Personal Finance

Incorporated contractor dealing with CRA review letter

  • Last Updated:
  • May 30th, 2018 4:27 pm
[OP]
Banned
Nov 19, 2017
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2 upvotes

Incorporated contractor dealing with CRA review letter

I'm a self-employed contractor who is incorporated.

My employers pay my corporation and my corporation pays that money to myself through a sole proprietorship.

Nearly all income except for minor expenses is paid from my corporation to my sole proprietorship, claimed as a consulting fee on my corporate return. Likewise on my personal/sole proprietorship that income received from my corporation is reported as "business income."

I recently got a review letter from the CRA for years 2014-2015. They're asking for supporting evidence for expenses.

To be honest, I didn't keep very good records during this period. When I transferred money from corporation to my personal account I didn't keep detailed records or make invoices. The CRA review letter is asking for 1) Detailed transaction logs or general ledger entries and 2) Invoices and receipts. I don't have any of these, but I have my personal income tax return which matches exactly the expense claimed.

I'm wondering what is the best way to proceed in this situation.
19 replies
Deal Addict
Jan 2, 2015
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richardz1 wrote:
May 27th, 2018 1:19 pm
I'm a self-employed contractor who is incorporated.

My employers pay my corporation and my corporation pays that money to myself through a sole proprietorship.
That is confusing. I looked that up online and found a Red Flag Deals thread :) question-about-paying-myself-sole-propr ... p-1182602/

But that's really confusing. Shouldn't your corporation be paying you either as a T4 or with dividends? It looks like you're going "employer" -> your corporation -> your sole proprietorship. I don't see how that last step is needed. Furthermore isn't the point of a corporation to insulate yourself? Yet you've added an extra step that increases the risks to you.

I think you're supposed to go from "employer" -> corporation -> choose how you want to be paid: employment income, dividends or some combination. Furthermore you would file a T2 corporate income tax return, and prove your expenses there.

Alternatively, your employer issues you a T4A, and you report that as gross business income on your personal tax return (as a sole proprietor), which means there's no point of having a corporation.
Nearly all income except for minor expenses is paid from my corporation to my sole proprietorship, claimed as a consulting fee on my corporate return. Likewise on my personal/sole proprietorship that income received from my corporation is reported as "business income."
Again, this is confusing. I think you might be regarded as an employee of your corporation (yes, you can be an employee if you're a 100% shareholder, you don't need to pay EI when that happens), and you're basically paying yourself your net business income. But that's bad, because you need to pay your payroll taxes too. Although I suppose you could claim CPP only, and you have paid both halves as a sole proprietorship...
I recently got a review letter from the CRA for years 2014-2015. They're asking for supporting evidence for expenses.

To be honest, I didn't keep very good records during this period. When I transferred money from corporation to my personal account I didn't keep detailed records or make invoices. The CRA review letter is asking for 1) Detailed transaction logs or general ledger entries and 2) Invoices and receipts. I don't have any of these, but I have my personal income tax return which matches exactly the expense claimed.
You are supposed to keep records for six years (2014 is only four years ago) including and especially proof that you paid expenses. The CRA can deny you those expenses claims because you cannot prove you had those expenses. That applies regardless of where you are claiming those expenses; on a T2125, a T2, or whatever you're doing.

Your bank statements can give the CRA a maximum limit of how much income you earned (hopefully matching your gross business income) but it can't really prove your expenses. You might have something on your statement proving you paid $1,000 to XYZ Office Products, but it doesn't say what you bought there. The CRA won't know if those are legitimate expenses.

I don't know what you could do, beyond hiring an accountant or a tax law firm, but in the future you need to download some accounting software (hopefully there's free software available) and scan your receipts, backing them up so you always have a record... and decide whether your business structure actually makes sense. A session with an accountant will help you with that.
Deal Addict
Jan 15, 2017
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^^^ I agree, very confusing. You can't be incorporated and sole proprietorship at the same time. It's either one or the other.

As you were incorporated, the expenses should have been claimed through the corporation. Your income should have been paid either as regular earnings and/or dividends. My guess is that claiming personal business expenses as SP when you are incorporated raised the red flag for CRA.

If you do not have any receipts, invoices or supporting documentation for your claims, the CRA will disallow all of them. You may wish to speak to an accountant about how to proceed. One thing is for certain, you may want to spend some time trying to find all the receipts and supporting documentation for your claims.
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Dec 26, 2010
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That is confusing. I looked that up online and found a Red Flag Deals thread :) question-about-paying-myself-sole-propr ... p-1182602/

But that's really confusing.
It's a way to weasel out of paying both sides of CPP, which is about 10% in tax. Dude is going to get nailed.
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Mar 3, 2018
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Hopefully CRA just limits their review to corporate expenses. As they could also look at whether you were actually an employee of your employers and all the implications of that.

