Tax Factor 2013-01

January 23, 2013

The 2013-01 issue of the Tax Factor is available for download. In this issue, we cover:

How to handle common employment perks & pitfalls
Would you be ready for a tax audit?


How to handle common employment perks & pitfalls

The calendar may have flipped to 2013, but these first weeks of the year generally herald the time when many payroll professionals begin focusing attention on meeting the many tax reporting and filing deadlines for the previous year. In the month of January, employers are usually busy preparing, distributing and filing T4 slips to report salaries and other benefits earned by their employees in the year past. With such a diverse range of employment perks being offered to Canadian employees as part of their compensation packages, it can become a challenge to employers to ensure that each of these benefits is treated correctly for tax purposes. Unfortunately, mistakes in accounting for and reporting employee benefits can lead to unnecessary Canada Revenue Agency (CRA) audits, penalties and interest charges.

Recently, we sat down with Janet Spence, Manager of Compliance Programs and Services, at the Canadian Payroll Association (CPA) to talk to her about the CPA's views on the most common payroll reporting pitfalls. The CPA has been representing employers' payroll interests since 1978. Through its extensive work in the area of professional development and payroll certification, the CPA represents an expert voice in identifying common areas of concern amongst employers, and provides guidance as to how reporting errors can be avoided or, if necessary, corrected.

Common reporting errors

Each year, the CRA compiles a listing of the top 10 most common audit adjustments and provides this information to the CPA as a means of assisting members to identify and avoid common pitfalls in reporting (see the box below for the CRA's complete list provided to the CPA).

Top 10 Audit Adjustments​

According to the Canadian Payroll Association, the following are the Top 10 Audit Adjustments as identified by Canada Revenue Agency in 2011:

  1. Salary expenses
  2. Reclassification of employment status
  3. Unreported payments for services to an independent worker (i.e. T4A forms)
  4. Automobile standby charges and operating expenses
  5. Vehicle allowances
  6. Security/Stock options
  7. Shareholder benefits not reported
  8. Parking
  9. Personal and living expenses claimed by corporate owners
  10. Travel and meal allowances

Note: This article includes a detailed discussion of the highlighted items.

Interestingly, this list of audit adjustments is comprised almost exclusively of employee benefits, which tells us that reporting taxable benefits correctly is a challenge commonly faced by many Canadian employers. Of particular interest is the identification of automobile benefits and motor vehicle allowances, stock options, shareholder benefits and loans, and parking as items commonly requiring adjustment by the CRA on audit.

In order to clarify why these items continue to raise red flags on audit, let's examine the specific employment benefits mentioned above in further detail to understand the kind of issues employers are encountering, and the pitfalls that should be avoided, when reporting these benefits.

Automobile benefits

If an employee is provided with the use of an employer's vehicle and the employee is not restricted to using the vehicle only for business purposes, the "personal use" portion is considered to be a taxable benefit. One of the top 10 audit adjustments identified by the CRA is to correct errors made in the reporting of automobile benefits. Specifically, the CRA has identified that employees are often failing to maintain proper logbooks to identify and segregate business and personal driving. Since an accurate computation of the related benefit is dependent on the actual personal and business use of the vehicle, insufficient records will generally result in an under-reporting by employers of the automobile benefits on their employees' T4s. Keeping detailed and accurate records of personal and business driving is imperative. For more information, please read our Automobile Expenses & Recordkeeping tax bulletin. You may also want to ask your BDO advisor for copies of The BDO Automobile Log, a compact, easy-to-use booklet for keeping track of automobile expenses and business driving. Use of this log can help ensure that you and your employees have all the information needed to support year-end calculations.

Vehicle allowances

Employees using their own automobile (rather than one provided by their employer) in the course of their employment may receive a vehicle allowance as part of their compensation package. This allowance is generally a taxable benefit to the employee, unless the allowance is based on a reasonable per-kilometre rate and the employee was not reimbursed by the employer for expenses related to the use of the vehicle. Although the amount that is "reasonable" may vary with circumstances, as a practical consideration, the CRA will accept that a "reasonable" per-kilometre rate for this purpose is the same as the rates annually prescribed in the Income Tax Regulations for the deduction of such costs.

For 2013, the accepted per-kilometre rate will be 54¢ per kilometre for the first 5,000 kilometres driven, and 48¢ per kilometre driven after that. Note that for distances driven in the Northwest Territories, the Yukon and Nunavut, the rates are increased to allow for an additional 4¢ per kilometre.

