Few letters cause the dread of an audit notice. The fear is rational: an audit can cost thousands if the auditor disagrees with how a return was filed. But a great deal of the outcome is within your control. Knowing what attracts an audit, and handling one calmly and methodically when it comes, is how taxpayers protect themselves. This guide collects the practical lessons.
What raises your audit odds
Some audits are genuinely random — the worst lottery there is, and nothing you can do about it. Apart from random selection, though, the odds rise with a set of recognizable risk factors:
- Being self-employed. Without tax withheld at source, income is more likely to be misreported, which makes sole proprietors a frequent target.
- Running a cash business. More cash means more opportunity for unreported income, so cash-heavy businesses are audited more often.
- Being in a targeted industry. Sectors with many cash transactions — restaurants and construction, for example — draw extra attention, and some industries are swept up in special projects to recover missing GST/HST.
- Expenses out of line with your industry. The CRA's computers compare you against peers. A restaurant reporting 15% cash sales when neighbours report 24–28% is a red flag. The book's blunt advice: blend.
- Large vehicle or home-office expenses. Because these are so often estimated, big claims invite scrutiny.
- Discrepancies. A mismatch between a GST/HST return and a T2 corporate return is a classic trigger. Some discrepancies are within your control — diligence prevents them.
Get off to a good start
The instinct to hide from an audit letter is human and counterproductive. Once you receive it, contact the auditor to schedule the appointment — but do not rush to start before you are ready. You want time to prepare. Getting in touch promptly signals cooperation; beginning the substantive review before your records are organized does not help you.
Lawyer, accountant, or yourself?
Your accountant can usually handle an audit — they know your books. The real question is whether they should. If your records are clean and your accountant is competent, there may be no reason not to use them. But if your records are imperfect, or there is something you would rather the CRA not learn, using your accountant is a poor idea: there is no privilege between an accountant and a client, and the CRA can compel an accountant to disclose what they know. Communications with a lawyer, by contrast, are protected by solicitor-client privilege. In many files the ideal is a lawyer and accountant working together, with the accountant's work product brought under privilege.
Control the flow of information
A handful of habits keep an audit from sprawling:
- Give the auditor only what is needed. For a three-year audit, do not hand over a QuickBooks file with ten years of data — provide the journals required, and nothing more.
- Provide organized records. Sort by year or month and by expense type or vendor. A shoebox of receipts and gum wrappers does not inspire confidence; neat statements and cheque stubs do.
- Do not chat about personal matters. An offhand mention of a Hawaii trip can set an auditor wondering how you afforded it. Keep the conversation on the file.
- Let your representative field questions. Hiring a representative is your right and is not a sign of guilt. A representative can answer a hard question with "I don't know — let me find out," which buys time to get the facts right, where you might sound cagey answering on the spot.
Protect your position
Two cautions can save you real money. First, do not sign a CRA waiver without legal advice. When an auditor runs short of time, they often ask the taxpayer to sign a waiver extending the period to reassess, and some can be insistent. Do not be intimidated into signing. Second, document the deductions auditors love — keep and show your vehicle log, and document your home office with photos and a floor plan. Without the log, as the book puts it, you are up the creek without a paddle.
Records: keep them, and keep them well
Whether you are preparing to sell the business or simply want an audit to go smoothly, good records are the foundation. Although you are typically audited only three or four years back, keep records for six to seven years from the end of the relevant tax year — and a year or two longer is wise, because the CRA can reach further back where it suspects fraud or gross negligence. Some records should never be discarded: purchase and sale agreements, share transactions, and registries needed to compute a future capital gain.
Remember too that copies are not always enough. If an auditor asks for an original receipt and you have only a scan or a credit-card statement, the expense may be disallowed. Keep originals, scan the ones that fade, and back everything up off-site. A missing record is a reason to deny an expense — far more costly than a backup drive.
Challenge a bad audit
If the auditor gets it wrong, the reassessment is not the end of the road. After an auditor issues a reassessment there are still further opportunities to challenge it — a Notice of Objection, the Tax Court of Canada, and beyond. Auditors are not infallible; a result you disagree with does not mean the auditor is right. Where the facts and the law are on your side, objecting and, if necessary, appealing is exactly what the system is for.
The bottom line
An audit handled well is an audit that ends without a costly surprise. Know your risk factors, prepare before you engage, control the flow of information, protect your rights, and keep records you can stand behind. For the documentation side, see our guide to vehicle and home-office deductions; if you receive a reassessment you disagree with, our objections and appeals resources explain the next step.
This guide draws on Dale Barrett's book Pay WAY Less Tax!, a plain-language collection of tax-saving tips and strategies for Canadians. The book is general information, not legal advice; the rules change often, so confirm the current treatment for your own situation before acting.