My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog do not reflect the position of Cunningham LLP. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Wednesday, January 4, 2012

Mitigating Your Exposure to 5 Popular CRA Audit Targets Areas

Being selected for an audit by the Canada Revenue Agency (“CRA”) can be a very stressful and costly experience. Aside from having a spiteful ex-spouse or former business partner report you to the CRA, in my experience, there are five specific areas the CRA targets for audit investigation that can generate audit headaches for even the most cautious of taxpayers. Below I discuss how you can facilitate the investigation process and significantly mitigate your tax reassessment should you be subject to an audit.

Employment and Commission Expense Claims


Expenses related to employment or commission based income, such as automobile, cell phone and salary paid to an assistant are key target areas for the CRA. For an employee to deduct these expenses, the employer must complete Form T2200-Declaration of Conditions of Employment.

To best mitigate any potential expense disallowance, keep a separate file folder for each expense category and place all applicable invoices in that file. For cell phone costs, clearly denote any personal calls on your phone bill and reduce your claim by these calls. Where you pay salary to an assistant, at minimum, keep a written job description and ensure you maintain payroll records. Where you pay salary to a family member to be your assistant, read this blog I wrote on paying salaries to family members.

The most contentious employment/commission expense claim is automobile expenses, specifically the percentage of business use versus personal use calculated by the taxpayer. Note your cars odometer reading at January 1st and December 31st, and keep a full and complete log book. This is the best evidence to support an auto expense claim. However, because the CRA knows that most people fail to heed this advice, they now offer to give some consideration to a logbook for a sample period, if you have kept a logbook for one consecutive 12 month period.

Interest Expense


As the rules related to claiming investment interest expense are complex, the CRA often audits these claims. This is especially true where funds have been comingled and a line of credit (LOC) has been used for both investment and personal purposes.

To mitigate any issues here, take the following steps. First, obtain a summary of interest paid for the year from your financial institution. Second, where LOC funds have been comingled, create a schedule that traces both the use of your investment funds and the monthly interest cost allocated between investment and personal use. Better yet, have a specific LOC for personal use and a separate one for investment use. Finally, keep back-up documents. This allows the CRA to easily trace funds going directly from any investment loan or your LOC to the related investment.

Rental Properties


Rental properties are yet another frequent target for audit by the CRA. They may question whether an expense is correctly categorized as a repair or an improvement to the property. An improvement needs to be capitalized and depreciated, while a repair can be expensed. The CRA’s basic position is set forth in Interpretation Bulletin-128R which states that if the repair betters the property, it may be considered capital instead of a deductible expense. When incurring a repair expense, you should consider the CRA’s “betterment” position, but the courts have considered repair expenses that are relatively minor compared to the value of the building as deductible.

Self-employment Income


For those who are self-employed, the CRA has almost no way to confirm your income and expenses without auditing you. Expect to be audited at some point in your self-employment working life. Follow the same advice offered above in regard to employment or commission expenses. However, self-employed people generally incur more marketing related expenses such as meals, sporting events, conferences, etc. Ensure that marketing-related receipts are marked with all pertinent details of the expense including the name of the client and the purpose of the expense. For conferences and travel expenses, provide back-up literature and lists detailing meetings you may have had with prospects, clients and suppliers.

Tax Shelters


The CRA has aggressively attacked any and all types of income tax shelters, save flow-through limited partnerships which are condoned by income tax policy. The CRA has been uncompromising on this issue. If your investment advisor pitches any kind of charitable donation scheme, Papaya Farm investment or similar type tax savings vehicle, turn and run the other way.

Taking the time to follow the preventive steps outlined above can help to mitigate both the financial pain and personal stress that can accompany an audit and income tax reassessment. Be organized and be prepared.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

10 comments:

  1. Great post, great reminders and tips.

    Will include in my Weekend Reading roundup Mark!

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  2. Good day Mark:

    Happy New Year.


    I still find it remarkable that many people still do not undertake simple organization that will vastly create less headache in the future and aid in any audit, if any. Regardless, good record keeping is a good habit to have for any purpose.

    Heck, if I found an individual will pristine record keeping I might give the person a break depending on the materiality.

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  3. Thx MOA

    Anon, you sound like a frustrated accountant :)

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  4. Hi Mark,

    I have a question about tax deductions for professional education. Specifically, I want to know if the Chartered Financial Analyst (CFA) exam fees are tax deductible. Since there are three exams and each exam costs around $1000 USD, it really adds up. The complicating factor, as I understand it, is that the CFA Institute is not based in Canada but I know that many Canadians take the CFA exams so this question must have come up at some point.

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  5. Hi Tom

    The original March, 2011 budget and the re-introduced budget in June, 2011 expand the tuition tax credit to include examination fees paid for an exam taken after 2010 if it is a requirement for obtaining a professional status or being licenced or certified to practice a profession in Canada. I don't have time to pursue the matter, but your fees may be deductible.

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  6. To Tom:

    Go on the CRA website and check tuition/education credits - it is updated with the latest budget changes and there is a breakdown of what exactly is included in the tuition credit.

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  7. Thanks Anon, Tom I think this is the link Anon was referring to.

    http://www.cra-arc.gc.ca/gncy/bdgt/2011/qa05-eng.html

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  8. Anon, do you mean there is actually a list of organizations/professions where it is laid out on the CRA website? It seems unclear...

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  9. Thanks for providing the link! Seeing as the CFA Institute is usually considered to be "a professional association," I should be in the clear to claim it as a deduction when I prepare my 2012 return next year.

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  10. Also, the investment interest expense is not deductible if the funds are used for capital gains.
    I mean if you buy and sell an investment and get a capital gain the interest is not deductible. It is only for revenue generating investments (i.e. dividends). However, if the company does not pay any dividends (for example Apple) the interest is still deductible as there is a reasonable expectation with every company that they will at some point in the future.

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