 |
|||||
 Info on CFP |
Tax Issues |
Biography |
Contact Info |
 Home |
|
|
In his case, they had made some errors on their past year's tax returns. I suggested he just let the auditor finish his work and then wait for the notice of re-assessment. At that time, he could file a notice of objection if he disagreed with any of CRA's findings and rulings. I mentioned to him that it's much easier to avoid an audit in the first place than to fight it once you've been audited. This, of course, was of little comfort to him at that point. So what I thought I might do here is point out a few of the areas where CRA often finds cause to audit taxpayers. Just so you know, CRA's 2000 budget was a little more than 3 billion dollars and it has roughly 43,000 people working nationwide. Approximately 20% of those people are involved with appeals, assessments and investigations for both personal and business taxpayers. The underground economy in Canada is estimated to be worth more than 2.6 billion dollars per year. And that doesn't include the people who actually file fraudulent or inaccurate returns. It's obvious that CRA is understaffed and underfunded to do the job that they've been asked to do. As a result CRA has a system (although officials would never publicly admit it) of screening tax returns by computer to "red flag" any questionable ones. Once a return is redflagged, an actual desk auditor will take a look at it and decide whether it should be investigated further. This system tends to focus on the areas of the tax return that are known for being abused. Believe me, if they catch a taxpayer fudging a number or claiming an unsubstantiated expense, they will be on them every year from that point on regardless of whether it was intentional or not. So what I'm going to do is look at just a few of these areas and I'm only going to talk about personal tax returns (T1s), not corporate returns (T2s).
One thing to remember : "proportionate continuity" from year to year is key: (if income goes up, then expenses should go up). If something on your return is DIS-proportionate from other years, it's almost certainly going to attract attention. Here are the areas I'll cover:
Mileage claims - If you're an employee of a company, your employer may provide you with a vehicle to use during your work duties, as well as during your personal time. The employer is required to assign a monetary value to you for the time you personally used their vehicle. This is known as a "stand-by-charge". It's a formula that takes the purchase price of the vehicle and assigns a part of it to the employee every year. The employer puts this amount on the employee's T4 slip to be claimed as a taxable benefit. I can't count the number of times I've had clients burned by this one. If the employee uses the vehicle 90% or more for business, then the stand-by-charge gets substantially reduced. However, CRA is notorious for checking on salespeople who claim they used the vehicle 90% for business. There is one simple way to avoid getting stung here: "KEEP A LOG BOOK". It's the only way you can prove to CRA that you did use the car 90% for business. If you haven't kept your mileage in a logbook, then CRA can assign any number they want. And by the way, don't try to create a phony logbook after CRA has asked to see one. They have ways of testing how old the ink on the paper is. Remember, they come after the employee, not the employer. Now if you're self-employed then you own the car anyway so there's no stand-by-charge. However, CRA still expects you to keep a mileage log to prove how much you used the car for business versus personal, since that’s how much of the cars expenses can be written off. Moving expenses - Another classic one that has seen many a person get snagged by CRA. You are allowed to write off any expenses incurred in moving, IF the sole reason for your move was to take another job. You also have to have moved at least 40 kilometers closer to the new job. You cannot have been reimbursed or subsidized in any way by your new employer for any of the costs that you're claiming. There also has to be some income to show from the new job in the year you’re claiming the moving expenses. Where people often get burned is that they get some kind of reimbursement from the new employer after the move and forget to mention it on their tax return. Another contentious area is when the employer reimburses an employee for the losses in market value on the sale of their former home. For example, they moved from a house in Vancouver that they'd bought in ‘94, and the sale price was a lot less than what they paid for it. CRA will let you receive up to $15,000 from the employer for this loss, TAX-FREE. However, on the amount over $15,000, half of it is taxable. In the above Vancouver scenario, you can imagine how many people forget to include ANY of the market-value reimbursement. Meals & entertainment expenses - Without question, the most abused tax deduction there is. Also the one that CRA takes the hardest line with when auditing a taxpayer. Most self-employed people figure that every dime they spend when they're out "entertaining" is tax deductible (subject to the 50% rule, except for charity events, which are 100% deductible). Well, that isn't the case. Entertainment expenses are only deductible if they were incurred in an effort to keep current customers/clients or to attract specific new ones. Such expenses include meals, trips, cultural events, sporting events, and gifts involving current or potential clients. During an audit, CRA has often required taxpayers to detail each entertainment expense they claimed by providing each customer/client's name and the situation in which they incurred that expense. The expense claim for entertainment also has to be reasonable. So if you own a dry cleaning business in Summerside, PEI and you take one of your best customers (whom you also happen to be dating) to Las Vegas for the weekend, then write off the cost as an entertainment expense, I'm pretty sure CRA is going to have a problem with that. There is some entertainment expenses that are not deductible at all! Section 18-(1) (L) of the Canadian income tax act states: NO deduction can be claimed for the following two types of expenses:
These rules created quite a stir over the past two years when CRA denied taxpayers’ expense claims for lunch with a client at a golf course even when they hadn't played. CRA backed down on this one just recently but stated that going forward, the meal has to be itemized separately from any golf-related expenses on the bill. So the lunch is deductible but the power cart isn't. It's easy to see why CRA takes a hard line on this one since the perception is these expenses are only deducted by the wealthy. The easiest way to avoid any conflict on entertainment expenses? BE REASONABLE! Don't try and push the limits. If it's not a legitimate business related entertainment/meal expense, don’t deduct it. Depreciation versus write-off - This one is tough because it can often be very subjective. A business that's having an exceptionally good year may be more inclined to write-off a borderline expense rather than capitalize it and only get to deduct the depreciation. CRA's interpretation bulletin states that: "If the asset purchased has a value to the business beyond its initial usage, then it must be capitalized and depreciated." A simple rule to follow here is: if the expense clearly fits into one of the stated CCA classes (like class 10-auto, class 8-furniture, etc.), then capitalize it. However, it’s not always that clear. For example, I have my own business and I buy a piece of tax software each year to prepare returns for that year. Once the tax year is over, that software has very little value to my business since I'll have to buy new software next year. So I write-off the full cost, even though there is a clearly stated CCA class for computer software, class 12. Yet it has no value to my business beyond this year. See what I mean by subjective. A related area that causes a lot of taxpayers problems is when a depreciated asset is sold. When a business asset is sold, the proceeds reduce the UCC (undepreciated capital cost) balance of that class. If there are no other assets left in that class; but there's still a UCC balance, then it's considered a terminal loss. A terminal loss can then be deducted as an expense of the business. However, when an asset is sold and the proceeds are MORE than the UCC remaining in the class, there is a recapture of depreciation. This amount must be added to the taxable income of the business. The taxpayer often overlooks this recapture, yet rarely misses the terminal loss. Funny how that is. Bottom-line: don't be greedy. When in doubt, capitalize it. The depreciation that you'll be able to write-off in years to come will make up for the lack of a big write-off up front and you'll keep CRA off your back.
Change in use of principal residence - the principal residence exemption is the last real tax shelter available to all taxpayers. If you sell your house for more than you paid for it, the profit is tax-free. However, there are two things that can happen:
There’s a similar affect to claiming more than 50% of your home as a home business/office, or making major structural changes to your home to accommodate a home business/office: both of these cases would trigger a "change in use", resulting in the loss of the principal residence exemption entirely. These are just a few of the more common areas to watch out for in avoiding a CRA audit. But they are by no means the only ones. If you're ever in doubt about a tax issue, make sure you contact a qualified tax professional. Remember, once CRA has you in they're system as a previous offender, you'll be there forever. |
||
 |
||