Donut Shop Accountants & Claiming Auto Expenses

Question: What is the difference between tax evasion and tax avoidance?
Answer: About 20 years in the slammer.

Let’s face it. You have to pay your share of income tax. But, you want to pay only your fair share. How can you ensure you don’t overpay? In this article, I will discuss one of the more common issues faced by business people – Claiming Auto Expenses. My goal is to help you find legitimate tax avoidance techniques.

Many people listen to Donut Shop accountants. Donut Shop accountants are not experts. They can’t be trusted. They always exaggerate the size of their refunds. Suppose your friend Joe claims a certain expense each year, and he’s always got his refund. He says you should claim this expense too. The fact that Joe has successfully claimed an expense proves nothing. Perhaps the expense does not apply to you. Perhaps Joe hasn’t been audited just yet. Getting correct advice from real experts who know taxes can lead to a satisfactory result at tax time, and reduce your worry and stress.

Incorporated Business/Employees

If you are an employee, or are the owner / operator of an incorporated business, there is a simple way to receive a tax-free allowance for the use of your vehicle. You are entitled to receive up to 43 cents per kilometer for the first 5,000 kilometers of business travel and up to 37 cents per kilometer for all additional business travel. (Current for 2005)

For example, I will drive 12,500 kilometers this year for business. I will be entitled to receive an allowance of up to $4,925. My company will record an offsetting travel or automobile expense of $4,925. I am the sole shareholder of my company. In my tax planning, I need to consider the combined personal and corporate tax payable. While the allowance is tax-free to me, it will have reduced my corporate taxes by approximately $1,000.

To properly support my claim, I need to keep a record of all business kilometers driven. I do this by recording in my daily log where I went on business, and the kilometers driven. At the end of each month, I add up the business kilometers, and bill my company. I do not need to keep any receipts for the operating costs of the car. So, the record keeping is very simple.

Proprietors and Partners

Life is not so easy for proprietors and partners. You cannot pass along vehicle costs to your business as simply as your incorporated friends. Here is what you must do.

First, you need to record the odometer reading of your vehicle on an annual basis. I recommend first thing in the morning, every January 1st, before the party hangover has lifted. Then, you must record your business kilometers in the same manner as discussed above. You will be asked to calculate the ratio of business kilometers to total kilometers driven on the Auto Expense form of your tax return. You may then claim that ratio times the total operating costs for your vehicle for the year.

For example, I will drive 35,000 kilometers in 2005. I am entitled to claim 12,500/35,000 = 36% of the operating costs of my car as a business expense on my personal tax return.

What are the operating costs of a vehicle? Operating costs include fuel, repairs and maintenance, insurance, license fees, loan interest and capital cost allowance if the vehicle is owned, or lease payments if the vehicle is leased. (Note there are restrictions on the total amount of interest, capital cost allowance and lease expense, which I’ll cover later).

Here are the operating costs I expect to incur in 2005, and the calculation of my allowable costs for tax purposes:
Fuel $ 1,820
Maintenance 650
Insurance 1,800
License and registration 74
Lease 4,625

Total operating costs $ 8,969


Allowable costs $ 3,203 ($8,969 X 12,500 km’s / 35,000 km’s)

Parking and toll fees incurred for business purposes are 100% deductible.

If I am in a 31% marginal tax bracket, my auto expense claim will reduce my taxes by about $1,000.

If I had purchased my car, I would be entitled to claim both loan interest and capital cost allowance, instead of lease expense. In most cases, this results in greater operating costs, and a bigger reduction in income tax.

You will need to keep receipts for all your vehicle expense. The record keeping does not need to be a burden. Simply keep a large manila envelope in your car. Every time you buy gas, change your oil, or spend money on the car, tuck the receipt into the envelope. On a monthly basis, replace the envelope with a new one. Place the old envelope in your files, marked “Auto Expense, month of ________”.

There are restrictions to the amounts you may claim for capital cost allowance, loan interest and lease expense. Capital cost allowance may be based on a maximum vehicle cost of only $30,000 plus applicable federal and provincial sales taxes. The maximum interest expense you may claim is restricted to $300 a month. The maximum lease payments you may claim is restricted to $800 a month plus federal and provincial sales taxes. The rules are somewhat complex, and you may want to talk to your tax accountant.

Saving your receipts and recording your business kilometers accomplishes two goals. You will have all the information you need at hand to prepare the Auto Expense form on your tax return. You will also have bullet proof documentation to support your claim, should Canada Revenue Agency ever want to do an audit or review of your return.

New clients tell me that worrying about what they can claim, and how to protect themselves from a tax audit adds a great deal of stress to their lives. When they know what to claim, how to claim it, and how to protect themselves from an audit, they worry less. They can concentrate on building a successful life. Surely, this is a wonderful outcome.

Allan Loiselle is a partner in On Target Presentations (www.ontargetpresentations.ca), a firm specializing in helping take the mystery out of starting and growing a small business. He can be reached at allan@ontargetpresentations.ca .

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NOTE: The preceding article may be reprinted in full without charge as long as author credits are provided and upon acceptance of a written request by e-mail to allan@ontargetpresentations.ca.