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A Lesson in Record Keeping

A Lesson in Record Keeping

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taxation

TAXATION

The Income Tax Act requires you to keep
all documents supporting your business
activity; in an audit, the CRA will
demand them.

Keep Everything

According to the Income Tax Act, taxpayers must keep
“records and books of account … together with every
account and voucher necessary to verify the information
contained therein” for a period of six years
following the last taxation year to which they relate.
For corporations, the start of the six-year period is the
fiscal year; for individuals, the calendar year.

Show Us the Proof

The recent appeal ruling in Tibilla v. The Queen before
the Tax Court of Canada, July 3, 2013, reinforces the need to maintain documentation. In summary here is what led to the ruling:

  • Mr. Tibilla (the taxpayer) acquired a rental property
    for $172,000 November 14, 2002, and sold it
    on December 18, 2007, for $285,000 but declared
    no capital gain in his 2007 tax return.
  • In 2010, the Canada Revenue Agency (CRA)
    advised the taxpayer that his return for 2007 was
    under review and that he was required to provide
    copies of the contract of purchase and sale, a statement
    of the capital cost allowance claimed over
    the years the property was owned, a list of any
    expenses related to the purchase and sale as well
    as the receipts for those expenses.
  • In a late filing of his 2008 tax return, the taxpayer
    declared a capital gain of $41,571.64 and a taxable
    capital gain of $20,785.82 (i.e., 50% of the capital
    gain). The taxpayer said he was declaring the capital
    gain in 2008 because, despite having signed the
    sale agreement in December 2007, disagreements
    with the new purchaser made the sale “uncertain
    and incomplete” until March 2008, when the disagreements
    were amicably settled.
  • Included in the taxpayer’s capital gains calculation
    was $52,810 in renovation expenses claimed
    to have been incurred before he actually acquired
    possession of the property (i.e., between April and
    November 2002). (The addition of this amount
    to the adjusted cost base would have reduced the
    capital gain when the property was sold.)
  • The CRA rejected the renovation expenses
    because the taxpayer provided no vouchers. The
    taxpayer said he had stored the receipts in his
    basement but they had been lost in a flood in
    2008. He was unable to explain why the existence
    and loss of these receipts had not been brought to
    the attention of the CRA during the audit, discovery
    or the appeal. The taxpayer said he had made
    no insurance claim for the loss because he did not
    want to increase his future insurance premiums.
    He therefore also had no documents from the
    insurance company attesting to his loss.
  • The appeals judge ruled that the sale had taken
    place in 2007 since it had taken place by deed of sale before a notary on December 18, 2007, and had been registered in the official land registry the next day.
  • The judge also ruled that the period between the
    date of purchase (November 14, 2002) and the
    date of sale (December 18, 2007) was not six years
    and, in any case, the Income Tax Act required the
    taxpayer to keep records of any claims until the
    expiry of the appeals process, which the taxpayer
    had not done.
  • The appeal was dismissed with costs to the taxpayer.

The burden of proof for deductions lies with the taxpayer.

Lessons

Referring to other cases, the judge emphasized
that, since our tax system is based on personal selfmonitoring,
the burden of proof for deductions and
claims lies with the taxpayer. Just keeping notes is
not enough; documents are required. If Mr. Tibilla
had been able to produce records of his renovation
expenses (and if they had been accepted by the CRA),
he would have saved himself a significant amount
in taxable capital gains and legal costs. The addition
of the claimed $52,810 in renovation expenses to
the $172,000 purchase price would have given him
an adjusted cost base of $224,810. His capital gain
would have been $60,190 ($285,000 – $224,810) to
give a taxable capital gain of only $30,095. Instead,
he incurred a capital gain of $113,000 ($285,000
– $172,000) of which $56,500 was taxable. Mr. Tibilla’s
inability to produce his expense records cost
him $26,405 ($56,500 – $30,095) in taxable capital
gains.

What about Your Past?

Prior to February 22, 1994, there existed a cumulative
capital gains exemption of $100,000. If this amount
was not fully used by the February 22, 1994, deadline,
taxpayers could use any unused amount to revalue
capital property. Effectively, the taxable capital
gain on any taxable capital property sold thereafter
would be reduced by the election amount of 1994.
Documentation to support 1994 valuations may be required. Consider the following types of transactions that may need to be substantiated with adequate documentation years after they have occurred:

  • If you purchase shares of a corporation from a
    third party, the adjusted cost base (ACB) of those
    shares will not be the paid in capital on the balance
    sheet. Shares could be purchased at different
    times for different amounts.
  • If you have investments in income trusts, part of
    the monthly payments are usually return of capital
    which reduces the ACB of the investment.
  • When calculating the ACB of a partnership, you
    have to take into account the partners’ taxable
    income, which is often different from the accounting
    income.
  • Corporations that incur a non-capital loss may
    apply to reduce all types of income in the three
    taxation years prior to, and the seven taxation years
    following, the loss (10 years for taxation years ending
    after March 22, 2005). It would appear from
    the Tax Court ruling that application of non-capital
    losses 10 years back would subject the applicant
    to another six years of record keeping in the event
    that CRA wished to audit the taxable years.

As a result of the 2013 Tax Court rulings, individual
and corporate taxpayers should consider the following:

  • Locate the original documentation pertaining to
    any capital property.
  • Review the record destruction policy to ensure you
    are retaining pertinent records.
  • Contact your lawyer, accountant, real estate advisor,
    appraiser or other professional to determine
    whether they have copies of any of your records
    that may be required. If possible, get the originals
    and leave them copies.
  • Keep in mind that professionals change firms, die,
    or sell their business to others. If your professional
    is no longer available, review past tax returns and
    statements to determine whether there are any
    issues that may require documentation held by
    their predecessors. Ask your current professional if
    they have documentation for the years in question.
  • Consult with your professional about losses and
    their applicability to prior years’ taxable income to
    determine whether the time and cost of a potential
    CRA audit is worth the dollars that may be
    recovered.
  • Establish a relationship with a CPA firm. Your
    CPA will be attentive to maintaining historical
    information.
  • Maintain originals of all documents. After all, as
    noted above, it is your responsibility to produce
    the necessary documents to support your claim(s).

Get It All Together

As you approach retirement and plan to sell the
company or transfer ownership to others, you will
need to have documentary evidence of past transactions
to ensure any tax liability is kept to a minimum.
Owner-managers should make reviewing the past and
gathering the required information a priority.


Disclaimer:

BUSINESS MATTERS deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other
appropriate professional advice should be sought before acting upon any of the information contained therein.
Although every reasonable effort has been made to ensure the accuracy of the information contained in this letter, no individual or organization
involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or
for any consequences arising from its use.
BUSINESS MATTERS is prepared bimonthly by the Chartered Professional Accountants of Canada for the clients of its members.
Richard Fulcher, CPA, CA – Author; Patricia Adamson, M.A., M.I.St. – CPA Canada Editor

 

Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.

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