Irecently read an article in March 2009 edition of The Bottom Line  about how your tax profile can lead an audit. The article mirrors what I have been saying when this question is posed to me: That the probability of you being audited depends on your personal situation and the likelihood you can take advantage the self-reporting system used in Canada.
What Is An Audit?
Simply stated, an audit is an investigation and verification by the Canada Revenue Agency (CRA), that every amount you reported on your income tax return is substantiated and that nothing is missing.
If you are like many Canadians and work for an employer and contribute to RRSPs, the Likelihood of an audit is small because you are low risk. Your employer is required to withhold a portion of your income for taxes and report both your earnings and deductions to the CRA when they provide you your T4. Similarly, your RRSP contributions or withdrawals are also reported to the CRA, as is any interest or dividends you earn outside of your RRSPs.
Self-Employment = High Tax Risk
The article in The Bottom Line  goes on to say that persons or entities that have the opportunity to use more deductions or have “cash oriented” businesses are considered high risk and will picked more frequently for audit than T4 earners. In addition, it appears that the more a self-employed person makes, the more likely they are to under-report their income.
Two Types of Audits
It is important to understand that the CRA can conduct both regulatory audits and criminal audits. In a regulatory audit, the CRA can ask for all your documents and is looking to see if you properly reported your income. You can challenge the assessment of the CRA if you disagree but you will not be subject to criminal proceedings.
In criminal audits, the focus is on tax evasion and the penalties can be more substantial. The author quite rightly recommends that if you are being audited you should ask regularly during the audit if the audit is routine regulatory audit or if there is some other purpose in mind. If another purpose is in mind, you should immediately seek legal advice.
What To Do If Your Are Audited
Cooperate with the auditor if the audit is routine. An audit is disruptive to your life and can generally make you feel un-comfortable. Cooperation and truthfulness will serve you well and should make the experience less uncomfortable.
If you worried about something you have done, seek legal advice. Perhaps you made a mistake and are worried about what will happen. A tax attorney can give you advise and provide some legal protection you if the matter is serious.
Do your best to report all income properly. Ultimately, if you are audited and everything is properly reported and substantiated, the CRA may leave you alone in the future.