Safeguard Your Small Business: Top 10 Signs a CRA Audit Might Be Coming

As unfair as it might seem, small to medium-sized businesses are often the Canada Revenue Agency’s (CRA) biggest targets for audits. In 2022 alone, the CRA sent out approximately 60,000 audit notices, with business tax returns receiving the most scrutiny. While there’s no surefire way to avoid an audit, you can significantly reduce your chances by paying attention to key red flags that increase the risk of a CRA audit.

Here are the top 10 signs that could signal a potential CRA audit for your small business:

1. Revenue Discrepancies

The CRA compares income across multiple tax forms, including your income tax return, your GST/HST return, and other information from third parties such as employers or financial institutions. If there are inconsistencies between these forms, it’s a red flag that could trigger an audit.

2. Being an Outlier

If your declared business income is significantly higher or lower than the average for your industry, you might draw the CRA’s attention. The agency closely monitors typical profit margins and earnings for various sectors, and deviations from the norm can prompt further investigation.

3. Deducting Large Business Expenses

While businesses can deduct certain expenses from their income tax, claiming excessively large deductions—especially in areas like advertising, meals and entertainment, travel, and interest—can raise eyebrows. If the CRA spots unusually high claims in these categories, it’s likely to scrutinize your tax return more closely.

4. Claiming the Home Office Deduction

The home office deduction is a great benefit, but it comes with strict rules. You can only claim this deduction if the space is used exclusively for business purposes. If you’re not following the requirements, the CRA will be aware, and this could trigger an audit. Before claiming this deduction, ensure that you meet the criteria and have documentation to back it up.

5. Claiming 100% Business Use of a Vehicle

While some small businesses may legitimately use their vehicles exclusively for business, the CRA knows that it’s rare. If you claim 100% business use of a vehicle and don’t have the proper records, such as a detailed logbook, the CRA will likely challenge your deduction.

6. Changes in Shareholder Loans and Large Balances

Corporate business owners should be wary of large changes in shareholder loans or significant balances. The CRA is on the lookout for personal expenses recorded as business expenses or loans taken from a company that may be improperly classified.

7. Running a Cash-Intensive Business

Businesses that handle a large volume of cash, like restaurants, bars, hair salons, and retail stores, are more prone to scrutiny. The CRA is aware of the temptation to underreport cash income, making cash-intensive businesses a prime target for audits.

8. Recurring Losses

If your business shows consistent losses over several years, especially if these losses offset other income, it could raise questions. To be classified as a legitimate business, there must be a reasonable expectation of profit. The CRA may question whether your business is truly sustainable, and multiple years of losses could trigger an audit.

9. Making Large Charitable Deductions

Large charitable contributions, especially if they exceed the average for businesses in your income bracket, can be a red flag. The CRA tracks typical donation amounts by income level and will likely scrutinize large donations, particularly those involving capital property.

10. Having Family Members on the Payroll

Having family members, such as a spouse or child, on the payroll is not inherently problematic, but it can attract attention if not done correctly. The CRA is cautious about income splitting, so be sure to follow all legal requirements when employing family members to avoid raising suspicion.

Self-Employment and Additional Scrutiny

If you’re self-employed, be aware that the CRA often places extra scrutiny on self-employed individuals. While self-employment offers several tax advantages, it’s important to follow the specific rules to qualify. Incorrectly claiming self-employment status can lead to disqualification of business expense claims and potentially result in penalties for previous years.

Honesty, Accuracy, and Prudence: Best Practices

The good news is that while the CRA does perform audits randomly, meticulous record-keeping and honest reporting can go a long way toward avoiding an audit. Keeping clear, accurate records of all transactions, expenses, and deductions can help ensure that your business remains in compliance with CRA rules.

Professional Help

If you want to maximize your deductions while staying compliant with the CRA’s guidelines, it’s wise to enlist the help of a tax professional. A chartered accountant can guide you through the tax process, ensuring that your small business tax return is accurate and complete. Should the worst happen and your business is selected for a random audit, having a professional handle the process can ensure that you’re fully prepared and have all necessary documentation on hand.

As professional chartered accountants, we’re equipped with the up-to-date knowledge and expertise that small business owners need to make the most of their hard-earned money. If your business is selected for a CRA audit, we can assist in ensuring that everything is in order for a smooth audit process. Contact us today to get started.