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Business Losses and the Pursuit of Profit

Posted by Ryan Rawluk Posted on 26 June 2019

Last month, the Federal Court of Appeal heard an appeal from an Ontario lawyer who operated a private law practice on a part time basis in addition to her full time employment with the Government of Canada.  This is a common situation in Canada and we often see people working full time that set up 'side businesses'.  Sometimes the intent is to start a business, build it up, make big profits and retire.  Other times the intent is to write off otherwise non-deductible or personal expenses to create a business loss which can be applied against their employment income creating a 'tax refund'.  A cautionary tale follows.

Ms. Renaud began working for the Government of Canada in 2000 and moved to the Ottawa region at that time.  Prior to 2000, she ran her own full time law practice in Repentigny, but reduced her hours after taking on the new position.

From the years 2001 to 2014, she claimed business losses every year, ranging from $1,956 in 2003 to $15,680 in 2012.  In addition to the losses, her gross billings were quite low with her maximum gross income reported in a year was $3,850.  In three of those years (2005, 2009, and 2010), she reported no gross income.

At issue were the years 2011, 2012, 2013, and 2014.  In those years she reported gross income of $2,500, $850, $850, and $3,850 respectively.  Her losses for those four years were $12,613, $15,680, $4,014, and $6,662 respectively.

Ms. Renaud made assertions that she spent on average about 5 to 10 hours working in her private practice per week.  She did not take on more work than she had time available and made sure there were no conflicts with her full-time job.

Her practice was varied; she practices family, civil, administrative and criminal law.  She does consultations, gives legal advice and participates in negotiations.

Some of her answers to questions were vague.  When asked how many clients she had or how many cases she handled, her answers were not very specific.

Ms. Renaud testified that she does not work on a volunteer or pro bono basis.  She does, however, adjust her rates based somewhat on a client's ability to pay.  She also testified that she does not advertise as she receives enough clients from word of mouth.

The issue in this case was whether Ms. Renaud had a 'source of income'.  CRA didn't challenge the legitimacy of her expenses but challenged whether or not she actually was operating a business.  If they can prove she didn't have a business, they could deny her losses.

To determine whether she had a 'source of income', the court turns to the Supreme Court of Canada and the 2002 case Stewart v. Canada.  In this case, the Supreme Court determined a two-step process for determining if a 'source of income' exists.  The first step equates 'Source of income' with an activity undertaken 'in pursuit of profit', which is consistent with the traditional common law definition of 'business'.

After considering the facts of the case, the judge stated that the practice "is quite simply not undertaken in pursuit of profit."  He came to this conclusion partly by looking at the hours worked by the appellant.  She claimed to work an average of 5 to 10 hours per week.  At 50 weeks per year, the judge concluded she worked at most 500 hours per year.  In the four years at issue, she billed $2,500, $850, $850 and $3,850 respectively.  This works out to $5 per hour in the first year, $1.70 per hour in the second and third, and $7.70 per hour in the fourth year for each hour worked.  He stated "This is not at all like a law practice as normally understood, even in the wildest sense."

Further, the judge pointed out that Ms. Renaud made no mention of cases that could be highly profitable later on and no evidence was provided to show Ms. Renaud sought to change her billing practices or make changes to her client base to increase income.

So if you are in a similar position to Ms. Renaud where you are operating a small business with multiple years of losses and deducting those losses from other sources of income, you may want to consider whether you have a 'source of income' and are operating 'in pursuit of profit'.  If not, you should be aware that CRA can simply wipe out your losses for tax years that are not statuted barred.

TFSA Contribution Limit

Posted by Ryan Rawluk Posted on 27 Nov 2018

Canadian's annual Tax Free Savings Account (TFSA) contribution limit will increase by $6,000 in 2019.  The annual increase in contribution limit has been $5,500 each year since 2013 (except for 2015 when the limit was raised to $10,000 for the year) and, thanks to inflation, will be $6,000 per year for the next couple of years.

