What Triggers a CRA Audit of a Small Business

How does the CRA pick a small business or corporation for audit?

The CRA publishes no list of audit triggers. It says its risk-assessment systems identify returns at high risk of non-compliance, and a CRA officer then reviews information from various sources to decide whether an audit is needed (CRA: business audits). The assessment looks at factors such as how often errors appear in tax returns, and the CRA may compare a file with similar files (CRA: What you should know about audits). The CRA's pages name only some factors and give no weights, so any longer "trigger list" is a guess.

The CRA does publish the signs that lead it to verify income indirectly in a business audit. They are in the next section. A case is not simple when business and personal money share an account, a corporation's owner owes it money across year-ends, reported income runs below similar businesses, or the CRA has already written. A letter that asks for support of one claim is usually a review, not an audit; the CRA review or audit letter guide explains the difference.

Gather first: every bank and card statement for the years in question (business and personal), sales records tied to deposits, the shareholder loan ledger if there is a corporation, and the filed returns tied back to the books.

What signs of unreported income does the CRA look for?

The CRA says it will generally use an indirect verification of income method when there are indications of one or more of five signs (CRA: business audits). These are the CRA's own words for when it checks income indirectly in an audit; the CRA does not say they decide which files are selected. Indirect verification means the CRA tests the income reported by an alternative method, not only the books.

The most common indirect method is the net worth method. The CRA says it needs a complete financial picture of the owner's family unit, so where it uses this method it will ask for the personal financial records of the business owner's spouse and any other contributing member of the household (CRA: business audits). Online platforms that report sales to the CRA are covered in CRA digital platform reporting.

Does using one bank account for business and personal spending raise the risk?

Yes, once an audit starts. The CRA names interchangeable business and personal accounts as a sign that leads to an indirect income check (CRA: business audits); it does not say the sign decides which files are picked. The Act requires records in a form and with information that let the tax payable be determined (Income Tax Act, subsection 230(1)). A mixed account makes each line a question: business expense, owner draw, or something else.

For a sole proprietor or partner, personal payments are owner draws and not expenses. For a corporation, personal costs it pays can become a taxable benefit to the owner (subsection 15(1)) or a loan the owner owes it; see shareholder benefits found in an audit. Where the accounts are already mixed, list each personal payment on a working copy with its support, and keep the statements as the bank issued them. For a corporation, a shareholder loan entry needs evidence of a genuine obligation to repay; without it the payment may be a taxable benefit instead, and an accounting entry alone does not decide which (CRA shareholder loan folio, paragraphs 1.13–1.14). See rebuilding books from bank statements. Business costs you paid personally are recorded the other way; see business expenses paid personally.

If sorting the records shows income or tax missing from a return already filed, read about voluntary disclosure before filing a correction: before any CRA contact, after contact. Whether a disclosure is accepted depends on timing and other conditions.

What does it mean that books are prone to error, and what do clean books look like?

The CRA says books and records may be prone to error when one person does most of the accounting, or when the main functions in a business are done by one person or a small group of related persons (CRA: business audits). If you keep the books yourself and nobody reviews them, see doing your own books or hiring a bookkeeper. The CRA does not define "clean books". The first row below is a legal requirement and the second is CRA guidance on it; the rest are practical steps that help with the signs above.

The signs table above also lists sales tied to deposits and a second reviewer.

If records are inadequate, the Minister may require a person to keep the records and books the Minister specifies (subsection 230(3)).

Do a big shareholder loan or large retained earnings get a corporation flagged?

The CRA's list of signs does not include retained earnings or a shareholder loan balance, and its pages on business audits, audit selection and GST/HST audits name neither as a trigger. Retained earnings is the profit a corporation has kept.

A shareholder loan matters for a different reason: if an audit reaches the corporation's books, the balance decides whether a tax rule applies. A shareholder, or a person connected with one, who receives a loan from the corporation or becomes indebted to it generally has the amount included in income for that year (subsection 15(2)). The rule does not reach a borrower that is a corporation resident in Canada, or a partnership made up only of such corporations. It is not included if repaid within one year after the end of the corporation's tax year in which the loan was made, and the repayment is not part of a series of loans or other transactions and repayments (subsection 15(2.6)). Other exceptions are in subsections 15(2.2) to 15(2.5).

A balance that has grown across year-ends needs a dated ledger showing what was taken, what was repaid and how. See shareholder loan account for the ledger and shareholder loans for the rule.

Can GST/HST returns be picked for audit separately?

Yes. The CRA says GST/HST returns are selected for audit or examination on both risk assessment and random file selection, and that these audits focus on filing errors and omissions (CRA: GST/HST audit and examination). The same page says refund requests are reviewed before payment and some are examined further. That CRA page shows the date June 22, 2017.

Random selection means a GST/HST return can be picked without any risk flag, so the GST/HST return needs to tie to the same sales and purchase records as the income tax return. For a GST/HST letter, see GST/HST reviews and audits.

