A Little on Income Sprinkling

income sprinkling, CRA

Income sprinkling is the concept of taking profits from a company and paying them out to family members, or other close people, in order to lower taxes and retain more of the revenue from the company. This can be done by paying someone from your family, usually a son, daughter, or spouse, who does little or nothing for the business. OFten they can do little for the business, and receive salaries that are not commensurate with their contributions. It can be as little as a few thousand dollars, it could be $30,000. Or it could be a lot more!

Income sprinkling has been something that has been against the spirit of our law for years. However, it has not been explicitly outlined as to what it is (not properly defined), nor what penalties would be in place for this. The legislation is still not passed. Part of the proposed legislation is that any company caught would be retroactively penalized. This means that if a company is caught for income sprinkling in 2018, then the CRA can review years past, as well. They may even choose to open prior years selectively.

My input? Don’t do it! It’s nice not to pay the taxes, if you can think you can get away with paying your spouse (or kid) for not working at your company. It’s also nice to be able to help them out if they are in a tough spot and need some help. Don’t pay them for nothing. Make them work! If they’re contributing, and they’re being paid a fair wage, commensurate with the contribution they are giving and industry rates, then there will be no issues. Yes, I’ve seen business owners pay their children or spouses who are not involved at all (or very minimally) in the business wages that are far above what they would earn for doing the same work for someone else. That’s income sprinkling.

Paying dividends to children or those over the age of 17 (adults) who are into actively involved in the business is also considered income sprinkling. Dividends are paid to owners of the company! He or she must be engaged in the business at least an average of 20 hours per week during the part of the taxation year that the business operates. If an individual does not satisfy this deeming rule, then it is a question of fact whether he or she was engaged on a regular, continuous and substantial basis. [CRA on income sprinkling]

The Casual Labour Myth

I don’t know where the whole concept of hiring people under a label of “casual labour” and paying them cash came from. I have seen other websites (in Canada) that even advise that paying cash or casual labour is okay. They are wrong for many reasons.

CRA Doesn’t Recognize Casual Labour

Paying someone out of the til and then trying to expense this in the business is something that a lot of businesses want to do. The problem is, it isn’t permitted by the Canada Revenue Agency. Trying to write off this expense is a big flag to the CRA and could open up a company to an audit. At the very least, the company will be liable for any payroll deductions that are owed, including CPP, EI, and (possibly) tax deductions. Whenever someone is hired, they must be either an employee or a subcontractor. Therefore, even the kid you hire for an afternoon to help clean a store, or the old guy who really knows how to make the trim for that cabinet, has to be on payroll or have their own company, and be treated accordingly.

What About WCB?

Many businesses are required to cover employees with WCB. If you are a contractor, then your subcontractors must also be covered, unless they have their own coverage. Part of the responsibility of the business is to ensure that WCB coverage exists. This means that if someone is a subcontractor, it is necessary to check. The subcontractor should have their own WCB number that can be checked with the provincial board, usually online. If a WCB audit is conducted, then the business becomes liable for the amount of coverage that was supposed to be paid to WCB, plus any possible penalties.

subcontractor, check GST registration, contractor accounting, bookkeeping services, business tax, tax returns, subcontractor bookkeeping, subcontractorContractors, some of your subcontractors also want to charge GST! Ensure that they have a GST number, and that it is still valid. I can’t count the number of times that I’ve seen contractors pay the GST on a subcontractor’s invoice only to find that the number wasn’t valid. And that means that the contractor is unable to use the GST paid as an ITC, instead it becomes part of the expense. It is better for the business to have the ITCs, as that is 100% refundable, rather than as an expense, which only saves the tax rate (for combined small businesses in Alberta, this is 14%). Which would you rather have? You can check that on the CRA site here.

Your Best Option

Any employer should make sure that anyone hired, whether for a few hours or a few days, is either put on payroll or has a contract. Putting someone on payroll requires obtaining their social insurance number, date of birth, address, and setting a rate of pay. It also requires that deductions are done correctly. This can be found on the CRA website (here).

If a contractor is hired, then it is best to have a contract in place. This should include the rate of pay, whether hourly or by the job, as well as the pertinent information including their business number or SIN. Make certain that any subcontract states that the subcontractor is responsible for paying income taxes, CPP, and that they are a subcontractor, not an employee.

And it’s always a good idea to review any labour agreements you have with your accountant to be sure that they are in line with current legislation. If you have questions, please contact me, and I will be glad to help.

Being Forthright: Good Bookkeeping Practices in Small Business

While it’s not the rule, most small business owners (and the CRA) are aware that it’s possible to hide a few transactions here and there in a retail establishment and no one would be the wiser, even during an audit. Whether this is morally right or not is not at issue here and not relevant for this discussion. The biggest issue is what effect it has on the owner’s knowledge of the business and what is really happening. How can one know what is really happening if things aren’t tracked?

