The following excerpt is from Chapter 12 of Stephen Thompson's book 167 Tax Tips for Canadian Small Business
The objective of the previous rounds has been to show you ways to reduce your tax bill using the existing set of rules that we all have to follow. By knowing a little bit about these rules and knowing how to use them to your advantage, you can save significant tax dollars. But what if the tax department doesn't agree with you. What if their interpretation of the rules is different from yours, or say that a particular rule doesn't apply in your case. What can they do? And more importantly, what can you do?
This round will look at the different steps of a Canada Revenue Agency audit and what rights you have under the tax system. Knowing the rules of this game can mean the difference between victory and utter defeat.
What Happens After I File My Tax Return?
The Assessment Process
After you file your tax return, Canada Revenue Agency's computers will conduct a number of tests on your return and will issue you what is called an Assessment Notice. The assessment notice is typically two or three pages in length, will include information such as how much income you earned, how much tax you paid, how much you can contribute to your RRSP next year, and what balance you still owe to the government, if any, for the current year's taxes. Also included with the assessment is a cheque if you were expecting a refund and you did not request direct deposit.
At the assessment notice stage, typically, the only checks that the tax department has done is to ensure that your tax return is mathematically correct and confirmed some of your deductions to available carry forward information, like how much you were eligible to deduct for RRSP purposes. Barring unusual circumstances, you are issued the assessment notice and either a refund cheque (or direct deposit), a request for additional funds, or an indication that your account is paid in full with no balance owing.
This assessment notice is a very important piece of correspondence. It tells you if the government has agreed with the way you filed your tax return or not. It is on the assessment notice that the tax department will indicate the amount of any interest and penalties that were assessed. If the balance owing or due as a refund on the assessment notice differs from what you expected, you should enquire further. The government's computers have been known to make errors at this stage. It may be a misunderstanding that can be easily cleared up. So review your assessment notice carefully for any unexpected surprises. It could make a big difference to the amount of tax you have to pay.
Review your assessment notice to ensure you're not paying more tax than necessary.
The Audit Process
Just because you have received an assessment notice from Canada Revenue Agency agreeing with how you filed your tax return, does not necessarily mean you're out of the woods. The government has up to three years from the time of issuing you the assessment notice to go back and audit that year. Longer if you provide them with a waiver for the particular year.
According to Canada Revenue Agency's mission statement, their objective is to promote compliance with Canada's tax, trade, and border legislation and regulations. Their main tool is the audit process. The majority of taxpayers file relatively simple tax returns with mostly T4 and T5 income. These tax returns do not represent a large compliance risk since tax is withheld at source on the T4 income and the amounts are easily verifiable. Accordingly, many taxpayers who report this type of income may never be audited by the tax department or have any dealings with a tax auditor.
Taxpayers who operate small businesses represent a greater risk of non-compliance to the government. Accordingly, more effort is placed on auditing taxpayers that report business or professional income. This is not to say that if you operate a small business you will be audited. There are hundreds of thousands of small businesses across Canada and Canada Revenue Agency can't audit them all. But your chances of being audited are increased when you report self-employed income.
If you are selected for audit, depending on the circumstances, the tax department may perform what is called a desk audit or perform a field audit. With a desk audit, a tax auditor may request that you provide supporting documentation for specific questions he or she has concerning your tax return. For example, they may request support for moving expenses or medical expenses claimed.
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