Tax Traps for Business Owners: Personal Benefits

When a shareholder treats a corporation like a personal piggybank, the consequences can be far-reaching. Conrad Black's legal woes are the most visible example of this. The tax authorities also take a dim view of business owners who fail to segregate corporate and personal transactions properly. 

Recently, the Canada Revenue Agency (CRA) went to court with Alberta Hot Oil Services¹, a private company controlled by husband and wife shareholders. The company had deducted personal expenses of the shareholders and in doing so, from the CRA's perspective, had evaded income taxes and GST. "Hot Oil" aptly describes what awaited the owners; the Court showed little mercy and convicted both the husband and wife of tax evasion.  Their appeals were dismissed earlier this year. 

Most business owners understand that deducting blatant personal expenses is illegal and will not be treated lightly if discovered by the CRA. The company will be denied a deduction for any personal expenses and the shareholder will be required to include the same amount in personal income. This amounts to double taxation when compared to paying a deductible bonus or a lower-taxed dividend to the individual to fund the expense. Penalties and interest may also be assessed and, in extreme cases like the one above, criminal charges can result.
There are other, more subtle ways to run afoul of the tax rules when using a business for personal use. Here are a few of the common tax traps into which business owners can fall:

Shareholder loans

Temporary advances are acceptable, but there are strict limits on when loans must be repaid to the company. These limits aim to prevent shareholders and their family members from withdrawing funds without paying taxes. Without these rules, shareholders might perpetually advance funds to themselves in the form of loans and never repay them, thus deferring the personal tax indefinitely. A loan caught by the rules will be taxed as personal income and denied as a corporate deduction.

Meals, entertainment and recreation

This can be a very confusing area of taxation, with specific rules dealing with deduction of gifts, restaurant dining, attending sports events, golfing, boating, parties and celebrations, season passes for ski resorts, and fishing and hunting trips. Some expenses are fully deductible, some are only 50% deductible, and others are specifically denied. The rules are actually quite generous, but clear understanding is required to take full advantage. The key is to document properly the purpose of any particular expense to show there has been some promotional or business benefit conferred by the activity.

Trips

Business travel is deductible, including attendance at meetings, conventions and trade shows, though only two conventions may be deducted per year. If a spouse or children also attend, or the trip combines business and pleasure, only the business portion of the expenses may be deducted. Be aware, the CRA states that employees enrolled in frequent-flyer programs must declare what they save on airline tickets as a taxable benefit. We suspect very few employees and business owners actually comply with this rule.

Vehicles

Vehicles are a common area of focus for tax auditors. Employees and business owners are responsible for tracking business and personal mileage. But, while official CRA policy requires maintaining detailed mileage logs, most people are too busy or undisciplined to do so. While a formal log is not mandatory, without some documentation employees and business owners are at the mercy of an auditor. At a minimum, diaries or computer records of appointments out of the office will allow at least some ability to reconstruct a record of business mileage in the event of an audit.

Expenses relating to travel from one place of work to another are deductible, while those relating to travel from home to work generally are not. However, employees and business owners having home offices used for work purposes may deduct expenses relating to travel between home and other work locations.

Personal use of company assets

A shareholder's personal use of corporate property is a taxable benefit. Normally, the benefit equals the fair market rental value of the property, net of any actual rent paid by the shareholder. In some cases, the courts have held the appropriate taxable benefit to be equal to a reasonable return on the amount of funds invested in the property. This might be considerably higher than the market rental value, particularly for luxury residential properties. We generally recommend that business owners steer clear of their corporations owning personal-use property.

Doug Greenhow is a tax partner in Collins Barrow's London member firm.

¹ Alberta Hot Oil Services Ltd. 2007 CarswellAlta 405 (ABQB)