Deducting personal expenses as business ones lands taxpayer in hot water years later
It may be tempting for some taxpayers to write off personal expenses as tax-deductible ones, especially under the guise of a business, but doing so could get your expenses denied by the Canada Revenue Agency and could even expose your prior years’ tax filings to reassessment beyond the “normal reassessment period.”
Indeed, this is exactly what happened in a recent Tax Court of Canada decision released last week in a case involving a taxpayer who was reassessed by the CRA in November 2018 for his 2013, 2014 and 2015 taxation years. The 2013 taxation year was reassessed after the expiry of the applicable normal reassessment period and thus would generally be considered to be “statute-barred.”
Under the Income Tax Act, once the CRA has initially assessed your tax return, it has the ability to reassess your return provided it’s done within what’s technically defined as the normal reassessment period. For an individual taxpayer (or private corporation), that period is typically three years from the date of the original notice of assessment. After that period, your tax return would be considered statute-barred.
There is, however, an exception to this rule if the CRA can demonstrate that the taxpayer “has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information.”
In this case, the Tax Court was tasked with deciding two issues: was the CRA justified in disallowing expenses for the three years in question and was the 2013 reassessment valid, since it was issued after the expiry of the applicable three-year normal reassessment period.
In 2010, the taxpayer, otherwise employed on a full-time basis, and his wife began a business, participating in a “multi-level marketing scheme,” called MonaVie, selling juice products. The controversial company, referred to in some media reports at the time as akin to a pyramid scheme, went into foreclosure in 2015 after defaulting on a US$182-million loan.
Like other multi-level marketing schemes, the individual, in order to make money, needed to recruit people to sell the product, with the recruiter making money based on team member sales. Throughout the six-year period from 2010 to 2015, the taxpayer and his wife only managed to sign up one person for their business and that person quit after a short time. Indeed, the taxpayer never had a profitable year for this business — not in any of the three years at issue, or in the earlier three initial years of 2010, 2011 and 2012. The taxpayer testified that he “consistently tried to make a go of it,” but did not expect “it would be so hard to recruit people for this business, and keep them involved.”
During the three years under review, the CRA denied the taxpayer a deduction for a variety of business expenses. The only business income reported during this period was $50 in 2014. Most of the expenses claimed were for meals and entertainment ($4,300), telephone and utilities ($6,450) and motor vehicle expenses ($8,600), along with some travel expenses.
The expenses the taxpayer claimed were apparently only 50 per cent of the total expenses said to have been incurred for business purposes, with the remaining 50 per cent presumably being claimed by his wife, who was involved in the same business. “These amounts, particularly being only the (taxpayer’s) 50-per-cent share, are surprisingly large given the virtually complete lack of revenue and deficiency of business records,” the judge remarked.
The taxpayer testified that he and his wife would meet prospective “clients” over coffee or a meal to discuss their potential participation. On a monthly basis, he recorded his kilometres driven, but did not keep a mileage log detailing the names of persons he said he had tried to recruit, nor did he volunteer any names at the trial. Similarly, he had no record of clients with whom he had meals. In addition, he testified that “whenever I had a meal that didn’t involve a potential prospect, my wife and I talked about the business so that it could be included for tax purposes.”
In 2014, the taxpayer and his wife travelled to Newfoundland to visit relatives, and “to discuss with them participation in this business,” although none accepted his invitation to join. He claimed the cost of travel as a business expense.
During cross-examination, the taxpayer acknowledged that, despite having claimed “advertising and promotion” as an expense in each of the three taxation years under review, he did not actually advertise the business other than by “word of mouth” and making “cold calls.”
Perhaps not surprisingly, the judge denied all the expenses. He found the motor vehicle expenses were not deductible “due to lack of evidence … as to what these trips were for and with whom did he … meet.” Similarly, he denied the meals and entertainment expenses due to the lack of any records showing whom the taxpayer actually met. As for the meals with his wife, “ensuring that they talked about the business during some portion of the meal so as to render the expense deductible” was not good enough to claim a tax deduction since the meals have to be incurred for the purpose of earning income.
As for the trip to Newfoundland to visit family, the judge found “the nature of this expense compellingly personal, and the evidence is completely inadequate to indicate any such discussions as may have occurred, were anything more than perfunctorily raising the matter for the purpose of trying to expense the (not inexpensive) trip to visit family.”
The court also addressed the issue as to whether, legally, the CRA could reassess the 2013 tax year in 2018, which was beyond the normal reassessment period. For the CRA to do so, there had to be a misrepresentation on the taxpayer’s 2013 return.
The judge found there were actually two misrepresentations. The first was that the taxpayer claimed advertising expenses although he had not engaged in advertising. And the second, perhaps more egregious one, was that the taxpayer claimed meal expenses for meals he had with just his wife. “That readily appears to be a situation of claimed business expenses that actually are personal expenses,” the judge wrote.
The judge, therefore, upheld the CRA’s reassessments, denying the taxpayer’s expenses in all three taxation years, including the otherwise statute-barred 2013 taxation year.