Remember to Document Cash Expenses

One of the matters dealt with in a judgment issued by the Tax court of Canada [Morrissey v. The Queen, 2011 TCC 373, (July 29, 2011)], http://decision.tcc-cci.gc.ca/en/2011/2011tcc373/2011tcc373.html had to do with the payments of cash expenses.

The Honourable Justice Johanne D’Auray had the following comments:

[23]         With respect to the amounts paid to drivers, Justice Bowman’s remarks also hold true. It is impossible for me to determine the amounts that were paid to the S&G’s drivers.  As the auditor stated, they could already have been deducted under the subcontractors account.

[24]         In Njenga v. R., [1997] 2 C.T.C. 8, 96 DTC 6593 (Federal Court of Appeal), at paragraph 3, McDonald J. A. speaking for the court, stated:

 The Income tax system is based on self monitoring. As a public policy matter the burden of proof of deductions and claims properly rests with the taxpayer. The Tax Court Judge held that persons such as the Appellant must maintain and have available detailed information and documentation in support of the claims they make. We agree with that finding. Ms. Njenga as the Taxpayer is responsible for documenting her own personal affairs in a reasonable manner. Self written receipts and assertion without proof are not sufficient.

[25]         I would also add that while it may not be illegal to pay in cash, when a taxpayer chooses to pay in cash he or she should be all the more careful to ensure that payment can be proven if a deduction is claimed. Here, the appellant did not succeed in reversing the burden of proof as she was not able to demonstrate how much she paid the S&G’s drivers on behalf of Gary Bumstead  [Emphasis mine].

Don’t Forget to Collect HST on the Sale of Illegal Drugs

Here’s something different!

One of the issues, in a judgment issued by the the Tax Court of Canada [Bailey v. The Queen, 2011 TCC 233, (April 28, 2011), http://decision.tcc-cci.gc.ca/en/2011/2011tcc233/2011tcc233.html],  had to do with whether or not the illegal sale of  cannabis and cocaine are taxable supplies or zero-rated supplies for the purpose of collecting the GST.

Turns out that not only are illegal drug sales taxable transactions for income tax purposes, they are also  taxable supplies subject to GST.   

… I wonder if they could claim an exemption as a small supplier in the first year of operation or apply to use the Quick Method of Accounting for the GST/HST?

Management fees

The following is from http://www.deloitte.com/view/en_CA/ca/services/privately-speaking/edf7892a2059d210VgnVCM1000001a56f00aRCRD.htm

Managing your management fees

By Robert Leombruno

Management fees are a powerful tax planning tool. However, case law has provided ammunition to the Canada Revenue Agency (CRA) in their review of  inter-corporate management fees. As such, proper execution is crucial when undertaking any tax planning using management fees.

Corporate groups commonly use management fees to shift income and expenses between companies. While such fees can help with risk management by keeping excess cash out of an operating company, corporate groups can also defer taxes by creating a company that earns management fees and accesses the small business deduction. However, if the rules surrounding management fees are not properly considered double taxation can occur; i.e., the company paying the management fee would not be allowed a tax deduction while the company providing the management service would still be required to include the management fee into income.

The CRA will generally allow management fees to be deductible to the extent that they are incurred for the purpose of gaining or producing income and provided they are “reasonable in the circumstances”. Even an expense that is specifically deductible under the Income Tax Act may be partially or fully disallowed if it is considered unreasonable.

While the CRA has a long-standing practice of not challenging the reasonableness of salaries or bonuses paid to a principal shareholder who is active in the corporation’s business, their position is that this practice would not extend to intercorporate management fees. To be fully deductible, any fees and/or bonuses paid to corporate shareholder-managers by an operating company (Opco) must be reasonable given the services actually rendered by the holding company (Holdco) through its employees. The resulting profits of Holdco may be distributed to the shareholder-employees of Holdco where the general practice of the corporation is to distribute profits of the company to shareholder-employees in the form of bonuses or additional salary. If the management fee from Opco to Holdco is not reasonable in the light of the services rendered, the unreasonable portion would not be deductible by Opco.

There have been significant court rulings surrounding the deductibility of management fees. The case law is clear that the deductibility of management fees should not be taken for granted. At a minimum, for the management fees to be deductible, bona fide management services are necessary for the payer in its income-earning activities. These services must actually be provided by the payee to the payer, should actually be paid, must be reasonable in amount, and should be documented pursuant to a written contract, the terms of which are adhered to.

Factors affecting the reasonableness of management fees include:

  1. The nature of the management services
  2. Whether the management services were performed on or off site
  3. A comparison to similar operations in similar markets in terms of efficiency, profits, etc.
  4. Effort applied and the responsibilities of the provider of the services
  5. Special expertise or know how held by the service provider
  6. The portion of the profit that reflects the expertise and quality of the management services performed
  7. Existence of a management-services contract

Documentation is key. We recommend that a formal management agreement be signed by the two parties and that this agreement include the nature of the services provided and the number of hours to be spent providing the services. Furthermore, this agreement should be supported by a corporate resolution authorizing the management services or payment for the services.

While management fees are a powerful tool to implement corporate strategy and tax planning, the mismanagement of intercorporate management fees could be costly and problematic.

Robert Leombruno is a tax senior manager in Burlington.

Foreign Income tax reporting

On your personal or corporate tax return you will be asked if you owned foreign property at any time in the year with a cost amount over $100,000?  If you do, you are required to file  form T1135  – Foreign Income Verification Statement with the Canada Revenue Agency.  The form provides detailed instructions on what types of property are included in the calculation.

The reason this form is in the news of late is because CRA  is showing  no tolerance for late filing this form.  It is due annually on or before the due date of your income tax return.  The penalties for late filing are substanstial — $25.00 per day to a maximum of 100 days — $2,500.

