They came to see me in July. He has a consulting business and says she does work for it. I had asked them to bring along the items on the checklist on Page 7. They produce a thin folder with a corporate return for March 2005, business bank records, and purchases to March 2006, personal tax returns for 2006. They inform me no instalments have been paid for the current year, and the bookkeeping has not been updated for 18 months.
Sales this past year doubled, but they have no invoices. She tells me they worry how much tax they will owe and asks, "We have a company. Why would you care about our timesheets, personal net worth, and cash flow? Our personal tax returns are easy. We do them ourselves."
I respond, "As officers and directors, CanRev usually considers you employees of the company."
"Oh!" They say, looking puzzled. "We don’t do timesheets or payroll. We don’t have personnel files. We don’t need them. It’s just us. Our accountant just prepared T4As for self-employed income of $30,000 for each of us. We take advances whenever we need cash. The company pays quarterly instalments to our personal accounts."
Shareholder/employee income is recognized on a calendar-year basis, not a fiscal-year basis. If your T4s reflect your income from your corporate year-end rather than your calendar year-end, as was this case in my example above, you are in for a rude tax-payable surprise when you retire or sell your business. If you die, it will be your estate that pays the tax and penalties and interest.
It always starts small. The books are not current, so the T4 preparer takes the income from the corporate year-end rather than requiring you to prepare your records up to the end of December to calculate and prepare the T4 by Feb. 28. The business grows. It gets harder to explain how far behind you actually are, or maybe the tax preparer does not know this is required.
CanRev expects you to report your personal income on a calendar basis. Keep your accounting up-to-date. Present the books and records current to December in February of the following year to prepare the T4s.
I continue, "Does the company own the vehicle, or are you reimbursed for kilometers?"
"We’re reimbursed at 50 cents per kilometer. Why do we need a kilometer log and calculations?"
"The tax-free reimbursement rate reduces after the first 5,000 kilometers each year.
They pay their business expenses with their personal credit card, and their single customer reimburses them.
There are no invoices. Instead, there’s a contract, and they get a cheque every month. I ask, "Minute book?"
"Well…we aren’t sure we have one, but we pay our annual fees to the province. Come to think of it, we did not see an invoice last year."
I probe a bit further, almost dreading the answer. "Do you have any idea if shareholder loans exceed funds owed to shareholders?
"What does that mean?" they respond.
I ask, "Did you hold back enough money to pay remittances for tax and CPP on draws as the business income doubled?
"We don’t have any savings, if that’s what you mean. We took a cruise with the extra money. We did make a $1,000 RRSP contribution, and we did send in some money to GST for the company GST return, but can’t find the form. We’re not sure how far behind we are. Our previous accountant never asked about GST/HST or PST and workers insurance returns. The company never pays any tax."
In BC, a company must be registered with the provincial workers insurance board (WCB) unless it is a Personal Services Business. No surprise — my clients aren’t registered.
As for questions about self-assessing provincial sales tax on out-of-province purchases, or using Air Miles generated by business related travel, I get blank stares.
My new clients are squirming. "Our tax preparer never asked any of these questions. Why are you asking these questions?"
Why ask these qualifying questions? Well, let’s see:
CanRev requires tangible proof that a spouse provides bona fide services. Record-keeping not completed for 18 months, no invoices, deposits once a month. What special skills does the spouse possess? Is there a job description? What would a third party be paid for similar work? Do customers or suppliers know that the spouse works for the business?
Directors and officers of privately owned companies are usually considered employees by CanRev. Proof of self-employment? Has a ruling been requested?
CanRev will check reasonability and entitlement. Will anyone believe you live on $60,000 when over half your net salary pays mortgage payments of $2,100? Is the spouse a shareholder entitled to dividends? Draws by the spouse might be classified as deemed dividends attributed to the husband if the spouse is not a shareholder. Can- Rev can and does refuse to reduce income claimed when reducing expense claims if not reasonable, resulting in double taxation.
Record keeping is a required activity, not something you get around to every few years. CanRev actively engages in books and records reviews. Last week a notice in my local paper announced visits to local businesses. Review CanRev’s Record Keeping Guide (Publication RC4409) and Electronic Record Keeping (Publication IC05-1), published in June 2005.
Accrual accounting is required. How much testing of subsequent events was done if the records are not current?
Liability for injury. In BC, all corporations must be registered for WCB, as the workers insurance program is called here. Even if dividends are paid instead of salaries and a Personal Services Business does not pay WCB, the ultimate employer is liable.
Liability for PST. Provincial sales tax rules are extremely complex, frequently not commonsense. Who checks liability to charge tax on goods and services or self-assesses when purchasing used goods or new goods purchased from other provinces or countries?
Self employed GST/HST registration. If truly selfemployed, did they invoice and charge GST for reimbursed expenses? Are the self-employed shareholders registered for GST? Reimbursed expenses are included in the threshold calculation of $30,000 in any four consecutive calendar quarters.
Personal Services Business tax rules are extremely punitive. One of the first signs that a business is a Personal Services Business is that the “employee/contractor” has absolutely no expenses.
CanRev has only two categories, self-employed and employed. Shareholders might not be employees of their customer, but most likely are employees of their own company.
If the company has only one customer and fewer than five full-time employees, it may expense payroll paid to employees but may not deduct expenses other than those a regular employee would be able to deduct. See CanRev’s Employment Expenses Guide (Publication T4404).
The small-business tax rate does not apply. All income taxable in the company is at the highest corporate tax rate.
Involuntary windup triggers deemed dividends at fair market value of net assets. In BC, your company will cease to exist under the new Corporations Act in early 2006 unless you did something to convert.
IVI Audits are triggered by poor record-keeping, lack of documentation, and suspicion by the auditors that they will find something. See my article on this topic entitled “New Canadian Winter Games” in our January 2006 issue.
CanRev has a voluntary disclosure program. Penalties can be forgiven if you come forward voluntarily before CanRev contacts you. You might ask why not just bring the corporation up to date this year and forget the past? You do not have a choice if you voluntarily disclose.
CanRev will require you to fix the past for both corporate and personal returns. CanRev may reassess inappropriate withholdings, apply penalties for late remittances, adjust personal taxes, and consider corporate adjustments for inappropriate expense claims.
Serious about your business?
Here’s what you need to provide if you really, truly want your accountant to get you and your small business onside with CanRev:
- Corporate minute book, tax returns, and financial statements for the company since incorporation.
- General ledger, electronic data files, asset files, vehicle use log, reimbursement calculations.
- Time sheets, personnel files, payroll records, workers insurance reports.
- Customer contracts, GST/HST and PST returns.
- All invoices, purchases, banking, investments, credit and debt documentation for business year-end and current year.
- Corporate cash flow forecast.
- Personal tax returns for past 10 years, any elections or carryforward calculations.
- Permission to access CRA account online for personal and business accounts.
- What you personally own, including all investments, RRSPs, capital or rental property.
- What you owe, bank statements, deposit details for all deposits, credit cards, debt documentation for personal accounts.
- Cash flow proforma for your household.