What better time than with year-end approaching to start gathering your 2021 tax documents to get a jump start on the upcoming tax season, which is particularly important for business owners looking to deduct myriad expenses on their 2021 tax returns.
Two recent tax cases, both decided last month, involve questionable business expenses that caught the eye of the taxman. The first involved a real estate agent who was challenged on various cash payments she claimed as business expenses, while the second case dealt with a financial adviser who racked up some big-time legal fees in convincing the Canada Revenue Agency (CRA) to allow his business expenses. Let’s take a quick look at each case.
The Toronto real estate agent was reassessed by the CRA for her 2002 and 2003 tax years, in which the agency challenged some of the business expenses she deducted in computing her income for those years. She objected and went to Tax Court in 2018 and was partially successful, but the court did not accept all the expenses she claimed. In particular, the taxpayer claimed she paid three individuals significant amounts of cash for helping her real estate business.
The taxpayer appealed the lower Tax Court’s decision to the Federal Court of Appeal. In an appeal, the appellate court is required to treat the lower Tax Court’s findings of fact with a “high degree of deference,” interfering only if the taxpayer can show it made a “palpable and overriding error.” A palpable error is one that is “obvious and plain to see.”
The taxpayer argued that because the Tax Court found her to be a credible witness, and accepted that she made payments for real estate leads, it should have made the “reasonable inference” that she made the cash payments she claimed to have made to the individuals she specified.
The appellate court disagreed, refusing to equate credibility with reliability. “Credibility is concerned with honesty, while reliability concerns the accuracy of the testimony, i.e., whether the witness accurately recalls and recounts the relevant events,” the three-judge panel explained. “A credible witness may give unreliable evidence.”
The Tax Court did, indeed, describe the taxpayer as “overall a credible witness,” but it also noted she was “struggling to recollect” various facts, and the court did “not accept everything she said as proven.” Specifically, the Tax Court said her records “were not very good,” and her testimony regarding the cash withdrawals she undertook to pay the individuals for leads when she deposited a commission cheque was not borne out by her actual bank records.
The court said “she was guessing a few times,” she had no records of the payments made, the individuals she said she paid did not actually report the income on their returns, and the amounts she claimed were “round thousand dollar numbers,” which the Tax Court found a “little coincidental, not likely, and inconsistent.”
In the end, the Tax Court concluded it simply didn’t have sufficient evidence to accept these deductions. The Federal Court of Appeal found no reason to overturn the decision and dismissed the taxpayer’s appeal.
The second case dealt with a Mississauga, Ont., financial adviser who was reassessed by the CRA, which disallowed various business expenses he claimed for the 2008 and 2009 taxation years in the amounts of $133,170 and $150,510, respectively. The federal tax in dispute totalled $64,135.
The majority of the denied expenses were incurred by the taxpayer to purchase and use a $105,000, 2008 Chevrolet Corvette Z06 during what was referred to as “track days,” presumably for business development purposes.
In September 2020, approximately 10 days before the case was set to go to trial, the taxpayer and the CRA ultimately agreed to settle the matter, allowing $116,543 of deductible expenses for 2008 and $130,821 for 2009. With the substantive matter now settled mostly in favour of the taxpayer, how did the case still wind up in Tax Court a year later?
As it turns out, the recent case wasn’t about the amount of the deductible business expenses, but rather about the costs that should be awarded to the taxpayer. Since the taxpayer and the CRA could not agree on an amount, they agreed to turn to the Tax Court to set the appropriate costs award.
Tariff B of the Tax Court Rules (General Procedure) generally prescribes a very low amount to be awarded as costs, but the Tax Court has “absolute and unfettered discretion” to award (or withhold) costs. This discretion allows the court to set “just and appropriate cost awards suitable to the particular circumstances of individual cases.”
In exercising its discretion, the Tax Court considers a variety of factors, including: who won the case, the amounts in issue, the importance of the issues, any offer of settlement made in writing, the volume of work, the complexity of the issues, and the conduct of any party that tended to unnecessarily shorten or lengthen the proceeding’s duration.
The taxpayer was seeking legal costs of $260,413, an amount the court noted was “approximately four times the amount (of tax) at issue.” The tariff costs, however, were much lower, set at $4,096, which included only $625 to prepare for the hearing, and $1,500 for the hearing itself.
The judge noted it took the taxpayer nearly three years to provide the CRA with information it had requested in September 2017, which included detailed breakdowns of the expenses the taxpayer incurred, along with copies of “invoices, receipts, bank/credit card statements” to support the amounts deducted by the taxpayer on his return.
“(The taxpayer’s) failure to provide such information for nearly three years impeded the ability of the parties to reach a settlement. A party who fails to comply with an order of the Court should not be rewarded by enhanced costs,” the judge wrote. “The (taxpayer) is fortunate to receive any costs at all.”
The judge fixed the costs award at $4,096, plus another $10,400 in out-of-pocket disbursements, but disallowed about $6,300 in “after-hours rush service” for last-minute printing fees.