditor tries to add additional taxes or make changes to a previously filed tax return. CRA can assess additional taxes on bank deposits where the source of the income cannot be identified. They can also assess additional taxes based on net worth and projections.
If income has been underreported and the CRA auditor has to use an assessing IVI technique to determine how much was earned, gross negligence penalties could apply resulting in an even higher tax bill than anticipated.
For more information about audit techniques, see the CRA’s Audit Manual (a public document).
If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.
Thanks to Stephanie Kwan of KWB Chartered Professional Accountants for providing this content.