If an owner has a habit of hiding transactions, such as not ringing sales into the cash register, there are a few issues that should be addressed.  Whether this is honest or moral is not to address here. Such an action will never allow the true overall sales and cost of goods sold to be known. This makes it very hard to have accurate financial statements. And if an owner wants to turn from simply being self-employed to becoming a true business person, then this accuracy is important! There is also the issue of loss. When an owner fails to ring in transactions, it sets an example for employees, making it easier for them to follow suit. And then what happens to the cash from such transactions?

These discrepancies also make compiling financial statements, and the connected tax returns, more difficult for your accountant. How is the accountant to know when a classification is correct if there is no backup documentation to show why imbalances happen? Many accountants will take the safest route possible (for them) when deciding where to put such imbalances, since this is what is in “the public’s best interest” and written into the ethics codes of professional associations. But that isn’t always in the owner’s best interests, and it could be incorrect as far as what really happened.

Accounting, corporate tax, financial statement preparation

For example, if there is a few hundred (or thousand) dollars discrepancy on the balance sheet that shows some money came out of the company, but there is no way to show where or how, it is likely the safest move to consider it as money taken by the owner. While this is “in the best interests of the public”, and follows proper accounting guidelines, it does not favour the owner. Instead, it increases the owner’s personal income, which increases personal taxes. And if the discrepancy is because of missing expenses or stolen cash from un-entered transactions, a whole different set of financial statements and tax liabilities result. And there is the issue of the owner knowing what is really going on in the business! Perhaps there is loss happening that cannot be traced because the owner is also not entering transactions into the books. It would be in the owner’s best interests to know what the true picture of what’s happening in the business.

So, it’s actually in the owner’s best interests to track everything and to never try to “hide” transactions and income, as then the owner knows what is really happening in the business and can make better decisions and thus increase the profits of the business legitimately. And this is what true business ownership is all about.

Catching the Dream – Sticking with Goals & Principles

“I love the man that can smile in trouble, that can gather strength from distress, and grow brave by reflection. ‘Tis the business of little minds to shrink; but he whose heart is firm, and whose conscience approves his conduct, will pursue his principles unto death.”

-Thomas Payne,   1776

In business and life we often have ideas and goals that we dream about and truly want to accomplish, yet our fears and those of the people who surround us will beat us down, sometimes defeating us before we truly get started. Catching your own dream and pursuing it is often elusive. Even finding that dream and what it truly is can be a great difficulty for many people. Some will spend years, even decades, in the pursuit of a goal that is not truly their own, only to find that they’ve lived an unsatisfactory life. This is one of the 5 greatest regrets of the dying – they wish they had lived a life more true to themselves, rather than the expectations of others.

It seems that most people will reach a point in their lives where they realize that they have not honoured even half of their dreams and die knowing that it is because of the choices they had made.  As business owners people often leave out much of their personal dreams in order to pursue their financial dreams and become a success. While this is laudable and certainly helps to keep some parts of life happy and fulfilled, we must remember not to sacrifice too much of this and still stick with our personal goals and dreams as well. There is no point in making lots of money if we cannot enjoy it!

Sticking with our principles means more than simply following our dreams; it also means to do what we believe is right, regardless of what others think. It means pursuing a higher path, whether it be in our business dealings or our personal lives. And that can be tough! There’s always pressure to give way, sometimes just a little bit, in order to make more or help someone else out. And this is sometimes at our expense or at the expense of our goals and principles. And these should never be compromised!

When posed with a decision, ask this question, “Would my young children be proud of the choices I make at this time?” Or ask, “Would someone I admire approve of the choice I am making?” And make sure that it is also something that you would be proud of and sticks with your goals and principles.

In my business I will sometimes get people asking me ways to lower their taxes, and some of the ideas they get are either incorrect, illegal, or sadly misinformed. Part of my dream is to run a business that is ethically pure and 100% honest, while still saving my clients as much as possible on taxes and improving their business’s bottom lines. I can only do this by being completely open and honest with them about all of these items. And, yes, I have lost a client because I refused to accept certain items on his financial statements that I knew were not business related. They would have been rejected in an audit – and I told him so. He walked away. I ran into him again sometime later, and he brought it up to me, saying that he should have listened, because he was audited. The penalties and interest he ended up paying weren’t worth the risk. His business no longer exists. I may have lost the revenue from a good business client, and even more from dealing with a difficult audit. But I can live with myself better knowing that the choice I made was the right one, and would have been for my client had he chosen to follow my advice.

Making these kind of choices isn’t always easy. And they aren’t always business decisions; they can be personal ones, too. Our business and personal lives really are intertwined and we shouldn’t have one set of values for each. Trying to do so really becomes a reflection of who we are. If we have the highest ideals in our home and personal lives, then these should also be in our professional lives. People will respect us more, and the rewards will show in the long run. And making such a choice allows us to better integrate our dreams in all aspects of our lives.