A tax guide to employee allowances and reimbursements for Canadian businesses: What are the differences?

An allowance is an additional periodic or lump-sum payment made to employees alongside their regular salary or wages. Its purpose is to assist the employee in covering anticipated expenses related to their employment. Allowances can be calculated based on various factors, such as distance traveled, or the number of meals consumed per day. In contrast, a reimbursement is an amount provided to indemnify an individual for actual expenses incurred, typically requiring the submission of receipts for verification. The CRA considers the following to be reimbursements:

• a direct payment made on account by an employer, partnership, charity or public institution as long as the liability for payment does not rest entirely with this person (for example, where an employer and an employee are jointly and severally liable to pay an amount on a corporate credit card);
• a cash advance obtained (either before or after the acquisitions are made with the cash advance) by the employee, partner or volunteer with the company credit card; and
• an accountable advance, which is an amount given for expenses to be incurred and to be accounted for by the production of vouchers, and the return of any amount not so spent.

Taxation of allowances and reimbursements

According to s.6(1)(b) of the Income Tax Act, any allowance received by a taxpayer must be included in one’s income from an office or employment, unless it is listed as an exception.

If a payment is provided as a reimbursement, it is necessary to assess whether the employee has obtained an “economic benefit” from it, such as when the reimbursement exceeds the actual expenses incurred by the employee. In general, reimbursements are not subject to tax for employees. However, if an “economic benefit” exists such as coverage of personal expenses, it can be considered a taxable benefit and subject to taxation.

Section 175 of the Excise Tax Act enables a person who is an employer, partnership, charity or public institution to claim an input tax creditor a rebate in respect of an amount reimbursed to employees, partners or volunteers for the acquisition, importation or bringing into a participating province of property or services for consumption or use in relation to the activities of the person.

The Queen v MacDonald: clarifying the nature of allowances

In The Queen v MacDonald, the tax court outlined three essential characteristics of an allowance:

1. Arbitrary Nature: An allowance is typically a predetermined sum that is established without reference to any actual expense or cost. It may be based on projected or average expenses.
2. Specific Purpose: Allowances are usually designated for personal, living expenses, or any other clearly defined purpose. The recipient need not account for the expenditure of the funds towards an actual cost or expense.
3. Discretionary Control: Once received, the allowance is entirely at the discretion of the recipient. There is no obligation to use it for a specific purpose or provide an account of its expenditure.

Campbell v MNR: Taxability of reimbursement for duties beyond scope of employment

In the case of Campbell v MNR, the tax court examined whether a payment made to an employee for the use of her car, beyond her regular duties, should be considered a taxable allowance. The court concluded that since the transportation arrangement was voluntary and not part of her ordinary duties under her contract, it qualified as a taxable allowance rather than a reimbursement.

The Queen v Huffman: reimbursement or allowance?

The case of The Queen v Huffman provided insights into distinguishing between reimbursements and allowances. Huffman, a plainclothes officer, claimed a reimbursement for $500 in clothing expenses used for his job. The court referred to The Queen v Pascoe, which defined an allowance as a predetermined sum paid to cover certain expenses, entirely at the recipient’s discretion. Conversely, a payment made to fulfill an obligation to reimburse someone is not considered an allowance. The court held that Huffman’s payment was a reimbursement since it satisfied the obligation to cover clothing expenses and was not subject to taxation.

Pro Tax Tip – Maximizing tax benefits: effective documentation of allowances

When it comes to allowances, it is important to maintain thorough and accurate documentation. By keeping detailed records of your allowances, you can maximize your tax benefits and ensure compliance with tax regulations. Here’s how you can effectively document your allowances:

1. Receipts and Invoices: Retain all relevant receipts and invoices for expenses covered by the allowance. This includes receipts for meals, transportation, accommodation, or any other eligible expenses. Ensure that these documents clearly indicate the nature of the expense, the date, and the amount paid.
2. Expense Reports: Create and maintain detailed expense reports that outline the purpose of each expense, the date incurred, and the amount spent. These reports should correspond to the receipts and invoices you have collected.
3. Supporting Documentation: In addition to receipts, gather any supporting documentation that can substantiate the need for the allowance. This may include business-related travel itineraries, conference agendas, or client meeting schedules. Such documentation helps establish the connection between the allowance and the expenses incurred.
4. Recordkeeping System: Establish a reliable recordkeeping system to organize and store your allowance-related documents. This can be a physical filing system or a digital solution, such as cloud storage or specialized expense tracking software. Whichever method you choose, ensure that it is easily accessible and provides a clear audit trail.
5. Consult a Canadian tax lawyer: If you are unsure about the specific requirements for documenting allowances or if you have complex allowance arrangements, it’s advisable to seek guidance from a top tax law firm in Toronto that can provide personalized tax advice based on your situation and help you navigate the intricacies of tax regulations.

FAQ

How do I determine if an allowance is taxable or exempt?

The taxability of an allowance depends on various factors, including the nature and purpose of the allowance and specific provisions in the tax laws. It is a fact driven analysis, so it is essential to consult the tax regulations of your jurisdiction and seek guidance from a top Canadian tax lawyer to determine the tax treatment of specific allowances when unsure.

What is a reasonable amount for an allowance?

The CRA will not allow allowances they deem unreasonable. It is a question of fact as to whether an allowance is reasonable. This determination for income tax is made on a case-by-case basis. Where it has been determined that a travel or motor vehicle allowance is reasonable for income tax purposes, the CRA accepts this determination for GST/HST purposes. If you are unsure if an allowance is reasonable or if the CRA has challenged the reasonability of your allowance, contact a top Canadian tax lawyer.

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a Canadian tax lawyer