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 Chartered Professional Accountant and a partner with a National Accounting Firm 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 are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, February 29, 2016

The 2016 Ontario Budget


Last Thursday, Ontario Finance Minister Charles Sousa delivered the provinces 2016 budget. While there were some interesting programs introduced; such as the Ontario Student Grant program for children from families making less than $50,0000, there were few new tax measures. 

I apologize to readers from other provinces, but Ontario is my home province, so I have a vested interest in this budget.

Personal Income Tax Rates


There were no new personal tax rate changes announced (not surprisingly given the tax rates below). For residents of Ontario who earn greater than $220,000, the combined Federal and Ontario tax rates are as follows for 2016:



Ontario-Federal Combined Top Marginal
Personal Tax Rates for 2016
Salary
Capital Gains
Eligible Dividends
Non-eligible Dividends
53.53%
26.76%
39.34%
45.30%

I  have written previously about how the "top 1%" of income earners are no happy with these rates, so there is no need to discuss them again.

Business Income Tax Rates

 

There were no changes to the corporate tax rates. For incorporated companies carrying on business in Ontario, the tax rates are as follows:


Combined Federal and Ontario
Corporate Income Tax Rates for 2016
General
M&P
Small Business
26.5%
25%
15%


The access to the 15% small business rate could be "shaken-up" if the Federal Liberals follow through in next months Federal Budget with their election promise to look at restricting the ability for certain small businesses and professionals (such as doctors, lawyers and dentists) to claim the small business deduction where they do not meet certain employee thresholds.
 

Miscellaneous Business Changes


  • The government stated that the legislation for The Ontario Registered Pension Plan ("ORPP") will be implemented in the spring of 2016. Though technically not a tax, the ORPP will eventually cost businesses 1.6% to 1.9% on employee pensionable earnings up to $90,000. The impact of this substantial additional cost to employers will have to be seen; I would suggest businesses may not just happily absorb the ORPP cost and the ORPP may cost some Ontarians their jobs.
  • Ontario will reduce R&D credits from 4.5% to 3.5% and the Ontario Innovation Tax Credit from 10% to 8%
  • The Apprentice Training Tax Credit is under review as previously announced

Miscellaneous Personal Changes


  • Ontario will discontinue tuition and education tax credits beginning in September, 2017
  • The government will also discontinue the Children's Activity Tax Credit and Healthy Homes Renovation Tax Credit as of January 1, 2017
  • Ontario will mirror the Federal Split Income rules for minors, whereby the top marginal Ontario rate will be applied starting January 1, 2016

So as noted above, not too much to get excited about. I have a feeling the Federal Budget may create a little more excitement.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, February 22, 2016

What Small Business Owners Need to Know - Insurance as a Corporate or Estate Planning Investment Class

Last summer, I attended a  BDO SuccessCare Program that dealt with helping small business owners plan for succession (in a couple weeks I have a post on "One Day You Will Sell Your Business" that discusses how less than 40% of corporate business owners actually have a succession plan).

At the course, Brodie Mulholland, a lawyer who provides insurance and tax based estate planning strategies spoke about how small business owners can use insurance for estate planning and investing purposes even where there is no specific need for life insurance in the traditional sense. I was very impressed with his talk and afterwards started speaking to him about some of the points he made. Brodie volunteered to write a blog post on using insurance as a corporate or estate planning investment class and today I am posting his blog.

Note: over the years I have had several clients purchase insurance in their corporation for estate planning and/or investment purposes. While for certain small business owners, such insurance clearly provides a substantial increase in value to their estate at death, please be aware, that neither Mark Goodfield, The Blunt Bean Counter blog nor the firm I work for is endorsing Brodie or the purchase of insurance for the purposes discussed below. You must obtain independent insurance advice and speak to your accountant on whether purchasing an insurance policy makes economic, estate and income tax sense in your own circumstances.

