Pitfalls and Common Mistakes on Corporate Tax Returns

by Sayem Hasan | Nov 7, 2024

Filing an accurate T2 Corporate Tax Return is critical to avoiding penalties, audits, and reassessments.

Misclassification of Expenses: Deducting non-business-related personal expenses as business expenses is a frequent issue. The Canada Revenue Agency (CRA) scrutinizes expense classifications closely, and failure to separate personal and business expenditures can lead to denied deductions and penalties.
Legal Precedent: In Choptiany et al. v. The King, the Tax Court highlighted the importance of accurately categorizing expenses and penalized the taxpayer for claiming personal expenses under business deductions. This case underscores the need for clear records and adherence to business-only expense policies.

Underreporting Income: Understating or omitting business income can result in steep penalties. The CRA uses cross-checks and audits to verify reported income, so all sources must be reported accurately.
Case Example: In Burke v. The King, a taxpayer was penalized for discrepancies in reported income. The case illustrates how minor discrepancies can trigger full audits and lead to significant financial consequences.

Shareholder Appropriations: Withdrawals of cash or assets by shareholders, without proper documentation or repayment plans, may be considered shareholder appropriations. These can be classified as income or dividends and may be subject to tax if not appropriately documented.
Penalties: The CRA can assess penalties for unreported appropriations, and any interest-free loans taken from the corporation must either be repaid within one year or treated as income.

Dividend Reporting and Documentation: Dividends must be correctly reported as income for shareholders, and dividend distributions require careful documentation to avoid reclassification as salary or other taxable income.
CRA Guidelines: Dividends declared and unpaid at year-end must be accounted for on T5 slips. Missing or incorrect T5 slips can lead to penalties.

Late Filing Penalties: Filing the T2 return late incurs a penalty of 5% of the unpaid tax balance, plus an additional 1% per month (up to 12 months). Repeated late filings result in higher penalties of up to 10% of the unpaid balance, with 2% added monthly.
Interest on Unpaid Amounts: Compound interest applies to outstanding amounts, with interest rates set quarterly. Interest penalties can accumulate quickly, creating a significant financial burden.

Key Schedules: Schedule 1 (Net Income for Tax Purposes) and Schedule 8 (Capital Cost Allowance) are essential. Errors on these schedules impact taxable income and eligible deductions.
Example of Error: Not reporting Capital Cost Allowance (CCA) correctly can lead to disallowed depreciation deductions and potentially increased taxable income.

Scientific Research and Experimental Development (SR&ED) Tax Credit: Incorrectly claiming SR&ED credits can result in audits, fines, or repayment of credits. This credit has specific criteria and reporting requirements.
CRA Focus: The CRA closely reviews SR&ED claims, requiring detailed documentation. Failure to substantiate claims may lead to penalties.

Pitfalls and Common Mistakes on Partnership Tax Returns (T5013)

Filing a T5013 Partnership Information Return also requires diligence, as common mistakes can lead to penalties for the partnership and partners.

Misallocation Issues: Incorrect income distribution among partners can cause reporting discrepancies and tax audits. Each partner’s share of income, deductions, and credits must align with the partnership agreement.

Legal Example: Disputes over income allocation may arise, as seen in cases where partners contest reported shares. Misreporting can lead to reassessment for each partner involved.

CRA Requirements: Not all partnerships are required to file a T5013. However, partnerships with revenue over $2 million or specific organizational structures are mandated to file. Failure to file when required leads to penalties.

Penalties: The penalty for late filing is $25 per day, with a minimum of $100 and a maximum of $2,500.

Late Filing Consequences: Penalties apply for delayed T5013 submissions, especially for large partnerships. The penalty structure aligns with CRA standards and is compounded by interest charges.

Accurate Reporting: Providing incomplete or inaccurate information on T5013 forms leads to potential audits and interest charges.

Accurate Information Requirements: Errors in partner details or incorrect financial information can cause processing delays and potential audits. Proper documentation of all transactions within the partnership is critical.