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If  your restaurant pools or shares tips, charges automatic gratuities, or receives a tip-out “to the house”, this article could save you thousands of dollars.

If you’re like most restaurateurs, you probably think that the Canada Revenue Agency’s only concern about tips and gratuities is that servers report them on their personal income tax returns.  While the CRA is concerned about this, now, they are even more interested in restaurants that fail to report certain types of tips.

The CRA’s policy on tips and gratuities can be found here.  The rest of this article may shock you.

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I’m certainly not saying that all, or even a significant number, of CRA’s tax auditors are corrupt, but this story in the Montreal Gazette highlights some very interesting issues surrounding restaurant tax audits.

The corrupt tax auditors seemed to focus on restaurants, knowing that they could “justify” large reassessments, unless the owners paid them bribes.  In at least one case, the auditor asked for the bribe before auditing the restaurant!  Finally, the auditors could just as easily make a restaurant appear to be reporting all of its income as it could make it look like they were evading large amounts of tax.

An RCMP investigation of Canada Revenue Agency employees has resulted in three former auditors being accused of shaking down restaurant owners for cash.

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There are about 80,800 restaurants in Canada (CRFA), and about half are audited every four years.  That’s a lot of restaurants being audited, and you just know that the majority of them receive reassessments at the end of each audit.

Rather interestingly, there are only about 10 significant court cases involving restaurants that had been audited using the mark-up methodHow can this be?

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Many restaurant owners think they’re protected from the tax auditors, simply because they have a good accountant.  While that’s true in some cases, just about every restaurant that gets hit with a tax audit reassessment (and usually a large one at that) had a “good accountant”!

In Canada, every restaurant that appealed tax audit reassessments in court had an accountant.  In the U.S., many states publish details of tax appeals by restaurants (informal tribunal appeals, roughly equivalent to Canadian appeals by Notice of Objection).  There are literally thousands of cases and virtually every one had an accountant.  In the vast majority of cases, the restaurants lost their appeals.  I’m sure most of these restaurants thought that their accountant would protect them from these tax reassessments.

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When the Ontario government repealed the Retail Sales Tax (RST) in favour of the new Harmonized Sales Tax (HST), it transferred audit and collection activities to the Canada Revenue Agency.  Unfortunately, that doesn’t mean Ontario restaurants can forget about the old RST!

Ontario is still responsible for auditing the old RST for periods up to June 30, 2010.  Under the Statute of Limitations, Ontario has up to four years to audit the RST.  Actually, they can go back more than four years, if they can show fraud or misrepresentation or if they obtain a waiver from the taxpayer.

Many of these Ontario auditors will be transferring to the CRA in 2012.  So, they are racing to complete audits of most Ontario RST vendors.  This is especially true for Ontario restaurants, which have always been a target of the Ministry of Revenue.

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Here’s a bold statement:  tax auditors don’t know your business.

It’s true!  You know it, I know it, even the tax auditors know it!

As a result, you may think you have an advantage over the tax auditors.  Unfortunately, you don’t.  What tax auditors lack in knowledge they make up for by making assumptions about your restaurant.  Often, these assumptions are nothing more than the tax authority’s decisions to use certain “standards”.  For example, the “industry average” shrinkage allowance for draft beer (or liquor, or wine).  Here’s a surprise:  there isn’t one!  In almost every case, the tax auditor makes assumptions that are not favourable to your tax position, leading to large tax reassessments.

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Here are the top five qualities of a “good” restaurant accountant:Drowning in paperwork

  1. Understands your restaurant and uses this knowledge to offer strong advice for improving your operations and finances;
  2. Analyses sales, expenses and margins to identify problems and improve profitability;
  3. Provides sound tax advice to legitimately maximize your deductions and minimize your taxes;
  4. Ensures that you comply with all tax laws, and
  5. Knows how to document and prove your margins to a tax auditor.

The last point deserves a bit of an explanation.

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