All the examples, numbers and discussion below are Brodie's solely and I make no representation as to their accuracy. Finally, Brodie's examples below reflect a whole life policy. Before considering any corporate funded insurance policy, you should discuss the advantages and disadvantages of Universal Life ("UL") vs Whole Life or any other alternative insurance product. Many estate and insurance advisors feel UL is a better product, while others feel a whole life policy is the way to go. You need to understand which product best suits your needs.

With all these caveats out of the way, I will leave it to Brodie to discuss the use of insurance as an investment class.

Insurance as a Corporate or Estate Planning Investment Class

By Brodie Mulholland


Today I will review how life insurance may be used, either personally or in a corporation, as vehicle for investments to grow and pay out tax free. It is important to understand that insurance facilitates the investment and in many cases, the person purchasing the policy may feel they already have sufficient life insurance in the traditional sense. As reflected in the examples below, compared to a GIC earning 3% per year after tax, the effective after tax rate of return with an insurance policy is substantially higher, if the policy is owned personally, the returns are even more compelling if owned by a private corporation. 

In general, you would typically only consider funding a life insurance policy as an investment where you anticipate having more funds than you will need to live and you want to leave this money to your estate.

An Example


Let’s take a couple, Thom and Sophie who are, respectively, 66 and 64, who have $100,000 to invest each year (while I am using an investment of $100,000 a year for this example, until the year in which the survivor of Thom and Sophie die, for many small business owners, the investment is often $25,000-$50,000 for say ten years). One option would be for Thom and Sophie to invest in a GIC. In Ontario, if you are paying tax at the highest marginal rate; 53.53% of the income earned each year on the GIC goes to pay income tax. How do you shelter that income from tax?

One option is to use life insurance. Under the current life expectancy tables used for income tax purposes, the statistical life expectancy of the last of Thom and Sophie to die is 25 years (for example, suppose Thom died in 20 years and Sophie in 25 years). If Thom and Sophie paid $100,000 per year into a GIC that earned 3% after tax (that’s like earning 6% before tax at a 50% marginal tax rate), after 25 years the GIC would be worth almost $3,800,000. However, the amount paid out on a tax free basis to their estate could be more than $6,300,000 if instead they acquired a “participating with paid up additions” whole life insurance contract that paid out on the last of them to die assuming current policy premiums and insurance company dividend payment rates (different types of insurance are explained below). That’s over $2,500,000 (or over 65%) more to their estate after tax.

Does this sound too good? Even if I lower the insurance company’s dividend payment rates by 1% (many experts believe they will be lower in the future given the historically low interest rates the last decade) the amount that would be paid out after tax would still be almost of $5,700,000. Still some risk you say? If they used a T-100 insurance policy that pays out on the last of them to die and where the annual premiums and payout amount are guaranteed for life, the tax free payout could be almost $6,000,000 – that is almost $2,200,000 (or 58%) more than the GIC after tax.

Which Investment or Type of Insurance to Choose?

 


Year
GIC 3% After Tax Rate of Return
Whole Life Insurance - Current Dividend Scale
Whole Life Insurance - Current Dividend Minus 1%
T-100 Life Insurance
10
$1,180,780
$2,922,055
$2,840,120
$5,940,856
20
$2,767,649
$4,980,042
$4,541,546
$5,940,856
25
$3,755,304
$6,315,893
$5,588,146
$5,940,856
30
$4,900,268
$7,787,482
$6,682,200
$5,940,856

Based on information obtained on or before November 26, 2015, assuming:
- Thom and Sophie are non-smokers in standard health
- $100,000 payments are made annually at the start of each year until the year in which the survivor of Thom and Sophie die

There are pros and cons to each option. The biggest “con” to using life insurance versus a GIC, is that life insurance does not pay out until death and so the insurance benefits your estate or the beneficiaries you designate, not you directly. When choosing between life insurance products, the advantage of a T-100 life insurance policy is that the amount that you pay and that will be paid out on death are guaranteed. With universal and whole life policies, generally there will be certain guaranteed minimum payout amounts, but the actual tax free payout amount will vary depending upon, in the case of universal life, investment performance and for whole life, dividend rates.