The cumulative limit for Canadians who were at least 18 years old in 2009 and who hold a valid social insurance number will be $63,500 in 2019.

CPP Enhancement

Posted by Ryan Rawluk Posted on 23 Nov 2018

Beginning on January 1st, 2019, Canadians will begin contributing more to the Canada Pension Plan (“CPP”).  This change is referred to as the CPP Enhancement and is being introduced in two phases, over the next seven years.  The purpose of the Enhancement is to increase pension benefits to recipients by approximately 50% over current benefit levels.

Since 2003, Canadians have contributed 4.95% (9.9% if self-employed) of their earnings (up to an annual maximum) to the Canada Pension Plan.  Beginning January 1st, 2019, that rate will increase to 5.1% and will increase each year until January 1st, 2023 when Canadians will begin paying at a rate of 5.95% (11.9% for self-employed individuals), a 20% increase over 2018 contribution levels (excluding the increase in contribution limits).

For an employee earning $45,000 per year, the employee will pay CPP premiums of $2,116.50 for the year in 2019 whereas they would have paid $2,054.25 in 2018; an increase $62.25 per year.  By 2023, the same employee on the same earnings would be paying $2,469.25 per year, or $415 more than they would have paid in 2018.

The same increase applies to businesses and organizations with employees.  A business with 10 employees each earning $45,000 per year will pay an additional $622.50 in 2019 and an additional $4,150 per year by 2023 before any increases in pay.  This would bring the total CPP costs to $24,692.50 for that business.

Phase 2 will begin in 2024 with the introduction of a higher annual limit for higher income earners.  This higher limit will be set at 7% higher than the normal 2024 annual limit and 14% higher in 2025.  Canadians and businesses will pay CPP at a rate of 4% (8% if self-employed) on this higher limit.  The government projects this higher limit in 2025 will be $79,400 but that will change based on increases in the average wage in Canada between now and then.

To assess the full impact of the changes, we can look at an employee earning $79,400 under 2018 rules and under 2025 rules.  The annual maximum earnings in 2025 is projected to be $69,700 and an employee would have otherwise paid $3,276.90 in CPP premiums under 2018 rates.  Under the Enhanced CPP, the same employee would end up paying $4,326.90 for a total increase of $1,050 per year, a 32% increase.

10 Things to Consider When Choosing an Accountant

Posted by Ryan Rawluk Posted on 19 Oct 2018

1. A Professional Designation
Consider whether a professional designation, like a Chartered Professional Accountant, is important to you.  CPAs are professionally regulated in each province and they help to protect the public through rigorous educational and certification programs.  So, not only can you be assured that its members uphold the highest professional and ethical standards, but you have recourse if something goes wrong between you and your CPA.  If a conflict or complaint arises between you and your non-designated accountant, you may find your alternatives are limited.

2. Fees
Always discuss fees with your accountant.  Fees can vary widely from firm to firm and from accountant to accountant.  Some accountants charge by the hour (ie. $150 to $400 per hour) and some charge by the job.  Fees should be part of the initial discussion and, for new clients, accountants should be able to estimate the fees based on a review and discussion of prior year work.  This discussion will help avoid surprises after the work is complete.

3. Level of Service
You will want to determine the level of service you need from your accountant and whether you can grow with your accountant.  For example, as your business grows and gets more complex, can your accountant provide the increased level of service that your growing business needs.  Many accountants do not provide audit services or review engagement services which you may find you need at some point.

4. Availability
You will want to find out how available your accountant will be.  How quickly do they return phone calls or emails?  Generally, within 24 hours is the norm, but two weeks is unacceptable.  Also, do you get to speak to the accountant or is someone more junior returning your calls or emails.

5. Use of technology
Technology is changing each year and you will find that you want your accountant to match or exceed your level of technological savviness.  If you're using a cloud based accounting software, you can often add your accountant and they can access your accounting records as you do.  Not only does this matter from a practical viewpoint (does your accountant ask you to print out a general ledger from QuickBooks Online) but can your accountant offer you advice or training in better use of the software.  Talk to your accountant about technology and you should also research them online.  Do they have a website?  Do they have a social media presence?

