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Most business decisions have tax consequences. One of the biggest mistakes a business owner can make is to not consider the tax impact of a decision before it is made. The financial impact of “not thinking” can be devastating for you and your business, and can get you in trouble with Canada Revenue Agency, or CRA. Six common, and potentially costly mistakes include:
1. Not remitting the money collected from payroll source deductions and GST on time. Often these amounts can sit in your business bank account for weeks, or even months before the remittance to CRA is due. The government considers these balances to be “funds held in trust” by the business on behalf of the government. The penalties for failing to remit these amounts are stiff, and CRA can be very aggressive in their collection procedures.
2. For source remittances, the penalty for late payment is 10% of the amount that should have been withheld. Any further late payments in the same calendar year will attract a 20% penalty. For GST, a late payment attracts a 6% penalty in addition to interest. In both cases, interest will be charged from the day payment was due and is compounded daily.
3. Treating employees as independent contractors. It can be advantageous for a business to consider its workers to be independent contractors rather than employees to avoid having to pay Canada Pension, Employment Insurance, or other benefits for them. But CRA has specific criteria that must be met to qualify for independent contractor status.
CRA may not discover the incorrect treatment of an employee until they conduct a payroll audit of your business. This may not happen for years. It may never happen at all. But if you are audited and they find this problem, CRA can assess you for years of unpaid source remittances (including both the employer’s portion and the portion that should have been withheld from the employee’s earnings). There will be interest and penalties as well. These amounts can add up quickly, so ensure that if you are treating someone as an independent contractor, they actually meet the criteria.
4. Not tracking the personal use of the company’s automobile. The benefit of any personal use of a company vehicle must be included on the employee’s T4 as employment income. CRA recognizes two benefits from using a company vehicle for personal use: a standby charge, which relates to the vehicle wear and tear, and an operating cost benefit related to the number of kilometers the vehicle is driven.
In a worst-case scenario, if detailed records of car usage are not kept, CRA could charge the user of the vehicle with a full standby charge and 100% of the kilometers as personal usage. This can add up to a considerable sum. For 2005, a car that originally cost $20,000 and was driven 25,000 kilometers in the year could result in an income inclusion of $9,800 if proper records are not kept.
5. Becoming “associated” with other corporations. Corporations enjoy a lower rate of tax on the first $300,000 of taxable active business income due to the small business deduction. Corporations that are “associated” for tax purposes have to share the annual business limit of $300,000. Association rules can be quite complex, but the general idea is that when two or more corporations are controlled by the same group of people they will be considered “associated”.
Control generally refers to ownership of a majority of voting shares. Trouble can arise when a corporation sells as little as one share to someone who, in conjunction with another shareholder, would control more than one corporation. Then, instead of each corporation enjoying the low tax rate on the first $300,000 of taxable income, the corporations will get only one $300,000 limit to share at the low tax rate between them. This area becomes very complex, especially as you add more shareholders and more companies. To avoid this problem be sure to consult with your accountant whenever you are considering selling or issuing any voting shares in your corporation.
6. Failing to notice offside shareholder loan balances. Often business owners “borrow” funds from their company to pay personal expenses. Over the course of a year they may also contribute personal money to the company. These regular withdrawals and contributions generally flow through a “shareholder’s loan” account. But if, at the end of the company’s year, the shareholder owes money to the company, this can be a problem.
CRA has specific rules about corporate shareholder loans. Since corporations often pay tax at preferred rates, CRA is concerned that owners could take money out of their company without paying personal income tax on it. CRA specifies that if a shareholder owes money to the company on two consecutive year-end balance sheets, the principal portion of the loan must be included in the shareholder’s net income for tax purposes. It also notes that a series of loans and repayments will be viewed as one continuous loan. This prevents the shareholder from paying the loan off just prior to year-end and then re-borrowing the money just after year-end so the loan does not show up on the balance sheet.
You need to be continuously aware of your shareholder loan balance. From a tax perspective, it is often advantageous to eliminate the “loan” by issuing a bonus or declaring a dividend to the shareholder rather than having the amount included in income by CRA.
Overall, the biggest mistake is that business owners often don’t think of the tax consequences of their business decisions. The key is to think before you act. If you are unsure whether a decision has tax consequences, get professional advice. It is usually much more difficult to fix a situation that is already offside from CRA’s viewpoint than it is to structure a transaction to fit the rules from the start. Knowing the tax implications of your decisions before you act is vital in Taking Care of Business.
By Wendy Lewis, CA. Originally published in Comox-Valley Record (April 27, 2005). For more information, contact your local MNP advisor or Wendy at 250.338.5464.
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