What will an auditor ask for first, and whose records are in scope?

The CRA says the auditor will normally ask for your electronic records before meeting with you (CRA: business audits). Auditors cannot receive files by email; documents go in by a secure online service, by mail, or to a CRA office.

The records in scope reach beyond the business (CRA tax tip; CRA: business audits):

The CRA may also group related entities as an economic entity and audit more than one member. If the auditor proposes changes, the proposal letter gives 30 days to agree or disagree (RC4188).

What records should I keep, in what form, and for how long?

Keep most records and books of account, with the supporting vouchers, for six years from the end of the last tax year they relate to (subsection 230(4); CRA: keeping records).

Records of long-term property and shares and other history that affects a later sale or wind-up may need to be kept indefinitely (CRA: keeping records). Other periods apply when a business or corporation closes or an objection or appeal is filed; see how long to keep business records. Scanned copies and cloud storage are in scanned receipts for the CRA. What a receipt must show is in CRA receipt requirements. How far back the CRA can reassess is a separate limit; see how far back the CRA can reassess.

Can clean books guarantee no audit?

No. The CRA picks files by risk assessment, may compare them with similar files, and for GST/HST also picks at random. It can also consider information from other audits or investigations (RC4188; CRA: GST/HST audit and examination). Random selection does not depend on your books, and information from other audits comes from outside them.

What clean books change is how an audit goes. The CRA's risk assessment looks at the likelihood or frequency of errors in returns, so accurate returns help on that factor; the CRA does not say how much it weighs. Tied-out records also let you answer audit questions with documents, though the CRA decides what it accepts. An audit does not mean the return was wrong: the CRA says it ends with no adjustment, a reassessment with more tax, or a reassessment with a refund (RC4188).

Example

These examples are illustrative; all amounts are Canadian dollars.

Groceries paid from the business account

A sole proprietor contractor has C$90,000 of revenue. All year, groceries and the owner's home rent come out of the business account, about C$24,000 in total. Interchangeable accounts are a listed sign. A common answer has two parts: open a separate personal account going forward, and record the personal part of the C$24,000 already paid as owner draws, not expenses. Business costs stay business expenses. A dated draw record lets the owner show which payments were which.

An owner who owes the corporation

A corporation with a December year-end lends its individual shareholder C$45,000 in March of Year 1. A written agreement shows a genuine obligation to repay, and no other loan exception applies.

• End of Year 1: the books show C$45,000 due from shareholder.
• End of Year 2: the balance is still C$45,000. The repayment window for the Year 1 amount closed on December 31 of Year 2.
• After Year 2: if it was not repaid in that window, the C$45,000 may be included in the owner's Year 1 income. A repayment that is part of a series of loans and repayments does not count. The loan ledger and repayment dates are the first thing to check.
• If included: a later repayment is deductible in the year it is made, unless it is part of such a series (paragraph 20(1)(j)).

Without a genuine obligation to repay, the same payment may instead be a shareholder benefit included in Year 1 income under subsection 15(1); a loan-account entry alone does not create the repayment window.

A shop that reports less than similar shops

A small shop reports sales of C$150,000, C$148,000 and C$152,000 in three years, and income below similar shops in its sector each year. That is a listed sign. The shop keeps daily till reports and reconciles gross sales to deposits, cash still held, documented cash spending, card fees and timing differences. Sales stay recorded even when the proceeds were not banked. It also keeps supplier invoices and the lease, so a lower margin than similar shops has a documented reason.

Different for you?

• The CRA has already written: follow the steps in the CRA review or audit letter guide. If the records behind the letter do not tie out, or they show income missing from an earlier return, get bookkeeping help before replying.
• Business and personal money are mixed, a shareholder loan balance has grown, or one person keeps all the books with no review: the records need sorting before the next filing, and sorting can show errors in earlier years. See shareholder loan account, doing your own books or hiring a bookkeeper and bookkeeping help.
• Your income looks low for your sector, or your spending is paid partly from money outside the business (savings from abroad, family gifts, a property sale): check that sales tie to deposits and that papers exist for the other money before the CRA asks; a gap is hard to explain with a total alone. See bookkeeping help.
• Books or returns are months or years behind: see catching up on overdue books, or rebuilding books from bank statements if you have only statements. If the records are that far behind, see bookkeeping help. A corporation with unfiled returns: see catching up on unfiled corporate returns.
• The CRA called some expenses personal: see shareholder benefits found in an audit.
• You have a GST/HST or payroll letter: see GST/HST reviews and audits or payroll audits.
• Your business or corporation is in Quebec or Alberta: the CRA still administers federal income tax, but it does not administer provincial corporation tax for Quebec or Alberta (CRA: provincial corporation tax), so a provincial audit follows that province's process. In Quebec, the CRA does not administer provincial income tax for individuals (CRA: provincial and territorial tax for individuals), and Revenu Québec administers the GST/HST for a business physically located there (CRA: register for a business number). This page covers the CRA.