TAXATION Law 504 (Sprysak)Course Outline - Amazon S3



Marginal Tax Brackets and Rates for Examination PurposesTaxable IncomeFederal RateAlberta RateCombined Rate$0 - $45,00015%10%25%$45,001 - $90,00022%10%32%$90,001 - $125,00026%10%36%$125,001 - $135,00026%12%38%$135,001 - $150,00029%12%41%$150,001 - $200,00029%13%42%$200,001 - $300,00029%14%43%$300,001+29%15%44%Selected Other Provincial Tax Brackets and Rates:ProvinceMarginal BracketsTax RateBritish Columbia$0-37,86937,870-75,74075,741-86,95886,959-105,592105,593-151,050151,051+5.06%7.70%10.50%12.29%14.70%16.80%Saskatchewan$0-44,02844,029-125,795125,796+11%13%15%Ontario$0-40,92240,923-81,84781,848-150,000150,001-220,000220,001+5.05%9.15%11.16%12.16%13.16%1.Introduction to Income TaxationWhat is a Tax?General Dictionary DefinitionsNo definition in income tax acta contribution to State revenue, compulsorily levelled on people, businesses, property, income, commodities, transactions, etc. (Oxford)[T]he involuntary expropriation of property without direct compensation to the person from whom the government takes the property. Thus, income tax is the compulsory contribution that government levies on transactions in goods, services and intellectual property to finance public expenditures that society considers to be for the public good. (Krishna)payment of money w/ no immediate or directly linkable good or service in return (Sprysak)SCC Def’n of Tax Lawson v Interior Fruit and Vegetable Committee of Direction A tax is a charge which is:Enforceable by law (compulsory as opposed to voluntary) Imposed under the authority of the legislative branch of government (no taxation w/out representation, or to one they have delegated it to)Imposed by a public body (allows legislature to delegate powers to another public body) (must do so explicitly)Imposed for a public purpose Constitutional Requirements/PowersFederal Government – s.91(3) Power to raise money by any mode or system of taxation BUTFeds must have jurisdiction (some connection to Canada) – 2 requirementsConnection between the country and the person (residence, citizenship, domicile) ORSource of income (regardless of where living, income can be traced within our borders) Provincial Government – s. 92(2) power of “direct taxation within the province in order to the raising of a revenue for provincial purposes” No Taxation w/out representation – Section 53, 54, 90 of Constitution Act In order for tax to be valid it must originate in the legislature (parliament or provincial leg.)Can be delegated to a public body (such as Executive) BUT must be done explicitly and intentionally (Eurig Estate) Question: Why do we have this requirement?Generally Accepted Answer: because government is taking our money we want to be able to hold them accountable (vote them out etc)An Alternative Answer: (minority in Eurig): wanted to prevent the senate from creating its own tax legislation Question: does this constitutional (and rule of law) requirement mean that Executive Branch of government cannot create a tax? Answer: legislative branch can delegate power to create laws to another body, so they could delegate to the executive branch (or another government body), only requires that the legislative delegate properly and explicitly delegate the power to the body, And the delegated body has to stay within terms of delegationImportant Summary Points: if we are dealing with a tax it has to originate in legislative government or leg has to explicitly delegate it to another government body. Otherwise tax would be unconstitutionalApplies to both fed and prov legislationDirect and Indirect TaxesProvince can only implement direct taxes, feds can do whatever they wantA direct tax is one that is demanded from the very person who it is intended or desired should pay it; whereas [charge the person who gets direct benefit from it] Example: PST, Income Tax An indirect tax is one that is demanded from one person in the expectation and with the intention that he shall indemnify himself at the expense of another (“paying off”) [tax one individual with expectation that will transfer liability to someone else] Example: Liquor tax/fuel tax Common Law DefinitionTEST (per Bank of Toronto v Lambe): court will consider “the general tendencies of the tax and common understanding of men as to those tendencies”.Bank of Toronto v Lambe (1887) - Direct vs. Indirect Taxation Facts/Issue: Quebec decided to tax any provincial institute that worked within its provincial boundaries. Bank operated primarily in upper Canada but had a few branches in Quebec. Quebec said we want to impose a tax on the entire bank (not just those in Quebec). This was going to be a significant charge to the bank of Canada, so they challenged it that Quebec imposing an unconstitutional indirect tax. Decision: Tax Constitutional Ratio: To determine whether a tax is “direct” or “indirect”, the court will consider “the general tendencies of the tax and common understanding of men as to those