Moneysaver

Money for Nothing

Owner/managers are constantly approached by individuals willing to work for cash only.

This under-the-table deal will enable the owner/manager to save money by paying below-market labour rates while the individual avoids paying income tax because the income is not declared. Or so the argument goes.

But do under-the-table payments really save a business money? Let’s see.

Assume for discussion purposes that someone is hired by a corporation as an independent contractor and works the entire year for $50,000. Assume further that the cash transaction does not produce the receipts that would make the expenditure deductible for tax purposes. Since provincial and federal corporate taxes together approximate 16.5% and the GST rate is 5%, the tax loss from the inability to recover corporate taxes ($8,250) and GST ($2,500) on the $50,000 approximates $10,750.

If a proprietorship or partnership took this route, the inability to deduct the $50,000 would increase the income tax liability and could, depending upon the tax bracket, be extremely costly.

Paying in cash is not in itself illegal. The owner/manager does not have responsibility for the data subcontractors submit to CRA or any other reporting agency. Owner/managers are entitled to believe that businesses or individuals paid in cash have integrity and report the cash sale as required by tax authorities or other regulatory bodies. Indeed, just because a business invoices your business and a cheque is issued does not guarantee the reporting integrity of the subcontractor receiving the cheque.

Potentially Corrosive Issues
In the event that this cash employee is injured on the job and requires medical attention most, if not all, provincial jurisdictions require the medical examiner to report the job-site injury to the provincial Workplace Safety and Insurance Board (WSIB). If you, as an employer, have not ensured that the individual is covered, either personally, or through your plan, a subsequent audit could cost your business time and money to defend any resulting reassessment levies and penalties.

Good Reasons to Reconsider
Individuals requesting cash may balk at providing receipts for the cash received. Failure to obtain a receipt creates negative business issues for the owner/ manager for the following reasons:

• Busy owner/managers may lose track of who has been paid cash. Thus, if challenged by the subcontractor, the invoice may end up being paid twice.

• In the event of inferior workmanship it is difficult to withhold payment, stop payment, or recover the payment once the cash has changed hands.

• Regular employees may resent that the individual working beside them is getting cash. Although completely without foundation, most employees would assume that the individual receiving the cash was working under the table and may not be paying income tax and other deductions.

• Misplaced or lost cheques can be voided and reissued without loss to the business. The cost of lost cash is equal to the amount lost.

• Lost cash may not be covered by corporate insurance policies.

• Cash payments upset cash-flow management. Businesses normally work on a 30-day invoice-to-payment cycle, which allows for the collection of accounts receivable.

• In the event of an audit by CRA, consistently large cash withdrawals may attract the auditor’s attention not only for business but also for personal income tax reasons. Business owners would be remiss if they were reluctant to reveal to CRA the purpose of the continuous cash withdrawals.

• Cash payments raise the question: “Where did the cash come from?” Naturally, if the cash is withdrawn from the business it can be easily verified. If bank records indicate cash was deposited before each withdrawal the owner/manager may have to prove the cash was deposited from verifiable sources.

• In the event cash payments to contractors are not traceable to the business bank accounts or other business cash sources but have instead come out of the deep pockets of the owner/manager it may appear as if the owner/manager of the business had failed to report all income. It may prompt further investigation as to whether these transactions are the launching point for other questionable activities.

Impact on Business
CRA and other regulatory bodies (in addition to generally accepted accounting principles) normally require expenditures be offset against earned revenue if that expenditure was made in the pursuit of business income.

Businesses are required to obtain a GST registration number from individuals with whom they conduct business in order to claim the input tax credit (ITC). Once the contractor has provided the business owner with a GST number, the business owner would assume the GST charge is included in the billing. Conceptually a $50,000 cash payment over the year would create a $2,380 ITC offset against GST collected and a deduction against income of $47,620.

However, the inability to provide a receipt may have a negative impact on the business. Tax authorities may disallow the cash-payment deductions because the business lacks appropriate supporting receipts. It is conceivable that the business would not be allowed the tax benefit of $7,857 and, as a result, be required to repay the ITC amount of $2,380 used to offset the GST remittances.

Impact on Owner/Manager
The absence of receipts from the contractror for owner/manager withdrawals from the bank for the purpose of making cash payments will undoubtedly raise the eyebrows of tax authorities. These withdrawals may be perceived by taxation authorities as personal income. This would require the owner/manager to claim the amount as additional income and pay personal income tax at the appropriate tax rate. If the owner/manager had already claimed personal income from the business of, for example, $40,000, an additional $50,000 would boost taxable income to $90,000. The result for an individual with basic personal exemptions would be to raise the personal income tax payable from approximately $7,000 to the $25,000 range.

Although the business, in this scenario, should be able to claim the additional $50,000 as a wage deduction against revenue to reduce the combined income tax, the business could be penalized for failing to remit appropriate CPP deductions.

You Can’t be Too Careful
Business owners who wish to pay cash should be aware of the cost to their business and the potential difficulties that may result if cash payments are not appropriately receipted. Ensuring that dated receipts include the name of the recipient, either the social insurance number or business (GST) number for the individual, a description of the work completed, the date of the invoice, the amount paid, and that the invoice was paid in full in cash is just good business.