The Canada Revenue Agency (CRA) is becoming more aggressive in how they select their audit subjects. What we’ve seen happening with a few of our clients is a new range of enforcement initiatives, including a much closer examination of professional fees claimed by taxpayers. The CRA has been requesting the submission of detailed invoices of all professional fees claimed. They may ask detailed questions to determine whether fees claimed were personal or corporate in nature, and whether they are incurred on income or capital accounts.
The Professional Services Audit
Professional fees may have been paid to a variety of different recipients, such as accountants, lawyers, consultants, management administrators, investment managers, and other advisors. As a follow up to an audit of professional fees, it’s possible that the CRA will conduct spillover audits on any of these groups of recipients to ensure revenues have been reported and treated appropriately for GST purposes. The CRA also hopes that these audits will not only analyze the corporate shareholders and other related parties, but will also increase the breadth of their audit reach to the employees and other distantly associated parties.
The CRA is likely to evaluate the reasonableness of salaries paid to family members, and to review the appropriateness of management fees paid to shareholders or other related parties while reviewing professional fees expenses.
However, this scope may expand beyond related parties with proposed adjustments to include taxable benefits to ordinary employees, or assessments of withholding taxes on payments to non-residents under certain regulations. These employees or non-resident recipients of the income will then likely be pursued by the CRA to ensure they have reported the income properly, and to ensure only limited expenses required by the taxpayer’s employment contract have been claimed.
When the recipient of the fees is a corporation, the CRA will determine whether the income qualifies as Personal Services Business income, as this income is subject to higher corporate tax rates with very limited deductions in accordance with the special rules.
How This Impacts Your Business
These audits are generally selected at random. What does that mean for your business? Well, your corporation could receive a letter requesting documentation for specific expenses claimed in a certain taxation year. A response to the CRA’s letter should be made within the indicated time-frame (typically 30 days), and an extension may be requested if necessary.
If you don’t responded within the allotted time-frame, you could be hit with a reassessment and denial of the expenses. This will also have the CRA wanting to dig deeper, and future audits of your corporation becomes more likely.
How You Can Prepare
Ensure copies of all invoices and receipts are retained on file, and maintain proof of payment for any expenses you claim in your business.
Note: The CRA will typically not accept a credit card statement as the sole document supporting the deductibility of a particular expense — a backup receipt or invoice is expected.
Be sure to confirm that no personal expenses are deducted in the corporation and are properly allocated to the shareholder loan/draw account. If you own multiple corporations, ensure that the expenses claimed relate to that specific company, and not a related corporation.
For business expenses that the CRA may construe as a personal expense, additional documentation might be required to support the business income earning purpose of the particular expense. For example, if you traveled to a convention held in Las Vegas the CRA may require a copy of the convention itinerary as part of the additional documentation required to satisfy that the expenses were not personal. The receipt for the hotel and airline alone may not be sufficient.
Any expenses that cannot be verified by a third party invoice, proof of payment and possibly additional documentation, may be denied. Additionally, any non-business related expenses that are not deductible for tax purposes may be denied, and reassessed.
Finally, if there are one or more denied expenses that lack any justification as business related and the CRA auditor is of the view that you should have known better, gross negligence penalties may be assessed. The gross negligence penalties may be equal to 50% of the tax otherwise payable.
If you are contacted by the CRA), please contact us for assistance and advice. We would be happy to help!