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Importance of Small Business Record Keeping

A recent BC Supreme Court Case has been a popular read for people following legal news.

Leroux v. Canada Revenue Agency, 2014 BCSC 720 outlines the importance for small businesses of keeping proper records, especially in a self-assessing tax system, where every expense can and will be challenged by CRA during an audit.

This 2014 judgement indicates that the CRA can be held accountable in some cases for so-called “negligent” behaviour. But after more than 15 years and $4 million, this may be a Pyrrhic victory for Lereux.

In short, if you do not have the records that explains why something should be considered a business (rather than a personal) expense, you may be in for a hard time.

In this case, in the mid-90’s, the CRA conducted a prolonged income tax and GST audit on Mr. Leroux, who owned a recreational vehicle park business near Prince George.

The CRA seized Leroux’s original documents during the initial audit, and subsequently stated that the original documents had been accidentally shredded and that it was his responsibility to provide more documents to substantiate his tax returns.

The audit back-and-forth between CRA and Leroux took many years. After 13 years of audit, assessment, reassessment, and collections activities, Lereux claimed his business was financially ruined. According to the judgement in the BC Court of Appeal:
In an assessment issued in 1999 and confirmed by the Minister of National Revenue after an internal appeal in 2000 respecting income tax for 1993, 1994, and 1995, Mr. Leroux was advised he owed over $600,000 in taxes, interest and penalties.  In a consent judgment in the Tax Court of Canada, issued June 16, 2005, respecting those years, adjustments were made to the tax debt, by then over $800,000 as a result of daily compounded interest, resulting in a settlement of about $57,000.  After some payments and a “fairness application” to the Minister of National Revenue, resulting in the cancellation of all interest and penalties, Mr. Leroux was owed an income tax refund of about $25,000, which was offset against outstanding GST, for a net result of zero.  In the meantime, Mr. Leroux had lost his business – an RV park which was also his home – and most of his property.
In 2005, he took his case to the Tax Court of Canada, where the CRA gave up in a so-called consent to judgment, essentially admitting its mistake. That reduced Leroux’s personal tax bill to zero and his GST bill to $20,000. Documents show that by 2006, Leroux was actually owed a $24,000 tax refund.

Leroux brought an action against the CRA for negligent behaviour during the audit, reassessment, and collection process. The British Columbia Supreme Court dismissed the CRA’s motion to strike portions of the claim.

So, Leroux has won, after all this time, a victory (Leroux will still continue his dispute in court), but the judgement does note that there were “deficiencies in record keeping, and the characterization of income” and that “CRA cannot be faulted for anything to do with the portions of the assessments, either in GST or income tax, resulting from Mr. Leroux’s failure to produce business records and receipts and to properly support and document his claims for business expenses.”

And any ability Leroux had to to support his claims vanished with his receipts and paperwork, what he claimed was his sole proof of his business expense claims, were shredded.

In a self-assessing tax system, where any expense claim can be challenged at a later date, this is a good argument for keeping good records.

DISCLAIMER: THIS MATERIAL DOES NOT CONSTITUTE LEGAL OPINION OR ADVICE AND IS GRATUITOUSLY PROVIDED FOR INFORMATIONAL PURPOSES ONLY.

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