By Ted McIntyre
Tips from the experts to help you save on your 2019 returns
Nobody wants to pay the Canada Revenue Agency any more than they have to. But what you can and can’t deduct isn’t always clear.
Sure, there’s the obvious stuff, such as advertising expenses, your cell phone, business travel and the company vehicle.
Then there’s the less obvious stuff, such as residential utility fees for those who have a home office, or the depreciation on tools and equipment (or even on more significant assets like buildings and cars), as well as repairs and maintenance. And there are deductions on wages you pay yourself or your partner. Or the deductions on workers’ insurance premiums, life insurance, car insurance, fire insurance and theft and loss insurance.
But the first piece of advice, particularly for new business owners, is to keep your accounting in order, cautions James Buckley, a senior tax manager with Golden Horseshoe-based DJB Chartered Professional Accountants. “I cannot stress this enough, quality record-keeping is so important for first-time contractors or smaller contracting and renovation firms,” Buckley notes. “Our staff have seen this a lot—receipts in a shoebox or losing/misplacing their business number as assigned by the CRA after incorporation/registration.”
“I see a lot of sloppy records with contractors,” echoes Anthony M. Cusimano, a chartered professional accountant and president of Toronto’s Cusimano Professional Corporation. “As your business grows, being fully aware of the various financial aspects becomes increasingly difficult. Properly maintained accounting software is a must-have for small business owners—even something like QuickBooks or Sage. If set up and utilized properly and to their full potential, these and other programs become immensely powerful tools, as they’ll help to generate accurate, timely and meaningful management information, which will help manage and grow the business.”
It is no small irony that the same warnings contractors and renovators share with their homeowning clients—‘Beware of cash deals and avoid just looking for the cheapest option’—are the exact same complaints CPAs often encounter when dealing with renovator/contractor clients. “When you’re going looking for cheap accountants, paying, say, $500 or some other low rate on accounting fees for year-end financial statements and tax returns, you’re not doing yourself justice,” Cusimano warns. “With someone like a practising qualified CPA with university training and ongoing professional development, you could receive a more comprehensive approach for the accounting, financial and credit protection advice. You’re also potentially receiving more accurate financial statements and tax returns and avoiding potential timely and costly CRA audits. The difference can be like night and day. Any extra fees could pay for themselves many times over.”
“Having a competent bookkeeper is crucial, but that will cost money,” Buckley says. “However, the costs of errors such as late filing, late remitting and missing input tax credits can really add up. These errors can also trigger reviews and audits from the Canada Revenue Agency. Unfortunately some bookkeepers don’t really understand the HST and income tax aspects when it comes to renovators, contractors or developers. Make sure you’re using a bookkeeper and accounting firm that has a specialty or at least experience in dealing with this market segment.”
But even established businesses are not immune to hamstringing themselves when it comes to something simple like their bookkeeping. “The bigger the business, the bigger the problems down the road if the bookkeeping is not being done correctly,” says Buckley. “Sometimes it’s worth outsourcing as opposed to endlessly trying to find a full-time staff bookkeeper.”
THE DANGER OF CASH DEALS
While all of our tax experts say they understand the existence of cash deals in a competitive industry plagued by labour shortages, they warn of the domino effect when engaging in such practices when it comes to everything from taxes to valuating your company.
“I’m sure some contractors think that a cash deal is good because they see an opportunity to avoid income tax. However, one must keep in mind that the implications of showing less revenue on paper, such as trying to get approved for a mortgage or whether or not you will be able to acquire financing so you can bring on staff or buy a business,” says Buckley. “Aside from it being illegal, it could significantly limit the ability for contractors to grow their businesses.”
There is also a challenge if the business owner wants to sell the company. “You need to plan years in advance for that,” says Cusimano. “If you tell a potential buyer, ‘I’ve also been doing an extra cash business,’ good luck to you. He/she will likely not pay a single extra penny to you if you can’t prove it. And the risk is even higher—and hence the business selling price lower—if you’re selling shares of a company that could have hidden CRA audit risks.”