There are ways to borrow against, or in some cases, withdraw, amounts you have paid into certain permanent insurance policies, although I do not recommend planning to use life insurance in this way as an investment unless you are quite certain that you will never need to use it during your lifetime. With T-100 policies, generally borrowing or withdrawing from the policy is not possible.

Funds in a Corporation


What if the funds to be invested are inside your corporation? Using corporate dollars to pay the insurance premiums is often better because, generally, corporate dollars have not been taxed as much. More importantly, because life insurance proceeds are credited to a special account called the Capital Dividend Account (“CDA”), depending upon the type of life insurance and how long the policy has been in effect, most, if not all, of the insurance proceeds may be paid out of your corporation to you/your estate tax free. See Mark's post on Capital Dividends - A Tax-Free Withdrawal from your Company for more information on the CDA account.

Thom and Sophie’s Corporation


So to carry on with our example, let’s suppose that Thom and Sophie had a corporation with $100,000 per year to invest and that their estate will need these funds and the accrued growth from the corporation to pay taxes on the death of the survivor of Thom and Sophie.

Again, let’s compare what would happen if Thom and Sophie used that $100,000 per year to have the corporation fund a GIC versus funding a life insurance policy with premiums of that amount. Let’s further suppose that the survivor of Thom and Sophie dies 25 years from now so their estate would need funds to pay its tax liability then. If the corporation earned 3% per year after tax on the GIC, as above, in 25 years that would amount to almost $3,800,000. Now how does the estate get the funds out of the corporation? Usually the corporation would pay a dividend on the shares formerly held by Thom and Sophie’s to their estate, assuming that their estate now holds their shares in the corporation. However, at current tax rates, if these funds were paid to the estate by dividend, the estate would have to pay tax of about 1/3 (or much higher after the Liberal tax changes - the accountants may use various tax planning techniques to lower the tax rate on removing the funds) of the dividend amount, leaving the estate with about $2,500,000 after tax.

If the corporation instead acquired the same “participating with paid up additions” whole life insurance as stated above and assuming current dividend payment rates, the payout amount would be over $6,300,000, much of which could be paid out to the corporation to Thom and Sophie’s estate tax free. 

If Thom and Sophie were to take the most conservative approach, and had the corporation acquire the same T-100 insurance policy referred to above, the proceeds would be almost $6,000,000 and these should be able to be paid out of the corporation tax free, so the difference to Thom and Sophie’s estate compared to the GIC would be almost $3,500,000 – over double. (again, there may be additional tax savings from further tax planning involving Thom and Sophie’s shares.)

Term vs. Permanent Life Insurance


There are two basic types of life insurance: term and permanent. Term insurance is the type with which most of us are familiar – it is in effect for a specified term, for example, 20 years. Its purpose is primarily to manage the risk to the family in the event of death (i.e. income replacement) – that is, if an income earning spouse were to die prematurely, what amount of capital would produce enough income to make up for the loss to the family of the deceased’s income. If the person whose life is insured lives longer than the term (e.g. 20 years) the policy’s term will have expired. Another type of life insurance is permanent insurance: insurance that is intended to payout on the death of the life insured, and has no specified term – it is intended to be in effect permanently until the insured dies.

Participating Life Insurance and Statistical Life Expectancy


Permanent life insurance policies can be “participating” or “non-participating”. Most participating policies are ones where the insurance company pays dividends to the policy holder. Depending upon how these dividends are paid or used, they may not be taxable to the policy owner/recipient. One of the most common ways that non-taxable dividends are paid or used is by way of “paid up additions” – the dividends are used to buy extra amounts of life insurance so the insurance contract payout amount increases every year. Again, in very general terms, there are three types of permanent life insurance: universal, whole life and T-100 policies. Generally, with Universal Life, the investments inside the policy are managed by you and those in a whole life policy are managed by the insurance company. Universal and whole life policies may be participating or non-participating and T-100 policies are non-participating. A permanent life insurance policy “matures” (that is, pays out) when the life insured dies, so for the purpose of comparing life insurance to other types of investments, we use statistical life expectancy as the date to which returns are calculated.