tendencies” even though the business recovers their costs from the consumer does NOT mean that every corporate tax is indirect a tax can have indirect effects and still be a direct tax Intention of the Quebec legislature and the general tendencies of the tax was that the banks were intended to pay and ultimately bear the burden of the tax.BUT if dealing w/ a commodity or export tax (tax added to the gross supply chain) and the legislature wants to impose the tax in the supply chain and this tax is passed down (from manufactuer to consumer), then this is indirect as the legislature will anticipate that the tax is pass down For example in PST as direct tax, there is one tax which is triggered when a consumer purchases something subject to PST. Retailer is acting as the agent for the government. The retailer does not pay the tax. There is not a case where the retailer pays it then recoups from individual consumer.NB: There is a fundamental difference in “economic tendancy” of the owner to try and shift the incidence of the tax and the passing on of the tax. When a tax is passed down the supply chain if tax is “related to a unit of the commodity or its price, imposed when the commodity is in the court of being manufactured or marketed than the tax clings as a burden to the unit of transaction presented to the market”) [Canadian Pacific Railway v Sask] if commodity type tax, which is levied early in the chain = indirect tax Kingstreet Investments Ltd. v. New Brunswick, [2007] 1 S.C.R. 3.Ratio: The surcharge placed on liquor purchase for resale was unconstitutional to the province because indirect tax. Taxes vs. FeesFee = exchange, and the amount relates to the cost to the government for providing that good/service (correlation doesn’t have to be prefect, some leeway)Tax = Government takes money from the person based on certain indicators (e.g. income) which may not directly relate to government expenditures on that good/service Two Requirements for a fee (RE Eurig)Charged with respect to a good/service that is being provided to you (some leeway here)Connection between the amount charged and the cost imposed on government for providing good/service Re Eurig Estate, [1998] 2 S.C.R. 565Facts: ON enacted a probate regime whereby for a fee, the provincial courts would examine the will and if it complied with the relevant law, provide letters of probate to the executors, which they could then take to third parties (who would have to comply with the terms of the will). Executive branch did this under authority of the Administration of Justice Act, which delegated to the Executive the power to make regulations regarding the payment of “fees” (but made not explicit mention of delegating the power to create “taxes”).Reasoning: Court considered Lawson factors and considered the fact that the fees:Were on a sliding/increasing scale,This scale depended upon (or were tied to) the value of the deceased’s estate, rather than the costs incurred by the courts to grant probate, andThese graduated levies were intended to generate a surplus for the province, rather than simply cover the costs of providing this service (see paras 20-23)Held: Probate system was actually a tax (direct tax) Types of TaxesThe Relative Importance of Each Type to Federal and Provincial GovernmentsTypes of Taxes (don’t need to know exact % just know relative magnitudesProvincial Tax (on aver for all provs)Federal Tax27.8% of total revenues comes from income taxes 21.8 personal income taxes5.6% for corporate income taxes.5% other income taxProperty taxes 16%GST 11%Property tax 16%60% of its total revenues are derived from income tax75%+ of its tax revenues are derived from income taxes 47.9% of income tax revenues are derived from personal income taxes Corporate income tax 12,7%GST raises 12% of total revenues (For a total govt revenues from tax of 72.6%Why do Parliament and Prov impose a Variety of Different Taxes?Governments have other objectives besides raising revenue from taxesAllows revenue collection to be needs focusedProvides government responsibilityAllows more revenue to be collectedReduces tax avoidance potentialCan tailor taxesRedistribution of income in societyTo encourage or discourage behaviorTo minimize economic distortions caused by taxation: avoiding changing people’s behavior thru taxation. Variety of taxes means that no one tax prevents market from functioning in an uninfluenced fashionMore stable base of taxation (in case on tax source declines)Allows governments (at diff levels) to specialize and levy their own types of taxesTaxation Rate RegimesProportional Proportional (flat tax) rate of taxation does not change as income changes {Alberta, not any more}Alberta currently employs this regime (excluding the application of tax credits) – by levying a 10% provincial tax on taxable income Of course, this is changing. Effective October 1, 2015 (but with full implementation beginning in 2016 – interesting way to implement as not to apply I