TO INCORPORATE OR NOT
One of the first—and most important—discussions tax consultants have with new renovators and contractors concerns the merits of incorporation. “Often people who are starting any type of business may think that they have to be incorporated but that is not always the case,” Buckley notes. “When you are incorporating, there are two main issues you have to think about up front: income tax and legal liability. Does what you’re doing have an element of risk in it that would impact your personal assets? Sometimes that’s reason enough to incorporate. However, in other cases it may make sense to hold off incorporating until there are more profits in the business. It’s more along the lines of just educating clients on it so they know why they’re making the decision to incorporate.
“From an income tax perspective, it is important to ask, ‘Are the dollars you’re earning needed to live your life?’ For example, if you’re a small painting firm that doesn’t take on much risk and all the money you’re generating is needed to live your life, then the only thing you’re gaining by incorporating are extra professional fees to a lawyer and accountant. Otherwise, you can just run it as a proprietorship on your personal tax return— T2125 Statement of Business or Professional Activities, which is like a truncated income statement for a corporation.”
But if you’re making enough money, there are tax dollars to be saved. “First and foremost, besides potential limited liability, from an income tax perspective, incorporation allows the deferral of income taxes on net profits retained within the company,” notes Cusimano. “If a business in Ontario is unincorporated, the business owner would pay personal graduated marginal tax rates ranging from 20.05% to 53.53% (once personal taxable income exceeds $220,000).
“The small business deduction is a reduced corporate tax rate offered to Canadian Controlled Private Corporations (CCPC) on any income received as a result of active business income earned in Canada,” Cusimano explains. “The normal income tax rate on a CCPC-earning active business income in Ontario is 26.5%, while the small business deduction permits the company to only be taxed at a 12.5% rate on the first $500,000. That’s a 14% or $70,000 savings on the first $500,000 of profits.
“This small business corporate income tax rate allows the business owner to defer personal income tax on the income earned until the profits are distributed to the shareholder(s),” Cusimano continues. “The tax deferral is close to $4,103 for every $10,000, assuming an individual is at the top marginal rate versus a company paying low corporate tax rates. These additional savings allow the company to retain additional needed cash, which would otherwise be paid in income taxes, to help grow their business, buy assets, fund working capital or pay for otherwise non-deductible expense items like life insurance or legitimate meals and entertainment expenses!”
While the benefits of maximizing your small business tax rate is obvious, “to avoid a misuse, the CRA requires the $500,000 to be allocated between ‘associated companies’ (a defined concept in the Income Tax Act),” Cusimano notes. “But there may be ways in which various members of the same family with more than one company can have separate small business deductions if the company shareholdings are properly structured. These strategies, combined with implementing optimal combinations of salaries and dividends, can minimize your overall corporate and personal taxes for the family unit. But every situation is different.”
STUMBLING BLOCKS
The biggest tripping point at tax time for those filing? “For contractors and renovators on a smaller scale, HST is always a pain point. It can be complicated and confusing,” Buckley says. “I suggest consulting a professional.”
Barry Sacks, a real estate expert and partner at MNP LLP’s Markham office, meanwhile, cites smaller firms attempting to write off expenses that aren’t deductible as a precarious practice. “Most little guys put everything through, thinking, ‘If worse comes to worst, they just won’t let me deduct it.’ But that’s not necessarily the case—the penalties are very high.”
When it comes to a cautionary tale among larger firms, Cusimano warns companies to beware of the penalties of improper employee classification. “Some businesses prefer to classify their workers as ‘self-employed’ in order to avoid employer obligations such as CPP and EI, or Employment Standards Act and WSIB,” Cusimano says. “The CRA and WSIB, however, evaluate individuals using set criteria. Should they assess self-employed individuals as employees, the business will be charged the premium, as well as compounded interest from the first year of improper classification. This penalty can quickly spiral out of control, with multiple employees each being incorrectly classified for a number of years.”
