The audit process for charities

The audit process for charities

As part of its ongoing efforts to make sure charities meet the requirements of registration, the Canada Revenue Agency (CRA) uses a variety of compliance activities. Historically, the CRA has audited approximately 800 to 900 charities per year, representing about 1% of registered charities.

More recently, the CRA has rebalanced its compliance activities to better focus and increase its coverage of the charitable sector. The CRA currently plans to conduct audits of 500 to 600 charities per year. In addition, we plan to contact an additional 700 to 800 charities outside of the audit process. These contacts include new initiatives, such as the Charities Education Program (CEP) that provides an opportunity to meet with charities to help them better understand and comply with their filing obligations. Overall, the CRA will now be able to reach about 1.5% of registered charities each year.

How is a charity selected for audit?

A charity can be selected for audit for various reasons including the following:

  • random selection
  • referral from another area of the CRA
  • complaints from the public
  • articles in the media or other publically available sources
  • review of specific legal obligations under the Income Tax Act
  • information from their T3010 annual information return
  • follow-up on a previous compliance agreement

Infographic: Audit process for charities (PDF)

Audit process for charities

How does the CRA audit a charity?

There are two main types of audit: the field audit and the office audit. The size and complexity of a charity, as well as the issues involved, will often decide the type of audit required.

  • A field audit is done on the charity’s premises and usually lasts between three and five days. It will include examining the charity’s books and records such as bank accounts, contracts, governing documents, annual reports, board minutes, and other documents that relate to its activities. The auditors will interview the charity’s directors and ask questions about the charity’s activities. They may also want to tour the premises to better understand the transactions recorded in the books and to see the charity’s programs and activities in action.
  • An office audit is done by the Charities Directorate at CRA Headquarters, as opposed to at the charity’s place of business. Office audits are commonly used to make sure the charity is following the terms of a previous compliance agreement. The auditor will review the information and documents in the charity’s file. This may include its most recent governing documents, descriptions of its programs and activities, its annual information returns, and its financial statements. With an office audit, it is often necessary to contact the charity to get more information about its activities.

What happens when the audit is finished?

When the CRA has finished its audit, it will send the charity a letter outlining the results.

If the charity’s operations and all its activities are in line with the Act, the CRA will confirm in writing that there will be no change to the charity’s registered status.

When the audit uncovers that the charity is not following the Act, the CRA will send the charity a letter that:

  • outlines in detail each of the CRA’s concerns
  • gives its preliminary view of whether the charity needs to take corrective actions or whether the non-compliance warrants imposing sanctions or revoking or annulling the charity’s registration
  • gives the charity the chance to make representations before the CRA comes to a final decision

Generally, the CRA gives a charity 30 days to reply to its concerns, although the charity can request an extension.

What types of letters might a charity receive after it has been audited?

The CRA takes an education-first approach. This means it will generally give the charity the chance to correct its non‑compliance through education or a compliance agreement before it resorts to other measures such as sanctions or revocation. Only a very small proportion of the CRA’s audits result in serious consequences like sanctions or revocation.

The facts of the charity’s case will determine which of the following compliance approaches the CRA will take:

  • Education letters: When the non-compliance is minor, the CRA will send an education letter. The letter will identify where the charity has not followed the law and will offer guidance to the charity so that it can make the required changes. An education letter does not adversely affect the charity’s registration, and the charity does not have to reply to the letter.
  • Compliance agreements: In cases of moderate non-compliance, the Charities Directorate may suggest entering into a compliance agreement with the charity. A compliance agreement outlines the non-compliance issues and the remedial actions that the charity has agreed to take, sets out the timelines for the necessary changes, and outlines the consequences if the charity does not follow the agreement. The CRA will follow up to make sure the charity is acting according to the agreement.
  • Sanctions: In cases of serious or repeat non-compliance, the CRA may propose imposing a sanction (financial penalties or the temporary suspension of the charity’s tax receipting privileges or both). The CRA may also propose imposing a sanction when the charity has been found to be disregarding the terms of its compliance agreement.
  • Revocation of registration: When the CRA finds a serious case of non-compliance, it will propose revoking the charity’s registered status. Although the CRA usually uses revocation as a last resort, under the Act the CRA can revoke a charity’s registration at any time, when it is appropriate. This includes situations where:
    • the non-compliance is serious and intentional
    • the non-compliance has had a substantial, adverse effect on others (beneficiaries, donors, or funders)
    • the charity had a previous record of serious non-compliance or cannot or will not follow the rules

A charity whose registration is revoked must dispose of its assets within one year to other charities or pay a 100% revocation tax on any assets remaining. This tax helps make sure the funds donated for charitable purposes stay in the charitable sector.

  • Annulment of registration: In rare cases, an audit may find that a charity was not established and operated for exclusively charitable purposes when it was registered, or a change of law has caused it to no longer qualify as a charity. Although the CRA is obligated to remove the charity’s registration because it should never have been registered, it may be unfair to penalize it by applying the revocation tax to any assets it has accumulated. In such cases, the Act allows the CRA to propose to annul the charity’s registration. A charity whose registration is annulled can no longer issue tax receipts, but it can keep its assets.

For information on how the CRA makes its decision on which approach to take, see Procedures in Guidelines for applying sanctions.

What recourse does a charity have during and after an audit?

As mentioned earlier, the charity is given the chance to make representations to the CRA. The charity’s response may include explaining why it disagrees with the CRA’s position, including giving more information or proposing changes to satisfy the CRA’s concerns.

