There are over 86,000 registered charities in Canada. Each year, the Canada Revenue Agency Charities Directorate audits approximately 700 of these charities. Some of these audits occur based on random selection, some as a result of targeted reviews of particular activities (including as a result of public complaints), and some to follow up on prior CRA compliance action. It's clear, though, that the Charities Directorate is very active in performing its audit function.
Being audited by the Charities Directorate is stressful for any organization. If the audit uncovers serious non-compliance with the charity’s obligations under the Income Tax Act, it can lead to sanctions against the charity, potentially including revocation of registration. If your charity receives a letter from the Charities Directorate indicating that it will be audited, there are steps that should be taken to give you the best chance of a positive outcome.
1. Review the Audit Notification/Information Request Carefully. The first step is to review carefully the letter from the Charities Directorate advising of the audit. If the audit is to be a field audit, in which a CRA auditor visits the charity’s premises and reviews its books and records, the letter will propose a date on which the audit is to be conducted. The letter will also set out a list of the documents that the auditor expects will be made available. The date of the field audit can generally be re-scheduled (within reason) if key personnel will be absent on the day that CRA proposes.
If the audit is a desk audit, the letter will list documents that are to be sent to the auditor for review. Typically, the list of requested documents is very thorough, and will include items such as financial records and supporting documents, general ledgers, duplicate donation receipts, as well as copies of agreements, governance documents, and Board and committee minutes.
CRA has broad powers to request documents in the context of an audit, and the charity will generally be required to provide all documents requested and cooperate fully with the auditor. However, charities should be careful that they do not provide documents which the Charities Directorate does not have a right to review. Some documents may be protected, for example, by legal privilege. Correspondence and advice from the charity’s legal counsel should not be provided to CRA.
2. Consult Counsel. A charity should consult knowledgeable legal counsel as soon as possible upon receiving the audit letter. Counsel can advise on the parameters of the audit (whether it is a general review or activity-specific) and can assist, sometimes with input from the charity’s accountants, in conducting a pre-audit review of compliance. To the extent that the review uncovers non-compliance, it may be possible to address certain issues before the audit. This may involve locating missing documents or accounting data. Where agreements are missing or unsigned, it may be possible to document agreements with third parties that were in place but were not reduced to writing. It is important, however, to avoid inappropriate backdating of agreements and any agreements should be signed with a current date and (if appropriate) an earlier effective date. Even if all past instances of non-compliance cannot be fixed before the audit, the pre-audit review will ensure that the charity is best prepared to address any issues and identify steps that will be taken to address these issues going forward.
3. Manage Audit Day. On audit day, the charity should cooperate with the auditor to identify requested information and documents. It is generally advisable to assign one staff person to deal with the auditor, which should be someone who understands the seriousness of the audit and has a good familiarity with the Charity’s operations and its books and records. A single point of contact for the auditor is advisable as it ensure consistent communications. Charities should not view the auditor as a source of free legal or tax compliance advice. If the auditor asks questions that cannot be answered on the spot, the charity should request that these questions be put in writing.
4. Address Audit Results. After the field audit (or desk review) is complete, the charity will receive a letter outlining the audit findings. There are a range of possible outcomes, ranging from clean audit report, to an education letter, to a compliance agreement, and finally to sanctions that could include a proposal of revocation. To the extent that compliance action is proposed, the letter will set out CRA’s findings of non-compliance and will provide a time-limited period for response (usually 60 days).
It is important that the charity consult legal counsel as soon as possible upon receiving the audit findings. It is common for audit findings to be based on a misapprehension of the facts, or, in some cases, a misapplication of the law. Legal counsel can assist in responding to CRA and it is often possible to satisfy CRA that the bases for compliance action are unwarranted. It is also often possible to negotiate lesser sanctions, sometimes with an undertaking to improve future compliance.
Conclusion. Of course, the best defence against negative audit consequences is proactive compliance with the Income Tax Act. Charities should take care to familiarize themselves with the rules in the Act and ensure that they demonstrate compliance with these rules. Charities should contact their advisors if they are unsure of their obligations. This, along with proper preparation when the audit letter comes, will best equip your charity to deal with the audit.
Editor's note: This is an updated version of an article published in 2013.
Andrew Valentine joined Miller Thomson as an associate in the Charities and Not-for-Profits Group after completing his articles with the firm in 2008. Contact him by email.