CRA’s New Directive and Heightened Scrutiny of Tax Returns in 2024

Blog Post: CRA’s New Directive and Heightened Scrutiny of Tax Returns in 2024

The Canada Revenue Agency (CRA) has recently intensified its scrutiny of both personal and corporate tax returns, employing sophisticated algorithms to identify any abnormalities, year-over-year changes, or deviations from industry norms. This heightened activity aims to detect tax evasion, fraud, and avoidance, reflecting the government’s broader response to increased public spending, budget deficits, and national debt levels. The CRA is focusing on specific areas, including employment expenses, auto expenses, continual losses on proprietorships, and foreign tax credits, to ensure compliance and maximize revenue collection. However, these efforts have also raised concerns about phishing scams masquerading as CRA communications.

Targeted Areas in Personal Tax Returns

1. Employment Expenses

The CRA is paying close attention to employment expenses claimed on personal tax returns. This includes expenses for home office costs, supplies, and other work-related expenses, which have become more common with the rise of remote work:

• Home Office Expenses: Taxpayers must provide detailed records, such as invoices and receipts, to substantiate claims for home office expenses. The CRA requires a T2200 form signed by the employer, confirming that the employee is required to incur these expenses to perform their job.
• Professional Fees and Dues: Claims for professional fees and dues are also being scrutinized. These expenses must be directly related to employment, and the CRA may request documentation proving they were paid by the taxpayer and not reimbursed by the employer​.
• The CRA provides detailed guidelines on employment expenses, including eligibility and the types of expenses that can be claimed, such as home office expenses and professional fees.
• Visit the CRA page on Employment Expenses.

2. Auto Expenses (Mileage Logs)

Auto expenses, such as mileage claimed for business purposes, are another focus area for CRA audits:

• Mileage Logs: Taxpayers must maintain detailed mileage logs, including dates, destinations, purposes, and kilometers driven for each business trip. Claims without adequate logs are likely to be rejected, leading to reassessments and potential penalties.
• Vehicle Use Percentage: The percentage of vehicle use for business purposes must be accurately calculated and documented, based on the total kilometers driven for the year versus those driven for business purposes. The CRA’s algorithms flag unusually high percentages compared to industry averages or previous filings.
• The CRA outlines what auto expenses can be claimed, including fuel, maintenance, insurance, and lease costs, as well as the documentation needed, like mileage logs.
• Refer to the CRA guide on Motor Vehicle Expenses

3. Continual Large Losses on Proprietorships

The CRA is particularly vigilant about returns that report continual large losses from sole proprietorships. Repeated losses without evidence of a genuine profit motive may prompt further investigation:

• Reasonable Expectation of Profit: If a proprietorship consistently reports significant losses, the CRA may suspect that the business is not operated with a genuine intention to earn income. This is especially likely if there is no apparent effort to improve profitability, such as minimal sales activity or lack of marketing.
• Personal Use of Business Expenses: Businesses that appear to cover personal expenses under the guise of business expenses are scrutinized. This includes vehicle expenses, home office costs, or entertainment expenses not directly related to generating income. If such expenses are found to be primarily for personal purposes, they may be disallowed).
• Hobby Losses vs. Business Losses: The CRA differentiates between legitimate business losses and those incurred from a hobby. If a business activity seems more like a personal pursuit than a genuine business operation, claimed losses may be disallowed. The taxpayer must demonstrate efforts to make the business profitable, such as business plans, client correspondence, or marketing materials.
• The CRA expects businesses to have a reasonable expectation of profit. For more information on the rules regarding claiming business losses and what the CRA looks for in terms of documentation and intent, check the CRA’s guidance on Business and Professional Income.

Targeted Areas in Corporate Tax Returns

1. Business Expenses and Deductions

The CRA is closely scrutinizing business expenses and deductions on corporate tax returns, including:

• Meals and Entertainment Expenses: These deductions must be directly related to business activities and not overly extravagant. Receipts and proof that such expenses were incurred to earn business income are required.
• Employee Benefits and Salaries: Salaries paid to family members or shareholders are scrutinized to ensure they reflect the fair market value of services provided. The CRA also examines employee benefits to ensure they are reasonable and consistent with industry standards.
• The CRA provides a comprehensive list of allowable business expenses, including meals, entertainment, and employee benefits, as well as rules about claiming these deductions.
• For more details, visit the CRA page on Business Expenses.

2. Auto Expenses for Corporations

Corporations claiming vehicle expenses, such as fuel, insurance, and maintenance, must provide accurate records:

• Corporate Vehicle Use: Detailed records of vehicle use, including mileage logs, are necessary to differentiate between personal and business use. If a company vehicle is used for personal reasons, the personal use must be reported as a taxable benefit.
• Leasing and Depreciation Costs: Claims related to vehicle leasing costs or depreciation are also scrutinized. The CRA looks for consistent, justifiable use patterns and records that accurately reflect business use.
• Corporations can claim vehicle expenses, but must keep detailed records to substantiate these claims. The CRA explains what is allowable and how to document these expenses.
• Learn more at the CRA page on Automobile and Vehicle Expenses.

3. Foreign Tax Credits

The CRA has increased scrutiny of foreign tax credits claimed by corporations to prevent double taxation for Canadian companies that pay taxes in other countries:

• Proper Documentation Required: Corporations must maintain thorough documentation, including proof of foreign taxes paid, detailed calculations in Canadian dollars, and evidence that the foreign taxes were not refunded or reduced. The CRA demands a high level of detail to validate these credits​.
• Consistency with Income Reporting: The CRA checks if the foreign income reported for Canadian tax purposes matches that reported in the foreign jurisdiction. Discrepancies may lead to further investigation.
• Verification of Foreign Tax Rates: The CRA verifies that foreign tax rates applied are correct and align with tax treaties between Canada and foreign jurisdictions. Claims that appear excessive or inconsistent with applicable tax rates or treaties are likely to be flagged for review. The CRA provides guidance on how to claim foreign tax credits and what documentation is necessary. The rules are designed to prevent double taxation while ensuring compliance with Canadian tax laws.
• Visit the CRA page on Foreign Tax Credits for more information.

These links will guide you through the specific requirements for each expense category, helping ensure compliance with CRA regulations.

Why This Increased Scrutiny Now?

The CRA’s enhanced scrutiny of these areas reflects the federal government’s need to maximize revenue collection in response to rising public debt levels. By focusing on areas with a high risk of non-compliance, such as continual business losses, foreign tax credits, and questionable expenses, the CRA aims to close loopholes and ensure fair tax practices.

Conclusion

With increased CRA scrutiny, taxpayers must diligently maintain accurate records, understand new guidelines, and consult tax professionals. This is especially important for those claiming deductions in targeted areas such as employment expenses, auto expenses, continual losses on proprietorships, and foreign tax credits. Staying informed and vigilant against phishing scams masquerading as CRA communications is also essential to avoid unnecessary penalties or complications.

Protecting yourself and your business from the financial and administrative burden of CRA audits is crucial in today’s increasingly scrutinized tax environment. At Winston & Company CPA, we offer Audit Shield, a comprehensive insurance service designed to cover the professional fees incurred during post-assessment reviews and audits. Whether your personal or corporate tax returns are flagged for employment expenses, vehicle logs, or other areas of interest, Audit Shield ensures that you are not left vulnerable to the high costs and stress of dealing with the CRA. With coverage options ranging from $10,000 to $50,000 annually, Audit Shield provides the security you need to focus on running your business, knowing you’re protected. For more information on how to safeguard your financial well-being, visit our FAQ page.

For more detailed guidance on CRA requirements and tax compliance, visit the Canada Revenue Agency website.