How an Auditor Views Your Tax Return:

Proving Business Expenses

What is Income to an Auditor:

An auditor will take the position that "all bank deposits that you do not prove

to be something other than income", is considered taxable revenue to them

However an Expense

is not all withdrawals from that same account, expenses must be proven and

reasonable.

The extent and proof is usually at the discretion and whim of your chosen

auditor

I know not fair is it

Even when well documented a CRA Auditor can still decide expense is not

related to business or personal in nature.

What is a Business Expense?

Paragraph 18(1)(a) of the Income Tax Act (“ITA”) is the beginning of a long

list of limitations on potential expenses. It provides that no deduction shall be

made for:

18(1)(a) an outlay or expense except to the extent that it was made or

incurred by the taxpayer for the purpose of gaining or producing income

from the business or property.

Sometimes there is a business purpose to an expense; for example, a

restaurant business buying an oven, but the ITA restricts the deductibility of the expense (as capital

expenditure). The focus of a dispute may be on trying to get around a specific limitation in

the ITA.

In Symesv.R. the Supreme Court of Canada ("SCC") provided guidance on

how to determine the nature of an expense. That guidance is not easily

distilled into a test.

In fact, Iacobucci J., writing for the majority, provides a concise analysis of

the weaknesses of various “business purpose” tests posited in the

precedents and by the parties and concludes as follows.

Upon reflection, therefore, no test has been proposed which improves

upon or which substantially modifies a test derived directly from the

language of paragraph18(1)(a). The analytical trail leads back to its

source and I simply ask the following:

"did the appellant incur child care expenses for the purpose of

gaining or producing income from a business?"

A determination of the purpose of an expense is an examination of the

taxpayer’s intentions.

Iacobucci J. says that courts will “look for objective manifestations

of purpose.”

As always, intentions are determined by actions. There is no fixed list of

questions whose answers will determine the nature of an expense.

The CRA Audit Manual:

Almost all business audits include a review of the expenses of the business.

The CRA instructs its auditors to look for specific items in expense claims.

The existence of these items may trigger a more detailed audit of

business expenses.

The following is from the audit manual when I was auditing:

Personal Expenses:

When scanning purchases journal watch for the following:

1. Purchases from suppliers that do not carry goods that would

normally be used in the normal business activity

2. Purchases invoices made out to the taxpayer\registrant

personally or to another family member

3. The delivery address is the taxpayers residence (yes even

when working from home)

4. Personal purchases may be paid by credit card. Scan the credit

card statements to determine whether the purchases include

personal items. Ensure that the taxpayer/registrant has not

claimed personal travel as a business expense.

5. Where the business activity includes selling or purchasing

products that are general household items the risk of personal

use of products increases. Indirect methods of verifying the

amount may be required.