A new client refinanced his home to purchase a business, which is incorporated. The prior accountant claimed the yearly interest from the mortgage on his personal tax return and not the corporation to reduce his personal tax liability. Client also claim his basement as storage for the business which the prior accountant claimed as hone office expense on his persona tax return. Does this sound right?
I am of the view, if the financing was used to purchase the business, then the interest should be deducted to the corporation. The basement is not actually office space but rental space from client to corporation. What are your thoughts?
I think the interest is OK to deduct on either side (incurred to earn income from the biz - hopefully dividends. If it tanks, then disappearing source rules apply). As for the basement I would record is as rental to the corp.- better deductions, I have had this audited & accepted by CRA in the past.
The interest was properly claimed on his personal tax return. He borrowed money for an investment, whether it is in a business or to buy stocks, that interest goes on Sched 4 of his T1. The use of the basement for the business is Business Use of Home, doesn’t matter if it is an office or not. The Corporation claims the expense, can either pay the client for the use, or credit his shareholder account. T1 should have a Rental Income Sched and claim BUOH costs against that rental income based on sq footage.
IMHO, this sounds like a mess.
The way to solve it properly is:
The corporations CPA liaises with the corporations Lawyer, and reviews in detail the legal documentation and contracts in place, and prepares PROPER financial statements, which likely will only be possible after the incorrect and messy bookkeeping has been fixed up.
Then the Individual’s CPA liaises with the Corporations CPA, and also reviews the legal documentation and contracts in place, and reviews the history of realized and/or contractual earnings.
Issues like this have to be solved on the desk of the relevant responsible competent professional and the clients, as ball-parking on the internet will only result in more incorrect results, risking jail for any clients who wish to proceed on a basis which could run the risk of being deemed grossly negligent.
Joe, notwithstanding the absolute accuracy of your statement, very few if any small business corporations will do that - it’s just FAR too expensive an option. The minimum cost is likely starting at $1,000 and will escalate rapidly. And yes, an audit cost “could” be more.
In general practice, properly handled, the interest is generally personally deductible (likely vs Shareholder Loan if that’s the financing method for the business and the “flow” of loan to investment is appropriate). Yes, there are “gotchas”.
As for the Business Use of the Home, again, properly calculated and either with or without a formal rental agreement, CRA does not seem to generally have an issue with such. Again, there can be “gotchas”.
In a perfect world a business would have a CPA who is actually expert in tax (many are definitely not!) and a lawyer who is also expert in tax and contractual arrangements (again, many are not). It happens, but usually only with established and well-financed operations.
In the end, after all the various professionals that Joe recommends were consulted, the net result would be the same except that the client and the corporation would collectively be out $10,000 but they would have the peace of mind that comes from having expert advice.
It’s always a good idea to have a formal agreement in place, to specify the terms and conditions of the loan, otherwise, the purpose test, might be difficult to met and resulted in denial of the interest.
To avoid all the hassle and to save money on the legal expense, claiming it inside the corporation might be a better option