Low-Hanging Fruit for the Auditor
There are a variety of areas most often targeted by auditors because they are low-hanging fruit. The auditor doesn’t have to do much work in order to deny vehicle expenses, entertainment expenses and home office expenses. This makes them happy and makes their job easier. So expect that in every audit that the auditor is going to target these three areas.
Business use of a vehicle
The reality is that most small businesses, and certainly almost all sole proprietorships use a vehicle which is also used for personal purposes. Auditors know that people cannot generally substantiate the vehicle expenses that they have claimed. Many small businesses just pick a number – say 50% or 20%, and auditors know this.
It is perfectly fine to use a vehicle for dual purposes, but in order to make it through an audit it will be important to be able to distinguish the business use vs. the personal use.
What all auditors look for is a vehicle log. Plain and simple. If you have the vehicle log and it adds up, the auditor will allow the vehicle expense. Otherwise expect that they will give you a hard time. A vehicle log is simple to keep. Throughout the year you will record each business trip in the vehicle log: where you went, starting odometer reading and ending odometer reading. You also need to take an odometer reading at the beginning and at the end of the year. Once all the business kms are added up, you determine the percentage of vehicle use which was for business purposes (eg: 15,000 km business / 20,000 km total = 75% business use).
As a sole proprietor you can claim the business percentage of auto expenses as an expense.
If you run a corporation, you could have the corporation reimburse you for its share of the use of the vehicle expenses (lease cost, fuel, maintenance, insurance). This reimbursement is not taxable if it reflects the actual cost. In turn, the amount of the reimbursement to you becomes an expense to the corporation.
Meals and entertainment
Meals and entertainment are another prime target on the CRA’s list of items to be examined because of the frequent abuse in this area. Virtually every small business owner I have ever dealt with has written off an extra dinner here and there or a pair of tickets to the game or a concert which were actually used personally. This is normal. Not legal, but normal. Some business owners take this to an extreme level and attempt to expenses a huge number of meals, and tickets. This is low-hanging fruit as far as the auditor is concerned.
When the auditor approaches these expenses, they want to see the original receipts as well as documentation for every single meal or ticket purchased to show the name of the client and what the purpose of the expense was. If the taxpayer cannot produce this information during the audit, the auditor is more than happy to reassess and disallow the expenses.
Taxpayers also need to remember that only 50 percent of a client meal may be expensed (you can expense their meal, but not yours). These rules are different, however, when taxpayers have to travel for business.
Business use of the home
Taxpayers get into trouble with home office expenses. Most times people don’t bother to take actual measurements to determine the percentage of the home used for business purposes. Often times people inflate the actual square footage (or percentage) or they arrive at the figure using absurd logic. I once had a client claim their entire garage when its only business use was to store about a dozen banker’s boxes of old files. The CRA auditors see through this during an audit and unless the taxpayer can support their claim, they can expect the auditor to deny expenses.
To satisfy the auditor, one needs to show their actual expenses (e.g., property tax bills, mortgage statements, and electricity bills), plus demonstrate the percentage of the home being used for business purposes. Not a crazy percentage, but the real percentage. And in case taxpayers move and are not able to show their home office to the auditor, it is important to document the home office with photos and floor plans.
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