I took a client to lunch the other day and he made an interesting observation. He thinks the income tax system in this country is based on harassment, conflict and litigation (what I will hereafter refer to with your permission as the HCL of Canadian tax). I felt obliged to point out to him that although HCL is a dominant feature, the actual basis of our tax mechanism is quite the opposite. In fact it relies at its core on the “self assessment system” of taxes by the taxpayer himself (Let’s call it the SAS). If a taxpayer practices accurate and honest SAS, then he will completely avoid the HCL. Well, that’s what our government (the CRA) tells us anyway, and I guess that would be true, at least in a perfect world (APW). Of course we don’t live in APW, and in our constant efforts to SAS, we might inadvertently cross the line, receive a friendly visit from the CRA and get into some stressful HCL.
The next three articles will deal with what I believe to be among the most common causes of HCL in our system: meals and entertainment, and automobile expenses (MENTA). When MENTA are related to the process of earning taxable income they may be deducted from income for tax purposes. Therefore, I should have been allowed to write-off the cost of that lunch as well as the gas and other car expenses for my trip downtown, right? True, but what about the personal element to my expenses? Arguably, I had to eat anyhow, and what about my little side trip to Golf Town on the way back to the office?
Now you’ve got the picture, right? These business expenses will invariably contain some personal element and it is this problem that not only causes a great deal of HCL, they have led to constantly changing sets of rules developed and refined over the years that are so difficult to understand and comply with, that only The Tax Issue could be relied upon to explain them to you, kind reader.
Before we get into the actual details of what can be deducted, let’s talk about who can take these deductions. For the purposes of our discussion, let’s divide the world into two types of taxpayers: those who are employed and those who are in business. If you are in business, then you generally have no restrictions on what you can deduct as an expense as long as it relates to your earning of income. All you have to do is follow the specific rules relating to the MENTA as we will discuss later.
One more general note about business (and forgive the digression) – the calculation of deductible expenses is generally the same, whether the business is run by an individual (sole proprietor), partnership or corporation. So please don’t ask again.
Employees are not so lucky. In fact, they are treated in an opposite fashion. In general, they are allowed no deductions from income unless specifically provided for them under the law. In the case of MENTA, luckily, such provisions do exist, but there are certain conditions.
The most common MENTA deductions allowed to employees are automobile expenses. In order to claim auto expenses, employees must meet strict conditions. They must have a contract (verbal or written) with their employer providing that they are required, as part of their employment duties to travel, and that they must bear the cost of their auto expenses. As evidence, they must have their employer complete and sign a prescribed form stating the terms of their employment and whether auto expenses are reimbursed either directly or through an allowance.
Generally, you cannot deduct meals and entertainment costs if you are an employee. The only exception to this rule is if you earn commissions. A commissioned employee is generally treated similar to a person earning income from a business. That is, there is a general rule allowing the deduction of expenses relating to the earning of that income. The only restriction is that the deductions are limited to the amount of commission earned in the year.
Next time, we’ll be discussing the deduction of meals and entertainment expenses and the HCL that goes along with it!