Tax Free Investment Growth Inside an Insurance Policy


Under the Income Tax Act when you may make extra contributions to a life insurance policy they can grow tax free within certain limits (known as the MTAR rules). Generally, the larger the face amount of the insurance policy (that is, the death benefit or amount paid on death) and the older the person whose life is insured, the greater the extra contribution allowed. As mentioned, those extra contributions grow inside the policy on a tax free basis. You might be saying “yes, but I can do that in my RRSP”. True, but on death, your RRSP is fully taxable – often to the tune of almost 50%. That is not the case with the extra contributions and growth inside the insurance policy: on your death, they payout to your beneficiary’s tax free, in addition to the death benefit.

So you don’t Have a $100,000 a Year to Invest?


This type of insurance planning works for amounts less than $100,000 per year, but for various reasons, including of fixed policy fees, as amounts get smaller, the effective returns will not be as high and may not make sense for amounts less than $25,000 per year, for say at a minimum of ten years.

The Rules are Changing in 2017


The tax rules are changing for insurance policies issued after 2016, in some cases, substantially reducing the amount that may grow tax free inside an insurance policy. Thus, you may wish to consider this type of planning before 2017, especially since the process of putting such a life insurance policy in place can take several months; in other words, right now is a great time to look into it.

Brodie Mulholland is a consultant to tax and estate planning lawyers, tax accountants and investment advisors to assist their clients with insurance based tax and estate planning strategies. Brodie is a lawyer who has practised for over 30 years in the areas of trusts, wills, tax and estate planning, corporate and commercial law and corporate restructuring. He is a member of STEP (Society of Trust and Estate Practitioners) and received an Advanced Certificate in Family Business Advising (with distinction) from STEP. Please feel free to contact Brodie directly at 416-917-0058 or by email at brodie.mulholland@gmail.com.

The above blog post is for general information purposes only and does not constitute legal, insurance or estate planning or other professional advice or an opinion of any kind. Readers are advised to seek specific legal, insurance or estate planning advice regarding any specific issues.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Small Business Owners - Get on my Mailing List


If you are an owner-manager and/or a shareholder in a corporation and have not signed up for my corporate mailing list, please email me at bluntbeancounter@gmail.com

I will be sending out specific mailings on matters of importance to small business owners and I am considering, depending upon the interest, holding a roundtable for small business owners who are in the Toronto area.

Thanks to the many readers who have already signed up.

Monday, February 15, 2016

How my Dying Dog Impacted my Power of Attorney for Personal Care

Recently, I took my own advice and updated my will and power of attorney (“POA”) for both financial and personal care. The process was fairly painless and for those of you that procrastinate, as Nike says “Just do it”.

During this process, my wife and I discovered that we have a philosophical difference in respect to taking heroic measures if our health were to decline. I want no heroic measures and she does.

Reggie & Whitney Pic by Trudy Rudolph
As we were updating our POA for personal care, by unfortunate co-incidence, our dog Reggie (a schnauzer we got as a puppy), was having a terrible string of bad luck health-wise. Not to equate a dog with a human (although many people like their dogs more than humans) but Reggie’s experience became a reference point for our decisions on heroic measures.

Last year, Reggie who was then nine years old and in great health, started wondering off on our walks. For our other dog Whitney, who has a mind of her own, this would not be unusual; but for Reggie, this was strange, as he was a very obedient dog. We also noticed that he seemed to be having trouble finding his food dish. Long story short, he was found to have suffered from SARDS (“Sudden acquired retinal degeneration syndrome) and in a matter of a couple of days he had gone blind.

Over the next year, Reggie adapted to his blindness and did very well. This past December, we took Reggie to the Veterinarian (“Vet”) for a check-up and were told he needed some dental work. Following the dental work in late December, Reggie seemed unusually sluggish and was acting a bit strange. The Vet ran some tests and did an x-ray. The x-ray discovered a tumour in his lungs which he figured was lung cancer, but further tests were required to be conclusive.

