How to avoid future problems while minimizing your restaurant’s tax bill

By John Clausen February 24, 2015
How to avoid future problems while minimizing your restaurant’s tax bill

As an owner or manager of a small or medium-sized business, you are most often focused on what you do best: running your restaurant, bar, pub or franchised food outlet. You are trying hard to stay up-to-date with food service trends, retain customers and good staff, as well as increase your knowledge about laws ranging from labour standards to liquor control and management. Tax is just another headache you wish you could do without.

In this article, we will look at perhaps one of the most feared and potentially costly areas for small to medium-sized businesses that lack extensive resources to devote to tax compliance: The dreaded Canada Revenue Agency (CRA) re-assessment which may be issued after an audit.

CRA often focuses on industries, including foodservice, where there are high levels of cash transactions; or, from CRA’s perspective, transactions that may or may not be reported as business revenue. My belief is that it is best to examine what you can do to minimize a potential tax assessment before it happens.

Following are some of the best practices for managing your tax liability as well as the first in a series of in-depth looks at each of these individual practices.

Best practices for managing business tax liability

  1. Proper documentation — Track document ownership, shareholders, how the business is to be run, responsibilities, the roles of officers and directors if incorporated; related party transactions that occur while operating the business.
  2. Controls on cash flow and accounting — Set up financial controls (such as spending limits) on cash and business assets/inventory and document for training. Follow up and see that controls are adhered to.
  3. Systems (POS and other) – Whatever system is used, it must be well controlled and monitored with documentation to demonstrate this was done over time.
  4. Inventory — Strict controls on inventory and shrinkage should be in place and monitored.
  5. Losses — Losses occurring during business cycles must be documented (i.e. losses due to food or beverage spoilage).
  6. Theft — Control and document theft and “unaccounted-for” shrinkage. The challenge here is that CRA could say that if you do not have “proof of shrinkage” then it must be unaccounted-for sales on which they will tax you based on an estimate of sales derived from a mark-up on your average inventory cost. Unfortunately, you may only realize this when you are audited.
  7. Related party transactions — Where there are related transactions (between owners and business), ensure they are documented in areas such as leasing of property, loans to the business, etc.
  8. Operations — When there is a significant change (i.e. more than a couple hundred dollars) in the business operations, document it.
  9. Owner remuneration changes — declare and document bonuses.
  10. Personal (owner) reported income relative to lifestyle – document inheritances, gifts, and other positive financial events that are unrelated to your business, just in case CRA decides to treat these items as potentially taxable cash flow.

And importantly…

  1. Prepare and file your tax returns on time.

How does this relate to tax liability?

All of the above can have a significant impact on your tax liability in more ways than one. For example, proper control of inventory can, of course, reduce costs and therefore increase income, which could potentially lead to increased taxes. This creates cash flow for you, the owner, but there is another aspect to inventory control that will only become apparent to you if you are audited by CRA. However, due to space limitations here, we will examine this in closer detail in a future article.

Now back to a more in-depth discussion of each of the best practices for managing and controlling your tax liability. We will look at documenting business relationships, responsibilities and related party transactions.

Why is this important?

To ensure proper management and for the tax reasons below, it is important to establish from a common sense business perspective, who is an owner, shareholder, officer or director and if it is a corporation. For proprietorships/partnerships it is important to define what the roles and responsibilities are.

Define roles, functions and loans

You should be able to demonstrate that you perform specific business functions and therefore any reported income is correctly attributed to you. This is important if you are income splitting within the business to reduce taxes. CRA will want to test for the real purpose of your involvement.

When loans are repaid, this must be clearly documented. The CRA could erroneously assume that the payment is unreported income.

You should always get a loan agreement because there are special rules surrounding loans from an incorporated business to a related party. If you are a shareholder, officer or director, you must repay the loan in less than 12 months to avoid the loan deemed as income (more on this in a future article). Get professional advice when considering loans.

Finally, for incorporated businesses, there is personal tax liability for directors and officers for unpaid payroll taxes and HST/GST. So properly identify who is and who is not an officer/director and ensure that the business pays its taxes accordingly, otherwise the officer or director could be stuck with the bill.

Stay tuned for future articles where we will explore the other best practices for managing your potential business tax liabilities.

See also:


About the author

John Clausen CPA, CMA, Acc. Dir. is a practising accountant and business advisor with over 30 years’ experience working with businesses of all sizes. If you have questions you would like answered in future articles, please email jeclausen@clausenassociates.com.

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