Why is the Canada Revenue Agency (CRA) ramping up tax audits in the construction industry?
One thing that you can always count on is for governments to ramp up audit and tax collection activity after the “good times” are over. There’s some logic to this, but the theory is that governments need money as well when times are tough, typically because overall tax revenues go down in recessionary or deflationary environments. Also, there are some accounting professionals looking for work, so governments tend to scoop them up and expand their audit activity. Also, when the “good times are rolling”, companies and their owners become too busy and distracted, and mistakes are made.
In recent years, particularly because of the housing crisis, there was a belief in some government circles, that builders and developers were “alleged” to somehow be the cause of increased housing costs and affordability. In the fall of 2023, the Canada Revenue Agency (“CRA”) announced publicly to CPA Alberta and other professional bodies, that it would be targeting this industry for both income tax and GST/HST audits.
Due to the typically high value involving real estate development and construction activities, the CRA perceives a high level of “tax risk” for the entire sector. There are often complex arrangements such as multi-party joint ventures, single-purpose partnerships for each project, management companies and even family trust structures, which can be inherently “tax risky” in the CRA’s eyes. If your construction company is part of a larger group of entities (5 or more entities) with common ownership or directorships, it is likely that CRA could end up looking at all of them for one reason or another.
What does the CRA commonly look for in a tax audit in the construction industry?
Over the last several years since the announcement targeting the industry, CRA auditors have been looking for unreported income and sales tax from home flipping (based on new income tax and GST/HST rules) and renovations, as well as other “underground economy” companies and individuals. In addition, there are numerous other issues that CRA auditors can identify and assess income tax and/or GST/HST plus potential penalties and related interest, which has been near 10% for the last several years in this high-interest rate environment. Further, CRA auditors increasingly seem to be proposing to, or actually assessing gross negligence penalties, which can be financially crippling to smaller construction companies.
Construction Accounting and Bookkeeping | Achen Henderson CPAs
Common issues in the construction industry that our firm has seen the CRA take a look at are:
- Failing to properly report the income tax and/or GST earned in a Joint Venture. This mainly relates to business owners entering joint ventures without fully understanding how to account for joint venture income and what the tax reporting obligations surrounding a joint venture are. We’ve seen many scenarios where the CRA has attempted to, and arguably have the right to, assess double taxation, particularly with GST/HST;
- CRA often attempts to match GST/HST to income tax, through their revenue matching program, and we’ve seen the two numbers vary greatly based on the company’s accounting sophistication and their revenue recognition program. If the reported revenues on the GST/HST return do not match, they send out a short query letter, “offering” the registrant to explain the difference and correct the GST/HST return (or the T2 revenues as applicable) for one or more periods during a fiscal taxation year. Previously, the threshold for these variances was quite high, but recently we’ve seen revenue discrepancies under $50K (i.e., GST of $2K) being questioned.
- Timing issues relating to the realization of revenue and profit for tax purposes compared to accounting purposes. We’ve seen several home builders using their deferred revenue account as a way to try to defer income tax or GST/HST. Not only that, but many builders are inconsistent with their application of revenue recognition principles, making their tax filing positions tenuous. The CRA has well defined rules around the timing of reporting income that construction companies must understand if they want to take advantage of deferrals.
- The classification of income vs capital can quickly become a problem for companies who build homes and then turn them into rentals. The GST/HST implications of this can be complicated (and severe), as can income tax considerations. GST for builders who rent properties – AH LLP
- As a result of the new enhanced GST (and HST) rebate for multi-family developers who become landlords, the CRA is now looking closely at nearly all of these rebates where construction started after September 13, 2023 when the new rebate was first announced. There are several criteria that must be satisfied for CRA to allow the 100% rebate of the GST applicable to the property and auditors are checking closely, that each one is met. If not, then the rebate is limited to 36% of the GST/HST on the property. UPDATES: GST Rebate for Builders
What can construction companies do to ensure they are protected from CRA tax audits?
- Hire the right accountant: There are several things you can do, but the most important starting point is to ensure that your bookkeeper, accountant and CPA firm has a complete handle on all the issues and that they’re prepared to defend their work and tax filing positions, whether it be income tax related, GST/HST or even Underused Housing Tax. If you’re not sure, ask them to have an independent CPA (perhaps another partner in the firm) review everything that’s been done at a high level over the last 2 years of filings.
- Pay attention to your books: A pervasive problem that we’ve come across in working with company owners in the construction space is that they don’t pay enough attention to their books, or provide their accountant with all of the information they need to properly advise them. Be invested in your bookkeeping system and look at your numbers and ask questions.
- Find a firm that offers a professional fee waiver service such as Audit Shield, which is offered by certain accounting professionals to help safeguard your company from the high professional fees that come with managing and defending against government tax authority audits and reviews. Here is a link with more details about audit shield.
CPAs for the Construction Industry
At Achen Henderson, we’ve worked with loads of construction companies on various matters from bookkeeping for construction, construction company accounting, fractional CFOs with construction experience, tax for construction companies, GST/HST/PST for construction industries and help transitioning to software platforms like BuilderTrend and CoConstruct.
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