The Basics of an Income Tax Audit

An income tax audit often causes individuals and businesses to fear the skeletons in their closet.

No matter how prepared you are or how meticulous your record keeping, being asked to review your books and records for every single deductible expense going years back is a drag. In this post, we’ll review the basics of an income tax audit to arm you for your skeleton search.

What gives them the right to make my life, and the life of my accountant, bookkeeper, or accounting staff, miserable?

Generally, a Canada Revenue Agency (“CRA”) auditor is empowered by the Income Tax Act (Canada) (“ITA”) to “administer and enforce” the Act and the CRA as a delegate of the Minister “may exercise all the powers and perform the duties of the Minister under this Act”. What this generally boils down to is verifying that you’ve included income from all sources and that you’re entitled to all the deductions and credits that you’ve reported and claimed in your tax return.

In Canada, we live in a self-reporting tax regime. This means you, as a taxpayer, are responsible for reporting your income and the CRA is responsible for reviewing, auditing, and assessing your taxes based on your report (i.e., your tax return).

What are my rights in an audit?

Generally, the tax authorities have the right to request and review all documents that will assist them in assessing your taxes. The scope is broad, and the courts have repeatedly held that the CRA has the right to set the four corners of its own audit.

Your job is to respond to CRA’s request by producing only documents to which CRA is entitled and has requested. To that end, it is important to have a tax professional review your submissions both for legal privilege and to ensure the documents are relevant and responsive to the audit inquiries.

Also, the Taxpayer Bill of Rights is accessible online.

How long should I keep my books and records?

This is a trick question. The Act generally mandates “six years from the end of the last taxation year to which the records and books of account relate.” (ITA 230(4)(b))

But, there are many exceptions to this rule that can extend the time for which an individual or business must keep its books and records. Before you shred, give your tax advisor a call.

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