Jamie Golombek: Failure to provide appropriate backup for expenses claimed can lead to costly penalties
Businesses are required to keep records and receipts to back up their tax claims. Photo by Getty Images/iStockphoto The Canada Revenue Agency this week began accepting 2021 electronically filed tax returns through its popular NETFILE and EFILE services. The May 2, 2022, deadline still gives you plenty of time to file, but now is a good time to gather your receipts together, especially if you’re planning to claim business expenses on your return.
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Failure to file a return on time, or to provide appropriate backup for expenses claimed, can lead the CRA to issue an “arbitrary assessment” for tax owing, along with costly penalties. That’s exactly what happened in a recent tax case decided last month.
The taxpayer is a truck driver who operates his business through a private corporation owned by him and his wife. He is the company’s sole employee and he transports produce, meat and other goods across the Canada-United States border.
It turns out the taxpayer never filed tax returns for his trucking company for the 2012, 2013 or 2017 tax years. Or, if he did file returns, as he claimed, the CRA never received them. In May 2018, the CRA wrote to the taxpayer asking him to file corporate returns for those three taxation years. The agency wrote to him again in June 2018 asking him to file, but no returns were received.
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Consequently, the CRA proceeded to issue “arbitrary assessments” for each of the corporation’s missing taxation years. With an arbitrary assessment, the CRA has the power to assess tax owing based on its best (guess)estimate of a taxpayer’s income and expenses for a particular taxation year.
The CRA estimated the corporation’s gross income in each of those years by referring to its GST return for the calendar year closest to the particular taxation year. The CRA then deducted 30 per cent as an estimate of reasonable expenses, and deducted the salary expense as reported on the corporation’s payroll records. The CRA assessed federal back taxes owing of about $20,000 total for the three reassessed years, plus nearly $12,000 in failure-to-file penalties for those years.
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In order to fight an arbitrary assessment, a taxpayer must disprove, on a balance of probabilities, the assumptions of fact underlying the CRA’s assessments. In this case, the taxpayer testified he kept the corporation’s financial and tax data for 2012 and 2013 on QuickTax software on a laptop computer, which he kept in his truck. (QuickTax has since morphed into TurboTax).
Under the Income Tax Act, anyone carrying on a business is required to keep records. Photo by Stepan Popov/Fotolia In July 2018, the taxpayer was involved in a serious crash while driving his truck in the U.S. He spent one day in hospital followed by months of recuperation. He testified he was unable to retrieve anything from the truck following the crash, including his laptop.
The judge was unconvinced that the taxpayer couldn’t have retrieved the laptop from the truck following the crash, either by asking the towing company, police or anyone else to do so on his behalf, but in the absence of the laptop, the taxpayer would need to show some type of backup to justify his business expense claims.
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The corporation did not have an accountant, nor a bookkeeper, and the taxpayer testified he kept the corporate receipts and invoices at his Toronto home. Yet he chose not to bring any of those receipts or invoices to the hearing, saying they were in “big boxes.” Instead, he produced a one-page summary of revenue and operating expenses for each of the corporation’s 2012 and 2013 taxation years. He said he assembled each summary using the corporation’s receipts and invoices. The taxpayer claimed an additional $11,269 of expenses in 2012 and $27,435 in 2013, but failed to provide any reliable evidence to support his position that those additional expenses should be allowed.
The judge was skeptical about the figures listed on this summary. Fuel costs were listed at exactly $15,000, and hotel and food costs at exactly $2,000 on the 2012 summary. “Those amounts appear to have been rounded up or down,” the judge said. “It is unlikely that they reflect the total of actual invoices or receipts. It is more likely that they are simply estimates. But there is no way of knowing without reviewing the source documents themselves.”
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More On This Topic Tips so you don’t end up in tax court for overcontributing to your RRSP Everything you need to know about claiming home office expenses on your tax return What you can do when the CRA starts asking questions about your CERB relief Why do we even have to file a tax return in the first place? Under the Income Tax Act, anyone carrying on a business is required to “keep records and books of account … at the person’s place of business or residence in Canada … in such form and containing such information as will enable the taxes payable under this Act … to be determined.”
The judge stated that either such records do not exist or, if they do exist, they would likely have not supported his case. The judge concluded that the CRA’s approach to computing net income under the arbitrary assessment rule was “reasonable in the circumstances.” He added: “(I)n light of the complete absence of source documents, and serious concerns about the reliability of the summaries, the corporation has not disproved, on a balance of probabilities, the assumptions of fact underlying the (CRA’s) assessment of tax for each of the corporation’s 2012, 2013, and 2017 taxation years.”
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Article content The judge then turned to the failure-to-file penalties. The taxpayer attempted to argue that he did, indeed, file corporate returns for the years under review, but testified he could not recall exactly when he filed them “because it was a long time ago.” The taxpayer was unable to produce any type of confirmation of the electronic transmission of the returns, nor produce any hard copies of those returns or copies of any Notices of Assessment issued by the CRA.
After weighing the CRA’s evidence against the “vague, shifting, and contradictory evidence” given by the taxpayer, the judge concluded the late-filing penalties were, indeed, appropriately assessed.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com
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