Employees are extremely limited in the types of expenses they can deduct for tax purposes and the rules are particularly tricky if you’re deducting a salary or other fees paid to an assistant.

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Taxpayer who hired mother-in-law, wife as assistants gets pushback from CRA Back to video

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As a recent case demonstrates, the Canada Revenue Agency may decide to take a closer look at your employment expense deduction when the “assistant” you happen to hire is your spouse, partner or other family member.

Salary paid by an employee to a family member is often done to split income, especially if the employee is in a relatively high tax bracket and wishes to redirect some of their income to a zero- or low-income spouse or family member.

But when discovered, the CRA often challenges such planning, and asks the employee to prove the amounts paid to their relative were “reasonable” given the hours (allegedly) worked by that relative, and that the amounts were actually paid to that individual.

Both issues were at the centre of the recent case involving a Greater Toronto Area car dealership manager who claimed employment expenses of $55,945 in 2015 and $50,793 in 2016 against approximately $110,000 of annual employment earnings.

Those expenses consisted of $24,000 in assistant’s salary paid to a family member for each of 2015 and 2016, and motor vehicle expenses (leasing, parking, fuel and insurance) of $29,000 in 2015 and nearly $27,000 in 2016. He also wrote off “office supplies” consisting of an Apple Watch and an Apple laptop, totalling $2,850.

The CRA denied all the taxpayer’s employment expenses and the matter ended up in Tax Court.

The taxpayer explained he hired his mother-in-law in 2015 to do some work using a home laptop computer with a VPN connection to his office files. The work involved completing and closing the file on each vehicle sale, lease or financing arrangement as they occurred, and included entering confidential information of both the customers and the dealership.

He testified that given his numerous responsibilities at the dealership, he didn’t have the time to do this himself and needed to hire someone, such as his mother-in-law, “whom he could fully trust with this sensitive information” to do this work prior to submission to the dealership’s accountant for posting.

The taxpayer claimed a deduction of $24,000 against his 2015 employment income for salary paid to his mother-in-law for this work. As it happens, his mother-in-law lived with him in the same house, along with his wife and kids, and, as such, he testified he did not actually pay his mother-in-law the $2,000 per month, but rather “credited the amount against monthly rent for her living in his house, and against food charges and transportation charges to her and unspecified credit card or other charges.”

Unfortunately, no documentation corroborating this crediting was entered in evidence, the amount of the “purported” monthly rent was not stated and his mother-in-law did not testify. There were also no records as to the hours the mother-in-law worked.

During cross-examination, it was suggested the taxpayer’s mother-in-law’s knowledge of English was poor, to which he responded that she had had some ESL training and that the work he had her do did not involve knowing English as long as she was “able to add and subtract.”

In 2016, the taxpayer deducted another $24,000, except the assistant he hired this time was his wife. He testified that his wife was paid by way of monthly amounts of $2,000 being deposited into a joint account held by both spouses. In other words, there was no actual transfer of funds to his wife. No records of payments or hours worked were kept, and his wife didn’t testify in court.

Under the Income Tax Act, in order to claim a deduction for salary paid to an assistant, an employee must be required to do so by the employee’s employment contract, and a completed CRA Form T2200, Declaration of Conditions of Employment , signed by the employer, must be obtained.

The taxpayer was unable to provide any evidence that his employment contract required him to pay a salary to an assistant, nor could he produce a signed T2200 form for either the 2015 or 2016 tax year. In addition, no documentary evidence was submitted supporting actual payments of the alleged $24,000 salary for either year.

For the 2015 tax year, the judge concluded there was no evidence the taxpayer normally charged his mother-in-law for rent, food and transportation, so he found the $24,000 paid to her as an assistant was non-deductible.

As for the hiring of the taxpayer’s wife in the 2016 tax year, the judge noted, based on a prior case, that simply having an employee’s salary deposited into a joint account held by two spouses does not constitute payment from spouse A of a salary to spouse B “qua assistant.”

The judge also questioned the reasonableness of the payments in both years. How was the annual amount of $24,000 determined? It was clearly not based on the number of hours worked. When asked, the taxpayer simply responded that $24,000 was “what we predetermined.”

The judge felt that $24,000 annually for an assistant was an “arbitrary amount and overly generous for part-time hours of computer laptop work … (and) was not reasonable … for either year.”

The judge also challenged the legitimacy of the taxpayer’s expenses for two motor vehicles, a BMW and a Toyota. In court, the taxpayer admitted the Toyota-related automobile charges ought to be excluded as that vehicle was used entirely for pleasure. As for the BMW, he admitted that only 50 per cent of the expenses claimed were business-related. But the taxpayer was unable to provide a mileage log for the BMW or any receipts for fuel and parking. The judge denied the entirety of the taxpayer’s automobile expenses.

Finally, under the heading “office supplies,” the taxpayer tried to deduct the cost of an Apple Watch and laptop. The judge, aside from questioning the personal usage of the items, concluded they were capital expenses and thus not deductible by an employee.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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