I don’t want to scare you, but I feel it is my duty as a fellow restaurateur and as an accountant. After reading this headline, many of you will think this blog entry is going to be about the economy and how it will affect your restaurant business. As for the economy, I think the worst is behind us, but there is another threat to your business that is going to be a lot worse in the next few years. Let me explain…
Most economists seem to think that the recession has bottomed out and we are now on the road to recovery. To be sure, the recession was sudden and quite severe. The recovery is unlikely to be anything but a long, gradual improvement in business conditions. This is not good news to the many small businesses, including vulnerable restaurants, with their razor thin margins. We could all use a quick return to buoyant growth!
Governments at all levels need this too. The sudden, deep recession put a serious dent in government tax revenues. Also, they had to increase their spending to avoid an even worse fate. The federal and provincial governments are under intense pressure to limit their deficits, maintain key social programs and not raise taxes. A quick return to growth would do wonders for the government coffers, but it isn’t likely to happen. This leaves tax authorities with few options. They can find new taxpayers and they can make sure that “tax cheats” pay their taxes. Unfortunately, to the tax authorities, the terms “restaurateur” and “bar owner” are synonymous with “tax cheat”!
I am mainly concerned with Canadian taxes imposed on restaurants and bars, but it is usually a good idea to look at what is happening in the US, to understand what is likely to happen up here. A look at various state tax authorities reveals an ominous trend towards increased audit activity directed at licenced restaurants and bars. Few taxpayers will object to their government taking measures to ensure that all taxpayers comply with the tax laws. By increasing audit efforts, tax revenue can be increased without the negative political connotations of an increase in taxes. It is very easy to justify hiring more auditors to avoid increasing taxes! And this is what we see happening south of the border. You should expect to see the exact same trend in Canada.
But why target restaurants and bars? There are a number of reasons. All restaurants are required to charge sales taxes on their gross revenues. In Ontario, the rates are 8% on food sales, 10% on alcoholic beverages, and 5% GST on all sales. Generally, there are no deductions against these taxes. If a tax auditor can show that the restaurant failed to report sales, an assessment can be issued calculated at the appropriate rates, combined with penalties and interest. Tax authorities suspect 50% or more of all restaurants and bars are “cheating” on their taxes owing. It is easy for the auditor to accurately verify the alcohol purchased. There is a theoretical (or standard) cost for every drink sold. With a few simplifying assumptions, the auditor is able to estimate the sales that should have been generated by the restaurant during the audit period.
So, for a relatively small amount of work, the auditor is able to estimate the likely “true” sales of the business. Then, it is up to the taxpayer to rebut the presumption that the restaurant has failed to report all sales. In order to do so, the restaurant must document the reasons that costs deviated from the standards. This can be exceptionally difficult to do, after the fact. Few restaurants and bars have the time to document all of the factors that affect their margins. It can be done, but there can be a significant cost. Ideally, such information should be independently developed. While it can be costly to stay on top of your margins, it is still far cheaper than letting the tax auditors have their way with you, and an ongoing analysis of your margins will help you manage your restaurant more effectively.
If I have scared you into action, I’ve done my job. Continue reading this blog site for a comprehensive list of procedures to help protect your business.