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The CRA employs various audit approaches, ranging from desk audits to comprehensive field audits, depending on the complexity of the taxpayer’s financial situation and the issues identified. These approaches are designed to verify the accuracy of reported income and deductions, ensuring compliance with Canadian tax laws. KWB can help businesses and individuals understand these CRA audit approaches and prepare effectively for any potential review.
Overview
This article details the various CRA audit approaches the Canada Revenue Agency uses to ensure tax compliance. It covers how the CRA selects cases for review and the different methods employed during an audit.
The sections below outline the types of audits, the techniques used to verify income, and how businesses can prepare for these processes.
- CRA Audit Approaches: Understand the various methods the Canada Revenue Agency employs to ensure tax compliance and how to effectively navigate these approaches for your business.
- Indirect Verification Techniques: Explore the CRA’s use of indirect verification techniques (IVI) to assess income when direct methods are insufficient.
- Assessing IVI: Learn how the CRA assesses IVI techniques and what this means for taxpayers undergoing an audit.
- Common Questions: Find answers to frequently asked questions regarding CRA audit processes and verification methods.
Navigating CRA Audit Approaches for Your Business
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 Indirect Verification of Income (IVI) Techniques by CRA
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.
 Ratio Analysis
- 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.
FAQ
To further clarify common concerns regarding CRA audit approaches, we’ve compiled answers to some frequently asked questions below.
| Question | Answer |
|---|---|
| What specific audit approaches does the Canada Revenue Agency (CRA) use? | The Canada Revenue Agency (CRA) primarily employs direct verification, scrutinizing financial records like receipts and statements. When direct evidence is lacking, they turn to indirect verification of income (IVI) techniques, such as analyzing bank deposits or net worth, to estimate income for individuals and businesses in Edmonton, Alberta. |
| What steps should individuals and businesses in Edmonton take to prepare for a CRA audit? | To prepare for a CRA audit in Edmonton, individuals and businesses should maintain meticulous financial records like income statements and expense receipts. It is crucial to carefully review the audit notice to understand its scope and consider seeking professional guidance from a local tax advisor to navigate the process effectively. |
| What common triggers initiate a CRA audit for individuals or businesses in Edmonton, Alberta? | In Edmonton, common triggers for a CRA audit include random selection, significant changes in reported income or deductions, or undisclosed income. Discrepancies in tax filings or information from third parties can also prompt an audit for individuals or businesses in the city. |
| What immediate steps should Edmonton individuals and businesses take after receiving a CRA audit letter? | After receiving a CRA audit letter in Edmonton, thoroughly read the letter to understand the audit’s scope and what information is requested. Begin gathering all relevant financial documents and consider contacting a tax professional in Edmonton to guide you through the process. |