FIVE REASONS WHY USING SOURCE DEDUCTIONS TO FINANCE YOUR BUSINESS IS A VERY BAD IDEA

CRA-source-deductions

Legal and ethical breach of trust

Employers are required to withhold deductions from employees’ wages to pay income tax, CPP/QPP and employment insurance premiums. The funds are deemed to be held in trust for Government of Canada. Abusing these funds is both a legal and ethical breach which may raise some eyebrows.  Breach this fundamental obligation, and you might cause your employees, shareholders, lenders and other stakeholders to question your commitment to meet other obligations.

Incur significant penalties and increases risk of a CRA audit

The penalties for late remittance of source deductions are punitive:

  • 3% if the amount is one to three days late;
  • 5% if it is four or five days late;
  • 7% if it is six or seven days late;
  • 10% if it is more than seven days late, or if no amount is remitted; and
  • 20% penalty if it happens more than once in a calendar year.

If your business is chosen for a full or partial audit, then your costs will escalate. Audits will also distract your finance and management team, consuming resources better applied to growing your business.

Finally, CRA will withhold any tax refunds including your SR&ED refunds until the audit is satisfactorily resolved, further crimping your cash flow.

Exposes directors to personal liability

In Canada, directors are personally liable for unpaid source deductions. In addition, an officer or another person who has control over the collection and remittance of source deductions is also personally liable. Not knowing that source deductions were being diverted does not get the directors off the hook because it is their duty to ensure that these deductions are being remitted to CRA on a timely basis. We prefer to invest in companies with bona fide outside directors because we know that no competent director would allow this conduct to manifest itself on their watch. It’s also worth noting the liability is not limited to the amount of the source deductions but also includes interest and penalties.

Reflects poorly on management’s judgement and acumen

Your CRA remittance history is one of the most important inputs in a lending decision. CRA delinquencies reveal a great deal about a company’s people, processes and financial health. Using source deductions as a source of bridge funding calls into question management’s cash forecasting ability. Repeatedly using source deductions as bridge financing is a sure sign that the business is severely undercapitalized.

Could put you out of business

CRA can garnish bank accounts, and can escalate its recourse to freezing or seizing your assets. Since CRA ranks ahead of your lenders and shareholders, a track record of remittance delinquency result in other funders deeming you too risky for continued support.

Conclusion

Avoid exposing your business to the consequences of not remitting source deductions. If you foresee a cash flow problem, it’s much better (and cheaper) to arrange for some type of bridge financing in advance than to use CRA to solve any funding gap.