You will find out about your upcoming audit, when you receive an officious telephone call from the auditor assigned to your establishment. He or she will try to schedule a start date for the audit within the next couple of weeks. They don’t like to give you too much time to get ready for their arrival, but they have some scheduling flexibility. It all happens very quickly (in the space of a minute or so). Even seasoned tax professionals begin to sweat!
Proceed with Caution
Rather than panic, explain to the auditor that your accountant and/or tax advisor will be assisting you during the audit process and that you will need to contact him or her to arrange a mutually convenient time for the audit. This will provide you and your advisors time to assess the potential risks, estimate the time necessary to assemble the required documents for the audit, and amass sufficient support for the previously filed tax positions. Agree to contact the auditor within the next few days to arrange an appropriate time for the audit.
Typically, auditors will start the audit with a tour of the entire restaurant. From a business perspective, it is extremely important that the auditor not undertake the tour while customers are present. Ideally, it is wise to avoid tours when staff are present, too. Most auditors will agree to take the tour early in the morning before any staff or customers are likely to be present.
Ideally, you would like the auditor to work away from the restaurant, so that his or her presence will not disrupt normal operations. Also, you do not want the auditor to have unsupervised access to your employees. The auditor may request interviews with some employees, but you must be able to observe the interview and correct any misstatements that the employee may make. It is best to have the auditor work at your accountant’s office, if at all possible.
The auditor will send you a letter confirming the agreed upon audit start date and providing you with a list of documents that will be required by the auditor upon arrival. This will be a formidable list of documents, including all bank statements, cancelled cheques, deposit slips, purchase invoices, several months’ daily sales totals, and copies of all tax returns, financial statements, general ledger of accounts and a variety of other documents, covering an audit period that may be as long as four years. Unless your recordkeeping is fairly organized, this will be a significant task just to pull all of the requested documents together, let alone review them!
Preparing for the Audit
Subsequent blog entries will cover this topic in much greater detail, but for now, I want to emphasize the importance of being ready for the auditor’s initial interview of the taxpayer. After the tour of the premises, the auditor will interview the taxpayer to gain an understanding of the type of operation being audited and a variety of key metrics that the owner claims for the business. These comments will become the almost irrefutable support for the auditor’s assumptions that will be used to support the reassessment. Consequently, it is crucial that the taxpayer responses to the auditor’s questions be truthful and accurate, yet completely supportive of the taxpayer’s previously reported sales throughout the audit period.
Determining the appropriate responses to the auditor’s questions can be an extremely time consuming process involving a tremendous amount of analysis covering the entire period of the audit. The best analyses are performed on an ongoing basis, as the sales data is being generated. It is far more accurate and credible than analyses prepared long after the fact. Even subsequent analyses may be useful, but they will never be as persuasive as ongoing analyses. Advice to you: start analysing your sales every month, in order to be able to discuss and support your actual margins achieved and reasons that they may differ from the theoretical margins. Document every possible reason why the margins fall below the theoretical margins, for all types of alcoholic beverages.
Ideally, have an experienced accountant assist you in determining the proper ongoing analyses to perform and the daily data that will be required to support your sales, margins and taxes collected. This approach is, by far, the most cost effective method of protecting your business from adverse tax reassessments. If you have to generate supporting analyses just prior to the audit (or in response to the auditor’s report), they will be less credible than ones that would have been available from your ongoing analyses. They will also likely be far more expensive to prepare!
The only truly cost effective method of preventing significant sales tax reassessments is to proactively perform the same analyses that the tax auditor will be preparing during the audit. This will provide you with the appropriate assumptions that will support the previously reported sales figures. Also, you will need to be able to support the assumptions with credible analyses, data and historical reports.
Just as it is not advisable to provide the tax auditor with unfettered access to your employees, it is equally unwise to give the auditor free access to the owner of the restaurant. Obviously, as the owner/manager, you can’t not talk to the auditor during the course of the audit, but you should have your accountant or tax advisor monitoring your interactions with the auditor. There are several reasons why this is exceptionally good advice.
- Your advisor should be able to quickly assess your comments to the auditor and provide additional information to clarify your comments, so that there are no misunderstandings.
- The advisor should be able to correct your comments, should you make a statement that is harmful to your reported tax position or not in accordance with your tax situation.
- Your advisor can help you limit your responses to the scope of the queries raised by the auditor. You are required to provide truthful responses to the exact questions asked – nothing more, nothing less.