Income Tax Audit Manual
Compliance Programs Branch (CPB)
Information
This chapter was last updated July 2026.
Chapter 9.0 Audit planning and preparation
Table of Contents
- 9.1.0 Introduction
- 9.2.0 Preliminary review
- 9.2.1 Introduction
- 9.2.2 Sources of information
- 9.2.3 Trailing documents
- 9.2.4 Audit Case browser
- 9.2.5 Screener's comments
- 9.2.6 Prior audits
- 9.2.7 Collections information
- 9.2.8 Historical information – Mainframe databases
- 9.2.9 Filing history
- 9.2.10 Sector Profiles
- 9.2.11 Consultations with specialists
- 9.2.12 Other sources of information
- 9.2.13 Knowledge of business
- 9.2.14 Legal Entity Seach Tool
- 9.3.0 Ratio analysis and review of financial statements
- 9.4.0 Analytical review
- 9.5.0 Unfiled returns
- 9.6.0 Audit Plan
- 9.7.0 Audit tools
- 9.8.0 Working papers
- 9.9.0 CRA mainframe as a source of information
- 9.10.0 Determining the need for computer-assisted audit techniques
- 9.11.0 Audit scope
- 9.12.0 Audit period policy
- 9.13.0 Workload referral procedures for GST/HST and Small and Medium Enterprises
- 9.14.0 For future use
- 9.15.0 Concurrent audits of related, associated, or affiliated corporations
- 9.16.0 Continued risk assessment while the audit is in process
- 9.17.0 Audit risk and materiality
- 9.18.0 Contacting the taxpayer
- 9.18.1 Initial contact
- 9.18.2 Taking the necessary steps to begin the audit
- 9.18.3 Communicating with the taxpayer by letter
- 9.18.4 Scheduling
- 9.18.5 Audits delayed at the taxpayer's request
- 9.18.6 Communication with taxpayers for information requests
- 9.18.7 Guidance for the appropriate use of signatures when communicating with the taxpayers
- Appendix 9.1.0 Letters
- Appendix 9.2.0 Forms, templates, and checklists
9.0 Audit planning and preparation
9.1.0 Introduction
This chapter provides detailed information on how to prepare an Audit Plan, acquire and review information available from sources within the CRA, and make initial contact with the taxpayer.
Auditors must use the Integras suite of solutions (Integras) to prepare, conduct, and complete the audit.
The laptop computer includes Interactive Data Extraction and Analysis (IDEA) for Windows. IDEA is a useful tool when the taxpayer's records are in electronic format.
The auditor has the support of the team leader and when necessary, may consult other auditors who have experience in the industry being audited. Auditors should attempt to resolve audit issues by completing their own research. If there are unresolved technical issues, the auditor should discuss with the team leader, who may request technical assistance from Headquarters.
When an audit of a small or medium business needs to be transferred from one auditor to another, the originating auditor (or their team leader, in exceptional circumstances) must complete the Audit Transfer Form and the team leader must approve it. The form is available in the Integras Template Library, listed as A-9.1.1 Audit Transfer Form. It is also available in the CRA Electronic Library > Compliance Programs Branch > Reference Material > Audit > Income Tax – Forms and Letters > Forms > under A-9.1.1.
For instructions on transferring the case in Integras, the team leader should refer to the Audit case – Transfer Requests page of the Integras Reference Guide.
The Audit team leader may reassign a file from an auditor to another auditor without going through the regional Business Intelligence team leader. However, the Audit team leader must document the reason or reasons as to why the file is being reassigned.
For guidelines on conducting audits under unusual circumstances, go to 4.6.0, Auditing under unusual circumstances.
9.1.1 Topics in this chapter
The elements to plan and prepare for an audit include:
- overview to planning the audit
- preliminary review
- ratio analysis and review of financial statements
- analytical review
- unfiled returns
- Audit Plan
- audit tools
- working papers
- CRA mainframe as a source of information
- determining the need for computer-assisted audit techniques (CAATs)
- audit scope
- audit period policy
- workload referral for GST/HST and Small and Medium Enterprises
- concurrent audits of related, associated, or affiliated corporations
- continued risk assessment while the audit is in process
- assessment of materiality
- contacting the taxpayer
9.1.2 Overview to planning the audit
The most significant step at the beginning of an audit is to prepare an Audit Plan specific to each audit. All auditors should be familiar with policies and procedures before beginning any audit.
It is important to have a good understanding of the CRA's systems and the data available to prepare an Audit Plan.
The topics in this chapter are limited to preparing for the audit and contacting the taxpayer. Conducting and completing the audit are discussed in subsequent chapters.
Team leaders should ensure that auditors are familiar with the information in this chapter and that auditors prepare and use an Audit Plan for each audit.
9.1.3 Letter templates for the Economic Entity Program
The letter templates are available in the Integras template library. Go to the library for the current version.
The letter templates are also available at Letters (CRA Electronic Library > Compliance Programs Branch Reference Material > Audit > Income Tax – Forms and Letters > Letters > Economic Entity). If there are any changes to the letters, the templates available in the CRA Electronic Library and in the Integras Template Library are updated when the manual revisions are released.
9.2.1 Introduction
The preliminary review is the first stage of preparing for an audit and provides the information necessary to prepare an Audit Plan. Preparing for and planning the audit are essential to ensure that the audit is completed efficiently and effectively. Complete the preliminary review, including information in the Audit Plan, before contacting the taxpayer.
The preliminary review includes an analysis of the screener's comments. Review and note in the Audit Plan, concerns that have been documented from previous contact with the taxpayer and items from a previous audit that indicated that a follow up is necessary. Also review previous forms T401 and T401A from Appeals, Report on Objection, and, Notice of Objection - Negotiated Settlement Report, respectively.
Review historical information as well as any new information or changes to the taxpayer's business operations. However, changes in operations may not become evident until visiting the taxpayer's premises. The Audit Plan should be flexible to allow for these changes.
Initial contact with the taxpayer should confirm that the tombstone information is current and accurate. If the taxpayer's business activities have changed or the information on file is inaccurate or outdated, update the information as soon as possible. For updating business number (BN) accounts, auditors complete the Audit BN Change - CRITICAL Report available in Integras Reports template library. For more information, go to 9.18.0, Contacting the taxpayer.
9.2.2 Sources of information
A list of sources for valuable information during the preliminary review of the audit includes (this is not an exhaustive list):
- trailing documents (formerly permanent document (PD) folder) and audit file
- Integras tabs: Case Attributes, Program Attributes, Relationship Overview, and Taxpayer Views
- screener's comments (reason for the audit, Form T133, Lead or Project Information)
- Forms T401 and T401A from Appeals, Report on Objection, and, Notice of Objection - Negotiated Settlement Report, respectively
- prior audit information
- Collections information
- historical information (log of action) available from various mainframe databases
- filing history (income tax returns, GST/HST returns, excise tax returns, and financial statements)
- legislation, amendments, and related publications
- Sector Profiles (go to CRA Electronic Library > Compliance Programs Branch Reference Material > Audit > Income Tax Sector Profiles)
- specialist sections such as Real Estate Appraisals and Business Equity Valuations, Employer Compliance Audit, Computer Audit Specialist, and industry specialists
Note: If the taxpayer has outstanding returns, go to 9.5.0, Unfiled returns.
9.2.3 Trailing documents
Trailing documents were formerly called permanent documents (PD) or attachments. They contain significant information about the taxpayer’s obligations and operations, including the organizational structure, business operations, prior audits, and other information useful to the planning of subsequent audits. Trailing documents may also contain information on the books and records (location, type of record keeping, software), prior Audit Plans, Audit Reports, and correspondence (including rulings), and information on concerns that were noted during other contact with the taxpayer that need follow up. For more information, go to 11.8.4, Trailing (permanent) documents.
Trailing documents are stored with Iron Mountain (IRM). For more information, go to Request registered taxpayer records, Request tax records.
9.2.4 Audit Case browser
In Integras, the case browser contains tombstone information about the taxpayer such as their name, address, telephone number, person to contact, major business activity, NAICS (North American Industry Classification System) code, filing history, elections, and the screener’s package (in Relationship Overview tab).
In addition, Launch provides the following information:
Taxpayer View (T1)
Launch from within a T1 Case Browser and it consists of:
- T1 Tombstone
- Audit (AIMS)
- T1 Assessing
- Tax Information Slips
- T1 Financial Statements
Taxpayer View (T2)
Launch from within a T2 Case Browser and it provides a view of all T2 returns and related forms for a corporation. It displays data that exists in the Corporation Tax Processing System (CORTAX). It allows for quick and easy retrieval of tax year-end information for the year 2000 and subsequent.
Profile View (T2 only) is a tool for T2 cases that displays the ranking of non-compliance based risk issues.
In each of these Views, Integras provides much more information. As part of the preliminary review, the auditor should open and read all the relevant nodes within Integras.
Verify the tombstone information at the time of initial contact and make changes as required.
9.2.5 Screener's comments
The Relationship Overview tab in Integras contains the screener’s comments. It helps to determine the scope of the audit based on the reason for selection. It is a tool used to communicate the items of concern that require specific review and comments by the auditor. The auditor uses this information to develop the Audit Plan. If the audit is the result of a lead or referral, the reason is noted on the referral form. All screener's comments must be addressed on Form T20, Audit Report. For more information, go to 9.11.0, Audit scope.
9.2.6 Prior audits
If there has been a previous audit, review the information when preparing and planning the audit, which helps develop the Audit Plan.
Information from prior audits, such as Form T20, Audit Report, is stored electronically as trailing documents with Iron Mountain (IRM). For information on requesting trailing documents from IRM, go to Request registered taxpayer records, Request tax records.
Auditors must use Integras to retrieve prior audits that were completed using WinALS. From Tools menu, select Search Cases.
Note 1: All audits completed using the WinALS system between 2008 and 2018 have been migrated to Integras. You must use Integras to access these archived audit cases.
Note 2: Audits stored in the NAA prior to 2008 have been purged in accordance with CRA Information Management policy.
The auditor must review previous T401and T401A forms from Appeals, Report on Objection, and, Notice of Objection - Negotiated Settlement Report, respectively.
9.2.7 Collections information
The auditor must review the taxpayer's account to check for outstanding balances payable to CRA and to determine if a collection problem has been identified. Collection information is in the Common Menu System, which is available in the Automated Collections and Source Deductions Enforcement System (ACSES). For more information on how to navigate within this system, go to ACSES.
Review of collection information may indicate:
- a hold has been placed on the account
- the taxpayer is in bankruptcy (previous, actual, or anticipated) or
- there are outstanding returns indicating non-compliance
If a hold has been placed on the account, the auditor should determine the reason for the hold. If there are refunds that have not been disbursed, the auditor should determine the reason before contacting the taxpayer.
If Collections and Verification has been in contact with the taxpayer, the auditor should discuss the situation with the team leader and should contact the Collection officer before contacting the taxpayer or starting the audit.
9.2.8 Historical information – Mainframe databases
The mainframe databases provide access to historical taxpayer filing information as well as to audit processing functions that add completed audit results to the taxpayer information. Mainframe access is restricted and monitored to ensure that information is retrieved only as necessary. Specific mainframe applications are available to CRA employees and are based on their job function.
9.2.9 Filing history
Income tax returns
All relevant information from income tax returns that are filed electronically by taxpayers or their authorized representatives is accessible from the mainframe.
Income tax returns, including those filed using paper and physically stored, can be accessed through the Document Management Portal (DMP).
The DMP stores digitized incoming taxpayer paper correspondence and forms associated with the T1 Adjustments business lines, including taxpayer requested (TPR) adjustments. To request access, search and view a document, and other tasks, go to Document Management Portal (DMP). The Document Management Solutions provide the DMP and Digitization and Automation Services. For more information on the DMP, go to The Document Management Portal.
Individuals and partnerships
Audits of individuals and partnerships must include a review of the spouse or common-law partner's T1 and other related, associated, or affiliated persons, as appropriate.
Corporations
Audits of corporations must include a review of the shareholders' income tax returns as well as related, associated, or affiliated persons’ T1, T2, and T3 returns. Auditors may also review T4 slips issued by the taxpayer.
9.2.10 Sector Profiles
Sector Profiles provide information that applies to the industry or sector in general. These profiles are an excellent source of information to establish the Audit Plan and to help guide the auditor in aspects that require specific review for that industry.
The specific details that are available include:
- general overview
- accounting practices
- performance indicators
- typical books and records
- specific audit checks
For more information, go to CRA Electronic Library > Compliance Programs Branch Reference Material > Audit > Income Tax Sector Profiles.
9.2.11 Consultations with specialists
The CRA has specialists for many areas that are located in the TSO, the regional office, or Headquarters (HQ). Auditors must research the application of a policy or of the law (technical issue) relating to their files and discuss challenging issues with their team leaders. If the application of a policy or law remains unclear, the team leader may request technical assistance from HQ.
Examples of specialists or specialty sections include:
- Real Estate Appraisal and Business Equity Valuation (TSO)
- industry specialists for major industry sectors (TSO/HQ)
- International Tax (TSO)
- Computer Audit Specialists (TSO)
- Business Tax Incentives Directorate (BTID) (TSO)
- Employer Compliance Audit (ECA) (TSO)
- Aggressive Tax Planning (TSO)
- Underused Housing Tax (UHT) (HQ)
If the team leader approves a request for assistance from these specialists, the procedure to follow is to create a new case in Integras. For more information, go to:
- Integras Reference Guide
- learning product HQ1147-102, Integras Planning Workshop – Small & Medium Enterprise (SMED) – Webstart
- learning product HQ1147-104, Integras Conducting Workshop – Small & Medium Enterprise (SMED) – Webstart
- learning product HQ1147-106, Integras Finalizing Workshop – Small & Medium Enterprise (SMED) – Webstart
9.2.12 Other sources of information
Real estate information
The real estate database provides the auditor with specific historical information on real property transactions. The information includes values, dates, purchaser and vendor information, and other data including type of property and type of transaction such as open market or non arm’s length. Current ownership and tenant information is also available through this database. For more information, go to 10.11.4, Referrals for real estate appraisal or business equity valuation.
Other regulatory bodies
Other regulatory bodies include provincial and municipal jurisdictions and professional organizations. Depending on the nature of the audit, it may be necessary to search these sources for additional information.
As an example, provincial vehicle registration may be searched to identify transactions that have occurred between parties and to determine the current ownership of vehicles. Search by name, plate number, and by vehicle identification number (VIN). This information is available for each provincial jurisdiction.
Certain types of information owned by provincial and municipal jurisdictions may be useful in conducting the audit. One example is the total of liquor purchases by the taxpayer from provincially-owned liquor distributors. This information may be needed to complete a projection of sales based on liquor purchases. To obtain these types of information, the auditor should consult the team leader and also the TSO federal-provincial liaison before proceeding.
Intranet
Visit Small and Medium Enterprises Directorate to use the intranet for reference material on CRA audit policy and other more general information.
Internet
The Internet may provide information for the auditor, including:
- information about the taxpayer's business activities
- goods and services provided by the taxpayer
- third-party information regarding the taxpayer
9.2.13 Knowledge of business
Auditors need to understand the way a business functions to conduct an effective audit and to assess the taxpayer's compliance with the relevant acts. Sector Profiles give useful information that applies to the industry, including common types of records and performance indicators. For more information, go to CRA Electronic Library > Compliance Programs Branch Reference Material > Audit > Income Tax Sector Profiles.
Specific information is gathered during the audit, as each business is unique and may function according to local requirements and customer base. During the audit, the auditor will obtain and apply knowledge of the taxpayer's business activity. This knowledge will assist the auditor in updating the Audit Plan and complete the audit effectively and efficiently.
Some knowledge of the taxpayer’s business is required to prepare questions for the initial interview and to be able to understand the taxpayer's response to the questions. Auditors are not permitted to use audio or video recorders to record interviews nor should they allow themselves to be recorded. If an auditor becomes aware that they are being recorded, the interview should be stopped, the reasons explained, and alternate arrangements made.
Information gathered during the audit will either verify the preliminary information obtained or indicate that changes to the Audit Plan are necessary.
9.2.14 Legal Entity Search Tool
The Legal Entity (LE) search tool helps identify both the Economic Entity (EE) and LE groupings and indicates their case status in Integras. The LE search application simplifies the process of identifying EE and LE groupings, offering quick access to entity details, case statuses, and points of contact. For more information, go to the Legal Entity Search Tool Job Aid on the EE Program SharePoint. For questions, email the EE team’s mailbox.
9.3.0 Ratio analysis and review of financial statements
Use ratios, such as gross profit and inventory turnover, to test information in the taxpayer's financial statements, to determine the reasonableness of the amounts as stated, and to indicate items that may require further verification. Compare ratios from year to year and also with ratios of other taxpayers in the same industry.
Auditors should exercise caution when relying on any ratio analysis. When the ratio calculated indicates a material variance from the norm or average for the taxpayer's type of business, further testing may be warranted. However, a ratio is only a guide and any variance can have many different explanations. Do not overlook the taxpayer's records and findings from the initial interview and internal control review simply because a ratio analysis does not indicate a material variance or immediate reason for concern. Ratios can return false results if the numerator and denominator in the calculation have both been materially understated.
Ratios can provide measures of average performance and can serve as a basis for identifying unusual financial relationships or issues that should be verified. Using projections can test the taxpayer's reported revenues, gross profit, or net income.
However, projections based on industry ratios cannot be used as a basis for assessment. Only a projection based on taxpayer-specific data (for example, units purchased versus units sold) may be used as a basis to assess additional revenue under limited circumstances or to deny, based on reasonableness, the purchases expensed.
The CRA's Computer-assisted Audit Selection (CAAS) System is built on models of industry ratio analysis. This is often reflected in the identified audit issues in the summary printouts provided.
