What are the most common areas where Canada Revenue Agency auditors find errors that they can assess?
Here are some of the most common tax problems or mistakes that people make, and for which tax assessments or reassessments may be issued. Watch out for them!
- Meals and entertainment. If you are deducting expenses — whether for a corporation, or for yourself if you are self-employed, or as deductible employment expenses where you’re an employee — expenses for meals and entertainment are normally limited to 50% of the amount you pay (although there are some exceptions). If you deduct the full amount of that restaurant meal, you’re leaving yourself open for reassessment! Of course, if you cannot show that the restaurant meal was for a business purpose (or qualifies as an allowable employment expense), you will get no deduction at all, rather than 50%.
- Shareholder appropriations and shareholder loans. If you take money or property out of your company without declaring a (taxable) dividend or paying yourself a (taxable) salary, you will normally be taxed on the value of what you have taken out — even if you just borrowed the money. Using the corporation’s property without paying enough will also trigger tax. These issues are a favourite target of auditors when auditing small owner-managed companies. There are a number of exceptions and ways to avoid the problem, but this can be a dangerous tax trap.
- Income splitting: attribution rules and TOSI. If you lend or give money, investments or other property to your spouse or child under 18, income earned from that property (e.g., interest, dividends, rent) will be “attributed” back to you and taxed in your hands, rather than in the hands of your spouse or child. Also, if you arrange for your child or even an adult family member to get dividends from a corporation, then even if the attribution rules do not apply, the Tax on Split Income (TOSI) may impose tax at the top marginal rate, for which you and that person may be jointly liable. The TOSI rules, which were vastly expanded in 2018 from the former “kiddie tax”, are extraordinarily complex.
- GST or HST input tax credit documentation. If you carry on business, you can in most cases claim an “input tax credit” for all GST or HST that you pay in the course of the business. Thus, you recover the sales tax from the CRA — either deducting it from GST/HST you collect or, if you do not collect enough GST/HST, getting a refund. However, if you do not keep detailed receipts that include prescribed information (including identification of what was supplied, the vendor’s Business Number and, in most cases, properly identifying you as the purchaser), your claims may be denied when the auditor comes calling. The same rules apply in Quebec for the Quebec Sales Tax (TVQ).
- Automobile expenses. CRA auditors love to deny automobile expenses. If you are claiming business expenses or employment expenses for your car, make sure to keep a detailed logbook tracking the extent you use it for business or employment. (Driving from home to work usually doesn’t qualify, unless your home is a place of business for you.) If you can’t be bothered to keep a logbook, you run the risk of having your deductions for gas, repairs, insurance, car washes and oil changes denied entirely or severely curtailed.
- Director’s liability. If you are a director of a corporation — anything from your own wholly-owned private corporation to a large public company — you may be on the hook if the company runs out of money. In particular, you can be assessed by the CRA for any unremitted payroll deductions (source withholdings for income tax, CPP contributions and EI premiums), and for any GST, HST or TVQ the company has failed to remit (or that the company received as a refund). Sometimes you can escape such an assessment via the “due diligence” defence, but this is uncertain and usually requires expensive legal representation. Make sure that any company you’re a director of is always up to date in its source deduction and GST/HST remittances! If you are at risk of being assessed, resign as soon as possible, and make sure your resignation is legally recorded in the government register of corporations. Once you resign, there is a two-year deadline beyond which the CRA cannot assess you as a director — provided you do not continue as a “de facto” director.
- Spousal support. If you are paying support to an ex-spouse, make sure you are aware of the myriad rules and conditions that apply before the amounts you pay are deductible. Child support is not deductible (unless your arrangements predate May 1997 and have not been modified since then — very rare now since most child support stops around age 18). For spousal support to be deductible to you (and taxable to your ex-spouse), it must normally be paid as an “allowance”, with the recipient having discretion over its use, on a “periodic basis”, pursuant to a Court Order or a written agreement. There are other conditions and variations on these rules.
- Transfer of property by a tax debtor. If husband H owes money to the CRA (or Revenu Québec), whether for income tax, GST/HST or some other tax, and transfers his interest in the family home — or anything else including money — to his wife W, then the government can assess W for H’s tax debt, up to the value of what was transferred (minus whatever W paid H for it). In most cases, transferring such property makes things worse, because the CRA or RQ can seize other assets from W for her new tax liability, not just the home or other property that was transferred. Another risk along the same lines: if H’s bank account has been frozen by the CRA, so he endorses his paycheques over to friend F who puts them into F’s bank account and immediately takes out the amount in cash and gives it to H, the CRA will assess F for the total deposits into F’s account made this way. F can defend against the assessment by convincing the CRA or the Tax Court that he had a binding legal obligation to pay back to H any amounts deposited — but in several reported Court decisions, F has lost such appeals.
- Capital gain or income? The difference between a capital gain (only half taxed) and an income gain (business profit) is significant. If you buy property such as real estate, and then sell it down the road for a gain that you report as a capital gain, expect the auditor to examine carefully your intentions. If your primary or even secondary purpose in buying the property was to sell it rather than to earn income from it, then your gain may become a fully-taxed business income gain. If you have bought and sold several similar properties, or if you held the property for less than a year, the auditor is very likely to treat your gain as income gain no matter what your reasonable explanation as to why you sold, and will likely assess you a 50% “gross negligence” penalty as well. The CRA has become very hard-line about this issue on sales of homes and condos.
- House hoppers. Similar to #9 above, if you’re in the home-building business, and you like to move into the homes you build, watch out! You may think that you don’t have to pay tax on the gain when you sell the home, but that’s not true. If you built the home to sell, then even if you live in it for a while, your profit will be fully taxed (just like #9 above), and you can’t claim the principal-residence exemption, which applies only to capital gains, not business income gains. Second, you will likely be hit with a GST or HST assessment for GST or HST on the full value of the home including the land, which becomes payable as soon as you move into the property (or rent it out), under the GST/HST “self-supply” rule. The CRA vigorously pursues “house hoppers” and has had great success in the Courts. Claiming that you really really (really!) intended to live in the house for a long time, and only sold it because of unexpected reasons, won’t get you very far with the judge if you build homes for a living. And note that, since 2016, you must report the sale on your tax return to claim the principal-residence exemption, so you’re waving a red flag in front of the CRA if you do this year after year.