As the income tax deadline draws near, here are some things to keep in mind when it comes to gathering documentation, slips and other records needed to substantiate your own business expenses.
A recent tax case (St-Onge v The Queen, 2010 TCC 579) involving an investment advisor’s questionable business expense claims sends a strong message to all advisors about the need to keep good tax records in case the Canada Revenue Agency asks to see them.
The case involved Alcidas St-Onge, an investment advisor in Bonaventure, Québec. In February 2004, he sold his client list and ceased business. In 2003 and 2004, he claimed nearly $54,000 and $28,000, respectively, in business expenses incurred to earn commission income. The CRA audited these expenses, and ultimately disallowed about $25,000 and $22,000, respectively, in expenses for 2003 and 2004. The CRA disallowed these expenses because it considered rental, travel, interest and vehicle expenses to be personal expenses. Other expenses were disallowed simply because they “were not incurred for the purpose of earning commission income.”
Here is a review of some of the disallowed expenses, along with the judge’s rationale for their disallowance.
St-Onge deducted $8,400 related to client buybacks. He claimed $1,900 for a buyback of a client and $6,500 to purchase clients — the latter substantiated only by a handwritten note, which the CRA found insufficient to justify the amount claimed.
The auditor noted the purchase of clients is not a current expense, but rather a capital expenditure. Therefore, 75% of the expenditure should have gone into the cumulative eligible capital (CEC) account, depreciable at a rate of 7% per annum. This is consistent with the 2004 Supreme Court of Canada’s finding in the Gifford case, where the tax treatment of the purchase of a client list was not found to be deductible.
The CRA disallowed about $342 of vehicle expenses in 2003 and nearly $3,900 in 2004 since St-Onge failed to provide “objective proof to substantiate them.”
St-Onge testified he had two vehicles available to him, and that one of them, a leased Toyota, had been used solely to earn income from his business. The CRA testified, however, that St-Onge previously estimated the percentage use of that vehicle for personal purposes at 15%.
The judge felt that without any “probative corroborating evidence in the form of documentation, such as invoices, cheques and travel records,” the CRA’s disallowance of part of the expenses was correct.
The 2004 vehicle expense included a $3,330 lease cancellation payment that St-Onge made after he left the business. Not surprisingly, the judge concluded that any expenses he incurred after St-Onge sold his business “[could not] have been incurred for the purpose of earning income from a business because he was no longer operating the business when the expenses were incurred.”
St-Onge deducted $8,000 as salary he purportedly paid to his spouse in 2003. Since he could neither provide objective evidence showing payment of the salary to his spouse nor explain the nature of the services his spouse allegedly performed and for what length of time, the judge disallowed the entire salary expense.
The CRA denied about $3,600 of interest expense in 2003 and $1,900 in 2004 relating to purchases paid for by credit card. While St-Onge testified the interest expense was incurred for the purchase of materials used to set up his office at his residence and to purchase Nortel shares, since he couldn’t provide any corroborating evidence or documentation, the judge denied this interest expense.
St-Onge lived in Bonaventure and had a home office. Since many of his clients lived in Québec, he travelled there about 12 days per month for business purposes. Rather than incur the expense of staying at a hotel, he lived in an apartment with his son and deducted $3,300 and $2,300 as travel expenses for the 2003 and 2004 taxation years. The judge denied the expenses due to lack of documentation.
In 2003, about $1,200 was claimed for meals, including restaurant and grocery store bills. The CRA found these to be “non-deductible personal and living expenses,” and the judge agreed.
In 2003 and 2004, the CRA denied a portion of his rental expense claimed relating to rent associated with his son’s apartment in Québec. St-Onge argued that a portion of the Québec rent should be deductible because the cost would have been much higher if he had to pay for a hotel.
The judge disagreed. Since St-Onge’s employer provided him with an office in Québec, the rental expenses on the apartment in Québec were determined to be personal living expenses and therefore not deductible.
While this may be an extreme case, it reinforces the message that advisors need to keep proper and current records, copies of receipts and even a logbook for kilometres driven. That way, if your expenses are scrutinized by the CRA, they will ultimately stand up in court.