A presentation on this subject was given at a seminar organized by the Canada Revenue Agency (CRA) for the Greater Toronto West tax practitioners. Most files are selected using a Risk Assessment System. CRA selects audit areas on the basis of costs and returns from audits. Typical audit areas are: Expectation of Profit, Capital Vs Current Expenses, Personal Vs Business Expenses, Other Expenses, and Capital Cost Allowance Creating Loss.
Tax payors who claim business or rental losses over several years are deemed to have no Expectation of Profit and hence most of their expenses may be disallowed generating large tax bills for them.
Expenses for procuring fixed assets of business, e.g. buying a computer or installing a new roof on your rental operation used partially or fully for rental income, can’t be claimed in full in the current year. These are claimed over many years as depreciation, called Capital Cost Allowance (CCA) when computed for tax purposes. For rental operations, if you already have a net loss before claiming CCA, you can’t claim it.
Many expenses, e.g. for automobile, constitute a part for personal use. These expenses must be split between business and personal portions using prescribed rules. Similarly, if you have an office at home, appropriate portions of total home expenses may be claimed for business.
Some bookkeepers can’t fit some expenses into standard CRA expense categories; hence they claim them as Other or Miscellaneous expenses. The very fact that an expense is hard to fit makes it a target of suspicion.
Other than the Risk Assessment System, files for audit are also selected based on internal Revenue Agency leads, referrals from other government departments and external leads. Files for audit are also selected based on complexity and size of corporation. Small files are audited infrequently. The largest files can be audited annually.