During the Christmas holiday break, our family was trying to figure out our next steps when Reggie suddenly lost the use of his hind legs (probably due to the tumour pressing on his spine), which for a dog is a disaster; as they cannot go to the bathroom own their own. Our family was devastated and could not believe how unlucky one dog could be.

At this point, it became clear Reggie’s quality of life had declined drastically; however, his mind was still very sharp as far as dogs go. We were faced with the gut-wrenching decision as to what was better for Reggie, while also considering our challenges as dog owners. The decision as owners is conflicting. On one hand you want to keep your dog alive because he is your loyal companion, but on the other hand, he was beginning to become a challenge for our family; because he was not able to stand and more importantly, could not urinate fully and independently which we were told can be life threatening to a dog and result in excruciating pain when the urine is not expelled.

Reggie’s health issues became a proxy for my wife and me and our POA for personal care, which were still in progress. I told her if I was Reggie and had all these issues, do not take any heroic measures (i.e.: No chemotherapy or any measure that would prolong my life). She told me, if she was Reggie, she wanted me to do whatever I could to keep her alive assuming she still had all her mental faculties and could move her upper body and arms.

As the person who does not want any heroic measures, I felt we should consider putting Reggie to sleep before he suffered further. But, I was not going to make that decision alone. My son had read about how a doggie wheelchair could assist a dog who has no use of his hind legs. He immediately went to a hardware store and came back with various tubes and wheels and started building Reggie a wheelchair.

We tried it for a couple days and Reggie would not move once harnessed in. We all helped and came up with a couple tweaks to his design and we soon had a Jerry-rigged wheelchair that worked. Reggie with the help of my daughter, who is studying occupational therapy accepted the wheelchair and even wheeled his way to his water bowl for a drink on one occasion.

However, the reality was Reggie still had to be carried everywhere and could not go to the bathroom on his own and at times was shaking (which we were told is often indicative of a dog in pain – dogs supposedly often suppress their pain to not upset their owners).

After much deliberation as a family, we eventually made the decision to put Reggie to sleep.

I have only scratched the surface on the issue of heroic measures in this post, as this saga was more about Reggie. This is an extremely complicated discussion and you should obtain legal advice. I would suggest as a start you read this excellent article by Mark 
Handelman
 of Whaley 
Estate 
Litigation, on the issues of heroic measures and end
 of 
life
 decisions. While the article discusses the duty lawyers owe their clients in respect of end of life decisions, it raises all the issues you would need to consider. And those issues are beyond complex. For example, Mark notes that some procedures may be considered heroic when they are first introduced, but maybe common place years later (such as open heart surgery). Note: each province may have differing legislation.

This blog post had a dual intention. It was an ode to Reggie, but it was also meant to alert you to the importance of having a current set of POA’s and how much thought you need to put into your decision regarding heroic measures.

Disclaimer: I am not a lawyer and I have provided no legal advice. I have just made you aware that you should have a POA for personal care. Seek legal advice before executing a POA for personal care.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Tuesday, February 9, 2016

What Small Business Owners Need to Know - Intercorporate Dividends are not Necessarily Tax-Free Anymore

For many years, it has been standard tax planning to pay any excess cash from your operating company (“Opco”) as a dividend to your holding company (“Holdco”) for asset protection, retirement planning or other investment or business reasons. Where your Holdco is connected to your Opco (in general terms, Holdco is connected where it owns more than 10% of the votes and value of Opco), those dividends will flow tax-free to your Holdco. Where Opco has refundable dividend tax on hand, a dividend paid to Holdco can trigger Part IV tax; so speak to your accountant first.

[Note: As discussed in my blog post the Capital Gains Exemption is Not a Gimme, you may not always want your Opco to be owned directly by your Holdco].

