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small-business taxes: audits

Accountant Kate Amangoulova of Langley, B.C., says not all audits are the result of CRA seeing red flags. ‘Sometimes it’s just a draw and you’ve been randomly selected.’Jeff Vinnick/The Globe and Mail

For many small business owners, the fear of being audited by Canada Revenue Agency ranks up there with the fear of heights, spiders and public speaking.

Even if the company's bookkeepers believe they've done everything right – such as kept detailed notes and filed away receipts – will the auditor feel the same way, or will there be a hefty penalty to pay? Make no mistake, there are definitely horror stories of small businesses going through an audit only to be charged thousands or even hundreds of thousands in back taxes, fees and penalties for non-compliance. But many other audits go smoothly and without dropping financial bombshells.

Dale Barrett, a Toronto tax lawyer and author of Tax Survival for Canadians: Stand up to the CRA, says small-businesses owners often hire him simply because they can't deal with the stress of an audit.

"A lot of people get freaked out and they get crippled. They're not able to do anything but just sit and think about it. They fixate on the audit," he says.

In reality, the anxiety can be worse than the audit itself, and with some preparation, your business can get through the process without paying significant tax dollars. Here are five tips to ensure a smooth ride if you have somehow popped up on CRA's radar.

Know why you've been audited in the first place

In some cases, audits are nerve-racking because it's not known why the small business was chosen in the first place. There's a sense of being caught – without actually knowing why it's in the wrong.

"But you can get selected for various reasons," says Kate Amangoulova, a chartered professional accountant in Langley, B.C., who works primarily with small businesses.

Although in some cases there is a red flag that gets CRA's attention – the business shows financial losses for years, for example – "Sometimes it's just a draw and you've been randomly selected," she explains.

Or sometimes your business seems to be out of whack with others in the same industry. If you're blowing through 23 per cent of your revenue on office space, but your competition only spends 8 per cent, that discrepancy could be enough to trigger an audit. "Understand that the CRA's computers are getting better, bigger and faster," says Mr. Barrett. "They match and they compare absolutely everything to everything else."

Hit the deadlines

Although you're required to keep your records for six years from the time you file your tax returns, the government has up to three years from the time of issuing your assessment notice to audit your business.

Once the assessment letter lands in your mailbox (and your accountant's, if you use one) you will be given 30 days to respond to the auditor so you can arrange a date, time and place for the audit.

Ms. Amangoulova says that she receives a call first before the letter arrives when clients are being audited for a specific reason – not randomly selected.

The letter will give you a list of documents the auditor wants to see and gives a deadline to pull them together. In some cases you can ask for an extension if the timing is bad.

It's reasonable for a retailer to ask for one if the deadline is two weeks before Christmas, or in the middle of tax season for the accountant.

Don't get chatty

In some cases the auditor will ask for a desk audit – you simply drop off or send the documents in question.

But when an auditor wants to do a field audit, be prepared to have the person come to your place of work.

Field audits can be tricky, however, says Mr. Barrett. People have been known to get chummy with a friendly auditor and reveal all kinds of things about themselves that could raise questions down the road.

"They are not your friends," he explains. "They'll talk to you about your summer trip to Hawaii – and meanwhile they're adding up numbers in the back of their head. What may just seem like simple dialogue and friendly chatter could actually be a fishing expedition."

So be courteous and polite, but zip it.

Always be prepared

To avoid any last minute scrambling, the very best way to prep for an audit is to keep the best records possible all year round.

That means keeping a detailed automobile log if you use your car for business and for schlepping the kids around after school. It can be as simple as keeping a little book in the glove compartment and writing down how many kilometres you travelled and where you went each and every time you get behind the wheel.

A pain? Absolutely. But automobile expense is the number one flashpoint for small businesses at audit time.

"Keeping accurate records of everything is really tough," agrees Mr. Kelly, president and chief executive officer of the Canadian Federation of Independent Business in Toronto. "But you've got to do it. It's important and can save your butt when times are bad."

Know you can appeal

Think the auditor made a mistake and you're now being overcharged? Fortunately, you have options.

For starters, if there are going to be any changes to your tax returns, ask the auditor to explain each and every proposed change. Then take the list to your accountant or a tax lawyer to run the numbers again. Try to work with the auditor or his or her superior first, but know tax court could be in your future if you can't come to an agreement at the lower level.

But being persistent and refusing to back down can pay off. Mr. Barrett recently managed to get an $800,000 tax bill down to $25,000 in a case of supposed undeclared revenue. The couple still refuses the charge, though, and the case will go to trial in the coming months.

Ms. Amangoulova says she's won some appeals for small-business clients, too.

"We have a great system," Ms. Amangoulova adds. "The taxpayers can defend their rights," she says.