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Business Meals/Entertainment And GST Issues
Click HERE for a brief introduction to the deduction for business meals and entertainment. The concept that you are only allowed to deduct 50% of reasonable business related meals and entertainment costs is complicated by the interaction of GST legislation in the Excise Tax Act (ETA) and Income Tax legislation in the Income Tax Act (ITA).
We will use a simple example of a meal costing $100 plus $7 in GST for a total cost to the business of $107.
Generally speaking under legislation in the ITA, a business may claim a business deduction for the full amount paid for goods or services used in a business if the amount is reasonable. In our simple example, this means that the business can claim an expense for $107. If the business cannot claim GST Input Tax Credits (ITC's) on business expenses (ITC's reduce the amount a business has to remit to the government for GST they have charged to their customers for goods or services sold to them) because they are not GST registered or are GST exempt, then the 50% rule under section 67.1 of the ITA is simple. 50% X $107 = $53.50 which cannot be deducted from taxable income.
The 50% rule becomes complex if the business is allowed to claim GST ITC's on business expenses. Under the ETA, the business may claim the full $7 of GST paid as an ITC. The business is allowed to claim and benefit from the 7% ITC, but at the end of the business fiscal year, 50% of the ITC's are recaptured. The $7 recovery becomes taxable to the business under section 248(1) of the ITA. That section basically says that any GST recovery is considered government assistance and section 12(1)(x) of the ITA says that any government assistance is taxable to the business. However, the full amount of the GST ITC of $7 is not included in income as section 236 of the ETA requires that 50% of the ITC be recaptured at the end of the businesses fiscal year. This is similar to the 50% requirement under the ITA (in other words, the business only gets to claim $3.50 in net ITC's at the end of the day). This recapture is considered to be government assistance that is repaid under section 248(18) of the ITA which is allowed to be a deduction for business income under section 20(1)(hh) of the ITA. Confused yet? To summerize, the business has paid $107 and gets a GST ITC initially for $7 but has to repay $3.50 of that at the end of the fiscal year. But the fun doesn't stop yet.
CRA had issued their opinion in 1992 on what the business actually gets to deduct for a business expense. At that time, their view was that the net out of pocket cost to the business, in our example $107 total paid less $3.50 in net ITC's recovered = $103.50 net out of pocket, becomes the base under which the 50% rule in section 67.1 gets calculated. In other words, the business gets to deduct 50% X $103.50 = $51.75. However, in 1998, CRA has reversed their opinion. In their view, section 67.1 applies to the amount actually paid or payable. In other words, the 50% rule should be based on the gross amount paid of $107, not the net of $103.50. Applying this new interpretation results in a deduction of 50% X $107 = $53.50 but this deduction is reduced by the net government assistance received which is taxable to the business of $3.50 which results in a deduction of $50.00.
To summarize the effect on the business:
Economically the business has paid $107 initially and received back $3.50 in net ITC's for a net initial out of pocket cost of $103.50. As the chart above shows, the business only gets to deduct $50 under the new interpretation as opposed to the $51.75 under the old rules.
Contact Keith Anderson CA at (780) 447-5830 if you need advice.
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