The Cost Could Be Very High: COMMINGLING OF PERSONAL EXPENSES IN THE BUSINESS

In a July 23, 2020 Tax Court of Canada
case, at issue were a number of expenses
claimed by the taxpayers (a corporation
and its sole individual shareholder) in
respect of the business of selling financial
products and providing financial planning
advice. CRA denied various expenses
spanning 2007 and 2008 and assessed
many of them as shareholder benefits.
That is, the amounts were taxable to the
individual shareholder and not deductible to
the corporation. CRA also assessed beyond the normal reassessment
period on the basis that the taxpayers made a
misrepresentation attributable to neglect, carelessness, wilful
default or fraud. They also assessed gross negligence
penalties which is computed as the greater of 50% of the
understated tax or overstated credits related to the false
statement or omission, and $100.
The following expenses were reviewed:
– bonuses paid to family members who were not
employees of the taxpayer;
– payments to family members under an Employee
Profit Sharing Plan (EPSP) where there was no
evidence that the payments referred to profits;
– salaries paid to family members (including the
shareholder’s daughter who received a salary of $5,000
in 2007 and $400 in 2008);
– salaries paid to the taxpayer’s children’s care
providers;
– salaries to the taxpayer’s former spouse, which the
taxpayer argued was the same as personally paying
spousal support;
– travel costs for the taxpayer and his family to go on a
cruise on which the taxpayer made business-related
presentations (CRA conceded the taxpayer’s travel
costs);
– significant interest expense with very little support;
and
– many other costs such as clothing, toys, jewelry,
personal items, lawncare, maid service, and pet
care for the shareholder and family members.
While the taxpayer originally claimed the travel expenses for
the taxpayer’s family to travel to Hawaii for a shareholders’
meeting, the taxpayer conceded these amounts.
The taxpayer argued that any benefits taxable to him
personally were conferred by virtue of his employment, not
his shareholdings, and, therefore, should be deductible to the
corporation.
Taxpayer loses
In dismissing the taxpayer’s argument, the Court found that
the vast majority of expenses reviewed were personal in
nature and denied the deduction. The Court also found the
vast majority of denied expenses to be a shareholder
benefit. These expenses were not, by and large, expenses a
reasonable employer would otherwise pay for the benefit
of an arm’s length employee. The taxpayer, through his
unfettered control, chose not to pay salaries or bonuses but
rather to deduct the disallowed expenses from the corporate
receipts and never report or ascribe any amount of benefit or
employment income to himself.
The Court upheld CRA’s assessment beyond the normal

limitation period as well as gross negligence penalties,
noting:
– the sole shareholder’s education and training
regarding complex tax integration, small business
deduction strategies, and corporate/personal lifestyle
structuring;
– the individual unilaterally directed which expenses the
corporation should deduct, even though some were
clearly personal; and
– the degree and scope of the upheld assessments
were very large – in excess of $700,000 for the
corporation and in excess of $1,100,000 for the
individual, both spanning a two-year period.
The Court stated that the gross negligence penalties exist
for these such situations: sophisticated taxpayers must
appreciate that using corporate structures to mask
inappropriate deductions and shield personal income from
tax should not be done.

The result of these inappropriate deductions was effectively
triple taxation – corporate tax on disallowed deductions,
personal tax on shareholder benefits, and a 50% gross
negligence penalty on both the corporate and personal taxes.
It would have been much cheaper had the taxpayer taken
additional salaries or dividends, and paid the additional taxes
up front, rather than running personal expenses through the
corporation.
In the case where personal expenses are paid by the
corporation, the accounts should generally be corrected by
adjusting the shareholder loan account or having the
individual pay the corporation back. This was not done in
this case.
ACTION ITEM: As best as possible, keep business and
personal expenses separate. Deducting personal
expenses in a corporation can lead to a very costly bill,
well in excess of the tax should the amounts have been
reported correctly.

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