Industry-based ratios are in copies of publications in the CRA libraries; for more information, also see the Sector Profiles at CRA Electronic Library > Compliance Programs Branch Reference Material > Audit > Income Tax Sector Profiles.
9.4.1 Introduction
An analytical review of financial statements and returns as filed is often completed during the preliminary review. To view financial statement information for prior years, access the T2 CORTAX menu in the Common Menu System when financial statements are not available until visiting the taxpayer. The returns can be used to prepare a preliminary analysis. The CAAS profile provides a multi-year comparison of financial data and is useful for analysis.
Perform an analytical review to help determine potential issues. Note unusual variances and address them during the interview with the taxpayer; develop additional audit procedures if necessary.
9.4.2 Review of returns as filed and ratio analysis
Analytical review includes a detailed review of returns as filed, such as:
- an analysis of cost of goods sold
- a comparison of gross profit to similar businesses
- a comparison of expenses and product mix from one year to the next
For more information, go to 9.2.0, Preliminary review.
For an example of common ratio analysis (liquidity, debt to equity, coverage, and profit) of financial statements, go to 13.1.8, Examples of computer-assisted audit techniques.
9.4.3 Reconciling the returns to the books and records
Before conducting any substantive testing on an expense account (beyond query), the account must be reconciled to the tax return. Expense reconciliation is a comparison of the amounts claimed as expenses to amounts listed in the final books of account along with any adjusting journal entries and explanations from the taxpayer. Adjustments cannot be made to the account until an audit conclusion has been reached to explain any variance.
Example: Purchase expense was identified as a risk. Final books of account indicate Purchases of $1M. Tax return claims $1.5M. Testing must be developed that verifies the $1M in the books, and testing must be developed that allows a conclusion to be drawn regarding the $500,000 variance.
9.4.4 Changes in taxpayer’s accounting policies
Changes in the taxpayer's accounting policies are important aspects of the audit process to ensure compliance. Changes in accounting policies that are made arbitrarily affect the degree of assurance that may be placed on the financial statements. For a meaningful comparison of figures from year to year, it is necessary that the figures be compiled on a consistent basis. If a change in accounting policy is the result of changes in operations, the comparative figures may not provide information that is useful for audit purposes.
If changes made to accounting policies appear arbitrary and affect the reporting of certain items, the motivation of the taxpayer may be to limit the usefulness of comparative analysis. For example, the taxpayer may have a significant increase in a certain expense and would prefer not to have the item questioned. As a result, segregating certain costs to form two expense accounts may alter the presentation of the expense account.
If a significant change is noted in the compilation of the financial statements, discuss with the team leader. A significant change in accounting policy includes:
- change from accrual to cash accounting (or cash to accrual)
- change in the method of valuing inventory, including finished goods and work in progress
- the timing of recognition of profits of long-term contracts, or
- other changes that can have a significant effect on the determination of income
Changes in the method of valuing finished goods and/or work in progress inventories are frequent in the manufacturing industry. Thoroughly review these policy changes during the audit to determine the tax effect.
While the results of the comparative analysis of the financial statements can be useful information, other audit steps, tests, and procedures are required to determine the degree of the taxpayer's compliance. Interpret the ratios calculated and variances noted when comparing amounts to determine their effect on the audit.
9.4.5 Gross profit ratio
A specific item to compare from year-to-year is the gross profit ratio, calculated as:
Gross income or gross sales – Cost of goods sold / Gross income or gross sales = Gross profit ratio
Compare the gross profit of individual items or product lines to the average gross profit ratio, as well as to the average ratio for the industry. Compare the calculated ratio to the ratio as stated by the taxpayer during the initial interview. A significant variance in the ratio may indicate overstated cost of goods sold or understated sales.
Example 1 – Gross profit ratio
In this example, the auditor suspects that the gross profit may be understated. Assume reported sales are correct.
Reported sales $320,000
Less: Cost of goods sold as reported 212,800
Gross profit $107,200
Gross profit as % of sales 33.5%
Gross profit industry ratio 43.5%
Projected gross profit ($320,000 x 43.5%) $139,200
Less: Reported gross profit 107,200
Estimated cost of goods sold overstated $ 32,000
Example 2 – Gross profit ratio
In Example 1, the sales figure was assumed to be correct. However, in this example assume instead that the cost of goods sold figure is accurate. If sales were not verified, the potential unreported sales could be as high as $56,600, as in the analysis below.
Reported cost of goods sold $212,800
Divide by (1 less the gross profit industry ratio 56.5%
given in Example 1 above)
Estimated sales $376,600
Less: Reported sales 320,000
Estimated unreported sales $ 56,600
If the gross profit ratio analysis determines a discrepancy, a review of the taxpayer’s sales invoices or other observations may determine the selling prices. From the purchase invoices and freight bills, the auditor can determine the costs incurred. If the auditor does this for a representative sample, the overall gross profit ratio can be roughly determined and the estimated discrepancy revised.
The auditor should be aware that if both sales and cost of goods sold are misrepresented, the gross profit ratio analysis provides a false projection. For more information, go to 9.16.0, Continued risk assessment while the audit is in process.
9.4.6 Inventory turnover
A taxpayer's inventory turnover is determined as annual cost of goods sold divided by average inventory.
Inventory turnover Cost of goods sold / ((Beginning inventory + Ending inventory) / 2)
Use an analysis of inventory turnover to calculate revised estimates of sales and purchases, based on figures for reported inventory.
Example 1 – Inventory turnover
In this example, the auditor suspects that the sales may be understated.
Assume reported average inventory and cost of goods sold are accurate.
Taxpayer's reported average inventory $ 45,000
Taxpayer's reported gross profit margin 40.0%
Industry average inventory turnover (times per year) 3.0
Inventory turnover (in days) 121.6 days
Estimated cost of goods sold (3.0 x $45,000) $135,000
Add: Taxpayer's reported gross profit margin (40%) 90,000
Estimated sales $225,000
Less: Sales reported 193,000
Estimated unreported sales $ 32,000
Example 2 – Inventory turnover
In this example, the auditor suspects that the purchases may be overstated.
Assume reported ending inventory is accurate.
Taxpayer's reported average inventory $ 45,000
Industry average inventory turnover (times per year) 3.0
Inventory turnover (in days) 121.6 days
Estimated cost of goods sold (3.0 x $45,000) $135,000
Less: Cost of goods sold reported 155,000
Estimated overstated cost of goods sold $ 20,000
Alternatively, if the taxpayer's reported purchases or sales are determined to be accurate, use an analysis of inventory turnover to calculate revised estimates of ending inventory.
Example 3 – Inventory turnover
In this example, the auditor suspects that the ending inventory may be understated. The revised estimate of ending inventory will be based on recorded purchases.
Taxpayer's reported ending inventory $62,000
Taxpayer's reported gross profit margin 40.0%
Industry average inventory turnover (times per year) 3.0 121.6 days
Using inventory turnover, the taxpayer's ending inventory can be estimated by totalling the purchases for the last 122 days (approximately 4 months) of the period.
September purchases $23,220 30 days
October purchases 22,710 31 days
November purchases 17,490 30 days
December purchases 15,580 31 days
Estimated ending inventory $79,000 122 days
Less: Reported ending inventory 62,000
Estimated understated ending inventory $17,000
Example 4 – Inventory turnover
In this example, the auditor suspects that the ending inventory may be understated. The revised estimate of ending inventory will be based on recorded sales and the taxpayer's gross profit ratio.
Taxpayer's reported ending inventory $62,000
Taxpayer's reported gross profit margin 40.0%
Industry average for inventory turnover 3.0 121.6 days
Using inventory turnover, the auditor can estimate the taxpayer's ending inventory by totalling sales for the first 119 days (approximately 4 months) of the subsequent period.
January sales $ 28,610 31 days
February sales 29,780 28 days
March sales 29,900 30 days
April sales 38,640 30 days
Total $126,930 119 days
Less: Gross profit (40% x $126,930) 50,772
Estimated ending inventory $ 76,158
Less: Reported ending inventory 62,000
Estimated understated ending inventory $ 14,158
If the analysis of inventory turnover determines a discrepancy, the auditor can verify the taxpayer's inventory control procedures and year-end physical count. If no year-end physical count of inventory was taken, the auditor may request that one be undertaken as part of the audit. If the analysis concludes that the taxpayer's sales or gross profit may be understated, the auditor should consider applying gross profit ratio analysis or in-depth direct testing of sales and cost of goods sold.
If both ending inventory and cost of goods sold are misrepresented, the inventory turnover analysis will provide a false projection.
9.4.8 Comparative analysis of financial statements
Comparing current and prior years' line items in the taxpayer’s financial statements can highlight unreasonable or questionable balances. For example:
- Does the trend of sales appear reasonable?
- Are there unusual changes in any assets or liabilities?
- Have asset and liability ratios remained constant or are there material changes?
- Have any expenses increased materially?
- Does any amount seem out of proportion when compared with other amounts for the current year or with the corresponding item for other years (for example, sales to advertising expenses)?
If there are significant items or changes, prepare a working paper listing items to review during the audit and update the Audit Plan.
Note: The CAAS profile provides an analysis of multi-year data and greatly facilitates this aspect of audit planning.
In addition to comparing items from year-to-year, review the balance sheet to:
- ensure continuity of the capital cost allowance (CCA) schedule
- verify that the closing asset and liability account balances are equal to the opening balances reported in the subsequent year (such as accounts receivable, inventory, accounts payable, and surplus)
- review credits made directly to accounts that form part of the business equity
- determine if there are credits that the taxpayer has classified as capital receipts that may actually be income
- review all reserves to ensure that no unauthorized reserves are being created and that reserves claimed in a prior year are included in income in the subsequent year
Complete information is required to determine the continuity of balance sheet accounts. If the information is incomplete, the situation should be discussed with the team leader to determine appropriate action.
Discuss unusual items in a return outside the standard audit period with the team leader to determine if the audit period should be extended to include those returns. For more information, go to 9.12.3, The common audit period (one-plus-one).
Use the CCA schedule to ensure that acquisitions and dispositions of capital assets are correctly recorded.
9.5.0 Unfiled returns
9.5.1 Introduction
Subsection 152(7) of the Income Tax Act (ITA) provides the minister with the authority to issue an assessment regardless of the amounts already filed in a return or where no return has been filed. This action is taken in certain situations if returns have not been filed voluntarily.
Assessments made under subsection 152(7) of the ITA must be based on factual amounts. Subsection 152(7) assessments are raised by the Non-filer Partner Centre (NFPC) in the Non-Filer Division (NFD).
SMED’s risk assessment and audit functions generally focus on taxpayers with filed income tax returns. Sometimes, however, issues are identified for taxpayers with unfiled returns. This can occur at the risk assessment or audit stage. Obtaining these returns is often required to properly risk assess the file or complete ongoing audit activities.
SMED has developed a collaborative relationship with the NFPC in the NFD to manage cases with unfiled returns. The success of this relationship depends on:
- Screeners and auditors informing the NFPC at the earliest stage possible of any unfiled returns that are relevant to their screening or audit workloads.
- Screeners, auditors, and NFPC officers proactively communicating with each other once a referral to the NFPC has been made and until such time as the referral is resolved.
- Screeners and auditors ensuring that referrals to the NFPC only pertain to unfiled years that need to be resolved in order to complete ongoing screening or audit actions.
- Auditors and NFPC officers being transparent with the taxpayer that they are working together to address issues of filing non-compliance. Note that for referrals made by screeners, NFPC officers will not advise taxpayers that their account is being reviewed for potential audit action.
9.5.2 Referrals to the Non-Filer Partner Centre
Auditors must ensure that referrals to the NFPC are fully warranted based on risk.
Referrals to the NFPC from risk assessment functions will focus on taxpayers under consideration for audit, while referrals from auditors will focus on taxpayers under audit, related entities of the taxpayer under audit, or third-parties that need unfiled returns resolved in order to facilitate the completion of an audit.
All communications and exchanges of information between screeners, auditors and NFPC staff must follow existing CRA protocols for dealing with taxpayer information.
Auditors must continue with their audit work after making a referral to the NFPC. The auditor can advance their audit while NFPC officers address the unfiled returns by:
- Making an initial request for the taxpayer to file their returns and providing a reasonable amount of time to do so. This is generally 30 days for each unfiled return up to a maximum of 90 days where multiple returns are outstanding. Auditors can complete this step prior to an NFPC referral, but they must advise the NFPC of the request and associated deadlines.
- Focusing audit steps on filed periods and those for which books and records are available.
- Reviewing GST/HST filings and/or GST/HST audits, if applicable.
- Sending requests or requirements for information to taxpayers, director(s), shareholder(s), the taxpayer’s accountant, financial institutions or other third parties, to secure books and records so that audit work can take place while the unfiled returns are being resolved.
It may also be useful for the auditor and NFPC officer to arrange for simultaneous field visits with the taxpayer to discuss issues related to ongoing non-compliance. Such options can be discussed and pursued with NFPC officers if case-specific factors suggest it would be beneficial.
9.5.3 Making a Referral to the Non-Filer Partner Centre
To make a new referral to the NFPC, screeners and auditors will use the Willow system. Its use will standardize referrals and ensure that the NFPC receives all of the information that they need in order to begin actioning the referral. Additional information will be gathered in subsequent discussions between NFPC officers and the screener or auditor.
The use of Willow will also assist with the tracking and management of referrals from the point of initial submission to when the file has been assigned to the NFPC. Go to the memorandum SMED Referrals to the Non-Filer Division of the Collections and Verification Branch for procedures on how to make a referral using Willow.
Prior to making a referral to the NFPC, auditors should check the screening information included in their Integras case to see if a referral had already been made to the NFPC at the risk assessment stage. If a referral had been made, the auditor should contact the assigned NFPC officer (if known) or by sending an email to NFPAS Requests - CVB / Demandes SAPND - DGRV (CRA/ARC) to follow up on the referral.
The screener or auditor will be contacted by an NFPC officer after the referral has been assigned. From that point forward, the screener or auditor and the NFPC officer will work together to develop an agreed upon plan of action. They should also communicate with each other whenever significant events happen with respect to the taxpayer or as the file progresses.
The screener or auditor and the NFPC officer will continue to work together until the unfiled returns have been resolved or another suitable outcome is achieved. Generally, one of the following 5 outcomes can occur:
- The unfiled returns are filed before the screening or audit work is completed. Screening and audit work can proceed as normal. This is expected to be the most common outcome.
- The unfiled returns are no longer required by the screener or auditor. The screener or auditor and the NFPC officer will discuss the situation and determine how best to proceed.
- The unfiled returns are not filed and an assessment under subsection 152(7) of the Income Tax Act (ITA) will be raised by the NFPC based on audit findings.
- The unfiled returns are not filed and prosecution for failure to file is initiated by the NFPC. This option would be reserved for the most serious cases of non-compliance due to the complexities involved and the likelihood that it would significantly prolong the audit.
- The unfiled returns are not filed, prosecution for failure to file is not being pursued and an assessment under subsection 152(7) of the ITA is not possible. This situation is expected to be rare and would lead to a closure of the case by the auditor and NFPC officer without further action.
With the exception of an initial request to file any outstanding returns, auditors are to defer the management of the taxpayer’s filing non-compliance to the NFPC. This includes subsequent requests to file, issuing demands to file, processing subsection 152(7) assessments, and/or the prosecution of taxpayers for failure to file. These CRA actions represent an escalation of efforts to manage filing non-compliance and are best managed by the NFPC.
If an auditor receives unfiled returns from the taxpayer, they must be sent to the Tax Centre for processing as soon as possible. This will allow the auditor to reflect the filed information in their Integras file and code the file appropriately when finalizing the audit. The auditor must also inform the NFPC if they receive returns directly from the taxpayer. This will ensure that no unnecessary actions are taken by the NFPC once the returns have been filed.
Refer to the SMED Referrals to the Non-Filer Division of the Collections and Verification Branch Memo for the complete procedure.
9.5.4 Pro-forma income tax returns
If the taxpayer has not voluntarily filed income tax returns, the minister can assess by preparing subsection 152(7) assessments. For more information, go to 11.5.3, Assessments under subsection 152(7) of the Income Tax Act.
9.6.0 Audit Plan
9.6.1 Preparing the Audit Plan
Prepare the Audit Plan after completing the preliminary review, as the Audit Plan is based on the reason for the audit. Identify potential items of concern noted during the preliminary review and the audit procedures that will address the concerns identified. Note that there may not be sufficient information to establish the appropriate audit procedures at this point in the audit. Additional information obtained during the initial interview, tour of premises, accounting system walkthrough or assessment of internal controls should be used to modify/update the Audit Plan and the relevant audit procedures. For more information, go to 9.2.0, Preliminary review.
Include workload referral procedures in the Audit Plan. For more information, go to 9.13.3, Workload referral process. In certain situations, an auditor will receive a file from Workload Development that has been classified as a consequential adjustment (CA). A CA is a non-complex adjustment originating in a referral from GST/HST. An auditor can identify a CA by noting that the audit action (“AUDIT ACT”) code = 03 and the work section source (“WORK SOURCE”) = 210. In addition, Workload Development will have entered a notation in the “SCREENER’S COMMENTS” that this is a CA.
Auditors who have received a CA must issue a proposal letter to the taxpayer using the information from the GST/HST audit as the basis. Auditors are expected to spend 10 hours or less in completing a CA. A specific Audit Report has been designed for CAs only.
If an auditor determines that the CA should be a full-scope audit, the auditor must discuss this with the team leader. If the team leader agrees that a CA should be a full-scope audit, then Workload Development will update the AIMS audit action code to 01. In this case, the auditor must follow regular audit procedures.
For more information, go to Appendix A-9.2.7, Sample Audit Plan.
