No one wants a Canada Revenue Agency (CRA) audit. But knowing what triggers one, and what to do if it happens, can make a stressful situation a lot more manageable.
A CRA audit is rarely a welcome prospect for small business owners and sole proprietors. They can be stressful, eat up a lot of your time, and potentially leave you with a bigger tax bill than you expected. Everyone hopes they won’t experience a CRA audit, but it’s important to be prepared for one.
Whether you’re facing one now or want to make sure you’re ready if one comes your way, this guide explains everything business owners need to know:
- When the CRA can launch an audit
- What to do if you’re being audited
- What your rights and responsibilities are
- How legal expense insurance can help you manage the process
When and Why the Canada Revenue Agency (CRA) May Audit Your Business
The CRA doesn’t pick businesses to audit at random – at least not always. They use risk assessments that look at a range of factors, like the likelihood of errors in a tax return, signs of non-compliance, or unusual patterns in reported income.
If their systems flag a return, an audit is likely to follow. Beyond the risk-assessment process, the CRA may also launch an audit based on an informant tip through their Leads Program, or simply as part of a random compliance check.
One important thing to know: the CRA generally has a three-to-six-year window to review or reassess your tax returns. But if there’s suspected fraud or misrepresentation, that time limit disappears entirely.
Common reasons a small business might get audited include:
- Frequent or substantial losses relative to your sales or business income that raise red flags.
- Discrepancies between the income you reported and information the CRA receives from third parties, like T4 slips, GST/HST filings, or supplier records.
- Being selected at random as part of the CRA’s routine compliance efforts.
- A tip filed through the CRA’s Leads Program, which allows the public, competitors, or even employees to confidentially report suspected tax cheating.
What Happens If the CRA Audits Your Small Business?
The first thing that happens is contact by mail, phone, or both. The CRA will let you know the date, time, and location of the audit. Depending on your situation, it may be conducted at your place of business, your home, or a CRA office.
You’ll be assigned an auditor whose job is to verify that you’ve been meeting your tax obligations, following tax laws correctly, and receiving any benefits or refunds you’re actually entitled to.
Here’s what a CRA auditor is typically allowed to examine:
- Filed tax returns, your credit history, and property details
- Business ledgers, journals, invoices, receipts, contracts, rental records, and bank statements
- Your personal bank statements, mortgage documents, and credit card statements
- Records belonging to related parties (a spouse or common-law partner, family members, corporations, partnerships, or a trustee)
- Adjustments made by your bookkeeper or accountant for tax purposes
The auditor will ask you to provide supporting documents. They may make electronic copies or borrow printed records. You’ll receive a receipt for anything they take, which will be returned once they’re done.
Once the review is complete, there are three possible outcomes:
- Your return checks out and the audit is closed with no changes needed.
- A reassessment is ordered, which could mean owing more tax.
- You’re entitled to a refund.
What Are a Business Owner’s Rights and Responsibilities During an Audit?
You’re not without protection here. Business owners and individuals are entitled to rights through the Taxpayer Bill of Rights – a list of 16 rights governing how the CRA deals with you. There are also five additional CRA commitments specifically for small businesses.
If you’re not satisfied with how an audit is handled, the Taxpayer Bill of Rights gives you the right to file a disagreement or complaint through the CRA’s complaints and disputes portal.
On the flip side, you have responsibilities too. Under Canadian tax law, you’re required to:
- Keep adequate books and records for a minimum of six years
- Make all relevant records available to the auditor (both paper and electronic)
- Provide complete and timely answers to the auditor’s questions
Heads up: Failing to provide required books and records isn’t just inconvenient, it’s an offence under the law.
What Type of Insurance Helps Small Businesses Manage a CRA Audit?
Business insurance won’t shield you from a CRA audit or reassessment. But legal expense insurance can cover the cost of getting professional legal advice to deal with or dispute one.
It’s broader than just audits, too. Legal expense insurance is designed to cover a range of situations business owners commonly face:
- Legal advice if you’re audited or want to appeal a CRA decision
- Legal representation if your business licence is suspended, altered, or cancelled
- Legal advice and defence for employment disputes with current or former employees
- Legal support for contract disputes and debt recovery
- Legal costs to take action against a third party that damaged your property or injured you or an employee
It’s worth knowing what it doesn’t cover, though:
- A lawyer reviewing contracts or legal documents
- A lawyer drafting formal letters on your behalf
- Insurance adjuster investigations into a claim you filed
- Inquiries into the status of an insurance claim
Moreover, legal expense insurance is surprisingly affordable. It typically costs $216 to $324 per year (less than what you’d pay for a single hour of legal advice). The best way to find out what it would cost your business is to get a free online quote in under five minutes.
Some Types of Insurance Are Tax Deductible
Here’s something worth knowing come tax time. The CRA allows sole proprietors and self-employed professionals to deduct commercial insurance premiums paid for coverage on buildings, machinery, and equipment used in your business.
If you run a home-based business, you may also be able to deduct expenses for the business use of a workspace in your home as long as:
- It’s your principal place of business, or
- You use the space only to earn business income and meet clients there on a regular and ongoing basis
Helpful Resources for Business Owners
The CRA offers a number of resources to help you navigate audits and stay on top of your tax obligations:
- A payroll deductions calculator
- How to send money to the CRA, receive payments, and options if you can’t pay a debt
- Business or professional income overview (T2125)
- A business benefits finder
- How to report business expenses
- Record keeping guidance
- GST/HST information for businesses
And if you’re facing a CRA audit or have concerns about your tax return, don’t go it alone. Speaking to an accountant, bookkeeper, tax advisor, or lawyer is always a smart move.
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– Reviewed by Brandon Bowie, Team Lead and Senior Broker, Professional Lines, Zensurance.
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