The following selection of articles contain information which may be useful for Canadian clients and visitors. No action should be taken with respect to any information contained in the articles without seeking professional advice. The copyright to the articles remains with Terry W. Elder, Chartered Accountant, and Elder Financial Services Inc.

Articles Currently on File

  • Buying Assets or Shares - What's the Difference? - Terry Elder

  • Business Owners Should be Alert to Fraud - Terry Elder

  • Employee or Independent Contractor - Risks and Benefits - Terry Elder

  • Tips for Starting Up - Terry Elder

  • Knowing the Rules Can Cut Your Employment Insurance Costs - Terry Elder

  • Records Retention - Terry Elder


    Articles

    Buying Assets or Shares - What's the Difference? - Terry Elder

    Tax accountants acting on behalf of either sellers or purchasers of businesses are often asked if it is better to sell/buy the assets or the shares of a company.

    Although there are many factors which enter into answering such a question, the simple answer is that, in most cases, if you are a vendor, you should sell shares and, if you are a buyer, it is better for you to purchase assets. However, as you would expect, there are many caveats and mitigating factors which will determine your best course of action, whether you are buying or selling.

    Tax Pros and Cons

    As an individual seller of shares, you have a definite tax advantage because much of any gain will either be sheltered by the capital gains exemption or taxed at a maximum rate of 25%.

    If a holding company sells the shares it holds or its net assets, it is the company that has the capital gain and, since a company has no capital gains exemption, it would have to pay taxes within the company on the gain.

    From a buyers' point of view, the purchase of shares provides no immediate tax breaks. The cost of the shares cannot be deducted against the earnings of the business acquired, although, with the proper structuring, the interest costs on money borrowed to finance the share acquisition can be deducted. The cost of buying the shares can be deducted only against the proceeds of a future sale of the shares and this could be many years away.

    If the buyer were to buy the net assets from a company, then the assets could normally be written off against future earnings of the business.

    Buying History

    Since the shares of a company represent a separate legal entity, when a buyer purchases the shares, he or she is buying the history of that business, including the name and any contracts and leases entered into by the company.

    If there are taxes owing from prior years and which are not recorded on the financial statements, the company continues to be responsible, as do the new directors. If a legal claim or other unrecorded liability arises as result of products sold in prior years, the company would continue to be liable for damages.

    Normally, on the purchase of shares of a business, the buyer would ask that the seller provide a warranty for such contingencies. Should a claim arise during the warranty period, then the amount would be deducted from the remaining amount owing to the vendor. If the full sale amount had already been paid to the seller when a claim arose, then it would up to the new owner to try to claim back the contingency cost from the
    seller (good luck!).

    On an asset purchase, the buyer would not necessarily have these concerns. The assets are sold out of the company and any claim or lawsuit would be against the limited company, not against the new owner of the assets.

    Employees

    A more important issue for the buyer of shares is that the company normally continues to employ its workers. Should the new owner wish to terminate any employee for whatever reason, the company could be faced with significant termination benefits.

    Unless these are factored into the purchase cost of the shares, the new owner could be faced with a serious situation if the employees' skills and requirements for the business had not been properly evaluated before the purchase.

    For someone buying assets, the purchaser could decide which employees to hire for the ongoing business and leave the worries - and costs - of terminating the rest of the employees with the previous company and its owner.

    Tax Loss Carry Forwards

    So far, the scale is tipped heavily in favour of a buyer purchasing assets. However, one good reason a buyer might wish to acquire shares would be if the target company had significant tax losses available for application against future taxable income. Providing the acquiror continues in the same or similar business as that which produced the tax losses, a purchaser could significantly reduce the company's future tax bills. In certain circumstances, this benefit could far outweigh the disadvantages of buying shares.

    The purchase and sale of a business can be extremely complex. Knowing the pitfalls and advantages of a share or asset sale/purchase will be an important first step in commencing the negotiations.

    Terry W. Elder, FCA, and Elder Financial Services Inc. provide financial consulting services to private businesses and their owners and managers.

    Business Owners Should be Alert to Fraud - Terry Elder

    Fraud, embezzlement, defalcation. Most business owners say it could never happen to them.