retroactively):Progressive Progressive: taxpayers tax rate increases w/ income Vertical equity satisfied Comparing Progressive Regimes Across ProvincesIn British Columbia, its combined Federal and provincial income tax rates begin at 20.06% (up to income of $37,869) and go up to 45.8% (for incomes in excess of $151,051);In Saskatchewan, its combined Federal and provincial income tax rates begin at 26% (up to income of $44,028) and go up to 44% (for incomes in excess of $138,587);In Ontario, its combined Federal and provincial income tax rates begin at 20.05% (up to income of $40,922) and go up to 42.16% (for incomes in excess of $220,001) excluding surtaxes; andIn Quebec, its combined Federal and provincial income tax rates begin at 31% (up to income of $41,935) and go up to 54.75% (for incomes in excess of $102,041)Terminology: Marginal, Average, and Effective Tax RatesMarginal Tax Rate: the rate at which incremental income will be taxed. Every additional dollar will be taxed at that (if you make 100k and are offered 10k more the marginal tax rate is the amount that additional 10k will be taxed at)Average Tax Rate: this is calculated by taking total taxes payable and dividing it by total taxable income.Equation: Avg Tax Rate = Total Taxes Payable/Total Taxable Income In a progressive system – marginal tax rate will always be higher than average tax rate Effective Tax Rate: this is calculated by taking total taxes payable/total net incomeNet income is what accountants would calculate as the total income from an activityProgressive vs Proportional: Relative Strengths and Weaknesses Progressive Pros: minimizes income gap, generates more revenue at higher end, balances out higher income individuals ability to be tax efficient, Can get same revenue as proportional rate because we can tax those at a higher rate more and give those with less income less. Proportional Pros: simpler, decrease animosity of high tax earners, reduce administration compliance costs, doesn’t discourage income growthProgressive Cons: Prop ConsRegressive Regressive taxpayers pay tax at a lower rate as their income increases Can still have vertical equity in this regime they still pay more tax, just pay a lower tax rate Might encourage people to earn more moneyConsumer tax is regressive as to income: don’t necessarily consume more as you make more, so it’s a smaller portion of your incomeEvaluating Tax Regimes and Changes to Tax Regimes1. Revenue GenerationEnact to generate revenue (car taxes, luxury taxes, sin taxes) Evaluate the taxes effectiveness by how well it achieves this goal Caution: too high a tax causes people to leave the province/country, decrease consumptionMay levy a tax to decrease consumption/ discourage activity (in this case not an effective evaluation method)Equation: Revenue = Tax base [income] x tax rate To increase revenue can either broaden the tax base or increase the tax rateGeneral trend has been to lower tax rates Non-taxable bases: income in RSP and RESP is not subject to tax while it is in the plan, tax free savings account, gifts and inheritances, lottery winnings, gambling, scholarships, capital gainsTax free savings account Components of the Tax BaseEquation: Revenue = Tax base [income] x tax rate To increase revenue can either broaden the tax base or increase the tax rateGeneral trend has been to lower tax rates Non-taxable bases: income in RSP and RESP is not subject to tax while it is in the plan, tax free savings account, gifts and inheritances, lottery winnings, gambling, scholorships, capital gainsTax free savings account 2. Efficiency (producing the desired result with minimal wasted effort)How Taxation (Potentially) Affects BehaviourLook at how imposition of how tax influences tax payers behaviourAn efficient tax is one that does not influence behaviour – let market govern Head tax does not influenceConsumption tax will influence EXCEPTION: The “income effect of taxation” = To the extent that the imposition of a tax provokes people to work more in order to pay for that tax, the tax is inefficient but it is a good inefficiency. But, there is also the “substitution effect” where a tax is implemented or increased and a person changes to non-taxable activitiesThe Costs of AdministrationLook at costs of administration (cost to comply w/ tax and administer and ensure compliance) common measure Cost from government perspective (enforcement, education)Costs from a tax payers perspective (time, money to pay someone to do the return)If easy to evade tax, it may not be efficient An Overview of the Efficiency Concepts of Neutrality and Simplicity3. Fairness/Equity Basic Principle if tax is unfair people will not comply To increase likelihood that taxpayer will comply it has to be seen as fair by those subject to itSimilarly if you think gov’t isn’t using tax revenue well = decrease likelihood of complianceThe Ability to Pay PrincipleAmount of tax should directly relate to persons ability to pay in Canada equate this