Harassment, Conflict and Litigation – Part Three

In the final instalment of this series on what creates the most HCL with the CRA in our SAS (“harassment, conflict and litigation” with the “Canada Revenue Agency” in our “self-assessment system”), we cover the granddaddy of disputable expenses – automobile costs. Any tax auditor worth his salt will zero right in on auto expenses like my tee shots to water. Why? Because everybody loves to drive and everybody loves to deduct car expenses. The problem is that the rules in this area are so onerous and complex, few taxpayers under investigation ever come out of it with no HC or L. It’s the record-keeping burden that gets most people into the HCL zone. So heed the following, and minimize your grief.

First, let’s summarize the basic rules for deductibility. As with any expense, the costs deducted must be in connection with your business. So how do we identify the business portion of the cost of something we regularly and continuously use for both personal and business purposes?

Kilometres.

Anyone who uses a car for business should keep track of the total amount of kilometres driven during the year, and a detailed account of which of those kilometres were driven in the performance of their business or employment functions.

Keep receipts and a detailed account of all your auto expenses, such as gas, repairs and maintenance, insurance, licence, registration, car loan interest and leasing costs. If you own your car, you may be able to claim depreciation (CCA).

Now you’re almost there, but you should be aware of certain limits that apply. If you lease your vehicle, deductible payments are restricted to $800 per month (or less, based on a formula, if the value of the car exceeds $30,000).

If you’ve borrowed to purchased your car, loan interest is limited to a maximum of $300 per month. For CCA purposes, there is a maximum on the capital cost of $30,000.

Finally, if you receive a non-taxable per-kilometre allowance from your employer, then you are not entitled to claim any auto expenses personally.

These rules are fairly detailed and objective, so where does the HCL come in? Problems normally arise in two areas – record-keeping, and what constitutes business mileage.

Most people by nature do not keep records as meticulously as the CRA would love to see. If you are audited, and need to justify the amount of kilometres you drove in a year for business purposes, the best evidence you could have would be a logbook where you keep track of where you drove, the number of kilometers, and the business purpose. Compare that to the total kilometres driven for the year, and you have pretty well justified your calculation. In most cases, however, a logbook does not exist, and the taxpayer is left to plead, cajole, regale and negotiate with mostly unsympathetic auditors to have them accept his ad-hoc percentage of business use.

In Quebec, the law requires that you keep a logbook if you drive a company car. Employees must provide their employer with a logbook within ten days after the end of the year, or face a fine of $200.

The second issue of concern is that sometimes it is not clear whether a trip qualifies as business use. Some taxpayers are unaware that travel from home to the place of work does not constitute business travel. However, here’s a tip: if you start out at home, make a stop for business purposes, say at a client’s premises, then proceed from there to your office, then the entire trip would qualify.

What about the case where home is the regular head office and work is carried out at remote sites, such as in the case of a self-employed contractor? If you can establish that your home is your center of operations, then all travel to a work site should be considered for business.

In this series of posts, we touched on some of the most common areas where taxpayers find themselves in hot water with the CRA. Our SAS requires good record-keeping and knowledge of the law. Hopefully, these articles have helped you with the SAS and your HCL level should go down from here.

Harassment, Conflict and Litigation – Part One

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!