At Mew & Company Chartered Accountants in Vancouver, we work with the Canada Revenue Agency (CRA) through an “honor system”, which means a business reports its income and expenses without having to remit receipts and bank deposit books to prove its accuracy. This honor system is an efficient and economical way to collect taxes.
Many savvy business professionals know that it is not wise to mess around with the CRA. These people work with competent bookkeepers and reputable tax advisors to avoid even small and unintentional mistakes. This savvy conduct tells me that they are either inherently law abiding or they have learned from a past run-in with the CRA.
Many professional tax advisors keep their clients on a short leash. This is simply accomplished by informing clients, in detail, as to what happens if a large personal expense is deducted for tax purposes. Many clients assume correctly that the large personal expense will be denied and taxes will have to be paid on it. This is true, but the following example illustrates the outcomes at both the corporate and personal level when CRA is done with the final reassessments.
Let’s take a simple example like the family vacation. A cruise for a family of four that costs $10,000 is deducted as a business expense by a sole shareholder. If CRA should audit the business, it would examine most of the receipts claimed as a business expense. Whatever expenses the business cannot prove as incurred to earn income would be reversed out of the books. Consequently, corporate taxes would have to be paid on the $10,000 (let’s say the additional corporate tax amount is $1,350). If your corporate tax return was filed late and an amount was owing, a non-deductibe late filing penalty of 5% would be applied to the $1,350. On top of that, penalties and interest would be calculated on a daily basis on this corporate tax amount owing, triggering a series of interest installment payments and late interest penalties, none of which are tax deductible as well. (Note: The interest rate in effect at the time of writing this blog post was 5%)
So, we’ve addressed the penalties at the corporate level, but wait…there is also damage at the personal level.
The $10,000 for the cruise would now be deemed a shareholder benefit, which means a benefit received by a person in his/her capacity as a shareholder of a company. Unfortunately, these benefits are taxable to the recipient which means the business expense should have been included as income on the recipient’s personal tax return, which means there would be personal taxes owing on the $10,000. In British Columbia, a personal tax rate of 43.7% would apply when taxable income is above $132,407. Again, the same late filing penalty and interest as corporate taxes would apply, with the same non-deductible tax treatment.
If a company also deducted other non-business expenses such as a luxury car or a private box at a sports venue, the potential damage at both the corporate and personal level accelerate and multiply.
This is why the CRA is commonly referred to as the straw that breaks the camel’s back. A business that is struggling might be tempted to save a little on taxes by claiming bogus business expenses, except the little savings they perceive today can actually become a giant tax liability once CRA has concluded its audit.
If you have any questions or would like to know more about how we can help you, contact us.
Disclaimer: All Rights Reserved for Mew & Company. This blog post is designed to provide information for personal use only. Please consult your professional tax advisor for further information. Mew & Company is not responsible for any legal disputes resulting form the content of this blog post.