to income Income does not always for how the person is actually living (value of dollar changes with location, can artificially reduce income, etc)Difficult to determine what should be included in a person’s income (inheritances, dependants etc) The Standard of Living PrincipleIf you can afford more or consume more you should pay more Allocate tax burden based on how well the taxpayer is livingAka consumption taxesCould just be financing off of debt – high standard of living but don’t have the means to support it.Horizontal and Vertical EquityVertical Equity = If you have a different amount of income, then you should pay a different amount of tax. More specifically, the person with the higher income should pay more tax than the person with the lower income.In Canada we have vertical equity but NO horizontal equity, as different types of income are taxed differentlyAll there regimes satisfy this principleHorizontal equity = individuals w/ similar income and assets should pay the same amount in taxes no matter the difference in situation between the two people Canada often violates this – because capital gains are taxed less than employment income In Canada, we distinguish between different types of income and DO NOT have horizontal equity5 types of income under the Income Tax ActEmployment incomeProperty/investment incomeBusiness incomeOther (eg. receipts from a pension plan)Capital gainsEach source of income has separate rules for calculating the tax on that incomeBecause of this there are advantages to having income counted as one form or another.EX. Canada often violates Horizontal Equity principal b/c an individual who does not work but makes $50,000 of capital gain will pay less tax than someone who works and makes $50,000 in employment income. A Brief Overview of Tax ExpendituresTax Expenditures: In addition to raising revenues, govts typically use income tax regime to provide benefits (in the form of credits, deductions or exemptions) to some or all of its constituents: these are referred to as tax expendituresExpenditures (can be in the form of a credit, deduction or exemption), which are direct spending by the gov’t contained and administered though the ITA and allows the gov’t to use the existing tax regime as a way of providing benefits to their membersCalled expenditures because its costing government money they could have hadHow do we analyze a tax expenditure? What is the goal of the change?Efficiency (how costly is it, how much waste)How equitable is it?How effective is it?Avoid looking just at revenueA Brief Overview of the History and Administration of Income Taxation in CanadaCanada has the practice of the Canada Revenue Agency administer and collect not only federal, but provincial income taxes. Province delegates their taxation power to the municipality, and delegate power to levy tax primarily through property tax. This is accomplished through “tax collection agreements” – which generally require the provinces to use the Income Tax Act’s calculation of “taxable income”HistoryThe first federal income tax legislation, the Income Tax War Act, was enacted in 1917 as a temporary tax to finance Canada’s participation in the First World War.Prior to this, the federal government relied primarily on customs duties and excise taxes and the province/municipalities on property sales and property taxesSomewhat interestingly, during the mid-20th century, the marginal tax rates went as high as 85%.Two Exceptions to system:Quebec own income tax legislation for corporations and trusts Alberta corporate income tax 2.The Basic Structure of the Income TaxBasic Questions:Several of these questions are addressed by the first substantive provision in the Income Tax Act (Act), subsection 2(1), which provides that:An income tax shall be paid, as required by the Act, on the taxable income (tax base) for each taxation year (period) of every person resident in Canada (tax unit) at any time in the year. Who is Subject to Tax?A tax unit (i.e. taxpayer), who is the subject of taxation, (who are we going to tax?) the taxpayerWhat will be Subject to Tax?A tax base (i.e. income), on which the tax is assessed, (what are we going to tax?) (taxable income)Defined by the income tax actOver What Period Will Taxes Be Calculated?A taxation year (aka “accounting period”), which is the period of time over which income and the associated tax liability (if any) is calculated, [time period over which tax calculated – most countries tax over a taxation year – could have a system where taxes calculated over a persons lifetime]What Taxation Rate(s) Will Be Applied to the Tax Base over the Taxation Year to Determine the Taxpayer’s Tax Liability?A taxation rate regime (aka “a structure of tax rates”), which is applied to income to calculate the taxpayer’s tax liability, and [mechanical calculation]Includes: Tax credits, which reduce the taxpayer’s tax liability calculated above. [tax credits]The Tax Unit – Who is a “Person” for Income Tax