Take care when deducting employment expenses

Advisors running a practice often incur expenses that are deductible for tax purposes. But if you’re an employee, as opposed to self-employed, the rules are quite strict.

Under the Income Tax Act, you can only deduct “the cost of supplies that were consumed directly in the performance of the duties of […] employment and that the […] employee was required by the contract of employment to supply and pay for.” In other words, to deduct employment expenses, such as non-reimbursed supplies, your employer must acknowledge that you were indeed required to pay those expenses. This requirement must be certified by your employer on Form T2200.

Every so often, a tax case reveals how some taxpayers push the limit of what is plausibly deductible. Take the recent case (Kalryzian v The Queen, 2016 TCC 186), decided in September 2016, of a commissioned Future Shop salesman. In 2007 and 2008, CRA disallowed all the taxpayer’s employment expenses and imposed gross negligence penalties for his attempt to claim inappropriate and disproportionately high business expenses.

High business expenses

In 2007, the taxpayer filed a tax return showing $44,781 in employment income and $26,571 in employment expenses claims—about 59% of his employment income. As a result of claiming these expenses and some carrying charges, his 2007 return showed no federal or provincial tax owing, resulting in a full refund of taxes withheld at source by his employer, along with some refundable tax credits.

Similarly, in 2008, the taxpayer’s return showed employment income of $45,623 and employment expenses of $25,012, representing just under 55% of his employment income. He paid no tax in 2008 and claimed a refund of all tax withheld at source.

The taxpayer had hired a tax preparer to prepare his returns. This preparer was “very popular […] and was used by other sales representatives at the Future Shop where he worked.” His particular skill was that he “would coach clients and explain how to get their receipts organized so as to take advantage of available deductions.” As the taxpayer explained, “if an expense helped to sell goods, then it was deductible.”

Curiously, on both the 2007 and 2008 income tax returns, the tax preparer did not fill in his name and address in the box for professional tax preparers on line 490 on page 4 of the returns.

The judge was quite skeptical from the start, saying, “I have great difficulty in accepting that the [taxpayer] had more than a modest amount of selling expenses that could be deducted.”

Here are some of the questionable business expenses the judge called out.

Clothing

The taxpayer brought copies of numerous receipts and credit card statements in support of his employment expenses. While these documents were organized under various headings, they “did not correspond with the headings in the expense statements […] included with the tax returns.”

For example, in 2007, he classified $2,461 in expenses under the heading “Boots and Gloves.” The taxpayer could offer no explanation for why his tax preparer called this “Boots and Gloves” other than guessing that it might relate to clothing, although the receipts provided didn’t show any clothing purchases.

The judge found that there was “simply nothing in the evidence to suggest a requirement for a uniform or other specialized clothing paid for by the employee. As a result, there could not be a basis for [a] deductible clothing expense.”

Mutual Funds

The total of the receipts and other documents reached about $20,000 of expenses, which included over $5,000 in mutual fund purchases, “amounts clearly unrelated to the Appellant’s job as a salesman.”

Automobile expenses

The taxpayer had also attempted to deduct all his car expenses, including fuel, traffic tickets and the cost of a second-hand vehicle, which was simply expensed rather than capitalized. He kept no log of his kilometres, but argued he was occasionally asked to work at a grand opening of a new store. He also testified that he would sometimes deliver large televisions to clients after he left work, adding that this helped “close sales because he was able to say, ‘If you buy it today I will deliver it tonight.’”

Internet and Satellite TV

The salesman further deducted his home Internet and home satellite television as sales expenses because “it gave him a better understanding of products he was selling.” The judge called this claim “a stretch” as these were personal consumption expenditures.

Home electronics

Another major category of expenses was labelled “product knowledge” and consisted of $4,000 in expenditures to buy various products from Future Shop. According to his testimony, “employees were given discounts to encourage them to buy products sold so they would know the products and be better able to sell them.”

These purchases included car speakers (and their installation), a wireless controller for the Blu-ray player on a gaming console and a Harman Kardon receiver. The judge found not only that these expenses were personal but that “the above claims are exaggerated to the point where I cannot accept that the Appellant is being forthright in his testimony. As a result I am unable to accept much of his testimony.”

Starbucks

In 2008, the judge noted there were 84 Starbucks receipts totaling $642 which the taxpayer testified were to purchase drinks for customers and for employees who worked at the front of the store at the customer service desk, to help “build rapport.” The judge noted that “[t]here appears to be overwhelmingly the cost of teas of various kinds and very little coffee—something that would be unlikely if these refreshments were for the benefit of a cross section of customers who came to the store to buy electronics.”

The judge did not accept that these were selling expenses.

Gross negligence?

In the end, the judge allowed only about $1,000 in expenses for each of the tax years.

The judge then turned to the matter of the gross negligence penalties. For such a penalty to apply, there must be two essential elements: a false statement in the return (of which there were numerous) and whether the taxpayer “knowingly, or under circumstances amounting to gross negligence, has made or has participated in, assented to or acquiesced in the making of […] the false statements.” Gross negligence includes “wilful blindness.”

The judge said the penalties were properly imposed, finding that “[w]hile taxpayers are not expected to be tax experts, they are expected to make a reasonable effort at ensuring the accuracy of their return.”

Jamie Golombek

Tax & Estate

Managing Director, Tax and Estate Planning, CIBC Private Wealth Team Jamie Golombek is Managing Director, Tax and Estate Planning with CIBC in Toronto. As a member of the CIBC Private Wealth team, Jamie works closely with advisors from across CIBC to support their clients and deliver integrated financial planning and strong advisory solutions. He joined the firm in 2008 after 12 years with a global investment company, where he was involved in both internal and external consulting on all areas of taxation and estate planning. Jamie has also worked for Deloitte as a tax specialist in the Toronto office, where he specialized in both personal and corporate tax planning. Jamie is quoted frequently in the national media as an expert on taxation. He writes a weekly column called “Tax Expert,” in the National Post, has appeared as a guest on BNN, CTV News, and The National, and for several years was a regular personal finance guest on The Marilyn Denis Show. He received his B.Com. from McGill University, earned his CPA designation in Ontario and qualified as a US CPA in Illinois. He has also obtained his Certified Financial Planning (CFP) and Chartered Life Underwriting (CLU) designations. In 2023, Jamie was named a CPA Ontario Fellow. The FCPA is the highest distinction that can be bestowed upon a CPA who brings distinction to themselves and to their profession through leadership and achievement in their professional, community or personal lives. Jamie is a past chair of the Investment Funds Institute of Canada’s Tax Working Group. He is also a member of CPA Ontario, the Illinois CPA Society, the Estate Planning Council of Toronto, the Canadian Tax Foundation and the Society of Trust and Estate Practitioners. For nearly two decades, Jamie taught an MBA course in Personal Finance at the Schulich School of Business at York University in Toronto.