My son recently asked whether it was illegal to pay his younger brother to do his chores. I couldn't find any law against this, but I vetoed the idea just the same.
Interestingly, our tax law doesn't always seem to recognize that certain behaviours may be against other laws. For example, while it's illegal to marry more than one person in Canada, our tax law will allow you to treat more than one person as a spouse if they each meet the appropriate definitions under the Income Tax Act.
But what about illegal payments? Today, I want to talk about the top non-deductible expenses. It's not that these items are all illegal. But the taxman has seen fit to limit or deny certain expenses for various reasons. Here's a list.
1. Illegal payments. Section 67.5 of our tax law denies a deduction for illegal payments. Specifically, any expense incurred for the purpose of doing anything that is an offence under Section 3 of the Corruption of Foreign Public Officials Act or under a number of provisions of the Criminal Code will not be deductible. And, by the way, our tax law allows the taxman to reassess a taxpayer to deny these deductions even beyond the usual three-year limitation period.
2. Fines and penalties. Section 67.6 of our tax law will deny a tax deduction for fines and penalties that are levied by any person or public body that has the authority to impose the fine or penalty under a law of a country or of a political subdivision of any country (including a state, province or territory). So, if you are charged any fines or penalties – including parking or speeding tickets – those amounts won't generally be deductible. I should mention that fines and penalties imposed under private contracts are not caught under this restriction and may be deductible.
3. Personal or living expenses. As a general rule, costs that are considered to be personal in nature can't be deducted for tax purposes. These include things like clothing, costs related to your home (mortgage interest, property taxes and repairs, for example), insurance premiums etc. The onus is on the taxpayer to draw a link between a cost incurred and an income-producing purpose. Drawing this link doesn't necessarily mean the taxman will agree that the cost was incurred to earn income, but be aware that you may need to build an argument that the cost was incurred to earn income from a business or property.
4. Capital expenditures. If a cost is considered to be a capital expense rather than a current expense, then it won't generally be deductible. Think of a tree-and-fruit analogy. If you spend money to buy a tree so that you can grow fruit and sell the fruit for a profit, then the cost to buy the tree is a capital expense and is not deductible. On the other hand, if you don't own a tree but rather purchase the fruit and sell it for a profit, the cost of the fruit would be deductible as a current expense. Our tax law may allow you to deduct the cost of the capital asset (the tree) over time through the capital cost allowance system (depreciation for tax purposes), but capital costs cannot generally be deducted in a single year.
5. Recreational facilities and club dues. Costs incurred for the use or maintenance of a yacht, camp, lodge or golf course (unless you're in the business of providing these things), will generally be denied as a deduction. In addition, membership fees or dues (initiation fees or otherwise) in any club, the main purpose of which is to provide dining, recreational or sporting facilities to its members, will not be deductible. Apologies to golfers everywhere in this country.
6. Meals and entertainment. It's been the case for many years that only a portion of meals and entertainment expenses are deductible. Our federal tax law will deny a deduction for 50 per cent of these costs, with some rare exceptions.
7. Personal services business costs. If you earn your income through a corporation you own but the taxman considers you to really be an employee of the business making payments to you, your corporation may be considered a "personal services business" and you'll be denied any deductions except a few, including salaries paid to yourself, or some other costs that may be available to employees more generally.
This list just scratches the surface of limitations on tax deductions. I'll share some other limitations next time.