A couple of months ago I received a letter from the Canada Revenue Agency (CRA) concerning the medical expense claims on my tax return. The letter requested that I back up the claims with official receipts within 30 days or the claims would be denied and my tax return adjusted accordingly.
Getting a letter like this from the tax department can be a rather disconcerting event.
The main role of the CRA is to collect taxes on behalf of the federal and provincial governments.
The tax system in this country is based on a system of self-assessment, which means that each taxpayer estimates their taxes owing by completing a tax return once a year to report income they received and eligible deductions and expenses.
The CRA then processes these returns and provides the taxpayer with a notice of assessment that indicates whether it agrees with the information on the tax return and confirms how much money you owe, or if you are claiming a refund, how much the government owes you.
However, the tax department does conduct tax reviews to ensure compliance with Canada’s tax laws and undertakes a number of enforcement activities — such as examinations, investigations and verifications — both domestically and internationally.
The CRA processed more than 27 million individual and 1.6 million business returns in the 2008-09 tax year and conducted 41,000 audits of international and large businesses and 323,000 audits of small and medium-sized enterprises. Slightly more than 870 audits were carried out under the agency’s special enforcement program and 164 income tax and GST/HST investigations were referred for prosecution.
Auditing is one of many ways the CRA ensures compliance with Canada’s tax laws.
Generally, the CRA reviews tax returns randomly, so there is no way to guarantee that your return will not be reviewed or reassessed.
However, there are some tax credits and other things the CRA looks for that can result in an audit being conducted. Some of the most common ones are moving and medical expenses, tuition transfer credits, home office deductions and unusually large expenses, such as large, lump-sum RRSP contributions.
Self-employed individuals may be more likely to be reviewed and audited than others. If your overall expenses are large in relation to your income, you could be a candidate for an audit.
Business expenses need to be reasonable and you need to have some expectation of revenue. Your business cannot be just a hobby and you cannot claim losses indefinitely.
The CRA has a program that tracks T4 income slips issued by employers and matches them against slips filed by employees to verify all income was declared. It also is on the lookout for under-reported income, which can be particularly prevalent in cash-dominated industries.
A lifestyle that does not seem to match with someone’s reported income might raise a red flag and result in an audit.
It’s important to keep good receipts and records to make the process easier should you be audited or asked to justify expenses. The CRA usually reviews one of the last three years but it can review another three years beyond that.
If the CRA does disallow some of your expenses, you will receive a tax bill for the adjusted amount, as well as accrued interest.
Your compliance history also can play a role in whether or not your return is reviewed. If you have a history of late filing or not responding, you may be more likely to have your return reviewed.
If you do get audited, don’t panic. It doesn’t necessarily mean you’ve done something wrong.
It pays to co-operate with the auditor so they can do their job more quickly and efficiently.
Although only a small portion of tax returns in Canada are audited, it’s a good idea to conduct your financial affairs as though you might be in the event the tax department comes calling.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.