How to Get Audited Thanks to 2 Simple Words: Shareholder Loans

Many taxpayers, especially business owners, are terrified of being audited by CRA. The internet has many blogs from individuals and professionals speculating on what causes one to get audited and how you can avoid it. 

It is true that certain behaviours on the part of the taxpayer can trigger an audit. One of the most dangerous as it relates to those who are incorporated is shareholder loans. 

Here is how it happens.  We know that many of you will relate because this is exactly what we see constantly from clients whose actions (often with their accountant’s ‘help’) have led to an audit.

And who ever heard of good news coming from a tax audit!

1. John and Mary quit their jobs.  As a hard working couple they have saved a little money and based on the good work they did as employees working on customer jobs (they are both plumbers) they believe they have enough referrals to triple their income by being self-employed.
2. Not being naïve, they know that they know their trades but nothing much about business.  They have seen their friends go bankrupt and they do not want that!  So they ask around and meet an accountant. In fact, they interview two accountants. Both told them that for personal liability reasons they should incorporate. Both accountants helped them estimate their cash flow and asked them what they needed for personal cost of living.  
3. That was all good, but accountant #1 told them to keep it simple and go onto payroll from their own company and pay the taxes every month. So they chose accountant #2.  He ‘won’ the competition because he told John and Mary how they can “pay no tax in year one”.  Wow! “We will be able to buy more tools, take a vacation, advertise more, etc. etc.” think John and Mary.  “We have found a very smart accountant.” 
4. The business starts to go quite well.  They are working every day and they are exhausted from all the tasks that come from running their own business and doing the work.  The good skills they had when they saved the money? Gone in the flurry of long days and Sunday emergency calls.  No worries!  John and Mary have never seen so much money in their lives.  Suppliers have given them terms.  GST/HST is only due every 3 months.  The bank sends them increased credit limits (lots of business expenses have been going through the credit cards which they pay off most of the time based on when customers pay them).
5. John and Mary put receipts in a special accordion file (now bursting and spilling onto the desk).  They continue to say they will catch up the bookkeeping and enter everything into QuickBooks tomorrow – which is just as hectic as today so that never comes around.
6. They take a vacation, buy a snowmobile and a new motor for the boat.  They are eating out a lot. Some unusual expenses occur. No problem! There is a lot of money in the business bank account.  
7. These are not negligent people and 4 months after accountant #2 calls then to ask where the books are they get them all together and send them over. Accountant #2 rolls his eyes at the mess but gets his bookkeeper to straighten the books out.
8. Accountant #2 calls John and Mary in for a meeting.  Here is what he tells them: “You owe GST/HST for two filing periods, we are missing receipts for many job-related expenses and tied only some of them into the credit card statements. You owe payroll taxes for the two apprentice plumbers and WSIB premiums. The company owes corporate income taxes but that is at the low rate of just 16% (“wow” think John and Mary, “we paid closer to 40% when we worked on jobs”).”  Feeling quite content (and just a tiny bit worried that they do not really know what this is all about) they have no real worries. The company bank account gets emptied and pays this all up to date.
9. In fact when the accountant shows these good plumbers the company balance sheet they see $110,000 as an asset!  What is that they ask? Accountant #2 tells them that they have drawn $110,000 personally from the company but do not have to pay tax on it this year.  So John and Mary go happily into year #2 not knowing what is about to happen.
10. Year #2 is not quite as good on the business front.  They lost one big account and had a bad debt to write off.  They spent another $120,000 personally – all just charged through the business account.  
11. At the end of year #2 accountant #2 does the financials and books.  He tells them the company owes corporate taxes again and because they did not pay quarterly installments there are interest and penalty consequences. They also have personal taxes to pay on year #1 to the tune of $110,000 - but he has done income splitting between them and “all” they have to pay is (combined) $27,000.  Lucky them - he declared a dividend for them to clear the $110,000 they owed the company from year #1 money spent personally.
12. Clunk! Their hearts drop. They quickly figure out how to tighten the belt and pay this off over the year at just over $2,000 per month.  But wait, we have to pay company tax instalments so the belt gets a little tighter – another $1,500 per month cash needed.  And it gets impossibly tight when they are told they need to pay personal tax installments quarterly on their year #3 income during year #2 (that is, while they are paying year #2 personal taxes).  
13. Worse still, the only source of money is the company and to get the money for personal taxes out they have to increase what they take out of the company. This drives up their tax rates and creates a bigger hole in their financial lives.
14. Confused? Well, to professional accountants it is simple: they are experts at spreadsheets and planning. However, to professional plumbers it is a recipe for disaster. 

Why not just follow the KISS principle?  Pay your taxes as you take the money.  Know that what you are spending is tax paid money and you are free to spend it.  Keep your business and personal financial lives separate.