I have known of cases where the individual has not bothered to file their tax return by April 30th because they knew they were going to receive a refund due to a contribution to their RRSP.  When they got around to filing they found they were assessed $2,500 plus interest for late filing the T1135.

For further information see Jamie Golombek’s article:  http://www.jamiegolombek.com/pdf/AER%20Oct%202010%20Golombek.pdf

The T1135 form and instructions are available from CRA at:  http://www.cra-arc.gc.ca/E/pbg/tf/t1135/t1135-07e.pdf

Employee or independent contractor?

 Prue v. M.N.R., 2011 TCC 9, (January 10, 2011), http://decision.tcc-cci.gc.ca/en/2011/2011tcc9/2011tcc9.html

This appeal brought before the Tax Court of Canada focussed on whether an individual was an employee or an independent contractor.  I haven’t read it line by line to come up with a detailed analysis but here is what I gleaned from the document.

1.  Document the  nature of the relationship – put it in writing, sign it.  Do the parties involved  want this to be an employee/employer relationship or that of an independent contractor.

2.  Individuals may find the idea of being an independent contractor appealing in that as a business venture they can claim expenses otherwise denied to employees.  However,  if, at some point in the future, the services of the contractor are no longer needed they might suddenly have a chance of heart.  Now they want to be an employee so they can claim Employment Insurance benefits.  To that end they can apply to the Rulings Officer at a Tax Services Office operated by Canada Revenue Agency (“CRA”) on the insurability of their employment.    This opens a whole can of worms for the employer with CRA - out of which very little of any good can result!

On the value of the US$…

Jim Rogers was recently quoted as follows:

“Paper money is made of cotton, and I’m long cotton, by the way.  One reason I’m long cotton is because Dr. Bernanke is out there running the printing presses as fast as he can.”

David Rosenberg  in Breakfast with Dave  – January 17th 2011

2011 Automobile Deduction Limits and Expense Benefit Rates for Business

The automobile expense deduction limits and the prescribed rates for the automobile operating expense benefit will remain unchanged for 2011. Specifically:

  • The ceiling on the capital cost of passenger vehicles for capital cost allowance (CCA) purposes will remain at $30,000 (plus applicable federal and provincial sales taxes) for purchases after 2010. This ceiling restricts the cost of a vehicle on which CCA may be claimed for business purposes.
  • The maximum allowable interest deduction for amounts borrowed to purchase an automobile will remain at $300 per month for loans related to vehicles acquired after 2010.
  • The limit on deductible leasing costs will remain at $800 per month (plus applicable federal and provincial sales taxes) for leases entered into after 2010. This limit is one of two restrictions on the deduction of automobile lease payments. A separate restriction prorates deductible lease costs where the value of the vehicle exceeds the capital cost ceiling.
  • The limit on the deduction of tax-exempt allowances paid by employers to employees using their personal vehicle for business purposes for 2011 will remain at 52 cents per kilometre for the first 5,000 kilometres driven and 46 cents for each additional kilometre. For Yukon, the Northwest Territories and Nunavut, the tax-exempt allowance will remain at 56 cents for the first 5,000 kilometres driven and 50 cents for each additional kilometre.
  • The general prescribed rate used to determine the taxable benefit relating to the personal portion of automobile operating expenses paid by employers for 2011 will remain at 24 cents per kilometre. For taxpayers employed principally in selling or leasing automobiles, the prescribed rate will remain at 21 cents per kilometre. The additional benefit of having an employer-provided vehicle available for personal use (i.e., the automobile standby charge) is calculated separately and is also included in the employee’s income.

Employment Insurance 2011

 

Employment Insurance (EI) premiums will be increasing in 2011.  The maximum insurable earnings for 2011, applicable to all provinces and territories, will be $44,200 – up from $43,200 in 2010. The employee’s premium rate will be 1.78% for a maximum annual premium of $786.76 ($747.36 for 2010) for the country except for Quebec and 1.41% for a maximum annual premium of $623.22 for Quebec ($587.52 for 2010). Contributions for employers will remain at 1.4 times the amount of the employee’s premiums, for all provinces and territories, unless the employer qualifies for a reduced rate.

If it’s too good to be true….

Canada Revenue Agency issued the following warning to  taxpayers about donations to a gifting tax shelter.  For more information check out the following link:

http://www.cra-arc.gc.ca/nwsrm/lrts/2010/l101223-eng.html?=eml20101223

Warning: If you donate to a gifting tax shelter, expect to be audited

Each year, Canadian taxpayers participate in gifting arrangements that result in donation receipts worth three or four times the actual amount donated by the taxpayer. The Canada Revenue Agency (CRA) continues to warn Canadians against these gifting arrangements and audits those who participate.

To date, the CRA has denied over $4.5 billion in tax shelter gifting arrangement donations and reassessed over 130,000 taxpayers who have made donation claims through a gifting scheme.

For most claims, the CRA has denied the gift entirely. The CRA audits gifting arrangement tax shelters that provide donation receipts three or four times the out-of-pocket cost.

Decisions in recent court cases have concluded that the “donation” made by the taxpayer was not a gift or, where it was a gift, the amount did not exceed the out-of-pocket cost to the taxpayer. In the Maréchaux case, the Federal Court of Appeal upheld the Tax Court of Canada (TCC) decision that there was no gift given as a result of the defendant’s participation in a leveraged cash donation scheme. In the Lockie case, the TCC concluded that the gift in a buy-low-donate-high scheme was the amount paid by the taxpayer.

Tax shelter identification numbers

The CRA reminds taxpayers that tax shelter numbers are used for identification purposes only. Just because a tax shelter has an identification number does not mean that donations made to it will result in tax benefits.

Property of Marino Vereecke Professional Corporation, CA