Everything you wanted to know about tax audits (but were afraid to ask)
By Peter Diekmeyer • Bankrate.com

Most Canadians are fairly trustworthy when it comes to paying their income taxes. Naturally, that may have something to do with the fact that we know there is always a chance of being audited.

Fortunately, most of us will be spared this experience. There were only about 300,000 traditional audits conducted last year by the Canada Revenue Agency. That's a drop in the bucket when you consider there were 24 million personal income tax returns and 1.5 million corporate returns filed last year.

"For most Canadians who earn salaried income, there is very little opportunity to evade taxes," says Donna Labonté a spokeswoman for the CRA. "Compliance rates are high. Our information is that 94 percent of Canadians complete and file their returns accurately and on time."

Much of the increasing reliability of Canada's income tax system in recent years has been due to CRA's T-4 slip matching program, says Labonté.

Each year, the program tracks approximately 1.5 million T-4 slips issued by employers against employees' tax returns, to make sure the income was declared.

"Individual returns are, for the most part, accurate because we can confirm that the bulk of their income was recorded," says Labonté.

As a result, the vast majority of tax audits the CRA conducts are on returns from small- and medium-sized businesses, where there is more scope for fraud, error or misinterpretation.

The goal of auditing is compliance

CRA audits are either conducted randomly or they are focused on specific sectors such as high-fraud-risk communities or professions.

"There are certain red flags that we look for and trends we monitor," Labonté says.

"If you live in a community where the average house price is $500,000 and your annual income is only $25,000, you may get a polite letter from CRA asking you to demonstrate how you can afford your lifestyle."

But surprisingly, according to Labonté, the ultimate goal of most audits is not to recover money, although that clearly does occur. The ultimate goal is to ensure compliance.

For example, when CRA staff got wind of the fact that there was a high degree of noncompliance among fishers in Atlantic Canada, they sent several audit teams into the region.

The first thing they did was meet with industry leaders to explain how the law functioned and what fishers had to do to comply.

What to do if you get audited

If you do get audited, the first thing to remember is that it does not mean you've done something wrong. In fact, auditors sometimes discover that you have paid too much tax.

That's why it pays to cooperate with your auditor, so that she can do her job quickly and efficiently.

By law, you are required to keep copies of all of your books and records that helped you determine your tax obligations and entitlements. Make sure these records are easily accessible to your auditor and that you get her all the supplementary information she asks for. Be respectful of her time.

In general, the time an audit takes depends on several factors, including how well your records have been kept, their size and their complexity.

During the audit, you'll have the opportunity to discuss key issues with the auditor. Use that time to ask any questions you may have. The auditor has likely seen many other taxpayers fitting your profile, and most auditors will be more than happy to give you tips or advice.

At the end of an audit, the auditor will tell you of any proposed adjustments or assessments and will explain the reasons why they were made. You'll usually have at least 30 days to respond.

If your return is adjusted, you'll receive a notice of assessment, and you may have to pay interest charges on the unpaid balance. You may also contest the assessment within 90 days of the issue date.

Probably the most important advice regarding audits is that you should be prepared. Conduct your affairs and file your returns as though you will have to one day explain your actions to an auditor. Then, if she comes, you'll be ready.

Peter Diekmeyer is the Montreal Gazette's management columnist.