    Over the last number of years, several spectacular frauds in Ontario have been reported in the financial press. One of the largest frauds occurred when a trusted employee stole over $19 million from a prominent Toronto real estate firm. Another fraud took place when three accountants stole over $1.5 million from their own partners in a large accounting firm. In addition, there have been many other employee frauds which have not merited the headlines received by these two defalcations.

    A recent report by a big 5 accounting firm indicated that "fraud is a billion-dollar problem in Canada". The report noted that 94 percent of fraud reported by small companies was perpetrated by insiders.

    The fact that forensic accounting, the investigation of fraud, is a high growth industry in Canada should be enough to scare most owners into reviewing their business operations to determine whether they are vulnerable to an employee theft.

    Why Do Employees Embezzle?

    The most common reason for fraud is the combination of motive (greed, family illness, revenge) and opportunity. When owners say that fraud is impossible in their business because all of their employees are long-serving, faithful and trustworthy, it is useful to know that most company frauds are committed by just such people. Also, in a smaller operation, there are not the usual checks and balances which serve to detect errors - and frauds - at an early stage.

    In fact, with the down-sizing which has taken place over the last five years, the internal controls at many mid-sized companies have also been reduced. Combine this with increasing employee workloads and declining morale, you have a potential for fraud.

    Another increasingly common cause in Ontario is gambling. There are now many more opportunities and temptations to gamble than there was ten years ago. As the number of casinos grows, there will be an increased number of people addicted to gambling.

    What Can An Employer Do?

    Many business owners are heavily involved in most facets of their operations through their day-to-day involvement and, as a result, they are normally aware of any unusual changes in the company's financial situation. However, as a business grows, the owner must inevitably relinquish some control.

    One of the most effective control procedures in a business is to ensure that financial statements of the business are produced promptly at each month-end and are reviewed by the owner for unusual fluctuations and trends. The owner should also carry out some basic reviews of certain balance sheet and income statement accounts, such as ensuring that the bank account, investments, accounts receivable and payable reconciliations agree to the balances reflected on the month-end balance sheet prepared by the company's internal accountant.

    Other simple, inexpensive control steps are:

    . During the employee hiring process, confirm at least two references and be suspicious of gaps in work history.

    . Minimize the receipt of cash by encouraging customers to use cheques, credit and debit cards as much as possible.

    . Use pre-numbered receipt books or controlled cash register tapes for the recording of cash. And make sure the receipt books are periodically accounted for.

    . Keep the company's blank cheques under lock and key and account for the numerical continuity periodically, including checking the bottom of the pile.

    . Divide responsibility for preparing payment documentation and signing cheques. Unfortunately, this is not always possible in smaller organizations.

    . Ensure that the person signing the cheques always reviews and approves all payment documentation. The payment support should also be cancelled to prevent subsequent duplicate payments.

    Outside Review

    When a business grows beyond the control of the owner, a useful exercise is to have the company's external accountant review the company's basic administrative and accounting controls with the specific objective of assessing the possibility of fraud and error in the business.

    Owner's Behaviour

    The owner's own behaviour and personal code of ethics have a significant effect on how honest their employees are going to be. If the owner is always putting personal expenses through the company, or using unethical business practices, the employees may think that they are justified in behaving the same way. Establishing a code of ethics and expected behaviour - preferably in writing - and clearly communicating it to the employees is an important step in any fraud prevention process.

    Terry W. Elder, FCA, and Elder Financial Services Inc. provide financial consulting services to private businesses and their owners and managers.

    Employee or Independent Contractor - Risks and Benefits - Terry Elder

    How can a company hire people without making them employees. Unfortunately, there is no easy answer to this seemingly simple question.

    There are significant differences for both the individual and the company with respect to the legal and tax implications of being an independent contractor or an employee.
    Generally, being an independent contractor is more tax advantageous for both the company and the individual.

    Advantages and Disadvantages

    From an employer's perspective, the company can avoid any responsibility for remitting the employee's income tax taxes, employment insurance and Canada Pension Plan deductions. It also does not have to pay the employer portion of the latter two deductions, thus realizing some real cash savings. More importantly, the company will not have to provide reasonable notice of termination, severance, vacation or statutory holiday pay.