The CRA has noted that employers paying a flat-rate vehicle allowance to their employees (one that is not based on the number of kilometres driven), or paying an allowance that is not based on a reasonable per-kilometre rate, are frequently failing to report the benefits as income. If you pay your employees an allowance for the business-related use of their vehicles, you may want to contact your BDO advisor to confirm whether those allowances are being correctly treated for income tax reporting purposes.

Stock options

Stock options are a common form of compensation provided by employers to their employees. For income tax purposes, there are specific rules that apply to tax the benefits employees receive from their stock options. Simplified, a benefit will generally arise when an employee exercises their options, unless the employer is a Canadian-controlled private corporation, in which case the benefit may qualify for deferral, to be recognized for income tax purposes when the shares are disposed of. Irrespective of when the benefit arises, this benefit will be taxed in the employee's hands as employment income. The benefit is generally equal to the difference between the fair market value of the securities at the time the option is exercised and the amount paid by the employee to acquire the securities. As a result of the number of audit adjustments, the CRA has recognized that taxable benefits with respect to stock options are frequently not being properly reported. That there are difficulties reporting stock option benefits is not entirely surprising, as the rules applicable to these plans can be very complex. Your BDO advisor can provide more information on stock option plans and how benefits arising from them are required to be reported.

Shareholder benefits and loans

It is not uncommon for an owner-manager to borrow money from his or her corporation with little to no interest being charged. When a low-interest or no-interest loan is made by a corporation to its shareholder, a taxable benefit is attributed to that shareholder for the value of the imputed interest benefit on the loan. The imputed interest is calculated as the difference between the amount of interest calculated on the loan using the CRA's prescribed rates for the period in the year during which the loan was outstanding, less any actual interest paid on the loan in the calendar year, or within 30 days after the end of the calendar year. Unfortunately, the CRA has identified that the interest benefit associated with loans made to shareholders is often calculated incorrectly or is simply not being reported at all. Note that in some cases the entire amount of the loan, and not just the imputed interest, will be treated as income of the shareholder. Contact your BDO advisor if you have questions about the taxation of benefits associated with shareholder loans.

Parking

The CRA generally considers employer-provided parking to be a taxable benefit to employees, in an amount equal to the fair market value of the parking provided. In some cases, it may be fairly straightforward to determine the fair market value of this benefit. For example, fair market value may be easily ascribed to parking if non-employees are being charged for the use of parking in the same location, or if there is equivalent paid parking nearby. Unfortunately, however, in most cases the determination of the fair market value may not be obvious. Note as well that there may be several situations where no benefit is required to be reported at all. For example, when parking is provided to an employee by his or her employer for business purposes, and the employee must regularly use his or her own vehicle (or one usually supplied to him or her) to perform his or her employment duties, the benefit related to parking will not be considered taxable. Similarly, if an employer is unable to determine the fair market value of the parking benefit, then a benefit does not need to be added to an employee's income. This may be the case where parking is available at no cost to both employees and non-employees (for example, at a shopping centre) or where scramble parking is provided (where there are significantly fewer spots available than there are employees, resulting in parking being available on a first-come, first-serve basis).

Likely due to the complexity of applying the policies above, the CRA has found that employers are failing to accurately report a benefit when one does exist, and when amounts are being reported, the fair market value of the parking is not being accurately reflected. This is not surprising, as there is much room for interpretation on this issue. Even recent decisions in Tax Court of Canada cases have reinforced the fact that the existence and the amount of parking benefits depend very much on the specific facts of each employee-employer situation. If you have questions about parking benefits, contact your BDO advisor.

Other reporting issues

Several additional employee benefits have also been identified by the CPA as being known to cause confusion amongst employers. Specifically, their payroll experts "are receiving a lot of calls on RRSPs and gifts and awards, and how those are treated" for tax purposes, says Ms. Spence.

RRSP benefits

As the RRSP contribution deadline for 2012 approaches, the CPA is receiving many requests for clarification on the tax treatment of employees' RRSP contributions. Specifically, Ms. Spence notes that "employers want to know how to treat the company's portion of contributions made to employees' RRSPs as part of company-match programs, and whether these amounts are taxable benefits".

Increasingly, companies are including RRSP-matching as part of their employment remuneration packages. These contributions must be reported as taxable benefits on an employee's T4. However, provided that contributions to an employee's RRSP are made directly by the employer and provided that the employer has reasonable grounds to believe that the employee can deduct the contribution for the year, taxes do not have to be withheld on this taxable benefit. The CRA will generally consider an employer to have reasonable grounds to believe that an employee can deduct the contribution if either confirmation is given by the employee that the contribution can be deducted for the year or he or she has provided a copy of his or her RRSP deduction limit statement from a notice of assessment.

