Whether you’re self-employed and deducting business expenses on your tax return or an employee working from home who has chosen to claim home office expenses under the detailed method, it’s critically important to keep receipts of any expenses paid, or potentially face an uphill battle with the Canada Revenue Agency should it challenge you on their validity.
Proving business expenses
In a seminal paper titled “Proving Business Expenses,” tax lawyer Andre Rachert, of Cook Roberts LLP in Victoria, B.C.. commented on the lack of consistently good record keeping, noting that “most tax advisers have been caught up in audits where the client’s business records resemble a Jackson Pollock painting — or worse, a blank canvas.”
Fortunately, there is some precedent for allowing expenses, including those paid in cash, to be claimed without receipts if the CRA or, ultimately, the court, believes the expenses were actually incurred. Indeed, in a technical interpretation, the CRA was asked whether it has the right to demand a receipt to support a taxpayer’s deductible expense claim. The taxpayer asking the question had encountered a situation where a service provider did not routinely provide a receipt for their services, and, in fact, charged a higher price if a receipt needed to be produced.
The CRA responded that while there is no legislation that requires a business to provide a receipt to acknowledge payment for services rendered, the Income Tax Act says that a taxpayer must keep adequate books and records “in such form and containing such information, as will enable tax payable to be determined.”
Nonetheless, the CRA went on to say that, in the absence of a receipt for an expense that a taxpayer is attempting to claim on their return, “it is open to you to substantiate that you paid for that service.” For example, a copy of the invoice for services rendered together with a cancelled cheque in lieu of a receipt, or an itemized monthly bank statement showing that the invoice was paid, would suffice.
The CRA audit manual
As taxpayers, we can glean further insight into the importance of providing evidence to justify our expenses from the CRA’s Income Tax Audit Manual, which is given to CRA auditors, but is also available online.
Under the heading “Auditing expenses claimed without supporting vouchers,” the CRA’s auditors are told that if expenses are not supported with the appropriate documents, “disallow the expense unless there is other satisfactory audit evidence to support the amount claimed.”
The courts, however, have been somewhat more forgiving when it comes to the ability to deduct expenses without having the corresponding receipts. For example, the Supreme Court of Canada ruled in a 1997 case that “where the (Tax Act) does not (explicitly) require supporting documentation, credible oral evidence from a taxpayer is sufficient notwithstanding the absence of records.”
This was expanded upon nearly a decade later in a case involving a taxpayer who lost money on a loan but had no documentation supporting the loan. In allowing the taxpayer to claim a business investment loss notwithstanding that the taxpayer didn’t have the supporting loan documentation, the Tax Court of Canada judge wrote, “Whatever may be the policy of the CRA to require documentation to support an expense, a payment or a deduction, it is not the policy of this court, unless the taxing statute specifically requires it (as for example, in the case of charitable donations). If a taxpayer in court can demonstrate through credible oral testimony that a payment was made or an expense incurred, the court must make a finding based on that evidence and give effect to it.”
That being said, there have been a variety of cases in which the CRA, and later, the courts, have denied business expenses in the absence of receipts as there was simply not enough other evidence to prove the expenses were incurred. As the Federal Court of Appeal wrote in another case, “As a public policy matter the burden of proof of deductions and claims properly rests with the taxpayer … (who) is responsible for documenting her own personal affairs in a reasonable manner. Self-written receipts and assertion without proof are not sufficient.”
Not surprisingly, this issue is not unique to Canada, and the Internal Revenue Service takes a similar stance when it comes to deducting undocumented expenses. Let’s take a look at a recent U.S. Tax Court decision, released in late June, that involved an Uber driver.
The case involved an Arizona taxpayer who not only drove for Uber himself but purchased various additional vehicles, financing many of them, and convinced other people to drive them, all while using his own Uber account. From Uber’s point of view, the company was paying just him, via weekly deposits, into one bank account.
For the 2015 tax year, Uber reported total payments to the taxpayer of US$542,000 but withheld fees totalling US$143,600. Each week, after Uber deposited his earnings into his bank account, the taxpayer would withdraw some cash personally and would move other amounts into a second bank account. He paid some of his drivers with the cash and others via electronic transfers. During the 2015 tax year, the electronic transfers to other drivers totalled US$157,800.
On the taxpayer’s 2015 tax return, he reported only wage income of US$19,000 but when he was audited by the IRS, it reassessed him for the entire US$542,000 of unreported income. The court initially allowed a deduction for the Uber fees and the electronic transfers to other drivers, which left about US$240,000 in gross income to be taxed.
The taxpayer asked the U.S. Tax Court for a review, asking it to allow a variety of vehicle expenses as well as the cash payments made to other drivers as tax deductions. The Tax Court judge acknowledged that “the Court may estimate the amount of the expense if the taxpayer is able to demonstrate that he has paid or incurred a deductible expense but cannot substantiate the precise amount, as long as he produces credible evidence providing a basis for the Court to do so.” But, the judge went on to say that the taxpayer “gave us no basis on which to estimate how much he paid, and we are unable to hazard a guess as to what additional amounts might be properly deducted or excluded from his gross receipts. Without such a basis, any additional allowance would amount to unguided largesse.”
The taxpayer lost the case, reminding us, once again, of the importance of keeping receipts for expenses we plan to deduct come tax time.