    There are advantages for the individual as well. There will be no tax or other deductions withheld at source, although, after the first year, quarterly tax instalments will be required by the individual. All legitimate business expenses can be deducted from the income earned and the costs of a home office can usually be deducted from income. The tax filing deadline for an independent contractor is June 15, instead of April 30, although taxes still have to be paid by April 30. Employment insurance premiums will not have to be paid. However, the individual will have to pay the employer portion of Canada Pension Plan which, fortunately, is a deductible expense.

    There are also disadvantages to the individual who becomes an independent contractor -there will be no employment insurance and severance benefits available when the contract ends and the person will be responsible for their own health benefits and insurance coverage.

    Canada Customs and Revenue Agency's (CCRA) Position

    Just because an individual and an employer decide to agree, even in writing, that the person will be an independent contractor does not mean that the tax department will accept it. It will not surprise you to learn that CCRA will often take the position that the person is an employee and will ask the individual and employer to prove that there is not an employer-employee relationship. CCRA relies on several tests to determine the answer to this question.

    The key points are who controls the work environment, and when and how is the job to be performed. For example, are you required to be at the company's offices from 9 to 5 each business day and are you are acting under the instructions of a company supervisor? A yes answer to these questions would not help your chances of being an independent contractor.

    There is also an integration test whereby Revenue Canada will consider whether you are an integral part of the company's operations or if your project or assignment is separate from the core company operations. For example, if you are contracted to manage the company's manufacturing plant, you are more likely to be considered an employee than if you were engaged to provide a training course to the executives on re-engineering.
    Another test is whether you use the company's computers and other equipment or your own. If you use the employer's, you are more likely to be considered an employee.

    The chance of making a profit is also important. If your compensation is based solely on the time you put in on the job, with no element of profit based on results, or, conversely, with no risk of loss, then you may be considered an employee.

    Also, do you have other clients for which you are performing services at the same time? Do you have your own business telephone number and address? Affirmative answers to these questions bolster your case for independent contractor status.

    What Are The Penalties?

    If CCRA decides that you are an employee when, in fact, you thought you were an independent contractor, the consequences can be severe. As a self-employed person, you would be denied the various expense deductions you claimed, along with any spousal income splitting. Interest and penalties would follow.
    As to the employer, CCRA would assess the company for failure to withhold income taxes, CPP and EI premiums, again leading to penalty and interest levies.

    Whether you are an employer or a self-employed independent contractor, you should be aware of the consequences of a potential reassessment of your respective positions.

    Terry W. Elder, FCA, and Elder Financial Services Inc. provide financial consulting services to private businesses and their owners and managers.

    Tips for Starting Up - Terry Elder

    Government and corporate cut-backs over the last several years have released a whole new wave of individuals who either have established their own businesses or who are contemplating starting one. In order for any of these individuals to be successful in their new entrepreneurial careers, they should consider the following points when setting up their new venture.

    Have A Business Plan

    Whether starting a business from scratch or buying a business or franchise, the most important thing to have is a business plan. It doesn't have to be a fancy plan in glossy covers but it should be comprehensive enough to demonstrate at least three things - the viability of the business; the maximum financing required in the most pessimistic situation; and details on how the financing, marketing and business growth will be carried out over the first two or three years of operation.

    Adequate Financing

    The key point in any start-up situation is the amount of financing required. Most business failures occur in the early years because of inadequate capitalization and, in many cases, because the owner was too optimistic about sales and cash flow, or there was no contingency plan for unexpected expenditures.

    The corner-stone of most viable business plans and getting financing is to keep your overhead costs low - invest in the important parts of your business, such as production equipment and productive people, not in the frills.

    Professional Help

    If you need professional help to fine-tune your plan, don't be afraid to spend money to have an accountant, lawyer or other specialist sceptically review it - after all, it is your future that is at stake.

    Structure It Properly

    And while you are paying the professionals, consider what structure you will operate under - a proprietorship, partnership or a corporation. There are advantages and disadvantages of each, from both a legal and tax standpoint. At the same time, consider who you want to participate in the ownership structure, both now and later. If you have a spouse and/or children who may be working in the business, even if it might be ten years in the future, it might be a lot easier and cheaper to have them buy in as partners or shareholders now.