Purposes (and Who Is Not)?Who Is a “Person” for Income Tax Purposes? (in reference to “every person resident in Canada”)Section 248(1) = defines who is person for income tax purposes Inclusive definition Supplements the dictionary meaning: which includes individualsIncludes: individualsCorporations, Tax exempt entities {entity that is not taxable due to an exemption e.g. charity, churches, government organizations/crown corporations], Trusts (inter vivos trusts and testamentary trusts], As a general rule a partnership is not considered a person for tax purposes The Importance of Status Canada taxes based on status, need status to be taxableSufficient connection between the person and the country If a person has the required status (residency) then the person’s worldwide income will be subject to Canadian income tax.Residency is the basis that Canada asserts jurisdiction to tax peopleSection 2(1): If you a resident of Canada at any time in the year then you are subject to your worldwide incomeIf the person does not have the required status, then Canada will have more limited, or perhaps no jurisdiction to tax that person’s income. (any more is beyond the scope of the course)Generally speaking, it will only be able to tax income that is sourced to Canada (and not always then)This is taxing based on source, not status, Must be a connection between non-resident persons income and Canada for Canada to be able to tax that incomeA Brief Overview of How to Interpret the ActGeneral rules for statutory interpretation is to rely on ordinary interpretation if another one isn’t provided Original questions who is a person: doesn’t mention human beings/individuals in definition (we still have to pay taxes)This is because we rely on the ordinary dictionary meaning, also definition provided is inclusive not comprehensive, if 248.1 (individual is defined: says it includes a person)CorporationsNon-Taxable PersonsStill required to complete income tax returns even if tax exemptInter Vivos and Testamentary Trusts and EstatesA Very Brief Overview of the Uses and Tax Treatment of Trusts3 Components:1) Relationship – with respect to property with separation of legal or equitable interest (if it’s same person then no trust because interests merge together – can have trustee be part of a group of beneficiaries because title still separated)2) Relationship with respect to property 3) Separation of equitable and legal interest 3 certainties that must be present – 1) certainty of intention – settlor to create a trust, must be sure they intended to create a trust (is there intention of a gift, license or bailment?) 2) certainty of subject matter – actually trust property, certainty to respective beneficiaries 3) certainty of object – refers to identity and existence of beneficiaries, or purpose/object of trustWhy do we have trusts: two related purposes 1)(protect property: protect assets by putting them in a trust) 2)(preserve property: don’t let kids squander money)Trusts for tax purposes: treated as a person (has to file a tax return, report its taxable income, pay taxes)To the extent that a trust earns income and retains that income it will be required to pay tax (and for inter vivos at the highest marginal rates)Testamentary changing (but not at same brackets at the individual (grace period, than the same as inter vivos trustsIf trust earns income and distributes it out to the beneficiaries in the same year the trust gets a deduction and beneficiaries have an income inclusionTrusts often referred to as flow through entitiesIndividualsOriginal questions who is a person: doesn’t mention human beings/individuals in definition (we still have to pay taxes)This is because we rely on the ordinary dictionary meaning, also definition provided is inclusive not comprehensive, if 248.1 (individual is defined: says it includes a person)PartnershipsNot a person for tax purposesA Very Brief Overview of the Tax Treatment of PartnershipsWhat does the income tax do with respect to partnership:? Partnership; relationship that subsists between persons carrying on business in common with a view to a profit (partnership doesn’t pay tax, income tax act looks through the partnership to the partners, flow through entity)But 96.1 for purposes of determining each partners income from partnership you pretend the partnership is a separate person, calculate its income and then you allocate that income to the partners (generally pursuant to partnership agreement, if not then equally to partners)Determining the Residency of an Individual for Federal and Provincial Income Tax PurposesPossible to get a ruling from the CRA on whether a resident or not required to fill out form NR-73 (if leaving Canada) OR NR-74 (entering Canada)CRA has published income Tax folio S5-F1-C1 to determine an individual’s residence statusCan be resident in more than one country at a timeTwo step test to determine if a resident:Are they a resident under the common law rules (per. Thomson) If