9.6.2 Factors to consider and procedures to include in the Audit Plan
When preparing the Audit Plan, consider 9.17.0, Audit risk and materiality, and the following, when identifying areas of risk and audit procedures to mitigate it:
- reviewing the taxpayer file to:
- determine the type and extent of audit techniques to use to clear the screener's comments
- understand the type and size of operation
- determine if there are any related and/or associated taxpayers
- determine the type of accounting system in place
- determine the extent of internal controls in place
- note prior difficulties encountered in dealings with the taxpayer
- determine the issues from a previous audit
- note any outstanding issues from prior audit
- determine the contact person
- review industry specific data to determine potential audit issues unique to that industry
- determine the need for specialists (for example, real estate appraiser, Computer Audit Specialist, and Non-Resident or International auditor)
- include flexibility to address issues that arise during the audit
- complete a comparison of the CAAS profile and the business profile (at the end of the audit, variances should be adequately explained)
- consider using assessing Indirect Verification of Income (IVI) techniques and the Income Tax Assessing IVI Decision Tree
- meeting with the team leader to discuss:
- expected length of audit
- issues to be addressed
- need for specialists
- technical or policy issues that need to be referred to Headquarters
- contacting the taxpayer to:
- request financial statements
- confirm type of accounting records
- set date and time to start audit
- ensure that space is available
- determine availability of employees to answer questions
- schedule tour of premises
- request chart of accounts
The Audit Plan is a mandatory document necessary to an effective and efficient audit. It is a document that is continually updated for evolving audit issues, determination of the level of internal controls, and the adequacy of books and records.
The audit programs within Integras are useful references during the planning and auditing stages.
Although template Audit Plans are useful guides, auditors must read each line and note when an audit step is or is not necessary. If an auditor enters N/A (not applicable) beside a pre-printed audit step, the auditor must include a sentence explaining why the step was not performed. Auditors are encouraged to use template Audit Plans as guides only, and create additional, relevant audit steps as necessary.
9.6.3 Team leader involvement in the Audit Plan
The team leader approval of the Audit Plan is required prior to meeting with the taxpayer. The auditor must follow the Integras procedures to send the Audit Plan to the team leader for approval. If the team leader rejects the Audit Plan, the auditor can revise it and resubmit.
However, if the team leader approves the Audit Plan and the auditor finds that they need to amend or expand it, the auditor will need to create another work item within Integras.
Team leader approval is necessary at various stages of the audit; note this approval on Form T2020, Memo for file.
The team leader must be actively involved in the planning phase of the audit, especially if the auditor is inexperienced or unfamiliar with the type of business. The team leader must ensure that the audit approach takes into consideration the nature of the business, the type of audit to be conducted, and the income of the relevant individuals.
In T1 audits, relevant individuals include, at a minimum, the proprietor and the spouse or common-law partner of the proprietor. Other relevant individuals may be included as the audit progresses. In T2 audits, relevant individuals include all shareholders and their spouses or common-law partners. If there is a series of holding corporations, the auditor must look to the individuals that control the corporations and their spouses or common-law partners. Other relevant individuals may be added as the audit progresses.
Significant changes to the Audit Plan must be discussed and approved by the team leader. For example, during the audit, the auditor may determine that a net worth is required; in this case, consult the team leader as soon as possible.
9.6.4 Time budget
The Audit Plan should include a preliminary time budget based on the information available. The taxpayer will likely need an estimate of how long the audit will take to ensure space is available for the auditor to work and employees are available to assist the auditor, if necessary.
The time budget may require adjusting as additional information becomes available and as the audit progresses. Keep the team leader and the taxpayer informed of material changes in the estimated time needed to complete the audit.
9.7.0 Audit tools
9.7.1 Integras
Introduction
From an auditor’s point of view, Integras is a computer-based audit system that provides the ability to manage audit cases for its entire lifecycle in both official languages. Its objective is to replace AIMS and WinALS. It is mandatory for auditors to use Integras to carry out their audits.
According to their different roles, Integras allows users to:
- request, create, assign/reassign, and transfer principal and secondary cases
- manage electronic workload inventory, including bringing forward cases
- access, manage, and automate working papers, templates, reports, and letters
- obtain and process electronic documents from taxpayers or their authorized representatives via My Business Account, My Account, or Represent a Client on CRA webpages
- work disconnected from intranet or Internet
- consult T1 and T2 Taxpayer Views
- search and access related cases and the national database
- approve or reject documents
- request assistance from other CRA programs
- benefit from automation of electronic T1 and T2 reassessment
- input electronic Audit changes (DCR/ACR)
- access the intranet and Internet to research CRA internal and external websites
- refer to the audit trail within the case (Case History)
- exchange notes
- report time spent on each case (Future Integras releases)
For more information, go to:
- Integras Reference Guide
- learning product HQ1147-102, Integras Planning Workshop – Small & Medium Enterprise (SMED) – Webstart
- learning product HQ1147-104, Integras Conducting Workshop – Small & Medium Enterprise (SMED) – Webstart
- learning product HQ1147-106, Integras Finalizing Workshop – Small & Medium Enterprise (SMED) – Webstart
This material is designed to introduce Integras users to the fundamentals of managing audits and to Integras functions.
9.7.2 Internal Notifications application
The Internal Notifications (IN) application centralizes taxpayer information and generates alerts to inform the auditor of various updates on accounts they are working on. A wide variety of updates will trigger a notification, such as changes in address or authorized representative, reception by the CRA of a taxpayer-initiated request, new objection filed, or assessment of penalties. Auditors should refer to the Catalogue of Events page for a list of the events and statuses that will generate a notification.
The IN eliminate the need to check other systems during the audit to see if there were any changes the auditor must be aware of, as the auditor will receive an email notification when activity occurs. The auditor can then log in the IN application and view the event notifications for the taxpayer.
To stay effortlessly informed throughout the audit, the auditor should add a taxpayer to their watchlist in the IN Application. They should also remove them from their watchlist when the audit is completed. For more information on how to request access to, and use the IN application, auditors should consult the SharePoint page Internal Notifications (IN).
9.7.3 Integras templates
Forms, audit programs and procedures, working papers, applications and reports, are located in the Integras Template Library. Template Library is only available within a case.
Templates may be added, customized, renamed, and removed from the Navigation region. However, it is important that the templates for requirements and compliance orders not be changed, for legal reasons. Once a template is added to the Navigation region in Integras, it becomes a working paper.
Auditors can use the templates to automate and simplify many tasks. If the document includes data tokens, the system replaces the tokens with the appropriate data, but only in Microsoft Word or Excel documents.
What are Tokens?
Tokens are similar to hyperlinks used to auto-populate information into a template, when the template is added to an Integras case. This is important, as it saves the auditor time in the audit process because they do not need to spend time manually entering this information. For example, tokens can be used to auto-populate a taxpayer’s address in letters.
Audit applications
Integras contains many audit applications, procedures, working papers, and forms, such as:
- vehicle benefits
- net worth
- leads (Forms T133, Lead or Project Information, and T134, Referral to the Criminal Investigations Division) (referrals to the Criminal Investigations Division are under review)
- capital cost allowance (Capital Cost Allowance tab)
- shareholder benefits (Shareholder Benefit tab)
The Audit Report
Form T20, Audit Report, provides all the information necessary for someone not familiar with the specifics of the audit to become fully informed about the audit, including the findings, conclusion, recommendations, significant issues, errors and omissions, and recommended follow up. For more information, go to 11.6.1, Form T20, Audit Report.
Reassessment documents
Go to Appendix 11.2.0, Nationally used forms and instructions.
Workload referral templates
The workload referral templates (WRT) are required for all audits, except for those excluded in 9.13.3, to provide the other taxes with business intelligence that will enhance their risk assessment. To access the WRTs and for more information, go to 9.13.0, Workload referral procedures for GST/HST and Small and Medium Enterprises.
The audit table of contents
The audit table of contents (ATOC) in WinALS has been replaced in Integras by a tab in the Navigation region. The following folders and nodes are created automatically for income tax Audit cases and arranged from top to bottom:
- Name of Account: This folder is automatically named as per the corporation or individual being audited. It contains Draft Work Item and Cases Issues nodes.
- Conduct: Accessing this folder displays tabs in the Detail region of Integras. These tabs help auditors conduct their audits. For example: List of Adjustments, RAP Simulation, Capital Cost Allowance.
- Finalize: This folder has a Compliance Documents subfolder, which holds multiple nodes. These nodes are a list of documents to be completed to finalize the audit.
Clicking on these folders will display different tabs in the Detail region of Integras.
Data Change Record
The data change record (DCR) is an Integras automation that records in a database, the individual changes made by an auditor in conducting an audit. Auditors use this feature to create all the forms required and to automate the assessment process to complete an audit.
Audit Change Records
Audit Change Records (ACR) records all changes made that have no reassessment implications in the current audit period. These records are not sent for a reassessment, but affect the TEBA calculation. An ACR is created when there is an adjustment to the taxpayer’s claims. For example, CCA balances on a T1 return (ending UCC) or when a taxpayer's request is denied.
Auditors can complete a DCR/ACR at the proposal stage or when the audit is finalized.
Completing the audit
For most audit cases, Integras replaces:
- Form T99, T1 and T3 tax calculation information
- Form T99A, T2 Tax Calculation Information Sheet
- Form T919, Request for online RAP
Integras includes templates and forms required to process and complete the audit, such as:
- Form T20, Audit Report
- Form T7W-C, Explanation of Changes on Reassessment
- AIMS audit results upload document (AARUD) and the Computerized Coding System (CCS)
- workload referral templates (WRT)
Archiving the audit file
After the team leader has approved the final phase of the audit, the completed file is archived in Integras. Auditors will be able to retrieve completed audit cases by using the search feature within Integras.
Note 1: All audits completed using the WinALS system between 2008 and 2018 have migrated to Integras.
Note 2: Audits stored in the NAA prior to 2008 have been purged in accordance with CRA Information Management policy.
9.8.0 Working papers
9.8.1 Purpose and content of audit working papers
Working papers are essential to any audit, as they provide a record of the extent of the audit work carried out, findings, calculations, application of legislation, rationale, and the final adjustments. The working papers must not contain personal opinions or comments about the taxpayer.
Copying of taxpayer's records or restructuring of financial statements should be documented in the audit file. Use working papers to document the audit techniques and procedures followed during the audit. Working papers:
- support items and issues that had to be verified but did not require any adjustments
- describe problems encountered during the audit
- provide audit evidence in support of avoidance, evasion, or suspected fraud
- provide information about items that require follow up in a subsequent audit
- provide audit evidence that material items of risk have been addressed
- support conclusions and recommendations
- provide a summary of communication with the taxpayer
- provide details of all meetings and discussion with the taxpayer, including who attended, issues discussed, and agreements reached
Audit procedures performed and any adjustments proposed detailed in the working papers must provide sufficient information to ensure that subsequent users of the working papers come to the same understanding and conclusion as the auditor who prepared them. All working papers must be clear, concise, logical, and comprehensive.
The working papers should summarize the results of each audit procedure. For example, if the audit procedure calls for an examination of a sample of sales invoices and no adjustment is required, the working paper conclusion should state that no adjustment is necessary and the reason. A copy of invoices tested is not required except when necessary to support an audit adjustment.
Documentation on file must indicate that the auditor was reasonable in dealing with the taxpayer. Working papers document:
- Was the taxpayer given the opportunity to provide additional information?
- If the circumstances warrant, was the taxpayer given additional time to provide information?
- Were the proactive taxpayer relief provisions considered and applied if the circumstances warranted (for example, waiving of interest for a specific period of time because of undue delays in completing the audit)?
- Do letters and other documentation indicate that dealings were conducted courteously?
- Is correspondence in the official language of choice of the taxpayer?
Meetings, including the initial and final interviews, held with taxpayers or their representatives, must be documented. Disclose delays in scheduling meetings. Documentation must relate only to the taxpayer under audit and not to other taxpayers.
Do not make markings of any kind, such as highlighting, underlining, or check marks, on any original documents submitted by the taxpayer, including correspondence, financial statements, CCA and other schedules.
Working papers – Integras
It is mandatory to complete audits in programs 17 and 18 in a paperless format.
For more information, go to the May 9, 2012, memorandum, Mandatory use of WinALS and use of scanners - Small and Medium Audits and GST/HST Pre-Assessment Examinations, which is also relevant to audits using Integras.
To facilitate a paperless audit, certain documentation must be scanned and included in the Integras audit file.
There is no limitation to file size in Integras for attachments; however, there is a limitation for documents containing tokens. If it exceeds 1MB in size, the tokens will not be populated. Either reduce the file size, or delete / write over the tokens.
Note: If there were data tokens in the working paper, they will be updated with the appropriate information.
The team leader must review the file using Integras. Once approved, the team leader uploads the audit case. The audit case is then archived in Integras. Completed audit cases can be retrieved from Integras.
The archived version can be retrieved as required, to prepare for a subsequent audit, access to information requests, or follow-up action by, for example, Taxpayer Services and Debt Management, Appeals, Criminal Investigations, and Aggressive Tax Planning.
The Integras cases are usually stored for a period of six years; TSO management may extend this period if warranted.
No paper documents should be kept from an audit. Correspondence sent to external parties after approval by the team leader will have to be scanned and uploaded into Integras. Forms T99, T99A, T7W-C, and any other schedules necessary for reassessment by the online RAP clerk or by the TC will only be electronic copies.
Trailing documents
Although the audit file is completed electronically, certain documents must be printed and stored as trailing documents with Iron Mountain (IRM). These documents include:
- internal reports, for example, Form T20, Audit Report, Penalty Recommendation Report, and Income Tax Internal Taxpayer Relief Recommendation Form
- special elections, agreements, and returns
- prescribed forms and legal documents
- net worth statements and schedules (not the working papers)
To send a document to IRM, the auditor completes and staples Form RC467, Trailing Document Records Transmittal Slip, to each document. For more information, go to:
- Information and Tax records, Sending, charging out and refiling, Send trailing documents
- Appendix A-11.2.16, Trailing document and retention period.
9.8.2 Working paper specifications
Working paper consistency and standardization
Integras contains many pre-defined working papers to be used by the auditor in carrying out an audit. Integras also allows the auditor to create and save custom working papers. Templates may be customized but it is important, for legal reasons, to not change the requirement templates.
Integras provides for some standardization of audit working papers. However, there are no standard working papers to which auditors must conform. Auditors have the flexibility to tailor the working papers to meet the needs of the situation. The working papers must be clear and meaningful to the auditor and understood by others. Auditors should prepare a working paper, keeping in mind that such a document could be read by an individual who has no knowledge of the case or even of details involved in a tax audit.
Working paper templates
The working papers and audit steps include a brief description of the reason for the procedure and why the procedure was not necessary or applicable. Checking the boxes, “Yes,” “No,” or “N/A," does not provide sufficient information. A brief summary of the results or findings of the procedure or step can also be useful.
Auditors can delete from the Integras - Navigation region, working paper templates that will not be used in a particular audit.
Format of working papers
Prepare audit working papers and schedules if possible, in a consistent format. This assists the team leader and others in their understanding of the contents and conclusions reached by the auditor. Include in each working paper:
- a header with the taxpayer's name, audit period, date prepared, auditor's name, and the subject (Integras generates information based on tokens for some working papers, reducing the amount of information that the auditor needs to enter)
- the source of the information
- the objective and description of any audit procedures carried out
- a summary of the findings of the specific procedure, test, or other audit step
- the conclusion reached by the auditor
- legislation, policies, and directives used for reference
Attach and cross-reference as required, any calculations, schedules, and documentary audit evidence in support of the conclusions reached. Narrative comments should have sufficient detail to explain to the reader what was done and why; a simple comment such as “cleared – no problem” is insufficient.
Indexing and numbering of working papers
SMED, ILBD, and the GST/HST Directorate have created a working paper numbering convention. For more information, go to Communiqué AD-16-14, Standardized Index of Working Papers.
The index of working papers, Index_WP_Index_FT, is available in the Integras Template Library.
Cross-referencing of working papers
Clearly and completely cross-reference working papers to make it as easy as possible for another person to follow the audit trail and findings that lead to the conclusions that have been drawn.
For example, electronic working paper cross-references can be shown as “to/from WP3100-2.”
In the case of a paper copy working paper produced manually, if information is carried forward:
- to another working paper, place the cross-reference below or to the right of the amount carried forward
- from another working paper, place the cross reference above or to the left of the amount carried forward.
9.8.3 Working paper documentation
The working papers document the audit from beginning to end. Of particular importance are:
- the Audit Plan
- changes made to the initial Audit Plan as a result of issues encountered during the audit
- Form T2020, Memo for file, which must include discussions with the team leader, and any decisions and conclusions reached relating to the taxpayer’s reassessment; a reviewer uses Form T2020 to confirm that the team leader has approved decisions
- the condition of the books and records recorded on Form T20, Audit Report
- the extent of taxpayer co-operation recorded on Form T20, Audit Report
- consultations with and referrals to specialists, formal or informal; this might include a request for assistance in interpreting legislation, a request for a valuation, or a request to the Non-Filer or International areas
- the determination of risk and materiality recorded in the Audit Plan
- the consideration and application of penalties, due diligence, and the taxpayer relief provisions recorded on Form T2020, Memo for file, Form T20, Audit Report, or the Penalty Recommendation Report, as appropriate; if the auditor considered applying penalties, working papers must:
- disclose the information reviewed in making the decision to apply penalties or not
- reference the approved Penalty Recommendation Report if a penalty is proposed
- clearly explain, if a penalty was not proposed - a Penalty Recommendation Report does not need to be prepared; however, the auditor must include sufficient details from the facts of the case to support the reasons for not applying a penalty
- document discussions with the team leader and others on Form T2020, Memo for file
- reference any internal correspondence
- cross-reference to DCRs and audit reports.