The government became concerned taxpayers were utilizing the tax-free nature of intercorporate dividends to defer or reduce capital gains tax, especially prior to the sale of a business. Thus, the 2015 Federal budget introduced anti-avoidance rules (draft legislation was released in July, 2015 with request for comments) effective for dividends received by a corporation on or after April 21, 2015. These anti-avoidance rules have caused uncertainty in respect to the payment of what were prior to the budget, tax-free intercorporate dividends.

Currently there are “capital gains stripping " anti-avoidance rules contained in Section 55 of the Income Tax Act. These rules have been in place for years and generally are only problematic where there is a contemplated or actual sale to an arm’s length person and the payment of a dividend and an ownership change are part of the same series of transactions. These rules are very complex, but in basic terms, dividends can be paid tax-free to the extent the corporation has what is known as “safe income”, which in simplistic terms is essentially income earned by the corporation after tax. To the extent the corporation does not have safe income, the dividend in whole or part will be converted to a capital gain.

The new rules are broad and now not only catch the arm’s length sales noted in the prior paragraph, but will now capture dividends for which the purpose of the dividend “is to significantly reduce the value of the share”. This is why the new rules are troublesome. When is the standard dividend planning noted in the first paragraph, a dividend to reduce the value of a corporation’s shares?

The rules leave taxpayers and their advisors in the positions of needing to prove that the significant reduction of value that obviously occurs when the operating company pays excess cash to its Holdco is not the intended purpose of the dividend. The issue is more vexing when you consider that often the reduction of the value of Opco was intended, but was not done for tax purposes, but for business or investing purposes.

We are left with uncertainty where large dividends are paid to a holding company, including where the dividend was paid for asset protection purposes and then loaned back to the Opco. The CRA has stated that “lumpy dividends” (large one-time payments) may be considered to have been paid to reduce the value of a share, which is disconcerting.

There are other concerns including stock dividends, but they are beyond the scope of this blog post.

You should discuss with your accountant whether intercorporate dividends should be deferred until there is further clarity in respect of the legislation or whether it is prudent to undertake a calculation of safe income (which are expensive and time consuming) prior to paying a dividend, even if not in contemplation of a sale.

To reflect how much uncertainty and confusion there is with these rules; I am going to have a double disclaimer today. In addition to my usual disclaimer at the bottom of my post, I will again inform you; do not act on any of the general information in this blog post without discussing the issue with your accountant.

I will also not address or answer any of the comments and questions on this post, because of the uncertainty of the rules.

Small Business Owners - Get on my Mailing List


If you are an owner-manager and/or a shareholder in a corporation and would like to be on my corporate mailing list, please email me at bluntbeancounter@gmail.com

I will be sending out specific mailings on matters of importance to small business owners and I am considering, depending upon the interest, holding a roundtable for small business owners who are in the Toronto area.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, February 8, 2016

Thanks for Reading

Last week I passed two million page views on my blog! Considering my topic area and the fact I write at most once a week, I am very proud of this accomplishment. I would like to thank you; my readers for helping me achieve this milestone.

Over the next couple months, I am going to try an experiment. Starting tomorrow, and then every second week, I am going to write blog posts under the heading "What Small Business Owners Need to Know". In these posts I will discuss topics such as inter-corporate dividends, corporate-owned life insurance, shareholder agreements and succession planning ("One Day You Will Sell the Business").

While these topics will be of greater interest to owners of small businesses, some of them, such as the post on life insurance will have a personal component; so you may want to at least scan through these, even if you are not a small business owner.

In the weeks I am not posting about small business issues, I have a couple blogs that deal with personal and estate issues for which I have high expectations. I will keep you in suspense on these, since there have been a few times when I or a guest poster have written a blog post I consider "excellent" and they turn out to be duds. While others times, I have written about what in my opinion are rather pedestrian topics and they turn out to be very popular blogs. So we will see if you share my opinion once these blogs are posted.

Until tomorrow... when I discuss how Intercorporate Dividends – Are Not Necessarily Tax-Free Anymore.