    Income Splitting

    Consider income-splitting opportunities both now and in the future. If your spouse is currently not employed, consider making him or her a partner in the company or perhaps an employee. Ensure that the remuneration is appropriate for the business duties being performed. Obviously, there are other factors of a non-financial nature to consider in this area.

    Registrations

    Research and determine the various government registrations and filings that your business will require - for example, business name registration; provincial retail sale tax; goods and services tax; corporate income tax (provincial and federal); employer health tax; workers' compensation; and others, depending on the industry you may be in.

    Accounting System

    Purchase and use a decent accounting system right from the beginning or even before the start of the business. Remember that all expenses incurred to earn business income are deductible. This includes all expenses incurred prior to the commencement of the company related to the business. The best way to keep track of them is to have simple, yet comprehensive, accounting records, preferably computerized. There are several excellent accounting software packages available for less than a couple of hundred dollars which are well worth the expense. Two of them are Simply Accounting and Quickbooks Pro.

    Transferring Assets To The Business

    If you are going to be using assets in the business that were previously personal assets, such as a computer or automobile, ensure that you transfer these assets to the business at their fair market value. You will be able to claim depreciation for tax purposes on these assets and reduce the tax you might otherwise have to pay.

    Home Office Expenses

    If you are setting up a home-based office, start to keep track of your home expenses immediately. If your home is going to be your principal place of business, you will receive more generous deductions than if it is your secondary business location.

    Although covering off most of the points above will not ensure the success of your business, it will go a long way towards shaping your vision of the company and minimizing your taxes at the same time.

    Terry W. Elder, FCA, and Elder Financial Services Inc. provide financial consulting services to private businesses and their owners and managers.

    Knowing the Rules Can Cut Your Employment Insurance Costs - Terry Elder

    Employment insurance premiums are a major cost to most Canadian employees and employers. The rules governing the payment of EI premiums are complex and all employers should be aware of some of the areas where savings can be achieved and where the pitfalls are.

    Exemptions

    Most types of employment are considered to be insurable earnings. Canada Customs and Revenue Agency's ("CCRA") "Guide to Payroll Deductions" provides a comprehensive listing of the types of employment for which EI premiums are not required.

    For example, a person who owns more than 40% of the voting shares of the company employing him or her does not pay EI premiums. This provision presumably was implemented to prevent an individual who was in a position to make significant decisions regarding the company's operations from paying EI premiums, then terminating their own employment and then collecting EI benefits. Note that it must be voting shares, so that if a person owns preference shares, even though it may be a majority of the equity of the business, EI premiums may still be payable.

    Another important exception to the insurability rules is the employment of persons who "do not deal at arm's length". This includes all individuals connected by blood relationship, marriage, common-law living or adoption. Just to make things more complicated, there is an exception to this latter exception. If you employ a relative under the same general conditions and terms of employment as you would employ a non-relative, and the remuneration paid is comparable to what you would pay someone else in a similar position, the relative will be subject to EI premiums.

    Let's take the example of a business where a husband owns 100% of the shares of the company and his spouse does the accounting and general administration for which she receives a salary. In order to determine whether she is subject to EI, an evaluation must be done to determine whether an outsider could do the same work under the same conditions for the same salary. In many cases, the spouse will do some of the work in off-hours and sometimes at home, either because of the confidential nature of the work or because of her other commitments. She is allowed to do this because of her special relationship with the major shareholder, which an outsider would not have. In this case, she would likely not be subject to, nor eligible for, EI. On the other hand, if the spouse worked a regular work day at the office under the same employment conditions as the other office staff, she would likely have to pay EI premiums.

    Independent Contractors

    Another area which can be of concern to owners is the hiring of independent contractors or consultants. The main question revolves around whether you have hired someone under a "contract of service", which is generally insurable employment, or a "contract for services" which usually is not. There have been many legal cases fought over this question and, despite the intention of the two parties (consultant and client), it essentially boils down to whether the individual contracted for is being treated as an employee rather than an independent person. If he or she is deemed to be an employee but is paid as an independent contractor, the employer and employee could be subject to a reassessment by EI and for other withholding amounts (Canada Pension Plan and income taxes).

