It is common for our Toronto tax lawyer firm to encounter Canadian taxpayers who have been reassessed by the Canada Revenue Agency ("CRA") disallowing expenses and who are having difficulty reaching a successful resolution with CRA on their own. Taxpayers come to us for assistance so that they can regain their normal lives while we deal with the tax department and the stress of an income tax audit.
Yet, one of the simplest things taxpayers can do to minimize headaches while dealing with CRA is to keep accurate records of their transactions and supporting documents. This is most evident when a taxpayer is subject to a tax audit ,reassessed and denied large amounts of business expenses they validly incurred yet do not have adequate records to support. When this happens, the taxpayer’s income tax liability can be substantially increased. Without adequate records a taxpayer’s only hope may be to try to convince a judge that the challenged expenses are legitimate—a difficult, costly and time-consuming proposition.
Let’s take the example of a sole proprietor operating under his own name. Sometimes he or she is running a business separate from his day-to-day employment and feels that he has little time to document his business transactions. Or he does not know what the accounting requirements are. Or pays cash to some service providers or for purchases to get a better price and does not obtain a receipt. This is where the trouble begins.
As a sole proprietor running a business, he is entitled to deduct expenses incurred to earn his business income. He may spend money on his motor vehicle, travel, business-related conferences, business-use-of home office, supervision and training, computer, internet and cell phone, fees, licenses, dues, memberships, and subscriptions, etc., all related to establishing, running and growing his business.
If after deducting expenses the business incurs a loss he has a business loss eligible for deduction thereby reducing his taxable income. He can use this loss to offset personal income in any previous three years or can carry it forward and apply it within seven, ten or twenty years depending on the year the loss is incurred. But first he will have to prove to CRA that he is carrying on a real business and that business expenses claimed against business income are properly deductible.
Often times when there is inadequate documentation, taxpayers need to hire professionals such as our Toronto tax lawyers to resolve their issues with CRA. Maintaining proper records can substantially decrease this expense.
The business owner must persuade CRA that the expenses were incurred to earn business income. For example, CRA in part recommends the following:
Details Required in Tax Receipts
Always get receipts or other vouchers when you buy something for your business. When you buy merchandise or services, the receipts have to show:
- the date of the purchase
- the name and address of the seller or supplier
- the name and address of the buyer
- a full description of the goods or services
- and the vendor’s business number if they are a GST/HST registrant. (T4002- Business and Professional Income)
If you take a client out for a meal make sure to keep the receipt and note on the receipt the purpose for the meeting. If you have a vehicle you use for business purposes, keep a log of your trips. Smartphone apps are available for this. Also, a separate bank account and credit card for your business is recommended, and of course retaining related receipts is necessary. Ultimately, make sure to retain and organize any receipts related to your business.
Depending on the size of your business you can use software or a simple paper file system. However, bookkeeping software is ideal to keep track of amounts. Make sure to identify each receipt by writing a note indicating the purchase type, for instance, as this is not always clear from the receipt itself. If you file receipts using a software program you can scan them into your program and they can be cataloged according to the information you enter. If you are using a paper file organize by day, week or month, depending on the frequency of expenses. Common sense will go a long way in this process. Accordion type file folders categorized by month and type of expense are ideal. Make sure your receipts and records are easily identifiable and easily retrievable. Avoid the shoe-box method if possible, but it is better than having no records.
Also beware of paying cash and not obtaining a receipt. You will not be able to prove the expense and will not be able to claim the tax deduction.
Lastly, CRA has the legislative authority to penalize you for failing to keep adequate business records. You do not want to go through the CRA tax audit and appeals process to learn that lesson.