What you need to know about the CRA’s self-assessment tax audit process
What you need to know about the CRA’s self-assessment tax audit process
How do you prepare when the CRA requests an audit of specific expenses or deductions you’ve made?
Canada’s tax system uses a self-assessment process in which taxpayers prepare, calculate, and report their own tax liability. The Canada Revenue Agency (CRA or the “agency”) then selects a number of tax returns for audit each year. The audit may be for specific expenses or deductions, or a general review of the taxpayer’s complete books and records. For this article, we are focused on the CRA’s audit of specific expenses or deductions, and not a general audit of a taxpayer’s business.
Based on our experience, reasons a file is selected for audit can include a mismatch in information received from third-party sources (e.g., T5 slips), the taxpayer’s compliance history, random selection, industries that are at a high-risk for non-compliance, and the types of deductions or credits that were claimed.
The audit of specific expenses and deductions may be performed before a taxpayer’s tax return is processed or after it is processed, and a notice of assessment is issued. An audit that is performed before a tax return is processed is known as a pre-assessment review. It is a post-assessment review when performed after a notice of assessment is issued. In most cases, these types of reviews or audits are limited to specific expenses or deductions. They are known as “desk audits” because they do not require the auditor to be at the taxpayer’s business and can be performed at the auditor’s desk.
The CRA may focus on different deductions or credits for audit from year to year. Based on past reviews, the agency has focused on items such as medical expenses, charitable donations, moving expenses, foreign tax credits and tuition expenses. More recently, we have seen increased focus on travel and motor vehicle expenses. Taxpayers whose expenses are chosen for review typically receive a letter informing them of the review and requesting information to support the expense claimed.
The standard CRA letter requests the taxpayer provide the following:
- A detailed list of the transactions (or general ledger entries) related to the expenses;
- A copy of the invoices or receipts for the ten largest transactions included in travel expenses for the year under review; and
- A copy of any travel logs.
Each of the items requested by the CRA are discussed below.
List of Transactions
The detailed list of the transactions would generally include items such as lease payments, repairs, insurance and registration costs, as well as fuel expenses. The general ledger would show the dates of the expenses and any seasonal change in the expenses would be apparent. The CRA may question taxpayers on changes in expenses during the year, and taxpayers are asked to provide an explanation as to why expenses vary over time (weather, travel time, inflation). For example, the CRA may raise questions on fuel costs to determine if a taxpayer has included receipts for non-business use in business expenses.
Copies of Invoices
At times, the CRA may require the taxpayer to provide invoices and receipts for all travel expenses. This is generally not an issue for insurance or lease payments as those amounts are non-discretionary and are typically paid in the same amount each month or year and may be clearly traced to a contract. However, fuel expenses are a different matter.
Fuel purchases can vary from week to week depending on vehicle use and a taxpayer is likely to make many more fuel purchases over the course of a year than lease or insurance payments. Keeping track of each fuel receipt is therefore more time consuming and burdensome when compared with tracking other expenses. Many taxpayers believe that proof of payment in the form of a credit card statement is sufficient evidence to support the fuel expense. Based on our experience from previous reviews, the CRA generally does not consider a credit card statement to provide sufficient detail to confirm whether the expense at the local gas station related exclusively to fuel, or whether other items (chips, drinks, lotto) were purchased. As a result, we have seen credit card statements routinely be rejected as proof of payment sufficient to support the expense claim.
In recent years, we have seen some CRA auditors require all receipts supporting an expense to be provided for the expense to be deductible. This is a departure from auditing procedures from past audits we have assisted with, where they request only a sample of expenses to support the expense claim. The shift in the standard of documentation from a sample of expenses to 100 percent of all expense receipts can put undue stress on the taxpayer to comply with the agency’s requests. A taxpayer must weigh the cost of paying a professional or staff to comply with the CRA’s documentation standards against the potential tax cost of foregoing the expense deduction, and also consider if not supporting a claim may increase the possibility of a future audit.
Travel Logs
The portion of the travel expense that is attributable to business use is a deductible business expense whereas the personal portion of the travel expense is not deductible. In the case of motor vehicle use, the CRA recommends the use of a logbook to support business use, advising that for each business trip, the taxpayer should keep a log listing the date, destination, purpose of the travel, and number of kilometres driven. The number of business kilometers driven in a year is then compared against the total kilometers driven to determine the percentage of business use. The company can claim the full cost of the operating expenses for a company-owned vehicle as long as the taxable benefits are calculated for standby charges and operating benefits and included on the employee’s T4 slip. The amount of personal use of the vehicle is needed to calculate these taxable benefits. The percentage business use is also required to determine what class to capitalize the vehicle for income tax purposes for non-passenger vehicles, as well as how much GST/HST paid on the purchase can be claimed back by the company (if registered for GST/HST).
Recently, the CRA has indicated it may accept the use of a “simplified logbook” in certain instances to record business use of a vehicle. Its position is that after one complete year of keeping a logbook to establish the base year, a taxpayer may use a three-month sample logbook to represent business use for the entire year, as long as the usage is within the same range (within 10 percent) of the results of the base year. Businesses will have to show that the use of the vehicle in the base year remains representative of its normal use.
Taxpayers are often required to reconstruct their travel logbook after the fact. Tools such as Google Maps, toll highway records or calendars/schedules are useful aids for determining mileage traveled and confirming travel dates. Taxpayers need to be aware that, even where they have a travel logbook, the agency may still take the position that the travel is personal in nature and not for business purposes.
CRA generally views motor vehicle travel from home to work and back as personal use and not for business use. However, it is common for a professional to travel from home to a hospital or directly to a satellite clinic prior to arriving at the practice. In that situation, the taxpayer has an argument that the travel to the hospital or clinic is business related. The Courts have held that where the taxpayer drives directly from home to a client or to a business meeting in order to be more efficient or reduce travel costs, then no portion of the kilometers driven to the client site and back to the taxpayer’s home should be treated as personal kilometers.
Preparing for your audit
Results of a CRA audit depend on specific facts. Taxpayers can take measures to minimize the risk of travel and vehicle expenses being disallowed by following these tips:
- Keep copies of receipts for all relevant expenses, particularly fuel expenses;
- Ensure you have the appropriate insurance for your business use of the vehicle;
- Calculate a taxable benefit for company-owned vehicles for standby and operating benefits and include on the T4 slip;
- If claiming GST/HST, determine if the full amount may be claimed or if the amount is restricted;
- Maintain a travel logbook or detailed diary (through an electronic calendar or similar tool) that will allow you to determine business travel; and
- Document where travel to a hospital or clinic location prior to the practice office constitutes business travel given the particular circumstances.
Contact us
To learn more, contact Brandon Hodge, LL.B, National Tax Controversy Leader.
Insights
-
December 19, 2024
How MNP’s Voting and Election Services supported Calgary Co-op through the election process
-
Progress
December 18, 2024
How your dealership can build a more gender-diverse workforce
With only 23 percent of employees in new car dealerships being women, the gender gap continues to persist in the automotive industry.
-
Performance
How will the CRA’s significant GST/HST update impact your dental and orthodontic practice?
How will the recent GST/HST update impact your dental practice? Understand the new requirements for claiming ITCs and opportunities for GST/HST refund claims.