Gifts and awards

Another common issue employers have raised to the CPA, especially around the holiday gift-giving season, is the income tax treatment of gifts and awards given to employees. The CRA's administrative position with respect to employer-provided gifts and awards generally provides that non-cash gifts and awards received by employees will not be taxable to the employee provided that the aggregate fair market value of such gifts and awards is less than $500 annually. Anything in excess of this threshold would be taxable. The $500 threshold does not apply to cash or near-cash gifts or awards (such as gift certificates or gift cards). These types of gifts and awards are always taxable to the employees.

Certain exemptions are also available in respect of specific non-cash awards paid to arm's-length employees in recognition of long-term service or an anniversary. The CRA's policies provide that, under certain conditions, these gifts or awards will not be taxable if the value of such a gift or award is less than $500 (any value in excess of $500 will be taxable). For further information on employee gifts and awards, please refer to our Year-End Tax Planning Checklist tax bulletin, or contact your BDO advisor.

Payroll deductions

In addition to the determination of whether or not a taxable benefit exists, errors can also occur when CPP, EI or income taxes are incorrectly, or simply not, withheld or remitted. Ms. Spence points out that "employers must remember that taxable benefits and allowances must be reported as they are enjoyed. Taxable benefits and allowances added to the employee's record at the end of the year will result in PIER (pensionable and insurable earnings review)." PIER is an analysis made to ensure that amounts deducted and withheld agree with amounts reported and as a result, discrepancies can often end in fines, penalties and interest charges being assessed to employers. Furthermore, an unfavourable PIER can result in further tax liabilities since employers will be held liable for both their portion and their employee's portion of under-remitted CPP and EI contributions, in addition to any related penalties and interest.

Preventing and correcting errors

To prevent errors, the CPA suggests that "employers [should] evaluate their practices with respect to [these] taxable benefits and how they are treated to ensure that they are compliant". This is sage counsel, as there is no better way to avoid potential problems then by ensuring you address employment benefit issues as they arise, rather than at year's end. If you recognize that any of these employment benefit issues are applicable to your business in 2013, contact your BDO advisor to discuss how these benefits will need to be treated. Furthermore, should you decide to make any new remuneration benefits available to your employees in the future, make sure that part of the planning prior to rolling out these benefits includes a discussion with your BDO advisor.

Even with advance preparation, we all realize that mistakes in year-end reporting of employment benefits can (and do) indeed happen. By now, many employers may have already finished preparing their slips and distributed them to employees or filed copies with the CRA. If you have already distributed or filed your slips, but are concerned that there is an error, contact your BDO advisor immediately. The CRA does have procedures in place to facilitate the amendment or cancellation of incorrectly filed T4 slips.

Your BDO advisor can assist you to amend, cancel, add or replace slips, and can provide guidance and help in correcting errors.

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Would you be ready for a tax audit?

Does the mere thought of a tax audit make you feel uneasy? If so, you are not alone. Whether you are in the middle of a tax audit or live in fear that the tax auditor is waiting for you around the next corner, we all have to accept that tax audits are an unfortunate fact of life for all individuals or businesses (whether you carry on business as a proprietorship, partnership or in a corporation). Fortunately, by understanding what triggers an audit, what the audit process entails, and how BDO can assist you through this unpleasant process, you will have the tools you need to survive the entire experience intact! Being prepared means that you can rest assured that if a tax auditor ever does comes knocking on your door, you'll be ready.

What can the CRA audit?

In an attempt to both uphold the fairness of our tax system and to ensure taxpayer compliance, the Canada Revenue Agency (CRA) selectively audits GST/HST and income tax returns, payroll records and excise taxes and duties. You should note that it is within the power of the CRA to conduct an audit with respect to any of the statutes or regulations that it administers. For individuals and Canadian-controlled private corporations, the CRA generally has up to three years from the time of issuing a notice of assessment to go back and audit that specific year. However, if a waiver for the particular year is provided, this time frame can be extended.

In the past, most audits of smaller businesses (generally businesses with annual sales less than $4 million) were conducted as combined audits. This meant that one audit would cover both income tax and GST/HST issues. Combined audits have since been discontinued, and businesses will now either be subject to an income tax audit or an audit that focuses solely on GST/HST filing errors or omissions.

How does the CRA select files for audit?

The CRA's computer system allows it to sort personal and corporate tax returns into various groups based on specific criteria, which in turn helps it select returns to be audited. The CRA has identified four common methods of selection that include:

  1. Computer-generated lists – Most returns are selected for audit review from computer-generated lists. For example, the CRA's computer system compares selected financial information of taxpayers engaged in similar businesses or occupations and generates lists of returns with audit potential.
  2. Audit projects – The CRA tests the compliance of a particular group of taxpayers, and if the test results indicate that there is significant non-compliance within the group, they may audit its members on a local, regional or national basis.
  3. Leads – The CRA compiles leads from other audits or investigations, as well as information from outside sources.
  4. Secondary files – The CRA may select files for audit because of their association with other previously selected files.