For more information, go to 11.6.0, Auditor’s reports.
- documenting workload referrals of the other taxes. For more information, go to 9.13.0, Workload referral procedures for GST/HST and Small and Medium Enterprises
- the research of technical issues and reassessments; amounts reassessed must be supported and fully documented in the working papers - include in the audit file, all sources of information and technical references used to support the auditor's position, including relevant court cases, CRA policies, income tax folios, income tax interpretation bulletins, income tax information circulars, and references to the Income Tax Audit Manual
Documentation of the audit's progress
Form T2020, Memo for file, must be used to:
- record the significant events that occurred during the audit
- note discussions with the team leader and approvals of decisions by team leader
- indicate whether there were undue delays in completing the audit
- document the results of any meetings, telephone calls, or interviews with the taxpayer or representative
- confirm if the audit was completed within an acceptable time, considering the complexity and scope of the audit
Significant events include initial contact, meetings, interviews, telephone conversations, proposal letters, representations, and extensions. If another working paper documents a significant event, for example, the initial interview or a proposal letter, it is sufficient to note the date of the event on Form T2020 and reference to the corresponding working paper. The purpose is not to duplicate the content of working papers, but to provide a comprehensive timeline of the significant events in addition to items that are not noted elsewhere in the audit (for example, conversations with team leaders, representatives, or the taxpayer).
By documenting the time spent during the audit, the auditor can readily account for the total audit time. Documentation supports any significant time variances, as they may affect taxpayer relief considerations and help explain delays in completing the audit.
Form T2020 contained in the Integras case must be used as a record of events and conversations.
9.8.4 Working papers as “government information holdings”
Government information holdings are defined by Treasury Board of Canada Secretariat (TBS) to include “all information under the control of a government institution, regardless of physical mode or medium in which such information may be stored. Without restricting the generality of the foregoing, this may include correspondence, memoranda, books, plans, maps, drawings, diagrams, pictorial or graphic works, photographs, films, microfilm, sound recordings, videotapes, machine readable records, published material and any other documentary material. Excluded from the definition are materials held by federal libraries that were not prepared or produced by or for the government.”
These information holdings, that by definition include all audit working papers and reports in paper or electronic format, are subject to the federal government's information management policies developed by TBS. For more information, visit the TBS Policy on Information Management www.tbs-sct.gc.ca/pubs_pol/ciopubs/TB_GIH/mgih-grdg_e.asp.
From an audit perspective, information holdings include:
- working papers prepared to test or analyze any account or document whether or not they contain any changes to a taxpayer's tax position
- any working paper, schedule, report, memo, or other document used to initiate or continue a CRA activity, provide comments on an activity in process that requires administrative action, or request an opinion on an activity of interest to the CRA
The CRA manages all its information holdings according to related federal legislation such as the Access to Information Act, Privacy Act, National Archives of Canada Act, and Copyright Act and program legislation such as the Income Tax Act, the Excise Tax Act, and the Underused Housing Tax Act, including any related legislation of a provincial or territorial government. This includes any instrument made under these acts or any part of such instrument. For more information, visit Canada Revenue Agency Public Affairs and Communications Policy and CRA’s Information Management Policy.
Authority for managing information is included in several federal acts and legislation. The relevant provisions of the legislation that relate to the management of information, and by which the CRA is bound, are provided in the Finance and Administration Manual, Security Volume.
Access and privacy
The Access to Information Act gives Canadian citizens, as well as persons present in Canada, the right to have access to information in federal government records. The Act ensures that a taxpayer can ask for information and if it is not exempt or excluded, is entitled to see it or to be provided with a copy. For more information, visit Access to Information Act.
The Privacy Act also gives Canadian citizens and persons present in Canada the right to have access to information related to them that is held by the federal government and protects against unauthorized disclosure of personal information. In addition, it strictly controls how the government will collect, use, store, disclose, and dispose of any personal information. For more information, visit Privacy Act.
TBS policies on access and privacy reinforce information management principles inherent in the Management of Government Information Holdings Policy and the Security Policy. The policies support the objectives of duty to inform, routine disclosure, and service to the public, which are fundamental concepts within the Communications Policy.
Deputy ministers and heads of agencies are responsible to ensure that their organizations comply with the Access to Information Act and Privacy Act. In addition, the minister of the treasury board coordinates administration of the acts by preparing and distributing policies and guidelines to help institutions interpret the laws and to assist them in their application on high profile issues. For more information, visit TBS’ Access to information and privacy and 3.0, Taxpayer rights and taxpayer relief.
9.8.5 Transitory records and section 67.1 of the Access to Information Act
Government records (including draft records) must be retained under the authority of the Access to Information Act. Section 67.1, adopted in 1998, creates an offence for destroying records to obstruct the right of access under the Act. This provision usually should not be a concern to the auditor respecting the regular working papers that are found on the audit file. However, the interaction of section 67.1 and the disposal of transitory records raise a particular dilemma for income tax auditors and for public servants in general.
The term transitory record is used in Canada to deal with records of a temporary nature of short-term value found in both administrative and operational records created by a government institution.
An interdepartmental access to information review task force was established by the federal government on August 21, 2000, with a mandate to review all components of the access to information framework, including the Act, Regulations, policies and procedures. A final report analyzing the administrative and legislative aspects of access to information and providing recommendations for improvement was released on June 12, 2002.
For more information, visit TBS Archived – Access to Information Guidelines – Requests.
9.9.0 CRA mainframe as a source of information
9.9.1 Introduction
The CRA mainframe information systems are tools used to process taxpayer returns, as well as to retain a filing history and other relevant information. Historical information is used to determine, for example, industry trends, establish ratios, and assess audit risk. This information is also used to select audits.
The CRA mainframe information systems can be used to provide information that may not be available in the download when the case is assigned or the audit is in progress.
Auditors have access to many databases, including RAPID (T1 and T2 income tax information), the Common Menu System, and the Automated Collections and Source Deductions Enforcement System (ACSES). These systems can provide details relating to an audit in progress that are not available on the audit diskette.
9.9.2 The income tax mainframe
The main menu includes separate menus for T1 and T2 filers. Screens provide useful information to:
- indicate an audit or other work in process on a related account - use the T1 or T2 charge-out menu
- review the income and deductions of all related accounts
- review the identification information screen
- review the summary T1 data for the most recent eight years
- determine if the taxpayer has a representative - use option M (Taxpayer Representative Identification System (TRIS))
- search for other taxpayer deposits – view T5 information slips filed by financial institutions
- verify if employment income is reported – view T4 information slips filed by employers
9.9.3 Income tax database (RAPID)
RAPID provides immediate access to up-to-date taxpayer and employer information for authorized users in the TSO, TCs, and other operating areas of the CRA.
The data available through RAPID comes from many sources, including: PAYDAC, CINDAC, CORPAC, ASSESSING, TAPMA, IPS, and ON_LINE CHARGE-OUT.
Access to RAPID information is restricted to holders of valid user identifications and passwords. Auditors have a mainframe access profile to allow access to the required functions and information.
Go to Appendices A-9.2.5, RAPID T1 menu, and A-9.2.6, RAPID T2 menu, for a sample of the RAPID menus available.
9.9.4 CORTAX
For information on CORTAX, go to Appendix 12.4.0, T2 CORTAX.
9.9.6 Other systems
Other systems include:
- GHRAPS – GST/HST Return and Adjustment Processing System
- ACSES – the Automated Collections and Source Deductions Enforcement System provides information about taxpayer contact and collection information
- PAYDAC – the Payroll Deductions Accounting and Collections System provides information on the taxpayer’s employees and deductions at source
- ECS – use the excise tax mainframe information system, Excise Commercial System, to verify that the taxpayer is licensed for excise tax purposes and to review returns filed by licensees
- ERRS – use the Excise Refunds and Rebates System for N15 refund information
- BN – the Business Number System provides one account number for all revenue lines, legal entity information, and elections filed
- SA – Standardized Accounting, based on the BN, establishes a single account for each taxpayer, integrating all business revenue types into one accounting system
- BCCS – the Business Client Communication System produces computer-generated letters, notices of assessment (NOA), and notices
- CSAUV – the Case Audit Management System manages audit workload
9.10.0 Determining the need for computer-assisted audit techniques
To determine if computer-assisted audit techniques (CAATs) need to be used during the planning stage of the audit, evaluate:
- key audit objectives and items of concern
- volume and depth of taxpayer information available in electronic format
- ease of downloading the available data
The volume of data is a key factor to determine if the use of CAATs is appropriate. If the volume of data is limited, it is unlikely that using CAATs will provide a significant benefit compared to completing the audit manually.
The detail of the information available is important to determine the effectiveness of using CAATs. If the taxpayer uses a batch processing system and consolidates transaction detail (common procedure with Accpac accounting software), the electronic records do not usually contain sufficient detail for computer-assisted audit purposes, as only the summary information from each batch is available.
If the costs to obtain or convert the information for audit purposes to usable format are material, the use of CAATs may not be desirable. Consider consulting with Computer Audit Specialists (CAS) to help determine the cost to download taxpayer information. For more information, go to 13.1.0, Computer-assisted audit techniques.
9.11.0 Audit scope
9.11.1 Introduction
The Workload Development Section is responsible for selecting the audit scope based on issues identified.
As the audit progresses and additional information becomes available, the Audit Plan may need to be adjusted. The additional information must be evaluated to determine its impact on the audit scope and if warranted, the audit scope is amended. Any change to audit scope must be approved by the team leader. Rarely, the audit may be closed or deferred without completing all audit steps. The auditor must document the rationale and obtain approval from the team leader for this course of action on Form T2020, Memo for file.
In Integras, full-scope audits are identified as Comprehensive in the Compliance Action field of the Program Attributes tab.
Restricted audit scope
All audits of principal files were initiated by Workload Development as full-scope compliance audits, unless a reduced or restricted scope was approved by HQ for specific purposes. As of January 6, 2021, restricted audits are a regular component of small and medium income tax audit workload.
In rare situations, a full scope audit may be changed to a restricted audit; such a change must be approved by Workload Development.
Restricted audits consist of no more than two material risk issues as identified by Business Intelligence (BI), such as:
- specific line items on the income statement (for example, verify motor vehicle expenses);
- specific line items on the balance sheet (for example, verify the increase to the shareholder loan account);
- specific issues on a tax schedule (for example, vouch existence of capital asset addition and verify interest deduction on T2SCH1);
- technical issues (for example, verify application of losses on Acquisition of Control);
- special projects (for example, review inclusion in income of T5018);
- provincial income allocations;
- certain consequential adjustment referrals from GST/HST based on BI's discretion; and
- taxpayer requested adjustments (TPRs) which would involve reviewing only the specific items requested by the taxpayer, even if the TPR contains more than two items.
Until further notice, restricted audits should be completed as desk audits.
A restricted audit approach is one where audit attention is focused on non-compliance with respect to a limited number of specific issues. In this regard, they are a unique workload, and they are managed as outlined below:
- Auditors are not expected to perform a thorough risk assessment or review of the taxpayer's complete filings and books and records outside of the identified risk(s).
- The auditor is only expected to address the risk identified in the screener's comments.
- Restricted audits are not used to address source of funds issues, and auditors should not conduct Indirect Verification of Income (IVI) testing as part of a restricted audit. Audit work should focus on the issues identified in the screener's comments. If a restricted audit is expanded to a full scope audit, an auditor should use their professional judgement to determine if IVI testing is required.
- Due to ongoing commitments to provinces and territories, auditors are still required to conduct a Provincial Income Allocation risk assessment for all restricted audits regardless of program.
- The auditor should only request access to the books and records that are required to resolve the screener's comments and needs to adapt the initial contact letter accordingly. For a letter template, go to the Integras Template Library, A-9.1.7 Restricted Audit Confirmation. Please refer to the note found below this numbered list.
- The taxpayer is to be advised at the initial contact stage that the audit is restricted but it could be expanded beyond the initial scope if other compliance issues are noted.
- A standard paragraph must be included in the final letter notifying the taxpayer which specific issue(s) the audit was restricted to, and that the return may be subject to audit in the future. For a letter template, go to the Integras Template Library, A-11.1.17 Change – Restricted Audit.
- If immaterial compliance issues were noted during the course of the restricted review, the auditor is to document them within the final letter as an educational opportunity. For a letter template, go to the Integras Template Library, A-11.1.26 No change – Restricted Audit. Auditors should follow the guidance outlined in Restarting Audits during COVID‑19.
Note: Despite point No. 5 above, it is now recommended that the auditor requests a full backup copy of the complete books and records in the case of a restricted audit – it remains that the auditor shall limit his or her review to the items provided for in the Business Intelligence screener’s comments for the restricted audit. This will make the process more efficient, less time consuming and easier for the taxpayer and CAS support agent. This clarification does not conflict with the guidelines listed in the memorandum dated January 6, 2021.
Any risk assessment or audit testing extending beyond the risks identified in the screener's comments is not expected or necessary. However, if the auditor notes other material risk issues while resolving the screener's comments, they must:
- expand their audit and document how the additional risk was addressed or resolved;
- inform the taxpayer of the expanded review; and
- request any additional books and records that are required at that time.
An expanded audit doesn't necessarily lead to a full compliance audit. It is possible for an audit to be expanded in order to address other isolated areas of risk. When expanding an audit, the auditor should use their professional judgement to determine the audit approach that is required to address any additional risks. Before adding an item to their Audit Plan, auditors are encouraged to have a discussion with their team leader.
Restricted audits are subject to Audit Quality Review (AQR), but reduced standards apply. For additional details, go to 8.4.1, Audit Quality Standards, Measurement criteria. If a restricted audit is expanded, additional Audit Quality Standards may apply (for example, if the audit is expanded to examine balance sheet issues and the original audit scope was focused on a specific expense account, balance sheet Audit Quality Standards would also apply).
In cases where AQR returns a file to audit for changes because the auditor did not address the screener's comments or they failed to mitigate additional material risks that were identified by the auditor in the file, the audit and AQR team leaders should first attempt to resolve any disputes about the rating between them. If they are unable to do so, the Assistant Director of Audit will have final discretion in determining if additional audit work will be completed. File documentation must reflect all decisions made by the Assistant Director of Audit with respect to the final resolution of the audit.
Restricted audits are identified by the use of Audit Action Code "02" in Integras. The Selection Reason Code for restricted audits varies depending on the nature of the file and the reason it was selected for audit. If an auditor expands an audit from restricted to full compliance, they must complete an Integras Case Attribute Change Request with BI in order to properly reflect the new nature of the case.
For more information on restricted audits, go to the January 6, 2021, memorandum, Small and Medium Income Tax Restricted Audits.
9.11.2 Reliance on the books and records
Auditors must use their professional judgement to determine the scope of the audit. If Business Intelligence has mandated IVI required, this means that you must do a minimum of two supporting IVI tests (for the most current year): the IVI bank deposit analysis test and one of: rough net worth or ratio analysis.
For all other audits, it is not mandatory to complete these two supporting IVI tests. However, the audit approach taken depends on the reliance that can be placed on the internal controls and the quality of the books and records. Therefore, even in these audits, if the reliability of the accounting records is suspect or the apparent lifestyle of the taxpayer is inconsistent with reported income, auditors should use supporting IVI tests.
For more information, go to 13.3.0, Indirect Verification of Income.
9.11.3 Types of audit adjustments
Auditors should consider both increases and decreases to taxable income for all audits. If the adjustments are in favour of the taxpayer, the auditor must ask the taxpayer to provide complete information to verify such a downward adjustment.
9.12.0 Audit period policy
9.12.1 Purpose
The audit period policy for income tax audits came into effect December 4, 1996.
9.12.2 Legislation
The ITA provides specific limits to periods that may be reassessed. For more information, go to 11.3.0, Normal reassessment period.
9.12.3 The common audit period (one-plus-one)
The common audit period (also known as 1 + 1, one-plus-one, or one + one) includes the current year being audited plus the immediately preceding twelve-month period. Audits should not usually go beyond the current fiscal period and the immediately preceding twelve-month period. However, some exceptions apply and must be discussed with the team leader.
For income tax purposes, the current year is defined as the most recent fiscal period for which an income tax return has been filed, assessed, and is available for audit.
Rationale
The common audit period policy (often called the one-plus-one policy) was implemented to make efficient use of limited audit resources while at the same time, to maximize the impact on non-compliance. The policy also ensures a common and consistent audit period across all business lines.
Extending the audit period
There will be circumstances that require the extension of the audit period beyond the current and preceding twelve-month periods. For example, if payroll deductions (income tax, CPP/QPP, EI) have been withheld and not remitted, the audit period should include all periods not statute‑barred because these amounts are funds held in trust. Errors in computation, classification, or elections are not intended, in and of themselves, to be grounds to extend the audit period.
Clearly document justification to extend the audit period on Form T20, Audit Report, approved by the team leader.
Situations where the audit period may be extended
Situations that may warrant extending the audit period beyond two years include:
- circumstances involving penalties;
- cases that involve restricted farm losses (RFL);
- cases to determine if a business could be the taxpayer’s personal endeavor and is operating without the pursuit of profit;
- isolated but significant items; a high rate of errors that involve material amounts noted in the common audit period;
- retroactive legislative changes;
- if the taxpayer makes a voluntary disclosure;
- if there are concerns about issues such as legislative changes, changes to the computer system, or large refunds outside the common audit period, the audit period should be adjusted to include the items of concern provided that the period is not statute-barred;
- if after a full-scope audit or a restricted audit, a taxpayer was advised that an issue was still open and would be completed after review of the CRA's position on that issue.
Note: If a recurring or system problem is noted that was present in prior years, extend the audit period to include periods that are not statute-barred. Audit procedures for periods outside the common audit period should only be directed to these items of concern.
