Backing up expense claims on your taxes could save you from CRA trouble
As you scramble to gather all your tax information to meet the Canada Revenue Agency‘s looming May 1, 2023, general filing deadline for 2022 personal tax returns, you should take special care to ensure that you have appropriate backup for any expenses you intend to claim.
Failure to provide adequate receipts or documentation to support those expenses could land you in hot water with the taxman, as one taxpayer recently found out when trying to claim employment expenses on her 2016 and 2017 returns.
The tax case, decided earlier in April, involved a Vancouver taxpayer who was employed as a “family service adviser” by a large funeral home conglomerate. Her employment duties included making cemetery arrangements for clients, selling pre-need arrangements for cemeteries and funeral homes, networking and building relationships to generate referrals, and establishing and maintaining strong business relationships with client families.
She was very successful at her job, earning employment income, together with commissions, totalling $400,333 ($355,905 from commissions) in 2016 and $446,845 ($412,887 from commissions) in 2017. In those tax years, she incurred a variety of employment expenses.
Under the Income Tax Act, an employee who is required to pay employment expenses that are not reimbursed by their employer, including expenses for a home office, may be able to claim a deduction on their return for such expenses. To be entitled to deduct employment expenses, the employee needs to obtain a copy of a properly completed and signed Form T2200, Declaration of Conditions of Employment from their employer.
Typical deductible employment expenses can include: certain food, beverage and entertainment expenses; out-of-town lodging expenses; parking; office supplies; allowable motor vehicle expenses; and even advertising and promotion expenses.
The issue in this case, however, was that the CRA questioned whether the taxpayer actually incurred all her expenses. Specifically, the CRA disallowed $59,800 of advertising expenses in 2016, and $58,000 in 2017, taking the view that they were either not made or incurred by the taxpayer, or, alternatively, if they were indeed made or incurred, they were not done so for the purpose of earning employment income, so they were not tax deductible.
It should be noted that the CRA did allow other advertising and promotion expenses totalling $32,493 in 2016, and $17,602 in 2017. Why did the CRA allow some of the taxpayer’s advertising expenses, but not others? It seems the denied expenses were related to services allegedly provided to the taxpayer by corporations wholly owned by her spouse and daughter.
In 2016, the taxpayer claimed an employment expense deduction for advertising and promotion expenses totalling $29,900 for services rendered by a corporation owned by her spouse, and $29,900 for services rendered by a corporation owned by her daughter. In 2017, she claimed a deduction for advertising and promotion expenses totalling $29,000 for services rendered by another corporation owned by her spouse, and $29,000 for services rendered by another corporation owned by her daughter.
That each of the four payments in question to family members was just below $30,000 doesn’t wholly surprise me. Years ago, at a tax seminar I was giving in Halifax, I was asked by a financial adviser: “What is the magic number I can pay my wife for ‘administrative services’ before the CRA starts questioning my tax deduction?” He had heard that it was $30,000.
Naturally, I responded that there is no “magic number,” and that all expenses you plan to deduct on your tax return must be “reasonable.” In other words, the expenses must be similar to what you’d pay an arm’s length party. In addition, the expenses must actually be paid. This latter point seemed to be the issue in the current case since the CRA took the position that the taxpayer “did not make or incur” the advertising expenses.
The taxpayer testified that she used various methods for marketing and advertising her services. In addition to newspaper ads, charity galas and radio advertising, she also used the services of her spouse and daughter. The taxpayer explained that her daughter provided “marketing services” to her, which consisted of organizing events during various festivals, and organizing various campaigns the taxpayer hosted. She testified that her husband made various cold calls to prospective clients in an attempt to increase her sales. The taxpayer argued that by hiring her daughter and husband in 2016 and 2017, “she was more successful.”
The judge was skeptical that the amounts were ever paid to the taxpayer’s daughter or husband, as the receipts presented into evidence showed neither a description of the services rendered, nor a method of payment. No other supporting documentation to justify the amounts paid to the two corporations, such as time logs, bank statements, cheques, journal ledgers, records of calls made or details of services rendered, was offered at the trial to substantiate the expenses
The judge cited a prior Federal Court of Appeal case that found the burden of proof is on the taxpayer to show that the expenses were incurred. “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 (taxpayer) … must maintain and have available detailed information and documentation in support of the claims they make,” the court said. While there is no need for a taxpayer to introduce “every single receipt,” the taxpayer still has to prove, by some “credible means,” that the expenses were incurred.
The judge also noted that the absence of the taxpayer’s daughter and husband at the trial led her to draw “an adverse inference, that is, that their respective testimony would have shown that she did not pay their corporations for the alleged marketing and promotion services.”
In addition, the taxpayer’s daughter was a full-time student at the University of British Columbia during the tax years in question, so it was “not credible” that she would have rendered the alleged services to the taxpayer while studying full time.
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As a result, the judge denied the advertising expenses, concluding that “on a balance of probabilities,” the taxpayer was unable to prove she had incurred the advertising expenses.
Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.
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