Canada: Claiming Expenses Without Supporting Tax Documentation – A Canadian Tax Lawyer Analysis

Last Updated: October 13 2017
Article by David Rotfleisch

Introduction – Tax Audits and Support for Deductible Expenses

For small businesses and businesses in general, maintaining organized books and records is essential to the business being able to withstand scrutiny on a thorough CRA tax audit. However, running a business can be time-consuming and exhausting and it is our firm's experience that ensuring the availability of documentary proof for legitimately incurred business expenses can often take a back seat to other priorities of the business owner(s). Unfortunately, this can cause serious issues for businesses because CRA tax auditors have a nasty habit of denying any expense claimed by a business that is not coupled with proper supporting documentation. However, in tax law, the deductibility of business expenses is not dependent on the availability of a receipt and/or proof of payment. The Income Tax Act contains no statutory requirements with respect to the audit evidence that must be presented to claim business expenses and the internal CRA Audit Manual explicitly acknowledges this fact. While a proper receipt and proof of payment is obviously ideal in all circumstances, it simply does not follow from the lack of such documentation that the expense was never incurred. Our Canadian Tax lawyers are familiar with the burden of proof in tax law and can quickly identify assumptions made by CRA in order to quickly assess a taxpayer's issues and chances of success.

Deduction of Business Expenses – Indirect Tax Audit Techniques

Absent a specific statutory provision to the contrary, expenses incurred for the purpose of earning income from business or property are deductible for tax purposes. The issue, more often than not, is convincing a CRA tax auditor that an expense was in fact incurred by the business. Although CRA understandably has internal policies that establish what documents a taxpayer should provide to support expenses, these internal policies are not law. In fact, the CRA Audit Manual explicitly endorses the use of "indirect audit techniques" by tax auditors in order to determine the reasonableness of expenses that are not supported by documentation. Indirect techniques cover a wide range of approaches, including conducting analysis of a prior years' books and records or reviewing the bank statements of the taxpayer. Our tax law firm also routinely advocates for indirect techniques with a common sense approach. For instance, if a taxpayer owns and rents out 6 residential properties, the fact that he or she cannot locate property tax statements to support that expense should not lead to the conclusion that they did not spend $20,000 on property tax. If CRA accepts that such a person is on title for the rental properties and earns income as a result, they should accept that the rental properties are each subject to property tax and that the taxpayer had to pay that expense. Likewise, a long haul truck driver should not be denied all unsupported fuel expenses simply because they are unable to provide receipts. While such a taxpayer may not get credit for 100% of the claimed fuel expenses, they should be allowed a reasonable amount of expenses that takes into account the nature of their business and the average gas mileage of the vehicle.

Unsupported Expenses – Oral Evidence and Settlement on Tax Court Appeals

If a taxpayer spends money on an expense, has no supporting documentation for that expense and CRA tax auditors and appeals officers do not otherwise believe the taxpayer that the expense in question was incurred, the taxpayer's next recourse is an Appeal to the Tax Court of Canada. In Benjamin v The Queen, 2006 TCC 69, Chief Justice Bowman accepted a taxpayer's oral testimony as proof that the taxpayer had in fact made an otherwise undocumented loan to his corporation on the basis that the taxpayer's oral evidence was credible. In Benjamin, Bowman CJ commented that the Tax Court of Canada does not require specific documentary evidence unless the taxation statute specifically requires it and also stated that the Court cannot avoid its responsibility by essentially telling a taxpayer "it doesn't matter how credible your testimony is, if you don't have a piece of paper you must necessarily lose."

Appeals to the Tax Court of Canada involving undocumented expenses do not necessarily have to result in a formal trial in order to find success. Counsel for CRA, the Department of Justice, are tax lawyers with ethical and professional obligations to the administration of justice and they will always entertain reasonable settlement proposals in lieu of running trials that are costly to both the individual taxpayer and Canadians on the whole. Our Canadian tax law firm is adept at explaining a client's business in a concise fashion and using publicly available information, such as Industry Canada business comparables, to make detailed and reasonable Tax Court appeal settlement offers to achieve good outcomes for our clients.

Tax Tips – Undocumented Business Expenses

In a perfect world, business owners would be able to provide a comprehensive invoice for every expense incurred on request by a CRA tax auditor. So the first tax tip is keep all of your receipts in an organized fashion. However, the reality is that many businesses struggle with organization and do not maintain suitable supporting documentation for significant legitimate expenses, particularly if years have passed since the expense was incurred. However, the presence or lack of supporting documentation is not determinative of whether or not a given expense is deductible by a business. CRA internal policy encourages auditors to use indirect audit techniques to verify otherwise unsupported expenses. Appeals to the Tax Court of Canada are ideal for taxpayers who rely entirely on oral testimony to support an expense and also present the opportunity for more creative avenues of settlement. If you are shocked by the result of a CRA tax audit, contact our top tax lawyers to discuss your case and determine the best course of action for you.

The information is thought to be current to date of posting. Income tax law changes frequently and content may no longer reflect the current state of the law. This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

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David Rotfleisch
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