That is what accountant #1 tried to tell them, but the urban myths about how the rich people and their accountants “know things” abound and John and Mary wanted some of that too.  Accountant #2 sold them on a wish that they would save money. Theoretically he was right.  Practically? He was dead wrong. The savings were only going to be the small benefit of deferring taxes one more year.  And even if accountant #2’s plan had worked, what happens when John and Mary retire and the first year they still have to pay taxes on the bigger income of the previous year?  

Outstanding shareholder loans should not be left unattended and if you are in this situation and need help please contact Tax Solutions Canada today by calling 1.888.868.1400.

Notionally Assessed? You Still Need to File Voluntarily

Many people who decide to delay filing a tax return think that as long as they have not filed they do not owe and so CRA will not come after them. This is one of the most dangerous misconceptions that lead so many people into a world of pain with CRA.

First and foremost – not filing your tax returns is tax evasion and CRA does prosecute people. So far there have been over 100 prosecutions in 2014 alone! Here are just two examples:

• From 2007 to 2010, Mitchell Rygiel of Winnipeg, failed to accurately report his income as a photographer. This resulted in $47,411 of federal tax being evaded. In addition, $17,547 of goods and services tax (GST) was not submitted for the tax years 2007 to 2010. The fine represents 75% of the total federal and excise taxes that were evaded. The court gave Mr. Rygiel 12 months to pay his fine which adds up to almost $50,000.  Remember he also had to pay the almost $65,000 in arrear taxes plus interest and penalties!
• Peter McCallion of Mississauga, Ontario, pleaded guilty to five counts of failing to file corporate tax returns, six counts of failing to file GST/HST returns and four counts of failing to file personal income tax returns. McCallion was fined $1,000 per count, for a total of $15,000 and has 27 months to pay the fine.  

CRA uses another weapon even more frequently than criminal court: the dreaded notional (sometimes called arbitrary) assessments. This is when CRA estimates your income by making an arbitrary decision as to what you earned, and therefore what you owe.  They assess you for this highly exaggerated, dreamed up amount that usually takes no deductions into account and tacks on large amounts of interest and penalties retroactively.

How to they do this? A very common example with contractors is when the companies who contract work to them file their copies of the contractor’s T4A, triggering an arbitrary assessment of the contractor if the return has not already been voluntarily filed. CRA just assess that income. They do not allow for the materials used, trucks driven and the labour costs paid.

Another common example is when CRA audits one of your suppliers or one of your customers, which can bring the heat to you. Prior to that you may have been behind filing returns and CRA may not have even known you had income – but now they are on to you and there is no turning back.

When this happens you have many options, including:

• Prior to CRA contacting you for your late returns, and only prior to, you can file an application under the Voluntary Disclosure Program, and if accepted, you can avoid interest, penalties and prosecution. The challenge here is that once CRA contacts you, this option disappears.
• If you are notionally or arbitrarily assessed you can refile your returns voluntarily (claiming all valid deductions) and object to penalties and interest. While your objection is under review CRA cannot take enforcement action which should buy you a small window of time to come up with a plan to deal with your tax debt.
• Leveraging other CRA programs to eliminate penalties and interest like the Taxpayer Relief Program. 

Do not end up like the hundreds of Canadians who are prosecuted annually for tax evasion and kick off 2015 with a solid plan to deal with your back taxes.

If you have a tax problem and need help please contact Tax Solutions Canada today by calling 1.888.868.1400.

Tax Problems and Who Can Help: The Difference Between Accountants, Lawyers and Specialized Tax Professionals

When you have a tax problem and are looking for help it is confusing to know who to turn to. Many different types of professionals claim to provide tax solutions – these include accountants, lawyers, tax consultancies, debt companies and trustees. Each group points out why you should use them and not the others – usually using fear tactics. Let’s review each type of professional and how they contribute to resolving tax problems to see which may be right for you.

Accountant

Accountants are generally excellent at preparing tax returns. This is increasingly complex and it takes a lot of time and skill to do this, not just accurately, but to also properly take advantage of any tax minimization steps.  Once returns are filed and assessed most accountants consider their mandates completed. Good accountants do not have a large number of clients with tax problems so they do not have the experience in handling tax problems that can only come from a high volume.  Many accountants specifically avoid taking an aggressive stand against CRA as all the returns they e-file for clients are tagged to their name and it would kill their business if CRA decided that there must be more problems in that accountant’s office so they begin auditing more and more of their clients. Accountants chose to become accountants because they like the detail and technical tax aspects. However, being highly organized does not make them effective negotiators and masters of navigating the dark passages at CRA.

