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Some “Secrets” Behind the Tax Audit Process

Ever wonder what triggers a visit from the auditors at the Canada Revenue Agency (CRA)? While they’re not sharing all their secrets, last November this group produced a report that shed light on some of their audit criteria.

Every tax return goes through an initial review to ensure it is consistent with information already on file, calculations are done correctly, and that certain deductions and credits don’t exceed allowable maximums. They will also compare the amounts on your return to information submitted by third parties such as your employer or spouse.

On top of this, the CRA particularly monitors areas where taxpayers commonly make mistakes (or cheat). The CRA looks for specific tax returns that have a high potential for tax recovery.

Next, the CRA uses a scoring system to analyze your return. Each of 32 different deductions and credits in your return are scored (particularly lines 207 to 235 and 200 to 349 says Tim Cestnick of The Globe & Mail). A high score means you’re more likely to get audited.

Other red flags for the CRA include: if refunds exceed a certain amount, claims for “other employment expenses”, or requesting an adjustment in your favour for a previously filed tax return. There are also certain tax strategies that the CRA is watchful for, notably: leveraged donation arrangements and “buy-low, donate-high” donation schemes; RRSP strip arrangements; loss pools and the application of losses to reduce taxable income; passing income to minors from private companies at low or no tax, and use of stock dividends to create losses.

Another important factor is your past history. The CRA’s scoring system is cumulative, so if you’ve scored highly in their points system in the past, your likelihood of an audit is higher.