Articles
The Tax GameTM
Written by Calin A. Lawrynowicz for the SEA (Self Employment Assistance) Program in Toronto Volume 19, February 2002
The Canada Customs and Revenue Agency (CCRA) replaced Revenue Canada in November 1999 with expanded responsibilities for tax collection. The CCRA is rule driven and those rules are similar to rules for a game. Everyone is forced to play this game and you must learn the rules and tricks in order to obtain better results. Although your tax education will never end, below are some tips to assist small business owners.[1]
Tax
Game Rule 1: Know the
Rules
The Income Tax Act (the “Act”) sets the rules of the game and the rules are extremely complex in their entirety. However, a small number of the rules and principles are more important to be familiar with and can greatly affect a business’s tax liability.
The most important rule to know is the General Anti-Avoidance Rule (GAAR). This rule is like a ‘catch-all’ rule that can set aside certain transactions that are not caught by existing rules and abuse the Act. It is the unwritten rule that provides incredible power in tax collection by essentially allowing the CCRA to disallow certain tax benefits in certain situations. Over time a taxpayer will learn to respect, fear, loathe and even hate GAAR.
Tax Game Rule 2: Identify and Deduct Legitimate Expenses
The primary benefit of establishing a business is the ability to deduct business expenses from business income. What and how much to deduct are important questions as there is a fine grey line between effective tax planning and tax avoidance.
Consider any expenditure as a possible business expense--so keep all receipts. There are several methods used to categorize expenditures, but what is important is to identify which expenses may be deductible and which are definitely not deductible.[2] Determining how much of the expense is deductible can be more difficult and will likely require a tax professional as there are tricky rules for expenses like depreciation, bad debt, payable accruals, meals, entertainment, home office, travel and vehicle.
Simply stated, the basic rule is to deduct everything legitimately possible without inviting an audit by the CCRA. Good advice should save you money and you will begin to view expenses with tax rates in mind.
Tax Game Rule 3: Plan for Deductible Expenses
Once a business becomes or is about to become profitable, it may be time to plan for expenses. The Act clearly states that no expenses can be deducted from one’s income unless it was incurred for the purpose of earning income from a business. Further the Act places a limit on the amount of each deduction stating that the deductibility of expenses will be limited to an amount that is commercially reasonable under the circumstances.
These standards are very subjective, and they allow the CCRA a great deal of discretion in considering the legality of a taxpayer’s deductions. Some of the expenditures commonly targeted by the CCRA are payments made to a family member working within the business, expenditures allotted to creation of a home office, automobile expenses and entertainment expenses. Nonetheless, a taxpayer must not completely fear the CCRA.
Business and personal expenses often merge in small companies. Personal credit cards are used for the business and the interest may be deductible. Phones, vehicles, computers and other items at home may also be used and be legitimate expenses. With the proper planning, a business owner can receive the benefit of a deduction without the threat of an audit.
Tax Game Rule 4: Income Splitting
Splitting income between two or more family members is frequently used and requires care. The Act has rules preventing certain forms of income splitting and GAAR can set aside certain transactions not caught by existing rules but abuse the Act. Many business owners attempt to reduce the income tax payable of the business by paying salaries to other members of the family. CCRA closely scrutinizes both the legitimacy and the amount of salaries paid to family members by businesses. While the ability to legitimize this type of transaction can be complex depending on the nature of the business, a small business owner needs to keep the following ideas in mind.
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Detail the services performed by the family member
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Make sure that there is a causal nexus between the services and the nature of the business and/or make certain services rendered are directly related to the income producing activity of the business
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Make sure the family member is qualified to perform the services that he/she have been assigned by the company
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Make sure the family member is paid a salary comparable to the industry standard for the services rendered.
Care must be taken to legitimately split income, but once you are in a position where you may pay taxes and you have close family members who may be able to assist the business, I would consult a professional for assistance.
These Tax Game Rules are a few of a virtually endless list. More rules will be provided in subsequent articles. Please remember that most business professionals would agree that the small gains associated with abusing certain deductions are often not worth increased scrutiny from the CCRA. Obtain solid tax advice and push the limits of your legitimate deductions without crossing the invisible line that will trigger an audit. The cost of being audited, even if your deductions are not adjusted at all, is simply staggering.
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[1] This article does not provide specific legal tax advice and information contained herein is not meant to provide legal tax advice. Please consult a tax professional about your specific circumstances. [back]
[2] Virtually everyone will require assistance or further research to fully separate expenditures into the correct groups, so do not hesitate to seek advice. [back]
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© 2000 Calin A. Lawrynowicz. All rights reserved.
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