Lawyer

Some lawyers specialize in the area of tax matters.  Most are involved in high level planning of tax structures and big corporate groups.  Some though do promote generally to people with tax problems.  Lawyers become lawyers because they want to fight for justice for their clients in Court.  That is all well and good but only when the other avenues have failed and the cost is worth it.  Remember: CRA cannot afford to just roll over – they have the whole Federal Department of Justice as their ‘free’ lawyer and they cannot risk losing so they will fight.  And your layer will fight – but on your dollar.  It makes no sense to bring a lawyer into the process – it sends the wrong message: “I am here to fight”.  It is far better to start the process off on the right note: “I am here to resolve my issue and I want to have full access to the CRA programs that let me reduce interest, minimize penalties and provide fair and reasonable repayment terms”.  Of course, different personalities start discussions in different ways.  A wise person once told me “you can so much more easily close the hand offered in friendship into a fist than try and get the person to accept your open hand from a clenched fist”. 

Tax Consultancies

Generally, tax consultancies are organizations that specifically specialize in resolving tax problems and handling CRA negotiations for individuals and businesses. Unravelling complicated decisions, assessments and problems with CRA are a specialty for these types of organizations. The best of these organizations will have significantly experienced and recent ex-CRA professionals. Both these aspects are pivotal when choosing the correct consultancy to assist you.  If they do not have experience in the actual area of tax you know they are of no use.  An ex-CRA tax auditor knows precious little about the types of payment arrangements available at CRA and how they are accessed, who approves them and where appeals get made.  That same person though is an expert in helping you navigate the perils of a tax audit.  Why recent experience?  Because CRA changes its policies and procedures.  What worked 5 years ago does not work now.  The contacts at CRA have all retired, been reassigned or promoted.  You do not need yesterday’s news – your problem is now.  This type of organization is not suited for someone who simply needs to file an annual tax return or has been charged criminally. 

Trustees in Bankruptcy

Of these 4 groups, the trustee in bankruptcy wields the most power. Many tax lawyers advertise to scare taxpayers away from trustees because a trustee can resolve many tax problems, without you needing to pay an expensive lawyer. If a client cannot pay their tax debt and CRA is creating financial chaos through collection action, a trustee can use their powers under Federal law to immediately stop wage garnishments, lift frozen bank accounts, etc… The trustee does not need you to have a bankruptcy to do this. Their powers come directly from the Federal Government under a special license that means they do not need CRA’s permission to do this.  Just as quickly as CRA jumps on you the trustee can remove them from your back. Trustees often work very well in conjunction with the other 3 groups in cases where the client cannot pay the tax debt, so while they compete with trustees, they also work with and refer clients to them too. This is true of every single accountant, lawyer and tax advisory service that works in the tax business. What causes many taxpayers hesitation is the fear created around solutions offered by trustees. Yes – a bankruptcy or consumer proposal will have impacts to your credit BUT nowhere near as bad as you may imagine. Get the facts from the trustee – it is usually free.

The best thing to do when choosing the right tax professional is:

1.    Do not respond to fear tactics or their advice about who you should not deal with.  Each professional has their place in the solution matrix.

2.    Check online to make sure that they have a good reputation.

3.    Have a face-to-face interview where possible.

If you have a tax problem and need help please contact Tax Solutions Canada today by calling 1.888.868.1400.

Have a Wonderful New Year - Start 2015 with a Plan to Deal with Your Back Taxes

The New Year is here and many resolutions on Canadians’ lists deal with getting a handle on their debt. This is a particular priority for many who owe back taxes to CRA. The one bright side of owing back taxes - you cannot be prosecuted for tax evasion for owing back taxes as you can for not filing returns or failing to declare income. On the bad side, once you owe, CRA collections will come at you with brute force.

The best thing to do if you owe back taxes is to begin 2015 with a plan to deal with them – so we have compiled a short list of tips:

1.    Review your budget – look very hard at your budget and what you can commit to paying monthly. Be realistic!

2.    Look at your assets – what do you have that could be leveraged to deal with your tax debt?

3.    Consult a tax professional – and we are not talking about an accountant. You are going to need a company experienced in dealing with CRA negotiations.

4.    Avoid direct communication with CRA – we are not saying ignore them, we are saying put someone in between you and them. If you speak to them directly they will deploy tactics to get you to divulge personal information about yourself that will later be used against you.

5.    Take a deep breath – dealing with CRA is not fun. The right tax negotiation intermediary will take away a lot of the pain.

Ignoring your tax problem will only lead to financial disaster. CRA is more powerful than other creditors.  They do not need Court approval to attack you. You can find a solution – you just need the right help in your corner.

For more about how to start 2015 with a plan to get rid of your back taxes, please contact Tax Solutions Canada today by calling 1.888.868.1400.