Other factors particular to a file, such as a series of transactions covering several years, may require reassessment of prior years as part of the process to correct the overall misstatement.
Team leader approval
Extending the audit period beyond the normal two-year period is a matter of professional judgement based on the facts of the case, and requires the team leader’s approval. The decision will be based on the circumstances, the significance of the potential adjustment, and the effectiveness of expanding the audit period for each case. The additional time needed for the expanded audit period should be minimal, if the auditor properly limits the review to the problem items. Audit prior years only if significant items are uncovered that give cause for such action. Auditors must include the reasons for extending the audit period on Form T20, Audit Report.
9.12.4 Re-auditing a previously audited period
There are certain circumstances when it may be necessary to conduct an audit of a previously audited period. This usually happens because misrepresentation, attributed to neglect, carelessness, or suspected fraud, is subsequently discovered. More examples where a second audit may be warranted include:
- The previous audit or review was restricted or limited in nature and scope and the taxpayer was advised at the time of the audit that there could be a second audit.
- There is new information, not disclosed or made available by the taxpayer at the time of the previous audit, and the failure to identify this information was not because of the lack of due diligence on the part of the CRA.
- The taxpayer requests an adjustment to correct an error that was not noted during an earlier audit.
- The taxpayer makes a voluntary disclosure.
- A retroactive change in legislation has taken place.
9.13.0 Workload referral procedures for GST/HST and Small and Medium Enterprises
9.13.1 Introduction
The goal of the workload referral (WR) is for one tax to provide the other taxes with business intelligence that will enhance risk assessment of the other taxes.
9.13.2 Applicable programs
Effective April 1, 2011, the WR process applies to the following audit programs in the Small and Medium Enterprises Directorate and the GST/HST and Digital Compliance Directorate:
Income tax
- Small and Medium Business programs
- Specialty Audit (income tax audits of trusts, flow-through shares, and non-profit organizations)
- Non-resident Audit, International Waivers and Non-resident Dispositions Program
GST/HST
- Small and Medium Business Audit programs
- Excise Tax
- Air Travellers Security Charge (ATSC).
The WR process also applies to the Film Advisory Services programs in the Business Tax Incentives Directorate for changes to income and/or expenses and/or if the auditor recognizes an issue for GST/HST.
9.13.3 Workload referral process
A WR is required when:
- an audit resulted in audit adjustments
- a significant issue or situation that may affect the other taxes is identified
- the answer to any of the questions in the workload referral template is “Yes,” or
- an early referral is necessary
Exclusions from the WR procedures:
Some audits and programs are excluded from the WR process. For more information, go to the August 3, 2012, memorandum, Revised Workload Referral Procedures, and read the embedded document, Workload Referral Procedures For GST/HST and Income Tax Small and Medium Business Audit programs.
9.13.4 Completing the workload referral templates
Complete the Income Tax Workload Referral Template (WRT) for all audits except for those excluded from the WR process. For more information, go to 9.13.3, Workload referral process.
The WRT, Income Tax Workload Referral to GSTHST.xlsx, is available in the Integras Template Library. The template is also available in the CRA Electronic Library > Compliance Programs Branch Reference Material > Audit > Income Tax – Forms and Letters > Forms > A-9.13.4.
For more information, go to the August 3, 2012, memorandum, Revised Workload Referral Procedures..
9.13.5 Workload referral package
The workload referral package (WRP) includes:
- a copy of the workload referral template (WRT) for each case
- Form T20, Audit Report
- any other information or documents that may be beneficial to risk assess the other tax
Making an early workload referral:
- If a significant risk is identified during the audit, the auditor must discuss with the team leader as soon as possible.
- If the team leader agrees that the risk is significant, the auditor will complete the WRT immediately.
- The audit issues identified and the rationale for making an early workload referral must be clearly documented in the Additional Comments area of the WRT.
9.13.6 AIMS reporting for workload referrals
Three fields are available on AIMS screen 5 (audit work completed section) to capture information related to a workload referral to GST/HST by an income tax auditor.
- The first field, Compliance Review, requires a “yes” or “no” response to indicate if a workload referral template (WRT) was prepared.
- The second field, Referral Done, requires a “yes” or “no” to indicate if a complete WRT package was forwarded to GST/HST.
- The third field, At Risk Amount, captures the estimated amount of GST/HST at-risk.
For more information, go to Workload Referral procedures for GST / HST & Small and Medium Enterprises.
9.13.7 Referrals to excise tax
If applicable, when an audit is completed, the auditor must send the excise WRT in an encrypted email, with the applicable excise standard naming convention format in the subject line, to their team leader, with a c.c. to the workload area of the tax audited.
9.15.0 Concurrent audits of related, associated, or affiliated corporations
In certain situations it is more efficient to expand the audit of the principal corporation to include related, associated, or affiliated corporations.
9.15.1 Situations that may warrant concurrent audits
Concurrent audits can be particularly efficient if:
- there are material inter-company transactions (material includes number and dollar amount)
- a subsidiary is dependent on the parent corporation
- the records of all corporations are standardized and at the same location
- the subsidiary's operations are similar in nature; compare different operating results to determine unusual trends (complete more detailed audit procedures, if necessary), or
- several corporations effectively operate as divisions.
9.15.2 Specialists
For additional information on referrals and consultations with specialists, go to 9.2.11, Consultations with specialists, and 10.11.0, Leads and referrals.
9.15.3 Restricting the audit scope
In some cases, the audit scope of the related, associated, or affiliated corporation’s operations is restricted to a review and verification of only specific inter-company transactions, for example, transfers of assets. When the secondary case is created in Integras, the audit action code should not be 01 (full-scope). Audit action should only be 01, if a full-scope audit was completed of the related, associated, or affiliated corporation.
Adding related, associated, or affiliated corporations to the audit in progress
During an audit of a principal corporation, the auditor may determine through Integras that a related, associated, or affiliated corporation is under audit. Depending on the circumstances, it may be more effective and efficient to complete the related, associated, or affiliated corporate audit at the same time as the principal corporation. The auditor should discuss this with the team leader, outlining why the audits should be completed at the same time. If the team leader is in agreement, then the auditor should take steps to ensure that the related, associated, or affiliated corporations are audited concurrently.
If the related, associated, or affiliated file is unassigned in the Workload Development inventory, the auditor of the principal corporation should prepare a referral to Workload Development to obtain the audit. The referral should outline why the audit of the related, associated, or affiliated corporation should be completed at the same as the principal. The referral would note the team leader’s approval.
If the related, associated, or affiliated corporation is under audit by a different auditor, depending on the circumstances, it may be necessary for the two auditors and their respective team leaders to determine how to proceed.
Cost vs. benefit
Determine the benefits of conducting concurrent audits before the audit is expanded to include the related, associated, or affiliated corporations. The primary consideration must be whether there is any significant advantage. For example, an audit of a group of corporations helps to obtain a complete picture of the operations, but carefully consider the additional audit time and the potential benefits.
Often a Computer Audit Specialist is needed because of the complexity and size of the electronic records.
Referrals of related, associated, or affiliated corporations between TSOs
During an audit of a principal file, the auditor may determine that an audit of a related, associated, or affiliated corporation is necessary. If the books and records of that corporation are located in another TSO’s area of responsibility, the auditor of the principal file must prepare Form T133, Lead or Project Information, signed by their team leader, and forward to the originating section manager or assistant director of Audit (ADA) for approval. The memo should then be sent to the ADA of the TSO where the books and records of that corporation are located.
9.16.0 Continued risk assessment while the audit is in process
9.16.1 Introduction
During the audit selection process, Workload Development uses a combination of computerized and manual risk assessment techniques to review and identify those files with the greatest risk of non-compliance and potential revenue loss.
The auditor must continue to risk assess during the many stages of the audit, including preparation, continual updating, and implementation of the Audit Plan. The preliminary risk assessment was based on information available at the time. During the audit, changes to the preliminary risk assessment may be required because the information used to draw conclusions changes. For example:
- The team leader or the auditor obtains information that was not available to the screener.
- The information used in the computerized audit selection process was incomplete or inaccurate, possibly due to incomplete or inaccurate information submitted by the taxpayer.
- Additional information becomes available as the audit progresses.
An effective Audit Plan uses risk assessment techniques to identify the areas of concern and to design the most appropriate audit tests to address those concerns. The Audit Plan must provide for periodic reviews and adjustments to reflect new information and changing conditions. Without continual risk assessment during the audit, the risk of performing unnecessary audit procedures or missing areas of non-compliance increases.
9.16.2 Risk assessment during preliminary review
During the preliminary review, the auditor reviews the information provided. It should not be assumed that every assigned audit would be carried out according to the screener's recommendations. The auditor prepares to make changes to the recommendations or to suggest downscreening the audit, if the risk is limited. Document reasons for the changes to the risk assessment and discuss with the team leader.
Risk assessment procedures during the preliminary review include:
- obtaining input from the team leader.
- reviewing the screening criteria to determine why the file was selected for audit. What areas of concern were identified? What information was available at the time of recommending an audit (ARGO and COMPASS reports, gross profit analysis, shareholder transactions, third-party leads, and internal referrals)?
- reviewing the information used during the screening process. Determine if information should be updated. Have returns been filed or amended recently? Has one of the other taxes been audited since the file was screened for audit?
- determining if there is any additional information available. Does the auditor have personal knowledge of the industry or the taxpayer?
Based on review of additional information, the auditor evaluates the original risk assessment and proceeds with one, or a combination, of these actions:
- proceeds with no changes
- deletes areas of concern
- adds areas of concern
- changes the audit scope
- recommends downscreening the audit
9.16.3 Risk assessment during audit planning
After identifying the areas of concern, the nature and extent of audit tests to address these concerns must be determined and are based on risk assessment. The nature of the tests depends on the nature of the potential errors and the taxpayer's accounting system, or lack thereof.
Audit policy is to obtain reasonable assurance that significant errors are detected and corrected. It is not policy to audit all of a taxpayer's transactions and audit tests should only be carried out to the extent necessary to ensure compliance. An in-depth analysis is required for those transactions with errors or if other non-compliance is detected or suspected.
The concept of reasonable assurance may result in the possibility that a significant error is not detected. However, a well-executed Audit Plan will uncover most significant errors and issues of non-compliance that require attention.
9.16.4 Components of risk
These three components combine to make up total risk:
- inherent risk
- control risk
- audit or detection risk
For more information, go to the CICA Handbook – Assurance (section 5130).
9.16.5 Reviewing risk while the audit is in process
As the audit progresses, update the assessment of risk based on the result of audit procedures and testing completed to determine if changes to the Audit Plan are necessary.
Evaluate the risk with respect to each area of concern, as well as to the audit as a whole. It is important to remember:
- Every audit procedure is designed to lower the detection risk of an identified area of concern.
- If the concern that was identified no longer exists (procedures have indicated that the concern is not relevant), further testing is not required.
- When all of the concerns have been adequately addressed, conclude the audit.
As audit procedures are performed, the auditor is always mindful of the concern being addressed. When a predetermined number of the tests directed at a particular concern are completed, the auditor reviews the results to ensure that the audit procedure addresses the concern or issue to ensure that testing is not done unnecessarily or that additional items are not required for testing.
Example
Audit concern identified:
Sales may be under-stated.
Planned audit procedures:
- Reconcile amounts recorded in the books and records to the returns filed. It is also possible to reconcile to GST/HST returns as well.
- Review all sales invoices greater than a material limit. This should be done to understand how the accounting system works and where cash is deposited.
Audit results:
Step 1: Completed. No errors or exceptions noted.
Step 2: After testing approximately 50% of the items selected for review for Step 2, the auditor reviews the audit results and asks these questions:
- Were there any errors?
- Were the errors material with respect to loss of revenue to the CRA?
- If possible, determine the cause of the errors.
- Were the errors isolated or recurring?
- Were the errors the result of system failure or human error?
- Based on these results and any other relevant information available, what assumptions may be made regarding the invoices that have not been examined?
- What is the potential tax recovery?
- How much audit effort is required?
- How does the potential tax recovery compare with the cost of the audit effort?
- What changes, if any, to the planned audit procedures are appropriate?
It is important to review audit procedures before completing the actual testing of items selected to ensure that the test addresses the concern identified.
Professional judgement plays an important role in assessing risk during the audit. The assessment of risk differs from audit to audit. Generally, if after testing 50% of the selected sample, no material errors are found, it is reasonable to conclude that the results are representative of the population as a whole. The risk assessment may be revised, resulting in a decrease in audit procedures. In this example, the auditor may consider adjusting the selection criteria to review only those invoices greater than $2,000. If no errors are noted, the procedure can be aborted. The auditor then proceeds to the next audit concern and repeats the process.
When approximately 60% of the budgeted hours for an audit have elapsed, the auditor should review the audit results. Based on the findings of the audit procedures completed:
- update the audit risk assessment, if necessary
- assess the potential tax recovery
- determine the most effective and efficient approach to conclude the audit
- update the time budget
The questions to consider are similar to the questions asked to ensure that the individual audit procedures meet their objective.
- What was the nature and extent of errors found?
- Should the assessment of risk be revised?
- What assumptions may be made about the likelihood of significant errors in the reported taxes payable?
- Given the potential tax recovery, how much audit effort is appropriate?
- What changes to the original Audit Plan are necessary?
The auditor's observations, conclusions, and recommendations should be documented and discussed with the team leader. The team leader should ensure that the audit is meeting the objectives and addressing any concerns noted. The degree of the team leader’s involvement during the review and decision making process depends on the auditor’s experience and confidence.
Summary
Continually assessing risk during the audit will result in a more effective and efficient audit. The auditor uses a systematic and rational approach to evaluate audit procedures against the anticipated benefits, such as taxpayer compliance and revenue recovery.
A review of audit results ensures that procedures that do not address identified concerns are aborted. Continual risk assessment ensures that the Audit Plan is updated to reflect any changes in circumstances.
9.16.6 Downscreening audits by auditors
An audit can be downscreened in Integras by an auditor, if the number of hours charged on a case does not exceed the following limits:
- SP-05 – 20 hours
- SP-06 – 20 hours
- AU-01 – 20 hours
- AU-02 – 37.5 hours
- AU-03 – Auditors should discuss the request to downscreen a case at the AU-03 level with their team leader
The increase to the number of downscreen hours will enable an auditor to conduct the early steps of an audit, such as the initial interview, a site visit, sample testing, and risk analysis, so that the auditor and team leader can make a more informed decision to either continue or downscreen the audit.
Auditors must clearly document their decision to downscreen the audit (case) and how all identified risks and issues were addressed and the steps taken to recommend that the case be downscreened. Auditors must update Form T2020, Memo for File, for any contact with the taxpayer.
A downscreened case requires approval from both the Audit team leader and a Regional Business Intelligence (BI) officer. All downscreen requests should be processed in accordance with the current downscreening policies and procedures.
Auditors must make sure that all documents indicating the team leader and BI officer approval to proceed with the downscreen are obtained, as appropriate, and attached to the Integras case before closing the case in Integras.
For more information, go to:
- April 3, 2019, memorandum, Increases to the downscreen hour limits in the Income Tax and GST/HST Small and Medium audit programs.
- August 29, 2019, memorandum, Integras update for increases to the downscreen hour limits in the Income Tax and GST/HST audit programs
If the case cannot be worked because of lack of contact (see 9.18.3) and is to be downscreened or returned to BI, Form T2020, Memo for File, and any correspondence sent, including any confirmation of delivery or non-delivery, should be sent with Form RC467, Trailing Document Records Transmittal Slip to Iron Mountain (IRM).
To downscreen an audit case in Integras:
- right-click on the Taxpayer’s name
- select Close Case Actions
- select Close Downscreen from the dialogue box menu
- select an applicable reason from the Reason* field drop-down menu
- enter a note detailing the specifics of the case
- click the Next button
- select an Approver
- click the Close button to send the down-screen request to the team leader for approval
*When Other(Specify) is selected as the Reason, auditors are required to provide details in the note portion of the window.
9.17.0 Assessment of materiality
9.17.1 Introduction
An auditor needs to understand and apply the concepts of audit risk, materiality, internal controls, substantive testing, and sampling in order to conduct audits in a cost effective manner, while ensuring that compliance objectives are met. Professional judgement, skepticism, and experience all play a key role in accomplishing effective audit risk management. For examples demonstrating these concepts, go to 9.17.9, Practical examples.
Definitions
Audit risk
Risk is the probability that the auditor will accept a transaction as correct for income tax purposes, when in fact, the transaction is incorrect.
Materiality
Materiality is defined as the dollar change in tax of a potential audit issue that a cost‑benefit analysis demonstrates that it is reasonable to invest further audit hours.
Sample
Sample size is the number of transactions in an account that the auditor will review in detail in order to draw reasonable conclusions about the entire account.
Material risk
This is the risk that the financial information of an organization has been misstated to a material degree. Materiality is evaluated by determining how much of an organization’s financial information could be misstated without affecting the decisions of the users of the financial information. Materiality is determined based on a variety of factors, including the size of the taxpayer, the size of the account, as well as the auditor’s and team leader’s professional judgement.
Example: An auditor sets materiality for the audit at $50,000. The travel expense account is $25,000 and therefore the auditor would not review this expense because it falls under the materiality threshold. However, the shareholder does not maintain a shareholder loan account and, from a previous audit, corporate money was used for the shareholder’s personal use. The auditor is applying professional judgement to lower materiality threshold on this account, as there may now be a potential risk that travel expenses may be personal in nature.
Inherent risk (IR)
This is the risk that a material misstatement has occurred in the taxpayer’s financial statements due to the nature of the business or types of transactions, before taking into consideration the effectiveness of internal controls.
Control risk (CR)
This is the risk that a material error occurs in the taxpayer’s books and records without the taxpayer’s internal controls detecting or correcting it. Control risk can be controlled by the taxpayer increasing or decreasing the strength of the internal controls.
