Tax Deduction | Canadian Tax Decisions & Tax Law

Reasonableness of Business Expenses

Peach v The Queen, 2017 TCC 40

There are a number of hurdles to overcome before an expense is deductible for income tax purposes when determining profits of a business under the Income Tax Act. One hurdle is the limitation imposed by section 67 of the Act, requiring that the expense be reasonable.

In this case, the TCC issued a Redetermination Order after the taxpayer had partial success at the Federal Court of Appeal. The FCA sent the matter back to the TCC to identify what particular expenses were unreasonable and to what extent, as under section 67 the court can reduce or eliminate an expense to make it reasonable. The TCC reviewed each category of expense, the evidence and testimony in relation to each category, as well as submissions by counsel.

ANALYSIS

The Court referred to the Supreme Court of Canada decision in Stewart v. The Queen, 2002 SCC 46, where the SCC at paragraph 57 addressed how a court should approach the reasonableness inquiry:

57 It is clear from these provisions that the deductibility of expenses presupposes the existence of a source of income, and thus should not be confused with the preliminary source inquiry. If the deductibility of a particular expense is in question, then it is not the existence of a source of income which ought to be questioned, but the relationship between that expense and the source to which it is purported to relate. The fact that an expense is found to be a personal or living expense does not affect the characterization of the source of income to which the taxpayer attempts to allocate the expense, it simply means that the expense cannot be attributed to the source of income in question. As well, if, in the circumstances, the expense is unreasonable in relation to the source of income, then s. 67 of the Act provides a mechanism to reduce or eliminate the amount of the expense. Again, however, excessive or unreasonable expenses have no bearing on the characterization of a particular activity as a source of income.

There are certain things that a court is not entitled to consider, including second guessing the business decisions of a taxpayer by asking:

whether the expense is the result of poor business judgment – Ankrah v. R., 2003 TCC 413 at paragraph 4, citing Gabco Limited v. MNR, (1968), 68 DTC 5210 (Ex. CF) at page 5216. The primary basis for denial is that no person of business would pay such an amount given the circumstances of the particular taxpayer; and
whether expenses exceed revenues as business expenses are incurred before profitability can be determined and for the purpose to gain business income, and cannot be part of the reasonableness inquiry – Williams v. R., 2009 TCC 93 at paragraphs 16 and 17.

The Court considered the following categories of expenses:

Meals and Entertainment
- the court stated that anything beyond $20.00 a day for lunch, when no client meetings are involved, is unreasonable.
- NOTE – the court considered travel meals under meals and entertainment – not the appropriate category of expenses, and also did not consider the particular circumstances (location, average meal, dietary needs) in setting out a hard line number.
Business Tax, Fees and Licenses
- these are costs that must be incurred to operate a business and as such are reasonable.
Office Expenses
- the Court determined that absent an explanation for an increase in the subsequent year, the amount in excess of the year previous was unreasonable.
Capital Cost Allowance
- The court determined that without a travel log the expenses were unreasonable
- The Court also determined that give vehicles were unreasonable
Motor Vehicle Expenses
- The Court held that the operation of five motor vehicles over two years for one person was unreasonable without a justification

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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Eligibility for Foreign Tax Credits

Arsove v The Queen, 2016 TCC 172

At issue was whether the taxpayer, who filed both Canadian and US tax returns by reason of being a Canadian resident and US citizen, was entitled to claim a foreign tax credit in respect of Canadian sources income.

ANALYSIS

Income Tax Act section 126 permits a foreign tax deduction in certain circumstances when calculating Canadian tax payable. Specifically, subsection 126(1) allows a deduction from TAX otherwise payable (not income) for part of any non-business-income tax paid by the taxpayer, for that year, to the government of a country other than Canada.

Subsection 126(7) defines “non-business-income tax” for purposes of section 126 as an amount actually paid for a taxation year to the government of a country other than Canada that is the portion of any income or profit tax so paid that:

was not included in computing that taxpayers business-income tax for the year in respect of any business carried on by the taxpayer in any country other than Canada;
that was not deductible (whether deducted or not) pursuant to subsection 20(11);
that was not deducted pursuant to subsection 20(12); and
does not include a tax or a portion thereof that fits under paragraphs (c.1) to (i).

The Court also referred to the Canada-US Income Tax Convention which provides specific rules for taxpayers who are citizens of the US and residents of Canada.

Here the taxpayer, in her US tax return calculated US tax but this was reduced to nil after deduction of a foreign tax credit and she was also refunded income tax that was withheld on a distribution (paras 6-7). She filed her US tax return as if she had filed tax on the income in Canada.

The Court noted that if she would have paid tax to the US government, then she would have been entitled to a foreign tax credit up to the amount of tax so paid (para 13). Where, however, not tax is payable in the US or paid in the US, it follows (one would think logically) that no tax credit would be available in Canada. The tax payable is not the tax that is calculated as due but rather the amount that, by operation of US tax legislation, is ultimately imposed on a taxpayer – Zhang v. The Queen, 2007 TCC 634, aff’d 2008 FCA 198.

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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Income Tax – HST/GST – International Tax