Tax man steals this musician’s sunshine for good reasons
“I know it’s up for me
If you steal my sunshine
Making sure I’m not in too deep
If you steal my sunshine.”
These catchy lyrics were penned
But it appears Costanzo may have been “in too deep” when it came to his personal taxes, the Tax Court of Canada found in a decision released last month.
Costanzo was reassessed by the Canada Revenue Agency for the tax years 2008 through 2011 for claiming various business expenses on his tax returns. During the years under review, he operated a sole proprietorship business as a singer/musician and freelance talent searcher. He also ran a music studio.
The CRA allowed many of Costanzo’s business expenses, but the main issue in the trial was the tax man’s disallowance of “associate musician fees,” which ranged, as a percentage of the total business expenses claimed, from three per cent in 2011 to 58 per cent in 2010.
At the trial, Costanzo explained that during the years under review he had been using the services of a “very good friend that he used to date in 1999 and 2000 and with whom he lived for a short period in 2003.” He testified he used her “as a sounding board when he needs a perspective as to what type of sound, beat or rhythm is hot or cool at any particular time.”
His friend testified in court that “she was Mr. Costanzo’s best friend” and that she was a professional dancer with no musical background. Costanzo contacted her every day — “sometimes many times a day” — by telephone and by e-mail. She stated she had no idea of the value of the services she rendered and that Costanzo alone decided on the amounts he was going to pay her and when.
Costanzo testified he did not have a written contract with this friend and “there were no specific terms and conditions regarding her remuneration … because the royalties he received for his songs were not paid to him on a regular basis.” He simply paid her “what he can afford.”
The payments were made irregularly by Interac transfers or in cash. He also failed to keep any records concerning the dates and the number of times he consulted his friend in any given week, month or year, and that she did not invoice him for her services.
Costanzo’s friend confirmed she received the amounts indicated, but did not report them for income tax purposes since she did not file a tax return for any of those tax years.
Indeed, it was only in January 2017 that Costanzo’s accountant filed tax returns for the 2008 to 2011 taxation years on her behalf to report the amounts received. The amounts reported were based solely on Costanzo’s records and not on her own records.
Costanzo also retained the services of another friend, an engineer who has a music studio, for various musical tasks, including the mixing of tracks. Again, he did not have a formal written contract with this engineer “because he is a friend.”
This friend did not invoice Costanzo for the services he rendered and Costanzo had no records concerning the dates and number of times he consulted or retained the services of this friend in any given week, month or year.
Under the Income Tax Act, you can only deduct business expenses if they were incurred “for the purpose of gaining or producing income from the business.” Furthermore, the expenses must be “reasonable in the circumstances.”
As the judge pointed out, our income tax system is based on self-monitoring, and, as a result, the burden of proof of deductions and claims rests with the taxpayer.
The Tax Act also requires taxpayers “to keep adequate books and records to justify the deduction of the business expenses claimed. Costanzo, as the taxpayer, “is responsible for documenting his own affairs in a reasonable manner.”
The judge acknowledged Costanzo was carrying on a commercial venture, but felt the documentation supporting his claims was “clearly insufficient to justify the deduction of the associate musician fees and that they were incurred for the purposes of earning income from a business.”
He stated Costanzo “has been very vague as to the nature of the services provided by his friends.”
The judge concluded that even if the expenses were incurred as stated by Costanzo, he was not satisfied “they were incurred for the purposes of earning income … Furthermore, the associate musician fees claimed by the appellant were not reasonable in the circumstances.”
The lesson from this case for taxpayers is clear: There’s no problem hiring friends or family members to assist you with your business, but if you plan to deduct the fees or wages you pay them for tax purposes, you need to ensure that any amounts paid are reasonable and can be justified, and that you keep appropriate documentation of the hours paid or the work performed.
This way, the CRA won’t end up stealing your sunshine.