As you hunker down over the next 30 days to file your tax return by the May 1
deadline, you should know what raises the red flag when the taxman looks at your
National accounting firm Deloitte puts out an annual top 10 list of items on
tax returns that are questioned most often by the Canada Revenue Agency (CRA).
Following are the top red flags from 2004 personal tax returns:
1. Verification of capital gains and losses The CRA has started asking for
details of capital gain and capital loss calculations. These calculations can
pose additional complexities when you dispose of certain investments such as
income trusts or foreign-currency investments.
Income trusts pose a unique problem in that they often distribute a return of
capital, which is not currently taxable but reduces your adjusted cost base
(ACB). You need to keep a record of these ACB adjustments so that the correct
capital gain or loss can be reported when the income trust is ultimately sold,
which may be many years later. Return of capital information appears on your T3
Also, don't forget about the foreign exchange component of any gain or loss.
The calculation should be done by comparing the foreign exchange rate on the
date of purchase with the rate on the date of sale.
2. Allowable business investment losses (ABIL) An ABIL is a special type of
capital loss that occurs when you sell debt or small business corporation
shares. The advantage of realizing an ABIL over an ordinary capital loss is that
an ABIL may be deducted against all sources of income, including employment
income, while capital losses may only be deducted against capital gains.
In order for a loss to qualify as an ABIL, it must meet certain complex and
strict rules. According to Deloitte, nearly all its clients who reported an ABIL
on their 2004 returns were asked for additional information.
3. Carrying charges While expenses incurred for the purpose of earning
investment income -- interest on borrowed money or investment counselling fees,
for example -- are typically tax deductible, it is essential to keep any
documentation. And make sure no personal expenses are being claimed. For
example, if a line of credit is used for investing, ensure that funds drawn from
it are not used for personal purposes.
If you need to use your line of credit for a home renovation or other
personal need, it's best to establish a separate line of credit. That way, you
keep your tax-deductible and non-tax-deductible interest separate.
4. Foreign tax credits If you earn any foreign investment income, be sure to
claim any foreign tax withheld as a credit on your Canadian personal tax return.
This foreign tax credit can generally be used to offset any Canadian tax payable
and will directly reduce Canadian tax dollar-for-dollar. Deloitte reports the
CRA has been questioning entitlement to foreign tax credits and reviewing the
5. Province of residence Provincial residency continues to be an item of
scrutiny for the CRA. Under Canadian tax law, you must pay provincial tax on
your worldwide income based on your residence in a particular province on Dec.
31. Choosing to vacation in Banff on New Year's Eve doesn't make you a resident
of Alberta. The determination of provincial residency goes beyond mere "physical
presence" and looks to the province where the individual has the most
significant residential ties.
6. Large charitable donations or donations of property The CRA seems to draw
the line at cash donations in excess of $25,000, asking for additional
information to substantiate such donations. The CRA is also taking a closer look
at donations of property other than cash.
7. Employment expenses The CRA is paying closer attention to employees who
attempt to deduct employment expenses from their employment income.
8. Child care expenses Deloitte's partners have observed that many
organizations provide receipts to parents for services that may not qualify for
tax relief because their main purpose is not the provision of child care.
Examples cited by Deloitte include athletic coaching, music lessons and
9. Mining and oil and gas investments There are specialized tax rules
governing investing in resource properties. If you choose to invest in
flow-through shares and other resource-based limited partnerships, you may wish
to seek professional help as the CRA often requests additional information.
10. Tuition and education expenses The CRA continues to ask for backup for
backup for any post-secondary tuition and/or education expenses claimed on a
student's tax return. Keep copies of all tuition slips.