Detection risk (DR)
This is the risk that audit testing will fail to detect a material misstatement that actually exists. The lower the level of detection risk, the more substantive testing needs to be done.
9.17.2 Risk assessing: Auditing to the risk
An auditor detects and addresses material non-compliance. Risk assessing is completed at all stages of the audit.
What is “Risk”?
The auditor’s job is to identify and risk assess areas of concern and particular items that relate to risk. Through the evergreen Audit Plan and audit procedures, the audit risk will be addressed. Auditors generally consider, discuss, and describe the risk assessed in terms of high, medium, and low. While conducting audit procedures, reviewing and analyzing the findings, auditors will make a final conclusion and often describe the risk of tax loss as minimal, material, or high. The auditor will conclude that either (1) additional auditor work is required, or (2) no additional audit work is required.
The scope of the audit is determined based on a combination of the mandatory screener’s comments, as well as what the auditor has identified as material risk. Using an “audit to risk approach,” an auditor continuously reevaluates risk as the audit progresses, discusses findings with the team leader, and updates the Audit Plan. For more information, go to 9.2.0, Preliminary review, and 9.11.0, Audit scope.
Auditing to the risk means that material risk in the file is addressed. Audit work focuses on areas where amounts may not have been reported correctly. During the preliminary review, the auditor identifies potential areas of concern or risk and starts to establish appropriate audit procedures that will address these identified risks. Information obtained during the initial interview, tour of premises, evaluation of internal controls, accounting system walkthrough, and substantive testing is used to modify and update the Audit Plan and audit procedures.
Risk assessment is a continual process. An auditor determines the nature and extent of audit testing to address the initial areas of risk identified in the Audit Plan. As the audit progresses, audit procedures can be added and modified based on the evaluation of additional information obtained from audit procedures and completed testing. Risk assessment throughout an audit ensures that audit testing remains efficient and effective. Audit testing ends when material risk no longer exists. This can be measured using a “cost-benefit” approach. The cost-benefit approach involves weighing the audit hours against the tax recovery. The analysis is used to decide whether to proceed with the audit or not. The audit hours on a file will depend on the amount of risk for that file. This also means that the number of files expected to be completed in a year will depend on the risk and complexity of the files. Continuous discussions with the team leader will help monitor the appropriate hours on the file.
An audit should be considered complete when the auditor has obtained a reasonable level of confidence that all material issues of non-compliance have been identified and resolved.
9.17.3 Audit risk: Inherent risk, control risk, detection risk
Audit risk is the risk that significant errors or misstatements remain undetected after the audit is completed. It is the risk that an auditor will conclude that a transaction or tax return is correct for income tax purposes, when in fact, there is an error.
Audit risk has three components: (1) inherent risk, (2) control risk, and (3) detection risk. Auditors generally consider and describe audit risk and its components in terms of low, medium, and high. A good understanding of these three components will help determine how much audit work and testing is needed to reduce audit risk to an acceptable level.
Audit risk is calculated as follows:
Audit risk (AR) = inherent risk (IR) X control risk (CR) X detection risk (DR)
An auditor’s working papers should support the risk assessed, in such a manner that the team leader or Audit Quality Review would find the level of audit work reasonable and risk ratings appropriate. The working papers, analysis of the facts, findings, and conclusions, all support the risk assessment.
Audit risk is a concept that is a fundamental part of every audit and cannot be eliminated. The objective of an audit is to provide reasonable assurance that the taxpayer is operating in compliance with the ITA. There is a risk that a significant error will be present and remain undetected by the taxpayer’s internal control system or by the auditor. It is the auditor’s responsibility to reduce the risk to an acceptable level.
Audit risk is set for the audit as a whole, but may be modified for different accounts or even certain transactions. The CRA does not have a specific policy on what amount of audit risk is suitable. However, audit risk is typically between 5% to 20%.
Substantive tests identify errors in transactions and balances. If audit risk remains high, the auditor will generally want to perform more substantive testing to acquire more audit evidence. The lower the audit risk, the larger the sample of transactions to be reviewed.
There are no formulas to calculate audit risk and materiality. For example, it is not expected the auditor will calculate a percentage for audit risk for each audit step undertaken. It is expected that the auditor consider audit risk and how additional testing lowers audit risk. To mitigate material risks, the auditor should determine audit steps must be taken. Audit risk should normally be set to a low amount. A low audit risk means that there is a minimal chance of errors going undetected during the audit. Consider how much additional testing will lower material audit risk, as it has a direct impact on audit hours. Auditors should discuss these situations with the team leader to determine whether additional audit work and hours are warranted.
Example
During an audit of a car dealership that deals with both new and used vehicles, the auditor evaluates the inherent risk as medium (50%), as it is low for the new vehicles, medium for the garage, and high for used vehicles. Control risk is evaluated as medium (50%), as it is determined that there are reliable controls.
The auditor notes that all the management personnel are related. Sales staff, administrative staff, garage and repair staff, and the financing officer are all unrelated. Related management means that it is easier to circumvent the controls between the time the accounting books are generated and the return is produced.
The auditor begins by setting the audit risk at a low level (5%).
Since the audit risk equation is AR = IR x CR x DR,
then the detection risk equation is DR = AR / (IR x CR)
In our example: DR = .05 / (0.5 x 0.5) = 0.2 = 20%
This means that the detection risk is calculated as 20% or enough substantial testing to produce an 80% level of confidence.
The following examples illustrate how an auditor can approach audit risk on a file.
Example 1
After consulting with your team leader, assume that you want the audit risk to be low. This means that you want there to be a low probability that a transaction or account is accurate, when in fact, there is an error. To ensure the low probability is met, it is likely that you will have to conduct a large sampling of an account. This is more practical with an account that has fewer transactions. But such a high sampling percentage is impractical and unnecessary in accounts with a large number of transactions. For more information, go to Sampling techniques and sample sizes, under 9.17.7, Substantive testing.
Example 2
Assume that you set the audit risk at 5%. This means that you accept there to be a 5% probability you will conclude that a transaction or account is accurate, when in fact, there is an error. Alternatively, this also means that you’re looking for a 95% level of assurance. To ensure the 5% probability is met, it is likely that you would be doing too much auditing. Ensuring this level of assurance is possible with an account such as capital asset additions of $2,000,000 made up of 10 additions in a year. However, such a high level of assurance is impractical and unnecessary in a meals and entertainment account of $150,000 made up of 5,000 transactions, where the average dollar amount of the transaction is $110. You must choose a higher level of acceptable audit risk in this case, as it is not efficient to be spending valuable audit hours verifying 5,000 transactions of $110. You may also need to increase or decrease your sample size based on the results of initial sampling. For more information, go to Sampling techniques and sample sizes, under 9.17.7, Substantive testing.
Inherent risk
Inherent risk are material misstatements as a result of an omission or error in the financial statements, due to factors other than failure of control. Inherent risk always exists and cannot be changed. In audits, inherent risk is most likely to occur in complex transactions or situations that require a high degree of judgement in financial estimates. To properly audit income taxes paid, an auditor should have a clear understanding of the industry of the business and the corresponding complexities.
Application on the job
The auditor needs to understand the taxpayer’s business and organizational structure to effectively identify inherent risk, and thereby identify potential audit issues. An auditor often identifies inherent risk as high, medium, or low, based on professional judgement.
The higher the level of inherent risk, the higher chance that material transactions have been recorded in error. As a result, larger testing and sampling need to be completed to ensure that an acceptable level of audit risk results.
Examples of inherent risk factors
Nature of the taxpayer’s business:
- cash-based business
- types of inventory and assets more susceptible to theft
- unearned revenue where judgement was required in the accounting transactions
Nature of the transaction:
- non-routine or complex transactions
- complex accounting or calculation
- large volume of account balances and transactions
- transactions require a high degree of judgement and estimation
- a taxpayer is more likely to incorrectly record new, complex, or unusual transactions
Specific transactions:
- transactions involving shareholders, non-residents, related parties, taxpayer and non‑arm’s length parties. Inherent risk is considered higher due to the possibility or opportunity of manipulation of the accounts to reduce taxes payable.
- prior period adjustments that need to be made
Non-compliance history or previous audit results:
misstatements may occur again because many organizations are slow at implementing systemic corrections to eliminate the misstatements
- integrity of management
- issuance of books and records letter in past
Specific sectors, specific tax issues related to the taxpayer’s industry, industry practices, type of software used and/or available – for example, the restaurant industry may have “zapper” software available.
Control risk
Control risk is the risk that significant errors are not detected by the taxpayer’s internal controls. It is the risk of a material error or misstatement in the financial statements or tax returns, arising due to absence or failure in the operation of relevant controls of the entity.
Application on the job
The auditor must consider that there is a risk that an error could occur in the taxpayer’s books and records without their internal control system detecting or correcting it.
Control risk is generally lower for large file audits, and higher for small file audits. Control risk can be controlled by the taxpayer by increasing or decreasing the strength of the internal controls.
The auditor is to test the effectiveness of internal controls and reduce substantive testing if the controls are working as designed.
The auditor is expected to identify the existing internal controls and evaluate their effectiveness. This occurs after the initial interview and initial documentation of the accounting systems. Testing of internal controls is completed to verify that controls operate as outlined by the taxpayer. For example, the auditor could test a sample of a few purchase invoices to ensure that they have been reviewed and approved by an authorized person before payment is made.
Controls established by the taxpayer may include:
- segregation of duties
- appropriate levels of authorization
- security surrounding the protection of assets and records
- existence of written financial policies and procedures
- properly trained staff
- monitoring of appropriate usage of corporate assets, credit card and bank account access
An auditor tests the internal controls to see if they are working as expected. The auditor can lower control risk by conducting more internal control testing, which can reduce substantive testing and sampling. Tests of the internal controls vary from audit to audit and depend on the nature of the internal controls established by the taxpayer. After identifying and testing the internal controls, an auditor rates control risk as high, medium, or low.
Where the auditor has determined that internal controls are working as anticipated, control risk can be set low and the sample size can be reduced. This contrasts to where internal controls are found to be poor or ineffective and control risk is set high, the sample size must be increased.
Internal controls should be tested early in the audit. It can save audit time when conducting sample testing, in turn making an audit more efficient. Without a test of internal controls, an auditor cannot draw any meaningful conclusion about control risk and must set control risk to high. For more information, go to 9.17.5, Internal controls.
Detection risk
Detection risk is the risk that significant errors, such as a material misstatement in the financial statements or tax returns, are not detected by the auditor.
There is a risk that audit testing will not detect an error. Audit procedures are applied to detect material misstatements in the financial statements and tax returns due to potential fraud or error. Misapplication or omission of critical audit procedures may result in material misstatements remaining undetected by the auditor.
Detection risk, set by the auditor at low, medium, or high, controls audit risk. To lower the level of detection risk, more substantive testing needs to be done. Detection risk can be reduced by an auditor by increasing the number of sampled transactions for detailed testing, or by conducting additional audit procedures.
The audit risk equation [AR = IR x CR x DR] explains the following mathematical relationship:
As inherent risk and control risk increase, the detection risk needs to be set at a lower level to keep the audit risk at an acceptable level. A lower detection risk may be achieved by increasing the sample size for audit testing. Detection risk will remain high when there is insufficient testing or where the sample sizes are set too low. However, when an auditor has determined that the inherent risk and control risk are low, then detection risk can be set at a higher level and a decreased sample size can be selected.
If an auditor believes that inherent risk and control risk are high for the taxpayer, and they want audit risk to be set low, more audit evidence should be collected. More substantive testing should reduce detection risk, as there is a higher probability that errors would not be detected.
Example
Corp A’s professional fees for the year are $122,500. Assuming a risk of 5%, as there was just a reorganization (acquisition of control), which is not something usual and therefore, there is the possibility of material error. Inherent risk is set to 50% and control risk is set to 60%, as a test of internal controls shows that the proper flow of information is followed and the appropriate safeguards are in place. However, the auditor was not comfortable with their amortization/capitalization policy, and it is possible that Corp A may have expensed capital professional fees. In this case, the auditor will need to conduct more substantive testing to ensure that the most errors possible are identified. In this situation, it is suggested the auditor start with a sample size of 60% of the account and expand the sample if issues arise.
As a result, the auditor would review $73,500 (60% x $122,500) worth of transactions and expand the sample size if issues arise.
9.17.4 Materiality
What is “Materiality”?
Auditing does not provide 100% assurance about the accuracy of taxpayer’s financial statements and tax returns. An auditor completes appropriate audit steps in order to provide a reasonable level of assurance that all material risk has been addressed. An auditor uses materiality to effectively risk assess issues and conduct the audit. The concept of materiality is used in conjunction with audit risk to establish a materiality threshold and the appropriate level of audit effort for an identified area of risk.
The initial determination is made during the planning stage of the audit, at the same time as risk assessing begins. The preliminary review is the initial step and provides the information necessary to prepare an initial Audit Plan, identify inherent risks, and identify potential areas of concern. As the audit progresses, changes may be warranted. It is recommended that materiality be discussed with the team leader.
Using the information from the preliminary audit review, initial materiality thresholds can be used to identify areas of risk that may be examined. However, once an auditor has completed the evaluation of inherent risk and control risk, they have the information necessary to determine detection risk and set more appropriate materiality thresholds before starting any substantive testing.
The concept of materiality recognizes that some transactions have a greater impact in a given situation and, therefore, warrant greater scrutiny. Material amounts or transactions have an effect on the outcome of the audit.
Materiality is another measure that is based on experience and professional judgement. It typically starts off in the 1 to 5% of gross sales range. Different factors influence materiality.
In the context of an auditor’s work, materiality can be defined as the dollar change (in taxes payable) of a potential audit issue where a cost-benefit analysis demonstrates that it is reasonable to invest further audit hours and resources. A cost-benefit analysis considers the additional audit hours and salary required to reevaluate a potential audit issue. Other potential costs of non-compliance, the reason for the audit, and other considerations may also form part of the analysis and decision to pursue or reevaluate a particular issue. Use materiality to evaluate a particular item or transaction relative to the total annual sales, total expenses, gross profit, or a balance sheet item. Determine sample size based on the risk areas identified. Examine the risk for reasonable assurance that material risk has been addressed.
Determining materiality is largely a matter of using professional judgement and cost-benefit analysis. Time is a valuable resource. An auditor focuses on audit issues or transactions that can have a greater impact. An item or amount is material if it can influence or change a decision if it were omitted or misstated. Adequately document the rationale for decisions.
Materiality for audits is generally related to the size of the business.
For example, an amount that is considered material for one taxpayer may not be considered material for another. A $1,000 transaction may be material if the taxpayer's annual revenues are $30,000 (3.3% of annual sales), while the same amount may not likely be considered material when sales are $3,000,000 (.03% of annual sales), unless the amount is recurring.
Setting materiality thresholds
There are no prescriptive or rigid formulas that auditors must follow to determine risk and materiality. It depends on the circumstances presented in a given situation, and the many factors that the auditor must consider altogether on a case by case basis. The concept of materiality is applied to effectively conduct audit testing and sampling of transactions. What is material in one case may not be in another.
When an auditor sets materiality, they are establishing a threshold, or a dividing line between significant and insignificant amounts or transactions. Setting thresholds will guide the auditor in deciding what additional steps are necessary. This allows the auditor to focus audit efforts on areas of non-compliance with greater potential tax recoveries.
Materiality is often expressed as a percentage or dollar amount at the planning stage. In some cases, the same materiality is set for the overall audit, but more often, individual materiality limits are set for different categories or specific tax issues. Materiality is also used to determine the point at which accumulated errors reach a material amount, on an individual and cumulative basis. A systemic error may involve small amounts that can become material if the error is recurring and there are a numerous transactions. The auditor may need to reevaluate materiality as the audit progresses and additional information becomes available.
A materiality threshold is usually between 1 to 5% of sales. There are no exact percentages, rather the auditor determines materiality on a case by case basis, incorporating professional judgement, experience, and in consultation with the team leader. It should be noted that not all accounts above the materiality threshold will be examined, as professional judgement may deem them to be low risk.
Example 1
If the auditor sets initial materiality at 1% of sales, and sales were $5 million, the auditor would then plan to test every account that is $50,000 or higher. Materiality set at the early planning stages is just a starting point. As the audit progresses, materiality may change, given new audit findings.
Example 2
During the review of the credit card statements, you notice travel expenses that appear to include personal amounts of the shareholder. Assume this expense account was not included in your initial review, however, now that you are able to see that the majority of the amounts claimed are personal, the account becomes material and you should expand your audit review to include this account.
Be prepared to adjust the materiality threshold or review other areas that fall below it.
Example 3
An auditor decides to review the professional fees account that has a balance less than the materiality threshold, as the account has materially changed after a corporate reorganization. This is a potential area of concern and, therefore, should be examined more closely. The cost of spending a few hours of audit time to review the account is outweighed by the benefits from auditing the identified risk. You can also see that there are individual transactions in the account that would be material for reassessment purposes.
9.17.5 Internal controls
Internal controls are policies and procedures that an organization puts in place to control and mitigate risk. An internal control system is meant to prevent or detect material errors in the books and records, to safeguard assets, and to ensure resources are properly used.
Auditors review:
- Preventative controls – typically rules and procedures that are put in place to ensure that no mistakes (or fraud) are made.
- Detective controls – often in the form of a reconciliation or comparison that are created to detect a mistake (or fraud) that occurred, because it was not detected by the preventative controls.
An auditor is expected to identify, test, and evaluate the effectiveness of internal controls in order to reduce the amount of substantive testing necessary to achieve the desired audit risk in the file. The auditor needs to determine the risk of material errors existing in the books and records of the business. The audit approach taken is impacted by the reliance that can be placed on the internal controls and the reliability of the books and records. Internal controls help determine the level of risk and the degree of testing required. If internal controls are effective and reliable, the amount of testing required can be reduced. However, if controls are weak, ineffective, or non-existent, then more substantive testing is required.
