What triggers an HST audit
Most HST audits are selected by data, not by suspicion. CRA's systems score each return against the registrant's own history, against other registrants in the same industry, and against the income tax filings for the same business, and a file that falls outside the expected pattern is queued for review or audit. The triggers we see most often, roughly in order:
- Refund claims. A net credit return, especially a large one or a run of them, is reviewed before the refund is paid and audited when the pattern persists.
- Credits out of line with revenue. Input tax credits that are high relative to sales, or that jump without a matching change in the business, particularly where sales are largely zero-rated or exempt.
- Mismatches with the T2. Revenue on the HST returns that does not reconcile to revenue on the corporate return, or a filing frequency that does not fit the revenue reported.
- New registrants. A first year with large credits, start-up capital purchases or a refund before any sales have been reported.
- Industry programs. Construction, restaurants and food service, real estate, vehicle sales and other sectors with cash sales or rebate activity receive periodic attention regardless of the individual file.
- Related-party transactions. Management fees, rent and intercompany charges between corporations under common ownership, and the election that lets closely related registrants trade without charging HST.
- Tips and referrals, including an income tax audit that widened, and the fallout from a supplier or customer that was audited.
Two of those deserve emphasis. The T2 reconciliation is the trigger owners think about least, because the HST returns and the corporate return are prepared at different times, sometimes by different people, and a gap of even a few per cent between the two revenue figures is visible to CRA before anyone has opened a document. And a refund position is not a problem in itself; a business in a capital build or selling zero-rated goods should be in one. The problem is a refund position that the rest of the file cannot explain.
What the auditor asks for
An HST auditor rebuilds the return from the records, so the request list follows the return line by line. Expect the general ledger and sales journals, the working papers behind each return, the listing of input tax credits claimed by period, the invoices supporting them, bank statements for every business account, and the contracts behind any large or unusual transaction. Where the business runs point-of-sale software, the auditor will often ask for the data export rather than printed reports.
The audit usually runs in two directions at once. On the sales side, the auditor tests whether all taxable revenue was reported and taxed at the right rate: unexplained deposits, zero-rated or exempt claims without support, sales into other provinces taxed at the wrong rate, and cash sales that never appear. On the credit side, the auditor tests whether each credit is supported, was claimed by the right registrant in the right period, and relates to commercial activity. Most reassessments in owner-managed businesses come from the credit side, so that is where preparation pays.
Sampling is common. Rather than examining every invoice, the auditor may test a sample of credits and project the error rate across the whole period, which is how a handful of undocumented claims becomes a reassessment far larger than the invoices themselves. If sampling is proposed, understand the method before agreeing to it, and challenge a projection built on a sample that is not representative. The wider audit playbook, meaning representation, written scope and one channel, is in what to do after receiving a CRA audit notice, and it applies to HST audits without change.
The ITC documentation rules and the most common denials
An input tax credit exists only if the document behind it carries the information the regulations require, and the requirements rise with the dollar value of the purchase. There are three bands, and the auditor applies them mechanically.
| Purchase size | What the supporting document must show |
|---|---|
| Small purchases | The supplier's name or trading name, the date, and the total amount paid or payable |
| Mid-range purchases | Everything above, plus the supplier's GST/HST registration number, the amount of tax charged or a statement that it is included, and enough detail to tell which items were taxable at which rate |
| Larger purchases | Everything above, plus the recipient's name or the name of its agent, the terms of payment, and a description sufficient to identify each supply |
The registration number is the most frequent failure. A supplier that charged HST without being registered, or whose number is invalid or belongs to someone else, produces a credit the auditor will deny, and the purchaser bears the loss. CRA publishes a registry where any number can be checked against the supplier's name, and checking your top suppliers takes an afternoon. The other common denials are predictable:
- Personal expenses run through the business, and mixed-use expenses claimed at 100 per cent.
- Meals and entertainment, where the credit is limited to 50 per cent to mirror the income tax rule, and where credits taken at the full amount are recaptured.
- Capital property: passenger vehicles capped at the income tax cost limit, and equipment that fails the primary-use test, which gives all of the credit or none of it depending on whether commercial use is the majority use.
- Credits on exempt activity, such as residential rent or many financial services, where no credit is available at all.
- Credits in the wrong entity, typically an expense paid by one corporation and claimed by another in the group.
- Credits claimed outside the time limit, or claimed twice across periods.
Capital real property follows its own proportional rule for corporations, with thresholds at each end below which nothing is claimable and above which everything is, and mixed-use buildings are where a great deal of HST is lost or found on audit. Anything involving real property, a related-party lease or a new-housing or rental rebate deserves a specific review before the audit rather than during it.
How the quick method changes the audit
A registrant using the quick method remits a fixed percentage of tax-included sales instead of tracking tax collected against credits, so the audit changes shape. There are almost no operating-expense credits to test, and the auditor focuses on three questions: whether the business was eligible, which turns on an annual taxable sales threshold and on the type of business; whether the correct remittance rate was applied for the business type and the provinces it sells into; and whether total sales were fully reported, since the remittance is a function of the sales figure alone.
Credits on capital property remain claimable under the quick method, and they are examined in full. The election has its own timing and revocation rules, so an auditor may also test whether the method was actually in force for the periods it was used. For a small service business the quick method genuinely reduces audit exposure; for a business with heavy taxable inputs it usually costs money, and an audit is a bad time to discover the method was the wrong choice.
How to prepare: the weeks before, during the audit, and after the proposal
The weeks before the audit are for reconciliation, in a fixed order. Tie total sales on every HST return in the period to the general ledger and to the T2, and write down the reason for every difference: timing, exempt revenue, bad debts, deposits, intercompany charges. Tie the credits claimed to the ledger by period, pull the invoices for the largest claims and a sample of the rest, and check the registration numbers of your major suppliers. Then remove what should not be there, because a credit you reverse before the audit is a correction, and the same credit found by the auditor is a reassessment with a penalty conversation attached.
During the audit, the discipline is the same as any audit: one channel, a written scope, a log of what was provided, and no explanations beyond the question asked. Provide organized, complete packages on the agreed dates. Where the auditor proposes a sample, agree the method in writing. Where the auditor is wrong on the law, say so with the provision, calmly and in writing.
After the proposal letter, respond inside the window with documents, not adjectives. This is the stage where a registration number found, an invoice reissued by a supplier or a personal expense conceded changes the number directly, and it is far cheaper than an objection. If the reassessment issues anyway, the objection route is in how to dispute a CRA reassessment, with one difference from income tax that matters: HST reassessments are collectible while the objection runs, so the payment decision has to be made at the same time as the dispute decision. If the reassessed amount cannot be paid at all, what your options are when the business cannot pay CRA covers the routes.
What changes the answer
Five facts decide how much preparation an HST audit needs, and how it is likely to end:
- Whether the business is in a refund position, and whether the file explains why.
- How well HST revenue reconciles to the books and to the T2, period by period.
- The quality of the credit documentation, and specifically whether major suppliers' registration numbers have been checked.
- Whether there are related-party transactions, real property or rebates in the period, since each carries its own rules and its own denials.
- Whether the quick method or a specific election is in play, which changes what the auditor tests.
We prepare and defend HST audits as part of CRA support: the reconciliations, the documentation review, the sampling conversation, the proposal response and the objection if it comes to that. For businesses inside an Ongoing Financial Partnership, that reconciliation happens every filing period, which is why the audits they do receive tend to close with small adjustments or none. If a letter has arrived or a refund has been held, a free 15-minute discovery call is enough to tell you what the auditor will find and what to fix first.
Source: CRA — GST/HST for businesses.
