A very important decision that small business owners regularly have to make is whether an expense should be considered a business expense or personal expense. This is a very important topic and can have a large impact on businesses when they come under scrutiny during a CRA review or audit. Many businesses do not have set guidelines or policies on making these decisions and owners often have to use their personal judgement when evaluating whether an expense is business or personal in nature. The CRA has very specific guidelines on criteria that businesses should consider when making these decisions.
The most important criteria would be whether the expense was incurred to earn income for the business. This is a very straightforward way of considering whether or not the expense is related to business activities. The logic is that the expenditure was necessary and vital to business activities. Using this metric will ensure that business owners will minimize their exposure by accidentally expensing items of a personal nature.
During a review or audit the CRA will review the general ledger and, should expenses appear that are out of the norm for the business’ core activity, ask why the expense was claimed. Failure to provide a good and clean answer will often result in the CRA agent digging deeper into the books and records of the company and will likely result in an unfavourable outcome for the business.
The importance of separating business and personal expenses appropriately cannot be overstated. If business owners use the criteria mentioned above, they will minimize their risk of having expenses disallowed during a CRA review or audit. If the CRA investigates and finds a large volume of personal expenses, not only will they be disallowed but the entity may be subject to non-deductible penalties and interest, and those responsible may have other legal consequences including further audits of the shareholders’ personal affairs.
Remember, if the expense was incurred by the business to earn revenue for the business, it is allowable. If it is at all questionable, professional advice should be sought or it should be considered personal in nature.
Submitted By:
Jonathan Carter, CPA, CMA | KATA Accounting Solutions Professional Corporation | (800)491-4803 | contact@kataaccounting.com | www.kataaccounting.com