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We are often getting questions from our clients on what is the best way to deduct automobile expenses. Buy or lease a car under corporation, or buy or lease it personally. There is no one best answer; it depends on number of facts. We summarized general information regarding each method.

Scenario 1. Employee or shareholder owns or leases a car personally.

This may be the easiest way to claim deductions. Corporation reimburses employee or shareholder for each business kilometer driven for business purpose. Compensation rate in 2012 is 53 cents per kilometer for first 5,000 kilometers and 47 cents thereafter.

Example: Employee drove for business purpose 13,000 kilometers

5,000 km * .53 cents = $2,650

8,000 km * .47 cents = $3,760

Total 13,000 km            =$6,410

In this example $6,410 is deduction that corporation will claim for car expense reimbursement to employee or shareholder. The corporation will issue a cheque for $6,410 to employee or shareholder. Money received is not taxable income on personal level.

All car related expenses (i.e. lease or loan payments, gas, insurance, repairs and maintenance and etc.) to be paid by employee or shareholder.

It does not matter whether a person owns or leases an expensive car or drives a cheap used vehicle. The same compensation rate per kilometer is used – 53 cents / 47 cents.

In case of CRA audit you have to provide mileage log supporting business kilometers claimed.

Scenario 2. Corporation owns or leases a car

In situation when a corporation leases or purchases a car, all car related expenses are claimed by corporation and a taxable benefit is allocated to employee or shareholder for personal use of the vehicle.

Taxable benefit is notional amount which is added to individuals taxable income and it is subject to income tax. Taxable benefit depends on number of kilometers driven for personal use and cost/lease of the car. Keep in mind that commute from home to your place of work is generally considered personal travel. Taxable benefit may result in a few thousands dollars added to individuals income and taxed at top marginal rate

Also, depreciation and lease expenses are restricted to certain cost threshold amounts.

Company owns a car

Cost limit for depreciation purposes is 30,000 before HST. For instance if a company purchases a car for $50,000 plus taxes only 30,000 will be eligible for depreciation and remaining $20,000 will never be deducted.

Company leases a car

Leasing expense is generally restricted to $800 + taxes per month. However, if the cost of the car exceeds $30,000 plus taxes the allowable lease expense is prorated and reduced.

Tax Advise

In many situations you will achieve approximately the same result if you buy/lease a car personally or through corporation. In a typical situation a car costing $30,000 plus tax which runs 24,000 km per year and 75% is for business use – tax results will be very comparable. When deciding to buy or lease you should also consider other factors such as years you want to use the car, interest rates, insurance cost, residual value and etc.

However in the following situations are recommendations are:

1. If you consider buying or leasing a car which costs more than $30,000 plus taxes it is usually better to do it personally rather than through a corporation. The reason is that you will not be able legally deduct all depreciation or lease payments. However your taxable benefit will be calculated on the full amount.

2. If you expect overall few kilometers driven by the car and more than 50% will be for business buy or lease it through corporation. The reason is that if you own/lease it personally the car reimbursement you receive from the company will be very low. That will be more beneficially to own/lease it through corporation and deduct all car related expenses. The taxable benefit allocated to you is expected to be low if you drive few personal kilometers.

Independent operators, executive officers and partners in a partnership working in construction will need to have WSIB coverage.

Independent operator in construction means, an individual who,

• does not employ any workers
• reports himself as self-employed to Canada Revenue Agency
• is retained as a contractor by more than one person during an eighteen month period.

or

• an individual who is an executive officer of a corporation that,
• does not employ any workers other than the individual, and
• is retained as a contractor by more than one person during an eighteen month period.

Two exemption from WSIB coverage are available:

 1. Home renovation work

Independent operators, sole proprietors, executive officers and partners in a partnership working in construction industry are exempt from compulsory coverage if they are engaged exclusively in home renovation work.

What is exempt home renovation work?

Exempt home renovation work means construction work that is performed by an independent operator, a sole proprietor, a partner in a partnership, or an executive officer in a corporation and, on an existing private residence that is or will be occupied by the person who directly retains the contractor, or by a member of the person’s family.

Independent operators, sole proprietors, partners and executive officers are subject to compulsory coverage when their business is engaged in non-exempt work.

WSIB coverage exemption is not available if you engage in what would normally be regarded as exempt home renovation work, as well as non-exempt work. The insurable earnings reported for the independent operator, sole proprietor, partners or executive officers must include the earnings related to all construction work, including the home renovation work.

