I’m often asked by my clients and fellow restaurateurs how the tax auditors arrive at their reassessments for unreported sales.
It is a pretty simple approach, though the calculations will boggle the minds of those who don’t know how to use Excel! In a nutshell, the approach is the same, regardless of whether it is an audit for PST, GST or income taxes.
- The auditor obtains a report of all known purchases from the LCBO and Brewer’s Retail. I’m using Ontario as an example, but each province will have similar procedures in place. With a bit of analysis, the auditor will be able to calculate a fairly accurate breakdown of the cost of sales (and the volume) for each major category of alcoholic beverage that the restaurant sold. Typical categories include: domestic, imported and draft beer, domestic and imported wine, and alcohol. Using these figures, the auditor is able to estimate the average cost of sale per serving for each type of alcoholic beverage sold by the establishment.
- Now the auditor requests copies of the restaurant’s alcoholic beverage and wine menus that were in effect during the period under audit. This allows the auditor to estimate average drink prices for each beverage category, for each year.
- Standard drink portions are determined from the menus, with input from the owner/manager during the initial interview.
- The auditor applies a standard theft/waste/shrinkage/spoilage allowance to each category of alcohol, to arrive at figures that represent what the auditor believes your true cost of sales per serving were likely to have been during the audit period.
- Now, it is a quick calculation to take the cost of sales in each category and project the total amount of sales that should have been realized by the establishment for each catgegory.
- The projected sales for each category is totalled and compared with the restaurant’s reported sales. Any excess of projected sales over reported sales is considered to be unreported sales of the establishment.
- In Ontario, the restaurant will be charged a 10% sales tax on the unreported sales, plus penalties and interest from the date when the sales were under-reported.
- Oddly, Ontario does NOT usually consider the unreported sales as additional taxable income of the restaurant (though there is no reason why they couldn’t)!
- The CRA will apply the same approach and charge 5% for the GST under-reported.
- The CRA will also consider the unreported sales as an increase in the taxable income of the restaurant, again, subject to penalties and interest.
- When the CRA reassesses the taxpayer for income taxes on unreported sales, Ontario will issue a reassessment for Ontario income taxes.
- Finally, and this is the scariest of them all, when a company is reassessed for unreported income, CRA may also attempt to reassess the individual officer or shareholder of the company with a benefit equal to the amount of the unreported sales. This can have extremely unfavourable tax consequences, as the individual is taxed on the unreported sales, the company does not get a deduction for this, and the company is taxed on the full amount of the unreported sales. In short, double taxation, combined with huge penalties and interest.
If these audit tactics don’t scare you, I don’t know what will. In future blog entries, I will address some of the more important areas of your restaurant operations that require attention, in order to avoid having a tax auditor present you with an unjustified tax bill.