6. Risk tolerance
Just as people have different risk tolerances, so do accountants.  If you're the type of person who likes to push the boundaries of tax law the opposite value in an accountant will not work long.  In addition, an aggressive accountant with respect to tax compliance for a client who may have a low tolerance for risk may quickly find themselves in trouble with a tax agency.  The accountant needs to be able to understand the clients' level of risk tolerance and advise appropriately.

7. Speak at your level
You will want to deal with an accountant that can speak to you at your level of financial expertise. You may be ok trusting your accountant to get your work done correctly, but the accountant should be willing to take time to explain or answer any questions you may have at a level that you will understand.  After all, you are the one signing off on the work.

8. Age
The average age of accountants in Manitoba is between 55 and 60 years old.  While this experience can be a huge asset, you may find yourself going through the process of finding a new accountant again in a couple of years.  You may want to find a trusted accountant that can guide you through to retirement.  If your accountant is older and working on their own, what is their succession plan?

9. Location
Consider the importance of location.  You may only meet with your accountant once or twice per year.  Do they have an office or are they meeting at a coffee shop?  Is parking available?  Would it be conveniently located to drop in on short notice?  

10. Ask for Referrals
Finally, accountants get a big portion of their new clients from referrals.  Happy clients are eager to share with friends and colleagues.  Ask someone you know and respect who they use as their accountant, considering the points discussed above, and ask if they'd recommend them.  Other people you can ask include your financial advisor, banker or lawyer.

Canada Revenue Agency Call Centres Fails Own Audit

Posted by Ryan Rawluk Posted on 21 Nov 2017

On November 21, 2017, the Auditor General for Canada released its 2017 Fall Reports and one section of this report was particularly scathing about Canada Revenue Agency's Call Centres.

The Agency's call centres are in place to give individuals and businesses timely and accurate information about their taxes, credits and benefits.  CRA currently operates nine call centres across Canada.

CRA publishes service standards each year and reports on its own results compared to these service standards.  For example, when a caller calls the general enquiries 1-800 phone number and indicates they want to speak to an agent, CRA's goal is to have an agent answer the call within two minutes, 80% of the time.  In fact, the Agency's own published results for the 2016-2017 fiscal year indicate this happened 81.2% of the time.

The Auditor General's findings were that if CRA could not handle the call volume, they would block calls.  This means you would get a recorded message that instructed you to call back later and then ended the call.  The Auditor General found that more than half of the calls to CRA call centres ended up being blocked.

The Auditor General also tested the Agency's accuracy as far as how it answered general tax related questions that people may have.  The Auditor General found that almost 30% of the time, the Agency gave incorrect information.

For example, one of the questions asked was "When will the interest begin to be charged on my 2015 initial assessment?"  The correct answer is May 2, 2016 but a CRA agent gave a different answer 84% of the time.

Obviously, Canadians expect and deserve better service than this.  That's why at Rawluk & Robert Chartered Professional Accountants Inc, our clients rely on us to answer the phone promptly and to give them accurate and reliable information.  This Auditor General report just reconfirms what our clients already knew.

Federal Government announces reduction in Small Business Corporate Income Tax Rate

Posted by Ryan Rawluk Posted on 16 Oct 2017

On October 16, 2017, the federal government announced a reduction in the Small Business Corporate Income Tax Rate.  The current rate is 10.5% after it had been previously reduced from 11% effective January 1, 2016. 

The reduction will occur in two steps.  The rate will be reduced to 10% on January 1, 2018 and further reduced to 9% on January 1, 2019.

The government also signaled that the non-eligible dividend tax rate will be increased on January 1, 2019 to compensate for the change in corporate tax rates.

As Manitoba's Small Business Corporate Income Tax Rate is already zero, Manitoba corporations will be subject to the above rates.