The selection of GST/HST returns for audit or examination is based on both risk assessment and on random file selection.

What is the letter writing campaign?

In 2010, the CRA began a campaign of sending letters to Canadian taxpayers, an initiative that they claimed would serve a dual purpose: "to educate taxpayers on specific claims they made on their income tax and benefit returns, and to provide notice of the CRA's intent to audit some taxpayers". If you receive such a letter from the CRA, you should note that it does not mean that the tax returns that you filed were incorrect. Instead, the CRA maintains that the letter is meant to provide you with an opportunity to request an adjustment should you discover that you claimed some items incorrectly on previously filed returns. Be mindful, however, that the letter may also serve as a signal that the CRA is targeting a particular industry sector to audit.

What can you expect when you are audited?

If you or your business is selected for an audit, you can expect that your BDO advisor will be actively involved in the process and will provide any assistance necessary. We can be of the most help if you notify us as soon as you are contacted by the CRA, and prior to providing the CRA with any records or answering any audit questions. You should note that the audit itself will be conducted as either a desk audit, where an auditor will review your records at a CRA office, or as a field audit, which will take place at your home or business location. An audit usually includes an examination of the following documents:

  • Information on file at the CRA, including the return(s) selected for audit, any related financial statements, audit reports from any previous audits, as well as any other information the CRA may have on file; and
  • Business records that you maintain, including your ledgers, journals, bank accounts, sales invoices, purchase vouchers and expense accounts.

Generally, the time frame of an audit depends on the state of your financial information and records, as well as the complexity of the issues being examined. Note that you will be given an opportunity to consider and respond to any issues identified by the auditor. Where the CRA proposes adjustment(s), you will be allowed, in most cases, 30 days to respond. The CRA will consider the explanations and responses you provide before finalizing the audit. Where an adjustment is made to your return, the CRA will issue a notice of reassessment to you.

Where an adjustment results in an increase in the balance of tax that you owe, the CRA assures taxpayers that it will provide an estimate of the amount before a reassessment is issued. If you disagree with the notice of reassessment issued by the CRA, you have the right to object to it by filing a notice of objection. For individuals or testamentary trusts, the time limit for filing an objection is on or before the day that is the later of the day that is one year after the taxpayer's filing-due date for the year and 90 days after the sending of the notice of reassessment. A corporate taxpayer or a non-testamentary trust must serve the notice of objection within 90 days after the notice of reassessment was sent.

As detailed on the CRA website, you may apply for an extension to file a notice of objection; however, the application to do so must be made within one year of the sending of the notice of assessment or reassessment, and acceptance of a notice of objection filed late is at the discretion of the CRA.

What can you do to prepare for an audit?

There are many things that you can do to ensure that you are well prepared in the event that you or your business is selected for audit. Here are some key items to consider:

  • Maintain good records: Have the receipts and documentation to support your claims ready in case you or your business is selected for review. You are required to keep your records and supporting documents and financial information for at least six years. You should note that if you keep electronic records, you must retain them in an "electronically readable format" for this time frame as well. Certain records, such as your general ledger or director's minutes for a corporation, must be kept longer. Remember that well-kept records will likely reduce the time required to complete the audit.
  • Be knowledgeable and ask questions: Before the auditor begins the audit, confirm what taxation years are under review and what records he or she will require. This will assist you in having the required information compiled and ready when the auditor arrives.
  • Know your rights: Don't give the auditor free reign over your files. Understand your rights as a taxpayer and don't hesitate to exercise them, when necessary.
  • Understand the information you are providing: Carefully review all information provided to the CRA and ensure that you are not providing more information than requested.
  • Be courteous and business-like: It is important to cooperate with the CRA and provide them with the information they request. Responding promptly and professionally to all correspondence received from the CRA may make the process go more smoothly.
  • Count on your BDO advisor: Take comfort in knowing that your BDO advisor can provide you with assistance at every step of the audit process. We can help you understand the auditor's questions and recommendations, and can assist with the negotiation process. We can also assist you if you need to file a notice of objection.

Summary

There is little doubt that a tax audit can be an experience that many people dread. However, by preparing yourself for the potential that you may in fact face one, you will be able to handle it without anxiety. If the auditor comes knocking — you will be ready.

In a future edition of the Tax Factor, we will delve into this topic further and discuss the CRA's risk-based audits.

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