Capital punishment

(August 2007) If you conduct your advisory practice through an employee-employer relationship, as opposed to being self-employed, no doubt you’re aware that your ability to deduct expenses is much more restrictive than if you owned your own business.

Each year, several tax cases make their way to Tax Court in which employees attempt to write off otherwise legitimate expenses but are told they can’t because of technical rules in the Income Tax Act.

The most recent case, Paes v The Queen (2007 TCC 311), was released last month and serves as a valuable reminder to employees of the types of expenses that may or may not be deducted.

Ken Paes was a commissioned salesman for Superpages, a company that sells advertising to businesses. In 2003, he earned a base salary of $53,000 and reported commissions of over $42,000.

On his 2003 tax return, he wrote off over $27,000 of employment expenses, most of which the CRA allowed. However, the agency denied about $5,000 of these expenses, including office expenses for the purchase of presentation equipment, a printer, phone and cabinet as well as seminar and training expenses for a real estate sales seminar, a motivational lecture and a basic HTML course.

The CRA claimed that the office expenses should be classified as “capital” and therefore not deductible and that the seminar and training fees were not incurred for business purposes, nor was Paes required to attend these seminars as part of his employment.

Office expenses Paes argued that in order to earn his income as a salesperson, working out of his home office, he needed to use a “table, chairs, cabinet, computer, printer, telephone among other equipment.”

The problem, however, is that under the Income Tax Act, an employee who earns commissions can only deduct certain expenses but specifically cannot deduct “outlays, losses or replacements of capital or payments on account of capital,” except capital cost allowance on vehicles and airplanes.

Paes testified that he failed “to see any rationale why there is discrepancy in the treatment of deductibility between motor vehicle expenses and office equipment expenses. Both are critical elements in earning income.”

This issue has arisen most recently in the Emmons case (see my previous column, “Expenses for Advice,” Advisor’s Edge Report June 2006) in which a broker’s computer costs were found to be of a capital nature and therefore not deductible.

Is also received national attention in the 2004 Supreme Court of Canada ruling in Gifford, a case involving a broker who was unable to deduct the cost of buying another broker’s client list. The Supreme Court publicly highlighted this unfairness, saying that, “… employees are treated differently than taxpayers earning income from business … is not novel nor readily seen as fair … This seemingly inequitable result for [Gifford] is the result of the structure of the [Income Tax] Act.” The judge quoted the Gifford case and found that Paes was not entitled to claim the capital cost of any of his office supplies.

Seminar and training expenses Paes also deducted the costs of motivational and a real estate sales seminar he attended. He testified that at these seminars, he learned “sales techniques and sold advertising to real estate agents.” Paes felt that the training he received in those seminars “has directly helped [him] in his present position as [a] salesperson.”

The Canada Revenue Agency in its Interpretation Bulletin IT-357R2, “Expenses of Training” distinguishes between deductible and non-deductible training costs. The CRA states that training costs are not deductible as a current expense if they are considered “capital expenditures.” This occurs “where the training results in a lasting benefit to the taxpayer, i.e., where a new skill or qualification is acquired.” By contrast, where “the training is taken merely to maintain, update or upgrade an already existing skill or qualification, the related costs are not considered to be capital in nature.”

The judge determined that Paes’ courses were of a capital nature and that he was not entitled to a deduction.

Canada Employment Credit If you find yourself in the same position as Paes, keep in mind that in last year’s budget, the federal government introduced some relief with the new “Canada Employment Credit,” designed to give “Canadians a break on what it costs to work, recognizing expenses for things such as home computers, uniforms and supplies.”

For 2007 the CEC amount is $1,000, which translates into a non refundable tax credit of $155 (equal to 15.5% of $1,000).

This article first appeared in the July 2007 edition of Advisor’s Edge Report.

Jamie Golombek, CA, CPA, CFP, CLU, TEP is the vice-president, taxation & estate planning, at AIM Trimark Investments in Toronto. jamie.golombek@aimtrimark.com.

(08/27/07)