Illustrative example based on the kinds of matters we handle — not a specific client engagement; outcomes depend on the facts.
The situation
An independent consultant — we will call her the taxpayer — ran a one-person advisory practice as a sole proprietor. Like many self-employed people, she deducted the ordinary costs of earning income: a home-office portion of her housing costs, vehicle expenses for client travel, meals while meeting prospects, equipment and software, and a share of phone and internet.
The Canada Revenue Agency selected two years of her returns for a self-employment expense review. After the audit, the CRA denied a large slice of her business expenses as personal, treating her vehicle and home-office claims as lifestyle costs, disallowing meals and part of her supplies, and reassessing additional tax plus arrears interest. The notice also flagged possible gross negligence penalties.
The taxpayer was rattled. These were, to her, plainly the costs of running her business — yet the reassessment recast them as private spending.
The challenge
A few provisions of the Income Tax Act sit at the centre of disputes like this. Under paragraph 18(1)(a), an expense is deductible only to the extent it was incurred to earn business income — the business-purpose test. Under section 18(1)(h), personal or living expenses are excluded. And under section 67, even a genuine business expense is deductible only to the extent it is reasonable. The CRA's denial leaned on all three.
The practical hurdle is the burden of proof. On a reassessment, the CRA's assumptions are presumed correct, and it falls to the taxpayer to demolish them with evidence — harder than it sounds for a busy consultant:
- Mixed-use expenses. A car, a phone, a home, and a meal can each serve both business and personal life. The question is rarely "business or personal" but what share was business — and that share must be supported, not asserted.
- Records that tell the story. A bank statement shows money left the account; it does not show why. A mileage log, an appointment calendar, and a note of who a meal was with are what connect a dollar to the business.
- Reasonableness. Section 67 lets the CRA trim an expense it considers out of proportion, so the amount — not just the purpose — has to be defensible.
How we approached it
The first step was the one clients tell us matters most: explaining, in plain terms, that an expense denial is the CRA's opening position, not a settled fact — then setting out a written strategy. From there the work was evidentiary.
- Rebuilt the business-purpose record expense by expense. We reconstructed mileage from calendars and client locations, tied home-office cost to the actual workspace and a defensible square-footage share, and matched meals and supplies to engagements rather than round numbers.
- Conceded the genuinely personal portion. Drawing an honest personal-use line built credibility and made the business share far easier to defend.
- Met section 67 head-on. For each surviving claim we showed the amount was reasonable for a practice this size.
- Treated the penalty as a separate fight. We addressed the gross negligence penalty on its own footing, because a good-faith deduction the CRA disputes is not the grossly negligent conduct the Crown must establish.
- Engaged the CRA directly. We dealt with the agency on the taxpayer's behalf through audit representation and, where the auditor would not move, a Notice of Objection — with a Tax Court of Canada appeal held in reserve.
The outcome
In matters of this kind, the result tracks the evidence. Where contemporaneous records genuinely connect an expense to earning income and the amount is reasonable, denied deductions can be restored in whole or in part, and the additional tax falls accordingly. Where the personal-use share was real, the outcome lands in between, with the defensible business portion allowed. Because a gross negligence penalty demands a higher standard of proof from the CRA, penalties of that kind can be reduced or removed even when some adjustment remains. What can happen is a smaller reassessment, a vacated penalty, or expenses reinstated on objection or appeal — never assured, always dependent on the facts and the records. These files take time, much of it spent reconstructing proof the return assumed it would never need.
The takeaway
A reassessment that brands your business expenses "personal" is not the last word. Deductibility turns on business purpose under 18(1)(a), the personal-use exclusion in 18(1)(h), and reasonableness under section 67 — and on audit the burden to prove each one sits with you. The strongest position is built from contemporaneous records that link the dollar to the business: a mileage log, a calendar, notes on who and why. Treat any gross negligence penalty as a distinct issue, because the CRA must justify it to a higher standard.
Our guides explain the framework: the deductibility and reasonableness analysis in Peach v. The Queen, practical business deductions for owners, the records that survive an audit, and the burden of proof if the dispute reaches court.
This is an anonymized, illustrative example. Results vary with the facts of each matter, and nothing here predicts or promises any particular outcome. For information about how we handle these files, see our overview of CRA audit representation and our work on unfiled and amended returns.