Yes, which province are they a resident of?If No, are they still deemed a resident under a statutory deeming rule?Common Law Test Per Justice Rand: (THOMSON V MINISTER OF NATIONAL REVENUE):Residence = Chiefly a matter of the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living with its accessories of social relations, interests or conveniences at or in the place in questionCan be a resident even though it is not your permanent and definite home (distinguished from domicile) Justice Rand also distinguished “ordinarily resident” from “occasional, casual or deviatory” residence. “[t]o dwell permanently or for a considerable time, to have one’s settled or usual abode, to live, in or at a particular place”.Primarily a question of fact (1.22 of Folio S5-F1-C5)Residency is ascertained by a comprehensive factual analysis:Primary Residential TiesDeterminative factor = residential ties of the individual under consideration including his spouse/common law partner, dependants (e.g. is the individual spouse living in Canada or have a place available to live)Secondary TiesSecondary Residential Ties – gain weight as more accumulate (italicized are the big three after residential ties)Personal property in Canada (i.e. furniture, clothing, automobiles, etc.),Social ties with Canada (i.e. memberships in Canadian recreational and religious organizations)Economic ties with Canada (i.e. employed with Canadian employer, involvement in a Canadian business, Canadian bank accounts, etc.),Landed immigrant status or appropriate work permits in Canada,Canadian hospitalization and medical insurance coverage,Canadian driver’s licence,Canadian seasonal dwelling place or leased dwelling place,Canadian passport,Memberships in Canadian unions or professional organizations, etc.CRA has stated they will place significant weight on obtaining landed immigrant status and acquiring provincial health careAdministrative PositionsResided in Canada for lengthy period of timeWill a certain period of time outside of Canada “guarantee” non-resident status?Where a taxpayer has resided in Canada for a lengthy period of time, clear and “virtually irreversible” measures are required to terminate this residency CRA would have to have significant change in facts or circumstances to validate claim that not a Canadian resident (not necessarily virtually irreversible just significant) (1.17 of Folio S5-F1-C1) Length of stay or the time present in the jurisdiction is not conclusive. An individual may be outside the jurisdiction for the whole year but may still be held to be a resident (if, say his/her spouse and family reside within the jurisdiction) No length of stay indicates becoming non-residentGenerally, if there is evidence that an individual’s return to Canada was foreseen at the time of his or her departure, (1.17 of Folio S5-F1-C1, ,)CRA will consider whether person filled out relevant ta provisions that engage when ceasing to be a resident (In paras 1.18 and 1.19 of Folio S5-F1-C1)128.1(4) of a folio: deems tax payer to have disposed of and reacquired all property at fair market valueResident of another jurisdiction:Little importance in determining Canadian residency (may be resident in more than one country at a time)Must be resident in at least one jurisdiction at all times: (Folio S5-F1-C5 at para 1.21)if someone purports to sever ties and doesn’t acquire new residency somewhere else, might still existThe Role of IntentionWhile a taxpayer’s intention to reside in a particular jurisdiction may be relevant to the determination of residence this intention is not determinative, but “must always be viewed objectively against all the surrounding facts”Taxpayers subjective intention is not relevant in determining residency LOOK at objective manifestations of intention (some judges have even said intention is irrelevant) Objective manifestations of residency: ex purchasing a cemetery plotAn Overview of the Taxation of Canadian Resident AboriginalsSections 87-90 of the Indian Act cover the taxation of aboriginalsThese Sections are incorporated into the Income Tax Act by paragraph 81(1)aCourts have found that their purpose of these provisions is not so that Indians can hold property in the commercial mainstream on diff terms than their fellow citizens (Mitchell v. Peguis Indian Band)Crown honour bound to shield Indians from any efforts to disposes them from property they hold as Indians (in relation to land base) (Mitchell v. Peguis Indian Band)Collectively (for income tax purposes), these provisions exempt the income (which was held to constitute “personal property” in Nowegijick v. R. [1983] 1. S.C.R. 29) that is situated on a reserve from taxation.Generally speaking these provisions exempt the income (which was held to constitute personal property) that is situated on a reserve from taxationSubsequent case law has focused on what constitutes situated on a reserveTwo Tests: 1. What are the connecting factors of a particular income source/receipt to a reserve (Williams v R)2. Can it be reasonably said that the income is earned/located in the commercial mainstream?Provincial ResidencyIf they are a resident under the CL test, next step is: where are they a resident for provincial tax purposes?Test for determining provincial residency is the same virtually as if resident for Canada – but two modification (Thomson test + modifications)Apply test as of Dec 31st of the year considered a resident of the province in which they were a resident as of Dec 31st of the particular taxation year (as opposed to ties over the entire year) You can only be found to be residents in one province or territory in the year (per Regulation 2607)You apply the test on the last day of the year – where personal family ties, social connections, economic connections, as of that date. EXCEPTION: where the individual earns business income through a permanent establishment in another province, then, effectively, income earned through that permanent establishment in the other province will be subject to provincial tax in that province.Statutory Deeming RulesApply Statutory rules as well as common law test“Special Individuals”Special Individuals Rule – s.250(1)(b) –(g)Special Individuals: These individuals are deemed even though they may not be a resident for purposes of the CLInclude: members of Canadian forces, government officers/servants, children (certain spouses to the above)While they may work and live abroad they are deemed Most countries have similar deeming rules country deemed residents are living in either deem them not to be a resident or deem them not to be a taxable entity In Canada we deem to be non-taxable NB: Section 114 of ITA: overrides or modifies s.2(1) [if resident at any time in the year, then taxable in world wide income for entire year] s.114 modifies this, if resident for portion of year and non-resident for another portion then 2(1) will apply only for period that Canadian resident, and for remainder of year when a non-resident only subject to 2(3) and 2(12) which says income sourced to Canada is taxed in Canada. Sojourner RuleDeeming rules are contained in s.250Sojourner Rule – s.250(1)(a) = Deemed to be a resident for entire year if that person sojourned in Canada for a period of 183 days or more (bright line test)Rule only applies for federal taxation purposes, does not deem you a resident for provincial tax purposes – thus per s.120(1) the feds levy a sur-tax on you to account for fact paying less tax Even if only lived in Canada for half the year then still taxed for entire year under this rule What does it mean to sojourn? Really it is about physically presence whereas CL is not. (purpose of the visit does not matter)Staying temporarily in a foreign land as opposes to ordinary residence To make a temporary stay in a placeTo remain or reside for a timeA place where one unusually or casually or intermittently visits or staysCRA Folio Paragrpah 1.33 sojourning – to make a temporary stay in the sense of establish temporary residence Cannot sojourn in a country you are a resident of (does not apply to common law residents)Ex if CL for first 100 days of the year and then severs ties, next 265 days must be checked for sojourner rules) Do not care why you have temporary residence here (e.g. jail, work, vacation) Commuting: travelling to work during the day and coming back, vs sojourningSome courts have no counted commutingWhat constitutes a Day?Generally the CRA considers any part of the day to countDays reset to 0 on January 1st.NB: A day for the purposes of sojourner rule does not mean a 24 hour consecutive period, can be here for less then 24 hoUncertainty where staying spans two days. Taxing One’s Status Around the WorldCitizenship Only applies to individuals who were born in the country or born outside but took necessary steps to get citizenship in that country In US citizenship is inherited Article 4 of Canada-US treaty where you have individual who is a resident of Canada and citizen of the US, such that each subject to tax, treaty says we will essentially break the tie and tell one of the countries they cannot apply their domestic law to that person. Treaty also provides that other country must enforce the other countries tax law/ exchange information Strength: Provides bright line test of whether citizen or not Weakness: Negative – criticised: a) overbroad (catches people who have no economic connections ot the country ); b) Under-inclusive – people living and working and generating economic activity in usa who are not citizensDomicileTwo elements:Must be physically present in that jurisdictionAlso have to intend that country to be your permanent or indefinite home Strengths: more sophisticated and refined then citizenshipWeakness: Somewhat subjective because intention to make permanent home can be difficult to determine AND can only have one domicile at a time, cannot have more then one permanent or indefinite home. A Brief Overview of the Role of Tax Treaties