Cash may be king, but it can cause headaches if the taxman denies your claims
It’s often said that cash is king, but it may not always be the best method of payment when it comes to dealing with the taxman, who may ask you some tough questions to justify tax-deductible expenses or, on the flip side, demonstrate you earned a minimum amount of qualifying income to take advantage of various benefits or credits.
For example, there’s been a slew of recent cases dealing with taxpayers’ eligibility for COVID-19-related benefits, such as the Canada Emergency Response Benefit (CERB) and Canada Recovery Benefit (CRB), in which taxpayers had to prove they had earnings of at least $5,000 to qualify for these benefits. If those earnings were paid in cash, and never deposited in a bank account, the validity of various taxpayers’ claims was challenged.
But the difficulty in proving cash earnings can also arise outside the realm of pandemic benefits. Take a recent case involving a taxpayer’s claim for the Working Income Tax Benefit (WITB), since replaced by the Canada Workers Benefit (CWB). The benefit is a refundable tax credit that supplements the earnings of low-income workers, and is available to individuals 19 years of age or older who aren’t in school full time.
For 2022, the CWB is equal to 27 per cent of each dollar of working income above $3,000, to a maximum credit of $1,428 for single individuals without dependents, and $2,461 for families (couples and single parents). The CWB is phased out at a rate of 15 per cent of each dollar of income above $23,495 for single individuals (without dependents), and $26,805 for families. (Note that amounts may be different for residents of Alberta, Nunavut and Quebec.)
In 2018, about 1.4 million Canadians received the WITB. The key to qualifying for the WITB (or the CWB now) is that the individual claiming the credit must have “working income,” which is essentially employment or business income.
But how does one prove working income if you’re paid exclusively in cash?
That was the question before the judge in a recent Tax Court of Canada case involving a Prince Edward Island resident and his WITB claim for the 2015, 2016 and 2017 taxation years. The taxpayer’s claims were denied because the Canada Revenue Agency concluded he “was not actively operating a business” and had “not earned any working income giving entitlement to the WITB.”
By way of background, the taxpayer lives “very modestly” in a trailer with his wife and was described by the court as a man “gifted with an independent spirit.” Throughout his life, he has held various jobs, including as a bar singer in Montreal, as well as gigs in technology and construction and renovation.
In court, the taxpayer was represented by a childhood friend, a tax specialist, who also prepared his tax returns for the three years in question. His friend also happens to own several properties, where the taxpayer carried out all kinds of work, including the renovation of bathrooms, installation of floors, repair of flood damage and construction of galleries and balconies, as well as plumbing and electricity — in short, anything related to renovation or maintenance.
During the tax years in question, the taxpayer only worked during the summer in order to earn enough money for him to spend the winter on a sailboat in the Bahamas. He didn’t need a lot of money because he didn’t have any dependents and had very few personal expenses. The annual expenses for his sailboat amounted to $5,000. Each winter while on his boat, “it cost him nothing to live. He ate what he caught,” and testified, “Life on the sea is not expensive … To live on his sailboat … is … the best possible life; it’s heaven on earth.”
In 2015, 2016 and 2017, the taxpayer declared business income of only $10,000 to $13,500, because he was sailing for six months of the year. He also didn’t incur, nor deduct, any business expenses, as his customers bought any necessary building materials.
His friend paid him in cash, but the taxpayer did not keep any documentation of the income he earned or a register, although, according to the judge, “he has since realized the importance of keeping a record and preserving any supporting documents.” His friend marked the work, or the amounts paid to the taxpayer, on a small calendar and, at the end of the year, did the accounting. The taxpayer didn’t deposit his income in his bank account, but claimed to have declared all his income to the CRA on his returns.
The CRA argued that the income the taxpayer declared was not related to the operation of a business or employment, because he conducted a cash-only business, kept no records, incurred no business expenses and produced no supporting documents to support his claims. The taxpayer and his tax specialist friend relied “almost solely on their memory, which is unreliable in nature.”
The judge acknowledged that “in a self-assessment system like we have in Canada, keeping books and records is very important,” but the failure to keep good records is not, by itself, sufficient grounds to dismiss a case.
Absent good books and records, the burden of proof is certainly higher and the judge must assess the credibility of the taxpayer and any witnesses, such as the tax specialist. As for running a cash business, the court cited prior jurisprudence which concluded: “The use of cash is legal and legitimate … and it does not necessarily lead to a conclusion of tax avoidance.”
The judge weighed all the evidence and was satisfied the income declared by the taxpayer during the years in question did, indeed, relate to the operation of a business, was corroborated by his tax specialist and constituted working income. The judge, therefore, concluded the taxpayer was entitled to the WITB for the three years in question.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com