These are just a few examples of why it’s important to have an experienced professional advising you along the way, Cusimano stresses—particularly given ever-changing CRA guidelines. “In the last few years, there have been huge changes in the Income Tax Act regarding small business taxes, intercorporate fees between related companies, earning passive income along with active business income, estates created upon the death of business owners and ‘dividend sprinkling’ among family members (known as Tax on Split Income or TOSI),” Cusimano highlights. “The documentation requirement threshold and risk levels have greatly increased! And the new rules are extremely complex. There’s still a lot of ambiguity and, hence, potential litigation with the CRA that may happen in the future.”
MOST OVERLOOKED WRITEOFF?
If you’re looking for a tax tip, Sacks suggests you consider a new CRA opportunity when it comes to charitable contributions. “One thing people often overlook is on the philanthropic side,” says Sacks. “For those looking to make donations to their charities, most of these folks have portfolios with shares. People might, for example, make $100, then take $50 out of the company to donate, and then get back maybe $25 after they file their return. One of the things you’re allowed to do now is donate your shares. Previously, if you have a $100 share, you have $100 capital gain on it and you’d pay tax on it. Then you’d tag the money for donation. But now you can actually donate shares and they’ll waive the capital gains tax. So you therefore have the whole $100 to donate to charity and get the $50 receipt. So the charity gets more and you get more back. I do it every year.”
If there’s an element of accounting that concerns Sacks moving forward—particularly with larger firms—it’s the threat of cyber attacks. “Cyber security—protecting your digital records—has become a priority,” Sacks says. “We have a whole branch at our firm devoted to it. So many have been hacked, including many you wouldn’t think would be vulnerable: banks, Amazon, Google. And not only is there the associated financial loss, it’s the damage to your reputation from those who don’t trust you anymore and the resulting loss of future income. It can have an incredible impact. The smaller firms—the ones doing things by the seat of their pants—don’t keep as many records online and are often safer from such threats.”
If there’s a universal opinion about accounting and income tax, it’s that every client is unique, the experts note. “There are very few things that work for everybody. Even buying an RSP doesn’t work for everybody,” Sacks notes. “And there’s always the question: ‘If you have an extra $10,000, is it better to pay down the mortgage or buy an RSP?’ The best thing people can do is talk to (one hopes) a smart accountant who can tell you what’s best for you.”
HST for First -Timers
—Cory Prince, CPA/CA, Taxation Manager, Durward Jones Barkwell & Company LLP.
For self-employed builders and renovators that are just starting their business, it’s important to understand the small supplier threshold for HST purposes. A taxpayer is considered a small supplier during a particular calendar quarter and following month if the amount of their revenue over the previous four calendar quarters does not exceed $30,000.
This means that HST registration is not required and therefore the taxpayer is not required to collect or remit HST. This would also prevent a taxpayer from claiming HST paid, and any HST paid would be considered a cost.
HST registration is required at the beginning of the following month once the small supplier threshold amount of $30,000 is exceeded. However, the smaller supplier threshold resets every four quarters, and once the threshold is exceeded, HST registration is required from that point forward indefinitely. We find this can become an issue when a taxpayer was required to register for HST but failed to do so and the Canada Revenue Agency doesn’t audit until an extended period of time has passed. This can result in significant amounts owing to the CRA that may not be recoverable from your clients anymore.
There are certain restrictions when claiming some HST amounts. Half of your HST paid on meals and entertainment expenses are permitted to be claimed, with the other 50% being required to be included in expenses. HST paid on passenger vehicles is generally capped at a capital cost of $30,000 (e.g. $30,000 x 13% = $3,900). However, there are specific exceptions in certain circumstances for vans and pick-up trucks. HST
paid on home office expenses can only be claimed when the home office is your exclusive place of work.
Keeping documentation is required when claiming HST amounts paid. One of the first things the CRA requires during an audit is paperwork to prove the HST was paid. Credit card statements are not sufficient documentation—complete receipts are required.
Become a member of the Ontario Home Builders’ Association.