Monday, February 1, 2016

CRA Audit Update for Individuals and Corporations

There is probably no five letter word that strikes more fear into your heart and pocketbook than the word "AUDIT". We are anxious receiving any letter from the CRA, in case it is the dreaded "you have been selected for audit" letter. So today, I thought I would provide you with a mini update on some interesting wording the CRA is now using in audit adjustment proposal letters. For those of you that own small or mid-sized companies, I provide some information on audit selection criteria and what is happening in the small and medium-sized enterprises ("SME") audit area.

Audit Proposal Letters


Gross negligence penalties under subsection 163(2) of the Income Tax Act can be imposed when the CRA can show that a taxpayer knowingly, or under circumstances amounting to gross negligence, makes a false statement or omission in a tax return. The penalty for doing such is equal to the greater of $100 and 50% of the tax due to the false statement or omission.

This subsection has been applied sparingly by the CRA in the past. However, lately I have seen reference to this subsection in a number of audit adjustment proposal letters where the CRA states it is considering imposing penalties. It appears this wording may have become common or standard wording in audit proposal letters, likely to provide the CRA greater leeway to levy the penalty if the facts of the situation later lend themselves to a negligence penalty. This type of language can be scary to clients who receive the audit proposal letter, but have not done anything untoward, and would not be anywhere close to being subject to the gross negligence provision.

Thus, if you receive such a letter, do not "freak-out" if the letter has the gross negligence paragraph, it is not necessarily directed at you.

SME Audits


One of the audit initiatives the CRA has is the SME sector. No one knows for sure how a SME is selected for audit, but it is thought that the CRA uses a risk-assessment system to select businesses for an audit based on various factors. Some of these factors may include:

1. Random Selection - You hit the reverse jackpot and your company is just randomly selected.

2. Audit Tips - This is the worst possible way to be selected. This usually involves a disgruntled spouse, employee or ex-partner. They can be vindictive with knowledge they actually have or think they have that may not even be factual.

3. Past Errors or Non-compliance - This would include revised and amended returns, late filing of corporate and HST returns.

4. Comparative Information -Corporate tax returns must include General Indexed Financial Information known as "GIFI". This information provides a comparative year to year summary of income and expenses. It is suspected by many accountants that the CRA uses this information to review year to year expense and income variances of the filing corporation and to also compare corporations within a similar industry sector to identify those outside the standard ratios.

5. Cash Transaction Industry - If your company is in an industry in which the CRA has seen other companies involved in cash transactions, you are at a high risk for an audit, even if you are compliant. In addition, even if your industry is not known as a "cash industry", if several companies in your space have had audit issues, the entire sector comes under scrutiny.

Record Keeping and Personal Records


The CRA perceives many SME's to have less than stellar record keeping. They also find that many small business owners tend to mix their personal and business expenses (so when your accountant tells you to get a separate credit card for your business, please listen to them).

As result of the above, the CRA may now request personal records such as your personal bank statements, mortgage documents and personal credit card statements to support the SME's expenses. This is something new and upsetting to clients. As per this CRA link to business audits, the CRA states:
  • Your personal records and the personal or business records of other individuals or entities are legally considered to be part of the items that relate, or may relate, to the business being audited.
  • An auditor can examine the records of family members.
  • An auditor may ask questions of the employees who do your accounting entries or know about the operations of your business.
You should speak to your accountant if you get such a request; however, the reality is the CRA feels they are legally entitled to these records and while some disagree, until there is a court case to  the contrary, you will probably be stuck having to provide these records.

Working Backwards


It appears that the CRA is now auditing parallel tracks (business and personal). They audit your actual corporation, while at the same time they are reviewing your net worth and sources of personal funds to support your corporate income and expenses. This new audit tack requires significant time and energy to provide such information (which is often not easily accessible), let alone significant stress. In addition, you may now need to document legitimate non-taxable sources of funds, such as gifts and inheritances, in order to support that they are not subject to tax.

I assume reading this post is not the way you wanted to start your Monday morning. But I figured you rather know what is happening on the audit front than not. Or maybe not :)

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.