It is possible, based on information gathered in the preliminary review, that an auditor may decide that the internal controls are ineffective. Any additional time spent evaluating internal controls would not be cost effective and, therefore, would not be completed. In such situations, no reliance would be placed on the internal control system and control risk would be deemed to be high.
Using professional judgement, information gathered, and the results of compliance tests, an auditor may identify and evaluate the internal controls to be effective in preventing and detecting material errors in the books and records.
There are various methods that auditors can use to identify, test, and evaluate internal controls.
Begin by obtaining a general understanding of the accounting and computer systems from the initial interview. Review the company’s procedure manuals, which contain formal procedures for record keeping that have been established by the company. Obtain a detailed organization chart to know who has custody of the assets and which employees are involved in the record keeping process. Some businesses may keep documentation or flowcharts on the accounting system, such as details on daily record keeping duties that specific employees are responsible for. Some companies may not have any of these documents and, therefore, the auditor must gather this information through discussions with the taxpayer or management.
Complete a walk-through test by following a transaction from beginning to end. For example, follow a sales or expense invoice to the posting in the general ledger, and lastly to the financial statements. This audit procedure helps to identify areas of concern with internal controls while providing the auditor with a better understanding of the accounting system and flow of transactions. The auditor is able to verify how each type of transaction is authorized, executed, recorded, processed, and whether adequate segregation of duties exist.
Use compliance tests to gain reasonable assurance that the control procedures were effective. They also support the initial evaluation of control risk. Examine a sample of transactions, verify there is audit evidence that control procedures were performed. An example is an authorization stamp or initials on a document. Common compliance tests include confirming that employees are performing control duties as described, asking the employees how they perform their duties, or inspecting the documents for audit evidence that the employee performed the tasks as described in the system description.
Example
The accounts payable clerk should check purchase invoices against packing slips to ensure that the invoiced amounts agree with the goods received. The clerk then initials the document once complete. Should the initialed purchase invoice and packing slip not match the quantities and description, the controls are deemed to have failed and are, therefore, inadequate. If this type of error is reoccurring, it would lead the auditor to place no reliance on the control.
9.17.6 Cost-benefit analysis
Auditors are expected to focus on areas containing the highest risks and materiality while continuously being mindful of adjusting the risk during the audit. This involves many factors, some of which include using a cost-benefit approach, professional judgement, identified risk, materiality, specific facts of the case, and discussions with the team leader.
A cost-benefit analysis should be continuous throughout the audit, where the remaining risk is evaluated in terms of the incremental hours required to address the material risk. If the risk does not warrant the investment of additional time, the auditor should document this in the file and discuss with the team leader. Without continual risk assessment during the audit, the auditor risks performing unnecessary audit procedures or missing areas of material non-compliance.
The Audit Plan will include the screener’s comments as well as other high risk issues to review. The auditor and team leader will agree to a reasonable amount of time to address these issues. As the audit progresses, the Audit Plan often is updated to include audit findings and on-going risk assessment. If additional audit time and resources are required, it needs to be discussed and approved by the team leader.
Audit time should be commensurate with risk. An auditor should always consider how many audit hours will have to be expended to obtain an audit change, and whether to pursue or reassess a particular issue. However, as previously stated, the screener’s comments must be addressed and properly documented in a working paper format. Sometimes, under certain circumstances, it will be necessary to continue with a specific audit issue even though the cost-benefit analysis shows low potential. These instances could include mandatory project files, a taxpayer’s previous history of non-compliance, or a particular reason the audit was selected.
It is the auditor’s responsibility to ensure that files are completed in a timely manner by planning, conducting, and monitoring the audit to avoid delays. Focus on the Audit Plan and auditing the identified risk. The Audit Plan is an evergreen document that should be continuously updated. Avoid excessive testing on issues once the material risk has been addressed. Instead, reallocate time and expand audit testing to risks that warrant more attention. Avoid over-auditing. The purpose of an audit is not to obtain 100% certainty that there are no errors or omissions on a return, rather it is to ensure that substantially all material errors or omissions have been addressed.
9.17.7 Substantive testing
Substantive testing is very different from control testing. Substantive testing verifies whether the information is correct, whereas control testing determines whether the controls in place are indeed working as specified and intended.
Material errors that are detected through the auditor’s substantive testing and sampling are reassessed. Substantive tests look for monetary errors in transactions and balances. These tests verify the accuracy of account balances and transactions to detect material non-compliance.
The main types of substantive tests are:
- inspection of documents (vouching) to verify the validity and details of a transaction or account item by inspecting related documents and records
- inspection of assets (or observation) to verify the existence and possession of the asset
- direct confirmation is the validation of balances and transactions through confirmation with third parties, such as banks, real estate boards, or suppliers
- validation of mathematical accuracy to verify an amount, such as account balances, line extensions, subtotals, and totals
Sampling techniques and sample sizes
It is neither possible, nor practical, to audit every item in a large population. Use professional judgement to select an adequate sample size to examine. The selected sample taken from a population can consist of specific items (such as high risk items, high value items, error prone items) or representative items (a sample that is selected using an unbiased sampling technique to reach a conclusion regarding all items within that population). The goal is to select an adequate sample that is sufficient to evaluate and address the identified area of risk. Audit working papers should document the objective of the test conducted, the population size, the number of transactions, and the total value that a sample will be selected from.
Select a sample by first defining the population, then selecting the sample technique, followed by identifying the sample items, and, finally, setting the materiality threshold for errors. An audit generally does not involve statistical sampling, but uses professional judgement while applying a combination of sampling techniques. Some sampling techniques include selecting high dollar transactions, stratified sampling, block sampling, random sampling, and judgmental sampling to select unusual or other items of interest.
As discussed, an auditor starts to prepare the Audit Plan after completing the preliminary review. The auditor sets initial materiality and identifies potential areas of concern noted during the preliminary review, and starts to establish appropriate audit procedures that will address these identified risks. Once an auditor has completed the initial interview and internal control testing, they evaluate inherent risk and control risk, and, based on that information, is able to update materiality thresholds. Materiality thresholds are used throughout the planning stage of the audit to determine the substantive testing, the sample sizes, and the identified areas of risk that will be examined. The completion of a proper risk assessment and setting materiality thresholds assist in effective sample size selection that is based on supported rational decisions.
In some situations, a taxpayer’s previous audit and non-compliance history may indicate that testing internal controls is not an effective use of audit time, as inherent risk and control risk are known to be high. It is more appropriate and efficient to set low materiality thresholds and increase substantive testing and sample sizes in such circumstances.
Professional judgement and materiality will assist the auditor in determining the items to sample, the sampling method, and the adequacy of the sample size. To obtain reasonable assurance about the accuracy of accounts, it is essential to select an appropriate sample size. The sample items selected are also impacted by the size of the company, the dollar value of the issue, and the transactions involved. Based on results from the initial sampling and reevaluation of risk, sampling is expanded or reduced, as appropriate.
While conducting sampling tests, an auditor may notice that many items are of a particular type or concern a specific tax issue, or see a pattern emerging. As a result, the auditor may allocate additional audit effort to those identified problem areas that have higher material risk. The auditor may decide to conduct further interviews or issue audit queries to verify the nature and extent of the errors before expanding sampling and committing additional time to a particular area of risk.
The basis of the reassessment will also incorporate an auditor’s professional judgement. For example, the sampling may have determined that a particular expense is not deductible based on the supporting invoices and records examined. In situations where the sample indicates that the majority of the amounts tested are non-business related, are unsupported or a pattern exists, it may be reasonable to deny similar transactions without the need for further sampling. A discussion with the taxpayer can confirm that all similar transactions should be denied as well, and expanding sampling will not be necessary to reassess the similar transactions. The audit findings and recommendations should also be discussed with the team leader to determine if the approach is reasonable and that the audit evidence gathered is sufficient to support the reassessment.
Example
An auditor uses IDEA to extract a list of 15,800 transactions with the word “coffee” in the general ledger’s transaction description and determines that a material amount of $280,000 of coffee was expensed under various expense accounts. A small representative sample is selected.
In the auditor’s professional judgement, after completing half of the selected sample, the auditor analyzes the results and concludes that there is sufficient audit evidence gathered to support a reassessment and further sampling is not required. The auditor verifies that no portion of the expenses were added back on Schedule 1. The auditor discusses the findings with the controller, who confirms the mistake, and agrees that 50% should be reassessed as non-deductible under subsection 67.1(1) of the ITA. In this case, the initial sampling that was completed, along with the IDEA extractions, and discussions with the taxpayer would be reasonable audit evidence to support the reassessment.
9.17.8 Conclusion
Audit risk, materiality, internal controls, substantive testing, and sampling are all important in planning and conducting an audit. Inherent risks and internal controls are analyzed to effectively determine the risk of material errors existing in records. An Audit Plan is developed with appropriate audit procedures and testing to address the identified risks. The auditor determines whether audit testing is expanded, reduced, or abandoned. Audit testing generally continues until there are no longer any material errors. The auditor detects and addresses material non-compliance issues in an audit file. Materiality thresholds are used to improve substantive testing and sampling. Materiality thresholds, substantive testing, and sample sizes can change as additional information is obtained and analyzed. Risk is continuously identified and evaluated throughout the audit, while applying a cost-benefit analysis to effectively plan and conduct the audit. An audit should be considered complete when a reasonable level of assurance is obtained that all material issues of non-compliance have been identified and addressed.
9.17.9 Practical examples
The examples below show the importance of continually identifying and evaluating risk as the audit progresses and additional information is gathered, and applying cost-benefit analysis in order to effectively plan and conduct an audit. An auditor reevaluates risk after a review of the relevant facts to confirm if these remain pertinent audit issues, if any material risk remains that is worthwhile pursuing, and to reevaluate materiality thresholds and substantive testing.
The practical examples below show how the concepts covered are applied on the job.
Example 1
Initial facts
- You have set 5% of sales as the materiality threshold for expenses.
- Other Expenses of $200,000 are claimed on the Income Statement, representing 6% of gross revenue.
- Other Expenses is a new account that did not exist in prior years.
- Therefore, the Other Expenses account meets both the inherent risk criteria and your materiality threshold, warranting further audit work.
Analysis
- Upon further review of the electronic records, you note that the $200,000 is composed of 10 smaller accounts.
- The largest account is titled “Penalty” and is $80,000, representing 40% of the $200,000 claimed.
- The remaining $120,000 is spread over nine small accounts, each with hundreds of transactions.
- You estimate that it will take two hours to review the $80,000 penalty and decide if it needs to be disallowed.
- You also estimate that it will take 10 hours to conduct testing of the $120,000 if you complete a sample size of 40% of the number of transactions; however, a review of the comments associated with the electronic records leads you to reasonably conclude these are business related.
Impact on materiality, cost-benefit, risk, and sample size
- It makes sense that you will spend the two hours to review the penalty.
- With respect to the $120,000, since the entries are business related, spending 10 hours is likely inefficient. However, you should obtain some level of assurance, which could be done by scanning the electronic records to get a better understanding of the type of transactions through the description field.
- Internal control testing was completed and it appears that all controls are working as described.
- Some level of assurance can be obtained from your internal control testing. If the testing shows that internal controls operate as stated, it adds assurance that these accounts are business related and, therefore, no more substantive testing is required.
- At this point, your professional judgement and discussions with your team leader should come into play. On one hand, since non-deductible expenses aren’t indicated in the comments and the internal controls test worked as stated, further testing could be abandoned. On the other hand, you could reduce your sample size to a point that it can be completed in one hour if you feel that you need the additional assurance that comes with a review of source documents. This could be represented by two transactions from each account, for a total of 18 transactions.
- This is a question of professional judgement. Your decision to not proceed with further testing may be reinforced if you have identified material risk elsewhere in the file.
- Alternatively, if the internal controls test did not work as stated, then you may undertake sampling of the entire expenses of $120,000, which can be done through stratification using IDEA.
- This highlights the relevance of the internal controls test that you prepare and complete and how this test can reduce substantive testing.
Example 2 - Continuation of Example 1, but with a variation of facts
Additional facts
- Auditor notes that coffee supplies totalling $20,000, included in the Other Expenses account, have been claimed at 100%.
- The $20,000 represents 10% of the $200,000 total Other Expenses.
- A review of the electronic data reveals that the majority of the transactions are for $85 each and from the same supplier.
- Based on the transactions described in the electronic books and records, you suspect that these expenses are for the personal enjoyment of the executives of the corporation on a regular basis.
- If you are correct, $10,000 may be non-deductible.
Analysis
- Since the majority of the transactions are at the same amount ($85) and since your potential adjustment is $10,000 (in a corporation with $4 million in gross revenue), you conclude that a small sample size will be adequate.
- You decide that 5% of $20,000, or $1,000, is an adequate review. In terms of the number of receipts to review, this is $1,000/$85 = 12 receipts.
- The analysis supports your suspicion that only 50% of the $20,000 is deductible.
The analysis supports your suspicion that only 50% of the $20,000 is deductible.
Impact on materiality, cost-benefit, risk, and sample size
- An increased sample size is not necessary. Your extrapolated conclusion based on 5% is adequate given the reoccurring nature of the amounts, which you were able to determine by reviewing the descriptions in the electronic data.
- This conclusion is an efficient use of your time.
- Note that if the amounts varied (that is, not all at $85), then it’s likely you would have to expand your sample size. This would be necessary, as it’s reasonable to reach a conclusion based on a 5% review of an account where the amounts are generally the same. But perhaps a 15% or 20% sample size would be necessary based on an account where amounts vary and are from different suppliers. Extrapolation could still be used in this case, assuming that a pattern exists and the transactions continue to reoccur.
- You may decide to disallow the $10,000 or you may decide that educating in the proposal letter is adequate. Make this decision after discussing with the team leader.
- It is necessary to ensure that the sample size and rationale are identified, justified, and explained in the working paper and Audit Plan.
Example 3 - Unrelated to Example 1 or Example 2
Initial facts
- Screener’s comments direct you to review motor vehicle expenses.
- Motor vehicle expenses represent 20% of sales.
- You already identified that 8% of sales was material. In addition, motor vehicle expenses are generally inherently risky.
Analysis
- During the initial interview and tour of the premises, you learn that the corporation, a heating, ventilation, and air conditioning corporation, owns a fleet of 20 working vans and a luxury car used by the sole shareholder.
- A standby and operating charge was included on the T4 slip of the shareholder. You are told this and you spend the hour necessary to review the calculations, which are correct.
- After the initial interview with the shareholder and a test of internal controls related to van use, you conclude that there is no personal use by the employees of the work vehicles.
Impact on materiality, cost-benefit, risk, and sample size
- No further audit work is necessary. Any further audit work would not generate any adjustment.
- Note your conclusions on your Audit Plan or working paper.
- Note the audit steps you completed: interviews, a review of calculations, and a test of internal controls. In other words, it would not have been adequate to conclude that amounts claimed were reasonable without some audit work. .Based on other audit steps you completed, it was not necessary in this situation to review the receipts.
Example 4 – Unrelated to the previous examples
Initial facts
- Screener’s comments direct you to review:
- Acquisition of control
- Amalgamation
- Intercorporate accounts
- Travel expenses
- The corporation’s sales were $20 million.
Analysis
- The auditor and team leader agreed to set 10% of sales, or $2 million, as the materiality threshold, after testing the internal controls, and finding they were excellent and there did not appear to be any shortfalls. In addition, the segregation of duties was also more than ideal. As a result, you set control risk to low.
- This means that only expense or Balance Sheet accounts greater than $2 million are to be reviewed, in addition to the specific screener’s comments noted above, or an account that has a high inherent risk.
- The only unusual item (other than salaries) with a balance greater than $2 million is the office expense account.
- You and your team leader conclude that an initial sample size of 20% for both Office Expenses and Travel Expenses is appropriate.
- It is expected that it will take 10 hours for each sample review, or 20 hours in total. Travel expenses were claimed at $1,800,000 and the average dollar amount per transaction is $3,000. You decide to review 20% of transactions greater than $4,000.à
- After two hours testing the travel expenses, no non-deductible expenses are identified. Also, the initial interview with the shareholder provided reasonable explanations as to why travel expenses were so high.
- You decide to set aside your testing of the travel expenses and move to office expenses, where you undertake testing using the same rationale as you did to verify the travel expenses.
- Within three hours of testing the office expenses, you identify $100,000 of non‑deductible expenses and from a review of the transactions described in the electronic records, you are reasonably certain that there are many more of these transactions.
Capital assets
- Your initial review of the Balance Sheet noted that machinery decreased by $2,200,000 with no corresponding disposition on Schedule 8. Further, the gain reported on the disposition was only included as an accounting gain, meaning it was deducted on the T2 return, Schedule 1.
- It was mentioned during the initial interview that the corporation sold a warehouse to a related party and you recognize that this could be what the disposition relates to. You request the information concerning the disposition to verify the transaction.
Acquisition of control
- During your initial review, you note that $700,000 of non-capital losses were transferred to the corporation you’re auditing (the newly amalgamated corporation). The $700,000 in losses were used to reduce taxable income.
- During the initial interview, explanations provided indicate that it is likely that you will have to deny these losses, but that another 40 hours of audit work will be necessary.
Impact on materiality, cost-benefit, audit risk, and sample size
- After reviewing the books and records, you determine that the focus of the audit will need to change. You decide to not conduct any additional testing on travel expenses given your preliminary findings. However, you decide to expand the review of the office expenses, as you determine that two more hours would be needed to review the remainder of the expenses that appear to be non-deductible. The potential adjustment is $100,000. Two hours of audit work for an additional $100,000 adjustment is worth the cost.
