If you own an incorporated business or professional corporation, it can be quite tempting to pay for various personal expenses out of your corporation’s income, but doing so is problematic for a couple of reasons.
For one thing, those expenses wouldn’t be tax deductible to the corporation unless they were incurred for legitimate purposes to earn business or investment income. But even more concerning is that you could be hit with a shareholder benefit for appropriating corporate funds for personal use, rather than taking them out the normal way via taxable salary, bonus or dividends.
A recent tax case, decided last week, dealt with non-deductible expenses, unreported shareholder benefits and gross negligence penalties assessed by the Canada Revenue Agency. The case involved a Montreal dentist who leases the premises for his dental clinic from a private corporation, which is solely owned by his 93-year-old mother. He is the corporation’s president and administrator and holds a general power of attorney for his mother.
The dentist’s tax troubles began back in 2009 when the corporation purchased a vacation property at Lake Archambault, a popular vacation destination about a two-hour drive north of Montreal in the Laurentian mountains. The purchase price was $550,000 and the corporation used $70,000 of its own funds and borrowed the remainder via a mortgage.
The CRA reassessed both the corporation and the dentist’s mother for the 2009 to 2013 taxation years. It imposed gross negligence penalties on the corporation for claiming non-deductible capital expenses along with various operating expenses, such as home insurance, property taxes, school taxes and mortgage interest, related to the vacation property.
In addition, it imposed gross negligence penalties on the dentist’s mother for unreported shareholder benefits conferred on her son from the corporation for the use of the property. The CRA also clawed back the mother’s Old Age Security payments as a result of her now-higher income, taking into account the assessed shareholder benefit.
The issue before the Tax Court was whether this vacation property was acquired by the corporation for the purpose of earning income or for personal use, thus giving rise to a shareholder benefit.
The dentist testified that he was looking for a house to renovate, rent out during the renovations and then resell for a profit. The dentist described the efforts made to rent the house and claimed it was listed on at least two websites for short-term rentals. As proof, he produced two screenshots taken in August 2019 of two rental websites. One shot showed that he had been a member since November 2010, and the other since May 2009.
At trial, the dentist produced a copy of the house’s first lease dated April 10, 2009, which was 12 months in duration, from June 2009 to May 2010. It was rented to his then-spouse. The dentist testified that his wife “may have continued to rent the house until 2014, when she ceased to be his wife.” The dentist was asked to name any other tenants of the house during the years in question, but was only able to name himself and his former spouse.
The judge found that the two initial website listings were made after the 12-month lease had already been signed with his spouse. Thus the judge did “not consider these listings to constitute good faith attempts to offer the house for rent … (Rather) they were only a sham and that they show that from the outset the intention was to deceive the CRA.”
The judge determined that there was simply not enough evidence to conclude that the dentist’s now ex-spouse really paid the corporation the rent stated in the lease. The dentist only produced a table that he had recently prepared based on bank statements, which included all the rents received by the corporation, most of which related to the rent paid to the corporation for his dental practice. He was unable to provide, in his testimony or by referring to the corporation’s financial records, a reliable breakdown of the rental income of the vacation home for the years in question.
The taxpayer then tried to argue that the insurance policy he took out in 2009 indicated that the house being insured was a “second home occupied by third parties.” The annual premium for this policy was $4,600. A year later, however, the policy was renewed and the house was described as a “second home occupied by the insured” and the policy was classified as an “owner occupant” one, with an annual cost of only $2,000. The dentist testified that he changed the description for insurance “because it was cheaper,” and not because there had been a change in the use of the residence, but the judge didn’t buy that argument.
The judge concluded that, based on the evidence, the vacation home was purchased by the corporation and used by the corporation for the personal use of its shareholder, her son, his then-wife and their daughters. Although there might have been a few short-term rentals of the house during the years in question, the evidence did not establish, on a balance of probabilities, that this was actually the case. Nor did the evidence show that his then-spouse actually paid any rent during the initial lease period of the house.
The judge stated that the taxpayer’s intention “has always been to make the residence available to himself and his spouse, for their personal use. The misleading listings of the residence on the web, when it was already rented to his spouse, even before the sale was closed, and the misleading description of the use of the residence in the insurance policy confirm that (the dentist) intended from the outset to try to deceive the CRA as to its real use.”
The judge concluded that the dentist’s income tax returns for each of the years in question contained an “incorrect presentation of the facts and a false statement or omission concerning the use of the residence and the expenses associated with it.” He characterized it as a “willful omission knowingly made by (the dentist), who is president and administrator of (the corporation) and agent of his mother.” For this reason, the CRA’s reassessments of tax owing were confirmed, along with the gross negligence penalties.