2. Exemption of a partner or executive officer

This exemption applies to partnerships, corporations with workers, and corporations without workers but with multiple executive officers. This exemption does not apply to a corporation with one executive officer and no workers.

A partnership or corporation may elect one partner or one executive officer, respectively, for an exemption from coverage if the partner or executive officer does not engage in any construction work. Periodic site visits are permitted, provided that the partner or executive officer is not performing construction work on the site.

Reporting of Insurable Earnings

Independent operators.

Independent operators must determine their own insurable earnings. The gross insurable earnings are based on the labour portion of the contract. If labour costs are not adequately recorded the following formulas should be used:

• If there is no evidence that the contractor supplied major materials and/or heavy construction equipment used in the direct performance of the construction work, the WSIB considers the entire contract value (100%) as the contractor’s gross insurable earnings.
• If there is evidence that the contractor supplied major materials, and/or heavy construction equipment, used in the direct performance of the construction work, the WSIB permits the principal to identify the labour portion using the following allowed percentages:

1. where a contractor provided labour and major materials, the principal is to use 60% of the contract value as the contractor’s gross insurable earnings.
2. where a contractor provided labour and heavy construction equipment, with or without major materials, the principal is to use 33 1/3% of the contract value as the contractor’s gross insurable earnings.

Sole proprietors with workers and partners in partnership with or without workers.

The insurable earnings for a sole proprietor in construction, and a partner in a partnership in construction, are the individual’s annual self-employment business income reported to CRA on line 135 of T1 General

Executive officers in a corporation

The gross insurable earnings of an executive officer is based on the total of:

• employment income reported on a T4 Statement of Remuneration Paid
• other insurable employment income reported on a T4A, Statement of Pension, Retirement, Annuity, and Other Income
• dividends reported on a T5 Statement of Investment Income, and
• director fees issued by the corporation to the executive officer.

Minimum amount of insurable earnings

The WSIB sets an annual minimum amount of insurable earnings for sole proprietors, partners and executive officers in construction. Each year the minimum amount is set at 1/3 the annual maximum amount of insurable earnings ($81,700 in 2012).

Who need to register?

Many independent contractors who provide services in IT, engineering, consulting and other areas operate their business through own corporations. Small Business Corporations are eligible to claim Small Business Deduction and pay in Ontario 15.5% income tax rate on first $500,000 of net income. Also, corporation would write off all business related expenses (i.e automotive, office, advertisement, office rent, telecommunication, salaries to family members and etc.). Very often corporate income would be cut in half or more after deducting all expenses. Then the company would pay corporate 15.5% corporate tax on net income and distribute remaining retained earnings in dividends (often splitting dividends between family member shareholders through special structure share capital), often trig erring no or very low personal tax. You may know that in Ontario income tax is zero on first $38,000 of dividends.

Does it sound good? Maybe it is too good to be true! Obviously, CRA is not happy with this situation. There are special rules for Personal Service Business (“PSB”) otherwise called “incorporated employees”. As of October 31, 2011 the rules became even tougher.

What are tax consequences to be a Personal Service Business?

PSB is not allowed to have Small Business Deduction and even General tax reduction. In Ontario corporate tax of PSB would be 39.5% (compare with 15.5% of Small Business Corporation!). PSB is very limited to expenses it is allowed to deduct. Generally, only salaries paid to shareholder would be allowed.

If your corporation is reassessed as a PSB that would create a huge tax bill!

What are some characteristics of a business that would cause PSB designation?

1. One or very few clients.

2. Working mainly at client’s office

3. Using client’s equipment and tools.

4. Being listed in client’s telephone directory.

5. Having business card issued in the name of client’s corporation.

6. Degree of integration with client.

7. Contractor might be reasonably considered as an employee of the client.

CRA Guide “Employee  or Self-employed” rc4110-11e provides more details.

 What to do to minimize risk?

1. Review terms of your contract if you have one or prepare and sign a contract if you don’t have one.

2. Try to get as many clients as possible

3. Use your own tools

4. Establish in the contract right to work from your office.

5. Get your business cards. website, HST number, business name (don’t use numbered company).

6. Involve in Research & Development and claim R&D credits. Doing that might show that your company developing products.

7. Discuss your situation with accountant in advance. Don’t wait till CRA reassess your tax return

For professional help please contact us

at (416) 739 – 1899

Toronto office:

4580 Dufferin Street Suite 401 
Toronto, ON M3H 5Y2

Richmond Hill office:

67 Alpaca Drive, Richmond Hill, ON L4E 0G1

email: ca4gta@gmail.com