If most of the corporate expenses were reported on your T1 return as self employed income that should be explained and accepted. Other minor expenses would be accepted if they are reasonable under the circumstances even without receipts. I would arrange a meeting with the auditor to discuss what you have and what else they would accept.
[OP]
Banned
Nov 19, 2017
11 posts
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wm009 wrote:
May 27th, 2018 2:54 pm
It's a way to weasel out of paying both sides of CPP
I didn't weasel out of anything. All the income was claimed in my sole proprietorship as "Self-employment income." under personal taxes. I paid both sides.
Last edited by richardz1 on May 27th, 2018 3:56 pm, edited 1 time in total.
[OP]
Banned
Nov 19, 2017
11 posts
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skeet50 wrote:
May 27th, 2018 2:46 pm
^^^ I agree, very confusing.
I don't see how it's confusing. All income was claimed on my personal return as "Self-employment income" (and this gave me the 2x CPP hit) Exactly the same amount that was expensed to the corporation as a "consulting fee".

The only thing I'm missing is a proper documentation to demonstrate this to the CRA
Sr. Member
Nov 6, 2015
718 posts
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Guelph, ON
richardz1 wrote:
May 27th, 2018 3:56 pm
I didn't weasel out of anything. All the income was claimed in my sole proprietorship as "Self-employment income." under personal taxes. I paid both sides.
Which leaves us all the more confused as to this complicated Customer --> Corporation --> Sole Proprietor business. What was the perceived advantage to this? Why not just be one or the other?

Anyways, you screwed yourself. If you can't prove your expenses, in the CRA's eyes they didn't happen. You will be reassessed with those expenses taken off and you will owe more in taxes.
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Mar 23, 2008
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richardz1 wrote:
May 27th, 2018 4:01 pm
I don't see how it's confusing. All income was claimed on my personal return as "Self-employment income" (and this gave me the 2x CPP hit) Exactly the same amount that was expensed to the corporation as a "consulting fee".

The only thing I'm missing is a proper documentation to demonstrate this to the CRA
It’s confusing because nobody else is running as both sole proprietorship AND incorporated. It doesn’t make any sense to do this.

You need to talk to an accountant and get this straightened out. Not asking for help off an anonymous website.

C
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Jul 3, 2006
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CNeufeld wrote:
May 27th, 2018 6:40 pm
It’s confusing because nobody else is running as both sole proprietorship AND incorporated. It doesn’t make any sense to do this.

You need to talk to an accountant and get this straightened out. Not asking for help off an anonymous website.

C
This is what prob triggered the review in the first place. They prob think you are clamming expenses on both sides. You should just had your corporation pay you DIV or Income via T4
Deal Addict
Jul 3, 2006
1945 posts
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richardz1 wrote:
May 27th, 2018 4:01 pm
I don't see how it's confusing. All income was claimed on my personal return as "Self-employment income" (and this gave me the 2x CPP hit) Exactly the same amount that was expensed to the corporation as a "consulting fee".

The only thing I'm missing is a proper documentation to demonstrate this to the CRA
Why didn't you pay from your corporation to your personal self..Why did you use sole proprietorship?
Sr. Member
May 16, 2017
742 posts
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richardz1 wrote:
May 27th, 2018 1:19 pm
I'm a self-employed contractor who is incorporated.

My employers pay my corporation and my corporation pays that money to myself through a sole proprietorship.

Nearly all income except for minor expenses is paid from my corporation to my sole proprietorship, claimed as a consulting fee on my corporate return. Likewise on my personal/sole proprietorship that income received from my corporation is reported as "business income."

I recently got a review letter from the CRA for years 2014-2015. They're asking for supporting evidence for expenses.

To be honest, I didn't keep very good records during this period. When I transferred money from corporation to my personal account I didn't keep detailed records or make invoices. The CRA review letter is asking for 1) Detailed transaction logs or general ledger entries and 2) Invoices and receipts. I don't have any of these, but I have my personal income tax return which matches exactly the expense claimed.

I'm wondering what is the best way to proceed in this situation.
I think the terminology reflects the starting issue that you haven't understood the financial responsibilities needed to separate corporate and personal finances.

Your "clients" not your "employers" pay you. Your employer is your corporation.

If your "consulting" work for your corporation is actually exactly the same work that is delivered to your clients you should have shown this is the proper related income/expenses/profit applying to this flow-through. If "consulting" is just a term to get paid by your corporation for what is (as others have said) really either a salary or dividend you got another level of problem properly classifying the income/expenses for the corporation and personally properly.

What do you mean by "Nearly all income except for minor expenses is paid from my corporation to my sole proprietorship". Is the corporation paying business expenses or is your sole proprietorship? Have all the expenses and revenue associated with the work done for your corporate clients flowed through the corporation? If not, another big problem.

Is the review on the corporate tax return or the personal (or both)? The way it sounds - it will trigger the other if it isn't both already.

The bold/underlined part is the big issue. You've effectively co-mingled corporate and personal funds by moving them around without proper documentation. Frankly, you are effectively embezzling your own money (or funding the corporate expenses personally without documenting it as a proper financial input).
[OP]
Banned
Nov 19, 2017
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2 upvotes
Thanks for the comments. I guess I need to speak with an accountant and maybe a lawyer.

Please PM me if you have any suggestions for an accountant in downtown Toronto.
Deal Addict
Jan 15, 2017
2597 posts
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CNeufeld wrote:
May 27th, 2018 6:40 pm
It’s confusing because nobody else is running as both sole proprietorship AND incorporated. It doesn’t make any sense to do this.

You need to talk to an accountant and get this straightened out. Not asking for help off an anonymous website.

C
Yes, it's confusing because sole proprietorship and incorporation are types of business structures. You can't have both - you are either incorporated or sole proprietorship.

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