- Capital asset dispositions will need to be reviewed in full, given the inherent nature of these transactions, due to their infrequency, the fact that they only relate to one or two transactions, and because they are material.
- The 40 more hours of audit time needed to review the acquisition of control and the use of the non-capital losses is also considered to be worth the audit time, because not only are they screener’s comments, but the amounts are material and the issue is complex. Educating taxpayers on tax issues is also part of your responsibilities.
- Given the inherent nature of the intercorporate accounts and because they were mentioned as a screener`s comment, it is necessary to review the accounts to ensure that transactions were valid and were conducted at fair market value.
9.18.0 Contacting the taxpayer
Auditors are allowed to use cellphone technology when communicating information with taxpayers or third parties up to and including Protected B information with devices issued by the Agency. For more information, go to section 5.2 of the security policy Transmittal and Transport of Protected and Classified Information and Assets Standards.
It is important to plan the initial contact and subsequent interview with the taxpayer or their representative to ensure the highest degree of cooperation and to obtain as much information as possible. Auditors are not permitted to use audio or video recorders to record interviews nor should they allow themselves to be recorded. If an auditor becomes aware that they are being recorded, the interview should be stopped, the reasons explained, and alternate arrangements made.
Record details of all communication with the taxpayer or their representative on Form T2020, Memo for file.For more information, go to 10.1.0, Interviewing the taxpayer.
Who should be contacted
In the case of a T1 audit, initial telephone contact should be made with the individual whose income tax returns are under audit. In the case of a T2 audit, initial telephone contact should be made with the controlling shareholder. If it is not immediately identifiable which individual controls the corporation or more than one individual controls the corporation, use the authorized representative screen in the BN System. The auditor must confirm verbally that the individual contacted has the authority to provide the necessary information before discussing any details of the audit.
Audits of partnerships
If a partnership is being audited, identify the individual who is the general partner or most active partner and contact the person.
Representatives
Correspondence in the audit file may indicate that a representative (attorney or accountant) be contacted for all financial matters. The auditor advises the taxpayer that the account has been selected for audit, confirms the name of the representative as indicated in the file, and advises that the representative will be contacted to arrange for the audit to take place.
Authorization
If the taxpayer indicates there is a representative and there is no authorization in the file, an authorization must be obtained from the taxpayer before contacting the representative. For information on authorizing a representative, go to Authorizing a representative under 3.4.1, Overview.
9.18.1 Initial contact
Initial contact with the taxpayer may be made by telephone. From the initial contact and throughout the audit, the auditor must ensure that the taxpayer knows what to expect.
Purpose of the call
As a representative of the CRA, the auditor explains that the account has been selected for an income tax audit and briefly explains the audit procedures. Also establish an appointment at a mutually convenient time to begin the audit.
A letter confirming the details of the telephone discussion may be sent to the taxpayer. For more information, go to 9.18.3, Communicating with the taxpayer by letter.
What should be asked
Discuss these details during the initial contact with the taxpayer:
- location of the business
- business activities
- location of the books and records
- type of accounting software currently used and if any changes have recently been made
- names of persons that will provide assistance during the audit other than the primary and contact person
- mutually acceptable time and place for the meeting
The audit procedure
The auditor discusses the audit procedure during the initial contact, including:
- audit period
- estimated time to complete the audit
- taxpayer's office hours
- list of information, documents, and reports required to complete the audit
Provide the taxpayer with the CRA webpage address or a copy of Pamphlet RC4188, What you should know about audits, if one has not yet been made available. It is mandatory to distribute this pamphlet for all audits in the small business ranges. The purpose of the pamphlet is to improve compliance through taxpayer education. To this end, the pamphlet is designed to provide small businesses with an overview of the audit process as well as an explanation of their rights and obligations with respect to an audit. The auditor briefly reviews the contents of the pamphlet with the taxpayer and provides further explanations or clarifications as required.
In an effort to ensure that taxpayers are aware of their obligations, their entitlements, and their rights, the CRA has published the Taxpayer Bill of Rights on its website.
The Taxpayer Bill of Rights is a set of 16 rights confirming the CRA will serve taxpayers with a high degree of accuracy, professionalism, courtesy, and fairness. Taxpayers have the right to privacy and confidentiality and they also have the right to complete, accurate, clear, and timely information. Taxpayers have the right to have the law applied consistently.
The Taxpayer Bill of Rights includes the Commitment to Small Business, a five-part CRA pledge to support the competitiveness of the Canadian business community by ensuring that interaction with the CRA is as effective and efficient as possible.
Books and records
During the initial contact, the auditor determines if the taxpayer has computerized records and the location of the records. If the records are computerized, obtain the names of the resource persons and the type of accounting software used.
Assess the need for assistance from a Computer Audit Specialist at this time. For more information, go to 13.1.3, Assistance from Digital Compliance and Audit Support Division specialists.
Borrowing records
In some cases, it is not possible to conduct the audit at the taxpayer's premises. Consequently, it may be necessary to borrow the records to conduct the audit at the office or at another location. Use Form T2213, Receipt for Borrowed Books, Records, and Documents, to give the taxpayer a receipt for the borrowed records. For more information, go to 10.2.6, Borrowing books and records from a taxpayer.
9.18.2 Taking the necessary steps to begin the audit
After contacting the taxpayer, the auditor may change the Audit Plan based on the information provided by the taxpayer. Additional research may be required if the auditor is not familiar with the taxpayer’s accounting software. For more information, go to 9.2.0, Preliminary review.
Determining the need for assistance
The auditor may request the assistance of other auditors, specialists, or other offices, in these circumstances:
- the volume of information cannot be reviewed in a reasonable period of time
- the records are not all kept at the same location (another TSO may be contacted)
- the taxpayer uses complex computer systems, or
- the main operations of the taxpayer are located elsewhere
For more information, go to 10.11.0, Leads and referrals.
9.18.3 Communicating with the taxpayer by letter
It is best to make initial contact with the taxpayer by telephone. However, in some cases, initial contact with the taxpayer may be in writing.
The letter advises the taxpayer that the account has been selected for audit and proposes a starting date for the audit. To ensure that taxpayers are aware of their entitlements, rights, and obligations, the letter includes a link to:
Every letter sent to the taxpayer or their representative must state: “You can also reach my team leader, (insert name), at xxx‑xxx‑xxxx.”
A paragraph on confidentiality, such as below, must be added as well in every letter addressed to the taxpayer:
“Personal information (including the SIN) is collected to administer or enforce the federal Income Tax Act and related programs and activities including administering tax, benefits, audit, compliance, and collection. The information collected may be used or disclosed for the purposes of other federal acts that provide for the imposition and collection of a tax or duty. It may also be disclosed to other federal, provincial, territorial, or foreign government institutions to the extent authorized by law. Failure to provide this information may result in paying interest or penalties, or in other actions. Under the Privacy Act, individuals have a right of protection, access to and correction of their personal information, or to file a complaint with the Privacy Commissioner of Canada regarding the handling of their personal information. Refer to Personal Information Bank CRA PPU 421 on Information about Programs and Information Holdings at canada.ca/cra-information-about-programs.”
For more information, go to:
- January 10, 2014, memorandum, Small and Medium Enterprises and GST/HST programs' action plan to improve communication with taxpayers
- CRA Privacy Practices Directive
While a wet or secure electronic signature is not required. All general correspondence must include a proper signature block to mitigate any concerns with respect to the authenticity of the document. A signature block for correspondence is a personalized block of text appended at the end of a document. It should include the name of the CRA-CPB official along with their title, division, and tax services office or compliance directorate as appropriate. Please refer to section 9.18.7 for more information.
For more information, go to Communiqué AD 24-01, Guidance on the appropriate use of signatures, Guidelines and Policies – Compliance Programs Branch (dce-eir.net)
For a letter template, go to the Integras Template Library, letter A-9.1.1, No Contact.
Follow the Writing Guide for the CRA when writing letters. Usually, letters intended to be printed must always be printed on pre-printed CRA letterhead to comply with the requirements of the Treasury Board of Canada Secretariat. However, employees may not be able to enter the workplace to print letters on letterhead. In this case, go to Letterhead – Information products to download CRA letterhead R350, and issue letters on this template.
Note that all external correspondence needs team leader approval before being sent out.
Confirming the audit
It is advisable to confirm the details of the audit in writing after the telephone conversation. To ensure that there is no misunderstanding as to the responsibilities of the auditor and the taxpayer, the letter includes:
- the tax that is being audited
- the audit period
- the account number being audited, only give the last three numbers of the social insurance number and use XXX XXX for the first six numbers
- confirmation of the start date of the audit
- confirmation that space is available for the auditor to work, including other requirements such as electrical outlets, telephone, photocopier
- a list of the books and records required
- the auditor's name and telephone number and the team leader’s name and telephone number
For more information, go to the Integras Template Library, letter A‑9.1.2, Audit Confirmation.
Difficulty in contacting the taxpayer
In some cases, it may be difficult to contact the taxpayer selected for audit or the taxpayer may not respond to a letter requesting that they contact the auditor. The auditor should attempt to call the taxpayer several times over a two-week period, at different times of the day. Maintain a detailed Form T2020, Memo for file, with the date and time of each call and if a message was left.
Unable to contact the taxpayer by telephone
If the taxpayer cannot be reached by telephone, send a letter requesting that they contact the auditor within 30 days to arrange for the audit to start (go to the Integras Template Library, letter A-9.1.4, Second Contact).
If the taxpayer does not establish contact, determine if another section, such as Collections, has made recent contact with the taxpayer.
No contact
If attempts at contacting the taxpayer are unsuccessful:
- Issue a second request letter, Integras Template Library letter A-9.1.5, Compliance Application Warning – Failure to Provide Books and Records, that has the header, “FINAL REQUEST TO PROVIDE BOOKS AND RECORDS.” Send by registered mail or electronically through the My Account, My Business Account (if a T2 audit), or Represent a Client online service portals.
- If possible, drive by the taxpayer’s residence or place of business (depending on the time of day), and knock on the door; also note on Form T2020.
- Follow 10.8.0, Requirement guidelines, and issue a requirement for information (RFI) for financial information. Identify known financial institutions in RAPID Option S. As well, glance through the Automated Collections and Source Deductions Enforcement System (ACSES) to identify possible financial institutions. For more information on how to navigate within this system, go to ACSES.
- Based on financial information received through RFIs, perform the supporting IVI tests. If there is material risk of unreported income, follow the hierarchy of the Income Tax Assessing IVI Decision Tree, completing an assessing IVI technique where warranted. To get all additional information required to complete this work, follow 10.9.0, Compliance order guidelines, and seek a compliance order.
- If the taxpayer owes or is about to owe an amount to CRA, place a refund hold on their account. The auditor should note the reasons why the refund hold was requested on Form T2020, Memo for file. The refund hold needs to be removed or requested to be removed once the audit is closed and the audit adjustments are complete.
The auditor is expected to pursue the use of legislated enforcement provisions (ULEP) for establishing contact with the taxpayer.
Visits to the taxpayer that are not pre-arranged
Although most audits take place by appointment, sometimes surprise visits are made. Discuss with the team leader and depending on the circumstances, ask another auditor or the team leader to attend the initial interview.
Drawbacks to surprise visits include:
- the taxpayer is not ready to receive the auditor
- the auditor may inconvenience the taxpayer
- the taxpayer may be absent
- the records, documents, and files may be located elsewhere
9.18.4 Scheduling
Before contacting the taxpayer, review work in progress and other commitments, such as training, to determine a potential audit start date. The date proposed should:
- be mutually convenient
- allow time for the taxpayer to prepare for the audit
- ensure that the contact persons are available
In some cases, records may have to be retrieved from a storage facility.
The auditor is sensitive to the taxpayer's needs to continue business operations. The taxpayer's hours of operation should be observed to reduce the inconvenience as much as possible.
The auditor also recognizes that the taxpayer may have other commitments in addition to operating the business, and may only be available during certain hours. Do not schedule audits around particularly busy periods such as month-end, when employees' workload may be greater than usual. People may not be available to assist the auditor in locating documents and answering procedural questions at that time.
The auditor should be flexible but maintain control of the audit and the audit schedule. By recognizing the taxpayer's commitments and assuring the taxpayer that the time spent by employees assisting with the audit will be limited as much as possible, the audit can usually be scheduled and proceed without problems or delay. Keep the taxpayer informed of changes to the estimated time required to complete the audit.
Factors that affect scheduling the audit
These factors affect scheduling the audit:
- the auditor's work in progress
- the availability of the taxpayer and the employees
- other audits that may be scheduled or in progress such as source deductions, provincial sales tax, GST/HST, or external audits by accounting firms for year-end purposes
- the availability of specialists, if required - if the records are only available in electronic format, a Computer Audit Specialist may be required to retrieve the records for audit purposes
- in the case of a team audit, the availability of the team members
- the availability to travel, if necessary
- the location of the records and available space to work
9.18.5 Audits delayed at the taxpayer's request
It is CRA’s expectation that taxpayers will be able to satisfactorily respond to the majority of initial requests by the initial request deadline. If a taxpayer does not satisfactorily respond to the initial request by the deadline or requests additional time, then a follow-up request may be issued with a revised deadline.
A request from a taxpayer for additional days past the initial deadline should be granted for factors or events that are outside of the taxpayer’s control, such as illness, death, natural disaster, and may include a change in representative. These events or factors are not intended to be exhaustive and professional judgment should be used when issuing revised timelines. The justification for granting or disallowing any additional days to respond to a request must be documented in the audit file.
In addition, the follow-up request will include a warning that a compliance order may be sought by virtue of section 231.7 of the ITA. There will be no further additional days provided beyond the follow-up request.
When considering issuing a revised deadline to provide information, auditors will adhere to established standard timelines for taxpayers to respond, as outlined in Annex A in Communiqué AD-20-01, Standard Timelines for Information Requests to Taxpayers for Audit Purposes, and discuss the file with the team leader.
Difficulty scheduling the audit
In some situations, the taxpayer may make scheduling the audit difficult, may have agreed to start the audit on a specific day and postpone at the last moment, or is not available when the auditor arrives. The auditor must use professional judgement to determine if the audit is being unreasonably delayed.
Repeated or undue delay of scheduled audit
If the taxpayer repeatedly or unduly delays the start of an audit and there are no extenuating circumstances, send a letter to the taxpayer requesting that a firm date for the start of the audit is set. The letter states that failure to comply might result in the application of penalties and a compliance order to provide access to records may be issued.
These procedures also apply if the taxpayer agrees to the audit and then delays or hinders the audit from progressing by limiting or restricting access to books and records. For more information, go to 10.2.0, Books and records.
9.18.6 Communication with taxpayers for information requests
The CRA commits that auditors will communicate with taxpayers or their representative within 30 days of the receipt of the information requested and will inform the taxpayer on the next steps of the audit.
For more information, see Communiqué AD-20-01, Standard Timelines for Information Requests to Taxpayers for Audit Purposes, available in 9.18.5.
9.18.7 Guidance for the appropriate use of signatures when communicating with the taxpayers
All general correspondence must include a proper signature block to mitigate any concerns with
respect to the authenticity of the document. For further clarity, a wet or a secure electronic
signature is not required. General correspondence includes:
- Correspondence addressed to a taxpayer or a representative such as engagement letters, query letters, proposal letters, or final letters
- Requests for information pursuant to subsection 231.1(1) of the ITA
- The general correspondence includes correspondence delivered through the business-to-CRA secure electronic portal, by mail or hand-delivered.
For more information, go to:
- Communiqué AD 24-01, Guidance on the appropriate use of signatures, Guidelines and Policies – Compliance Programs Branch (dce-eir.net)
Appendix 9.1.0 Letters
The letter templates are available in the Integras Template Library. Go to the library for the current version.
The letter templates are also available at Letters (CRA Electronic Library > Compliance Programs Branch Reference Material > Audit > Income Tax – Forms and Letters > Letters). If there are changes to the letters, the templates in the CRA Electronic Library are updated when the library material is published.
There are two versions of the letters: electronic and paper.
Use the electronic version to write to the taxpayer or their representative through Audit enquiries in the My Account, My Business Account (if a T2 audit), or Represent a Client portals. Otherwise, use the paper version.
There are differences between the electronic and paper versions of the letters. In the electronic version:
- the first line of the letter is right-justified and reads: SENT BY AUDIT ENQUIRIES
- the three blank lines before the date are deleted since there’s no letterhead
- links are attached to the website title, webpage title, and publication number and title
- paragraphs with a link are sometimes rephrased to remove repetitive text
- the signature space is reduced to one blank line since there is no signature
To identify the electronic version, the filenames include ED (electronic document) between the letter’s number and title; for example, A-9.1.2 ED Audit Confirmation. There is no change to the paper version filenames.
Text version
A-9.2.5 is an image showing the login screen for CRAs Income tax database for T1 returns.
Text version
A-9.2.6 is an image showing the login screen for CRAs Income tax database for T2 returns.
A-9.2.7 Sample Audit Plan
Taxpayer:
Taxation Years Audited:
Go to 9.2.0, Preliminary review, before preparing the Audit Plan.
Audit steps and additional audit steps
For more information, go to 9.6.2, Factors to consider and procedures to include in the Audit Plan.
List additional audit steps determined necessary that were not included in the original Audit Plan.
Some audit steps from the original Audit Plan may be determined to be unnecessary. These may be eliminated from the Audit Plan and the reasons for their removal noted.
The Audit Plan should remain flexible.
W/P#
Note working paper number (use index of working papers, Index_WP_Index_FT, available in the Integras Template Library) detailing the audit step and results as applicable.
Comments and disposition
Comment on results of the audit step.
Approved by team leader:
__________________________
Team leader signature
__________________________
Date