It’s Going to get a Whole Lot Worse!

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.

3 Replies to “It’s Going to get a Whole Lot Worse!”

  1. Thank-you for your informative blog. I have a restaurant in Nova Scotia. In the summer of 2008 CRA came to help me set up my record keeping so that I would not have to keep all the paper receipts. I am trying to set up a paperless operation. All my invoices are now scanned and the bookkeeping is outsourced to India. In February of this year CRA came this time to extract my data for audit purposes. They were with me for 5 hours. Last month they asked for one weeks worth of our daily sales reconciliation reports. Is this is an 8 month investigation? I do not personally handle any of the cash and my wait staff and cashiers are required to match up their cash and visa slips to sales at the end of every shift. How could CRA afford to spend this much time and effort on my restaurant? I only do about 1.1 million a year. I have been using Silverware POS since 1996 and quite frankly, I have never heard of a zapper.

    What is ironic is that for years I have been the brunt of much ridicule by my ex chef and even fellow restaurateurs for not being involved in the underground economy and I am the one to get audited! So you can imagine how miffed I am about this. Many of them don’t use a POS so a zapper is irrelevant.

    From my perspective it really appears that fraud is rampant. Everywhere you look you see owners stationed at the cash register day and night. This does not suit my life style one bit and no amount of money is worth me doing that every day. I am told that the way to make money is to fail to record cash sales toward the end of the night. The reasoning is that auditors don’t work past bed time.

    Furthermore, I have been having huge problems attracting cooks because I can’t pay them under the table. They are being paid in cash at all the other places. I am also at a disadvantage because I have to pay more per hour to keep the ones I have.

    If the CRA can level the playing field a bit with some enforcement, I would be all for it. But I think that the majority of cheaters will slip under the radar because they see a danger in having a POS.

    Your “getting a lot worse ” article is particularly worrisome because I have a suspicion that CRA’s emphasis will be on operators like me because we are easy to do.

  2. Thank you for your comments, Greg. Sounds like we have similar operations. Your being selected for an audit could have been random. Sometimes, these audits get drawn out over a long period of time. In your case, the late request for information may be simply for the auditor to complete documentation of an audit step, likely the result of a supervisor’s review of the file.

    I applaud your efforts to go paperless! There is a tremendous amount of paper generated in a restaurant, and filing becomes an issue, especially when it comes time to audit. However, in some audits, the CRA and provincial auditors have required paper copies of invoices that had been previously scanned!

    The lack of a POS system should be a signal to CRA that skimming is taking place in a restaurant of any substantial size. Perhaps you are aware of rampant fraud, because most of these restaurants do not have a POS.

    You highlight another point that needs to be addressed by all tax authorities. Restaurants and bars that are skimming (with a zapper or not) have a competitive advantage over honest operators. As you say, the dishonest establishments can pay workers in cash, saving on employee benefits, on top of the large savings from taking cash sales.

    I don’t know that restaurants with POS systems are more likely to be audited. Most jurisdictions use indirect methods of verifying sales, which do not require a POS system. Auditors can access alcohol purchases independently, from provincial alcohol boards, and use this to project likely sales.

    I appreciate your comments and hope that your audit goes well!

  3. I’ve been involved in taxes for longer then I care to admit, both on the personal side (all my working life!!) and from a legal standpoint since passing the bar and pursuing tax law. I’ve provided a lot of advice and righted a lot of wrongs, and I must say that what you’ve posted makes perfect sense. Please keep up the good work – the more people know the better they’ll be equipped to deal with the tax man, and that’s what it’s all about.

Leave a Reply

Your email address will not be published. Required fields are marked *