The CRA will fully consider the charity’s representations and make a determination on the appropriate compliance outcome. If, after considering the charity’s representations, the CRA finds it is reasonable to impose a sanction or annul or revoke the charity’s registration, it will send the charity a letter by registered mail outlining its decision.

When a charity receives one of these letters and believes the CRA has not interpreted the facts or applied the law correctly, it can object in writing to:

Assistant Commissioner
Appeals Intake Centre
Post Office Box 2006, Station Main
Newmarket ON  L3Y 0E9

The charity must set out the reasons for the objection and all the relevant facts.

The charity has to file its objection no later than 90 days after the date of the final letter it got from the CRA. The Appeals Branch is responsible for the objection process, and its mandate is to review the decision fairly and transparently. If the charity disagrees with the CRA’s decision about its objection, it has the right to appeal to the Federal Court of Appeal or the Tax Court of Canada, depending on the type of appeal.

What audit information is available to the public?

As an exception to the general rules around taxpayer confidentiality, the Act allows certain information about charities to be released to the public. When the CRA revokes or annuls a charity’s registration or when it imposes a sanction, it posts this information in the List of charities. Under the Act, the CRA can release a copy of the letter(s) it sent to the charity outlining the reasons for its decision. This is to make sure the CRA’s decision about the charity is transparent.

The audit process for charities

Tax Requirements for Not-for-Profits in Canada

Tax time can be stressful for nonprofit and charitable organizations in Canada, especially when the filing requirements are not well understood within the organization.

Even though not-for-profits don’t pay income tax, the requirement to file a tax return has been in place since 1993, and penalties exist for late filing. Organizations that may be filing their returns for the first time can set themselves up for success by having a clear idea of the nonprofit tax requirements set out in this article.

Understand the “Income Tax Act”

Both personal and corporate income taxes fall under Canada’s federal Income Tax Act, which is enforced by the Canada Revenue Agency (CRA). The complete text of the Income Tax Act is available to read online, in both English and French, though weighing in at 3,000 pages, it wouldn’t be considered light reading.

Both nonprofit organizations (NPOs) and registered charities are defined within the Act. The terms nonprofit and charity are often used interchangeably in everyday conversations, but there are important differences between the two types of not-for-profit organizations when it comes to tax filing. While charities must register with the CRA and can only operate for charitable purposes, nonprofit organizations can serve any number of purposes that do not generate a profit, including social welfare, civic improvement, pleasure or recreation. The tax forms that must be filed by registered charities and nonprofit organizations also differ.

The one aspect that charities and NPOs share in common is that they are both exempt from paying income tax. However, NPOs are not allowed to issue tax receipts for any donations they receive or for the membership fees they collect, while registered charities are required to do so.

Know your Tax Forms

The most basic form that nonprofit organizations will need to file is Form T1044, also known as the NPO Information Return. However, this is not the only form required since NPOs can choose to incorporate or remain unincorporated. Organizations that are incorporated must also file either a T2 – Corporation Income Tax Return or a T2 Short form.

Larger incorporated NPOs may also need to file Form T1044 if, during the fiscal year, they received dividends, interest, rental, or royalties exceeding $10,000, own assets totalling more than $200,000, or were required to submit form Form 1044 in the previous tax year. Finally, NPOs that are held by a trust, which are usually organizations that provide dining, recreational, or sporting facilities, must also file a T4013, T3 – Trust Guide form.

Registered charities must complete Form T3010 – Registered Charity Information Return and Form TF725 – Registered Charity Basic Information Sheet. The charity must include a copy of their financial statements with these forms, including any relevant notes. In addition Form T1235, a worksheet for directors, trustees and like officials, must be completed. A number of other worksheets and schedules may also need to be filed, depending on factors like the charity’s organizational structure or gifts received during the year.

Not-For-Profit Tax Time

The beginning and end of the fiscal year is not the same for every not-for-profit organization, as it is at the discretion of the organization to establish its own fiscal year period. Therefore the rule established by the CRA is that all returns are due six months after the end of the fiscal year for both charities and NPOs. For a not-for-profit organization that runs its fiscal in parallel to the calendar, from January to December, their returns would be due annually on June 30.

Penalties for Late Filing

Ideally, every organization will file on time, but if not, various penalties may be applied. If a registered charity fails to file their T3010 annual return by the due date, the charity’s registered status can be revoked by the CRA. A late-filing penalty of $500 may also be issued by the CRA anytime after the due date.

If the charity has not filed a return by seven months following the end of their fiscal year–so one month after their due date–the CRA will send a Notice of Intention to Revoke a Charity’s Registration (Form T2051A). In general, the legal process to revoke a charity’s registration will not begin until the tenth month after the charity’s fiscal year end. The CRA may also issue penalties if it receives tax receipts that are incorrect or incomplete, or if there are further problems with the charity’s books or other financial records.

The penalties for nonprofit organizations that file late are less severe as NPOs are generally under less stringent regulations compared to registered charities. If an NPO does not file its T1044, the CRA may issue a penalty of $25 per day, up to a maximum of $2,500 per year for each filing that was missed. NPOs also have the option of using the CRA’s Voluntary Disclosures Program, which would allow the organization to file outstanding tax returns.

Filing for the first time may still seem daunting for many not-for-profit organizations, but there are so many resources readily available that can help make it pretty easy. If you’re looking for assistance with these services please give our team a chat!