    An employer's worst nightmare can be engaging an independent consultant, not withholding EI and then the consultant goes and tries to claim employment insurance benefits. The reassessments resulting from such a situation can be extremely expensive.
    One last tip - a company can reduce its EI expense if it establishes a EI-approved wage-loss replacement plan. There may be some real savings here so it is worth investigating.

    Terry W. Elder, FCA, and Elder Financial Services Inc. provide financial consulting services to private businesses and their owners and managers.

    Records Retention - Terry Elder

    A question which often arises in discussions with business owners is "Which accounting records must we retain and for how long?" As usual, the answer is not simple.

    Requirement

    The Canadian Income Tax Act requires that all persons in business and those who pay or collect taxes must keep records and books of account in a form that will enable taxes payable to be determined. Interestingly, Canada Customs and Revenue Agency ("CCRA") does not specify what records and books of account are to be kept. That is left up to the company. These records must be kept for a period of six years.

    What Is A Record and Document?

    Under CCRA guidelines, a record is defined to include "an account, agreement, book, chart, table, diagram, form, image, invoice, letter, map, memorandum, plan, return, statement, telegram, voucher, and any other thing containing information, whether in writing or in any other form." A document is defined to include "money, security and a record" (see previous sentence). Basically, then, a record or document can include just about everything.

    Electronic Records

    Although computers have been prevalent in business for many years, CCRA has only, in the last few years, added a section to the Tax Act specifically requiring the retention of electronic files. In this age of electronic commerce, the definition of an accounting record has also been expanded to include systems documentation, back-up procedures and storage appropriate to the media being used. CCRA must be able to access the company's records during the six year period of retention. For companies that frequently upgrade their software and hardware systems, the company has two options. The company can retain the old software and hardware necessary to read the records, or it can advise CCRA at the time of each major system upgrade so that they can schedule an audit prior to the upgrade.

    Commerce on the Internet is presenting a host of new problems in the record-keeping area. Encryption is expected to be used extensively as commerce moves to more open networks. Encryption provides security and confidentiality to data transmitted electronically.

    If a company's accounting records are encrypted, the company will be expected to decrypt them for audit inspection.

    Location of Records

    The Tax Act requires that books and records of a business be kept on the business premises in Canada or at some other place approved by CCRA. Records that are stored or kept outside Canada and which can be accessed electronically are not considered to be in Canada. Permission to keep records outside Canada may be obtained from the tax department but they must be able to review these records, either at the Canadian location or the foreign location. Of course, if CCRA has to travel to the foreign location to inspect them, the taxpayer must pay their travel and living costs for the period of the audit. Each request to keep records out of the country is considered on its own merit -some countries do not allow foreign government auditors; there may be an inability to access company officials with knowledge of the company's transactions; or there may be language difficulties.

    Destruction of Files

    As noted earlier, the simple rule is that all records and books of account must be retained for a period of 6 years. There is also a provision which allows taxpayers to apply for written permission to destroy their accounting records prior to the 6 year limit.
    You have to be careful, though, in what you are destroying. You can get rid of most of a company's paper transaction records - sales and purchase orders and invoices; bank statements, deposit books and cancelled cheques; inventory, accounts receivable and accounts payable listings; expense accounts and vouchers.

    There are some records that should be kept until at least two years after a company has been dissolved. These would include the general ledger, cash receipts and disbursement journals, journal entries, and minutes of shareholders and directors' meetings. Also, any agreements or contracts of a long-term or enduring nature are to be retained.

    Records Management

    Many businesses find it useful to formalize their records management programme. Apart from the benefits of minimizing the company's storage area requirements by culling out old records, such a programme has the advantage of allowing companies to minimize the retention of their current records.

    Terry W. Elder, FCA, and Elder Financial Services Inc. provide financial consulting services to private businesses and their owners and managers.

  • Elder Financial Services Inc.,   17 Four Seasons Place, Suite 200, Etobicoke, Ontario, Canada,   M9B 6E6   Phone: 416-695-3222   Fax: 416-622-0874   E-mail: telder@elderfs.com