A Lesson in Record Keeping

TAXATION

The Income Tax Act requires you to keep
all documents supporting your business
activity; in an audit, the CRA will
demand them.

Keep Everything

According to the Income Tax Act, taxpayers must keep
“records and books of account … together with every
account and voucher necessary to verify the information
contained therein” for a period of six years
following the last taxation year to which they relate.
For corporations, the start of the six-year period is the
fiscal year; for individuals, the calendar year.

Show Us the Proof

The recent appeal ruling in Tibilla v. The Queen before
the Tax Court of Canada, July 3, 2013, reinforces the need to maintain documentation. In summary here is what led to the ruling:

• Mr. Tibilla (the taxpayer) acquired a rental property
  for $172,000 November 14, 2002, and sold it
  on December 18, 2007, for $285,000 but declared
  no capital gain in his 2007 tax return.
• In 2010, the Canada Revenue Agency (CRA)
  advised the taxpayer that his return for 2007 was
  under review and that he was required to provide
  copies of the contract of purchase and sale, a statement
  of the capital cost allowance claimed over
  the years the property was owned, a list of any
  expenses related to the purchase and sale as well
  as the receipts for those expenses.
• In a late filing of his 2008 tax return, the taxpayer
  declared a capital gain of $41,571.64 and a taxable
  capital gain of $20,785.82 (i.e., 50% of the capital
  gain). The taxpayer said he was declaring the capital
  gain in 2008 because, despite having signed the
  sale agreement in December 2007, disagreements
  with the new purchaser made the sale “uncertain
  and incomplete” until March 2008, when the disagreements
  were amicably settled.
• Included in the taxpayer’s capital gains calculation
  was $52,810 in renovation expenses claimed
  to have been incurred before he actually acquired
  possession of the property (i.e., between April and
  November 2002). (The addition of this amount
  to the adjusted cost base would have reduced the
  capital gain when the property was sold.)
• The CRA rejected the renovation expenses
  because the taxpayer provided no vouchers. The
  taxpayer said he had stored the receipts in his
  basement but they had been lost in a flood in
  2008. He was unable to explain why the existence
  and loss of these receipts had not been brought to
  the attention of the CRA during the audit, discovery
  or the appeal. The taxpayer said he had made
  no insurance claim for the loss because he did not
  want to increase his future insurance premiums.
  He therefore also had no documents from the
  insurance company attesting to his loss.
• The appeals judge ruled that the sale had taken
  place in 2007 since it had taken place by deed of sale before a notary on December 18, 2007, and had been registered in the official land registry the next day.
• The judge also ruled that the period between the
  date of purchase (November 14, 2002) and the
  date of sale (December 18, 2007) was not six years
  and, in any case, the Income Tax Act required the
  taxpayer to keep records of any claims until the
  expiry of the appeals process, which the taxpayer
  had not done.
• The appeal was dismissed with costs to the taxpayer.

The burden of proof for deductions lies with the taxpayer.

Lessons

Referring to other cases, the judge emphasized
that, since our tax system is based on personal selfmonitoring,
the burden of proof for deductions and
claims lies with the taxpayer. Just keeping notes is
not enough; documents are required. If Mr. Tibilla
had been able to produce records of his renovation
expenses (and if they had been accepted by the CRA),
he would have saved himself a significant amount
in taxable capital gains and legal costs. The addition
of the claimed $52,810 in renovation expenses to
the $172,000 purchase price would have given him
an adjusted cost base of $224,810. His capital gain
would have been $60,190 ($285,000 – $224,810) to
give a taxable capital gain of only $30,095. Instead,
he incurred a capital gain of $113,000 ($285,000
– $172,000) of which $56,500 was taxable. Mr. Tibilla’s
inability to produce his expense records cost
him $26,405 ($56,500 – $30,095) in taxable capital
gains.

What about Your Past?

Prior to February 22, 1994, there existed a cumulative
capital gains exemption of $100,000. If this amount
was not fully used by the February 22, 1994, deadline,
taxpayers could use any unused amount to revalue
capital property. Effectively, the taxable capital
gain on any taxable capital property sold thereafter
would be reduced by the election amount of 1994.
Documentation to support 1994 valuations may be required. Consider the following types of transactions that may need to be substantiated with adequate documentation years after they have occurred:

• If you purchase shares of a corporation from a
  third party, the adjusted cost base (ACB) of those
  shares will not be the paid in capital on the balance
  sheet. Shares could be purchased at different
  times for different amounts.
• If you have investments in income trusts, part of
  the monthly payments are usually return of capital
  which reduces the ACB of the investment.
• When calculating the ACB of a partnership, you
  have to take into account the partners’ taxable
  income, which is often different from the accounting
  income.
• Corporations that incur a non-capital loss may
  apply to reduce all types of income in the three
  taxation years prior to, and the seven taxation years
  following, the loss (10 years for taxation years ending
  after March 22, 2005). It would appear from
  the Tax Court ruling that application of non-capital
  losses 10 years back would subject the applicant
  to another six years of record keeping in the event
  that CRA wished to audit the taxable years.

As a result of the 2013 Tax Court rulings, individual
and corporate taxpayers should consider the following:

• Locate the original documentation pertaining to
  any capital property.
• Review the record destruction policy to ensure you
  are retaining pertinent records.
• Contact your lawyer, accountant, real estate advisor,
  appraiser or other professional to determine
  whether they have copies of any of your records
  that may be required. If possible, get the originals
  and leave them copies.
• Keep in mind that professionals change firms, die,
  or sell their business to others. If your professional
  is no longer available, review past tax returns and
  statements to determine whether there are any
  issues that may require documentation held by
  their predecessors. Ask your current professional if
  they have documentation for the years in question.
• Consult with your professional about losses and
  their applicability to prior years’ taxable income to
  determine whether the time and cost of a potential
  CRA audit is worth the dollars that may be
  recovered.
• Establish a relationship with a CPA firm. Your
  CPA will be attentive to maintaining historical
  information.
• Maintain originals of all documents. After all, as
  noted above, it is your responsibility to produce
  the necessary documents to support your claim(s).

Get It All Together

As you approach retirement and plan to sell the
company or transfer ownership to others, you will
need to have documentary evidence of past transactions
to ensure any tax liability is kept to a minimum.
Owner-managers should make reviewing the past and
gathering the required information a priority.

Disclaimer:

BUSINESS MATTERS deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other
appropriate professional advice should be sought before acting upon any of the information contained therein.
Although every reasonable effort has been made to ensure the accuracy of the information contained in this letter, no individual or organization
involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or
for any consequences arising from its use.
BUSINESS MATTERS is prepared bimonthly by the Chartered Professional Accountants of Canada for the clients of its members.
Richard Fulcher, CPA, CA – Author; Patricia Adamson, M.A., M.I.St. – CPA Canada Editor