in Determining ResidencyWhat Happens if Canadian and US resident in a year/periodCan get relief from bilateral tax treatiesArticle Four para 2 of Canada Us tax treaty sets out tie breakers (applied in order)Permanent home in just of of the two jurisdictionsCenter of vital interestsHabitual abodeCitizenshipCompetent authority (body under treaty that makes determination)If resident in one country and generating income in another country (2.3, 2.12) reserve the right to tax non-residentsPotentially alleviated by home country providing foreign tax credits (Canada’s credits are only for the amount it would have taxed the income at)Canada wants to know if you have property worth more than 100k outside the countryA Brief Overview of U.S. Reporting RequirementsIn media FBAR (foreign bank account reporting rules)US enacted foreign account tax compliance act: imposes reporting requirement on individuals and corporations, but also on financial institutions that they have to disclose that, and face financial penalties and banned from US financial stuff (this stuff isn’t taxable) But there is Canadian legislation to force this, challenged this to be a charter breach. Determining the Residence of a Corporation A Brief Overview of the Tax and Non-Tax Legal Implications of IncorporatingWhat is a corporation: is a binder of documents that are registered in a corporate registry. Given legal status under corporate lawFor tax purposes a corporation is a separate and distinct person from employees, shareholders etc.Set up a corporation or move to get access to Canada’s tax treatiesTax returns must be filed for a corporationStatutory Deeming RulesStatutory Deeming Rules: para 250(4)(a)If a corporation incorporated in Canada after april 26, 1965 from then on it will be a Canadian resident corporation250(4)(c): if incorporated prior to april 26, 1965 must have carried on business in Canada or Canadian resident under CL test250(5.1): if incorporated in Canada and continued into the Us from the point of continuation deemed to have been incorporated in the US (reverse also holds true)Common Law TestCommon Law Test:De Beers Consolidated Mines Ltd v Howe: central management and control test: primarily a question of factTo determine CM&C courts will looking to where the corps Board of directors meet and make decisions Unless BoD is a puppet of shareholders location of shareholders is irrelevant to residencyDouble residency: same article four para 3 Canada us tax treatyConsiderations in Determining the Appropriate Jurisdiction in which to Incorporate and in Determining the Members of the Corporation’s BoardPractice Points: when dealing with business people, think about where you want to incorporate (federally, provincially, which country, think about who are going to be directors, where they are resident, where they meet) (need more?)A Very Brief Introduction to Canadian Controlled Private Corporations and their ShareholdersDetermining the Residence of a TrustHistorical and Current Common Law TestPrevious CL rule Thibodeau Family Trust v The Queen: residence of trust = residence of trusteeWould merely determine trustee (as individual or corp’s residential status)If more than one look to where majority are residentGarron Family Trust: SCC adopted central management and control test for corporations to determine residency of a trustIf CM&C is done my trustee nothing changes, but if its someone else then trustee’s residence doesn’t matterAdministrative PositionsIT-447 Residence of a Trust or Estate (1980 Pre-garron)paras 4-5 that while the general “rule” was to look to the residence of the trustee (using the common law tests) to determine the residence of a trust, CRA would look, in cases where it was unclear who had management and control of the trust, to other facts in determining the trust’s residence including:The location of where the legal rights with respect to the trust assets were enforceable;The location of the trust assets;The residence of the settlor and/or beneficiaryThe Supreme Court’s decision in Garron Family Trust is reflected in its recently released Folio S6-F1-C1: Residence of a Trust or Estate (3 February 2015)The Tax BaseTax base = Taxable income“The taxable income of a taxpayer for a taxation year is the taxpayer’s income for the year plus the additions and minus the deductions permitted by Division C” (s.2(2))A person’s taxable income CANNOT be less than $0“the amount to which the rate (or rates) of tax is applied to determine the amount of tax payable”.Is taxable income which is calculated by following all the inclusions, deductions and exemptions in the Act Canada’s Source Concept of Income Section 3 is important as it indicates Canada’s approach to calculating taxable income, namely, a “source” approach taxed on worldwide income from each recognized source Five recognized and named sources of income for Canadian income Tax purposes:EmploymentBusinessProperty (investment)Net capital gainsOther = miscellaneous receipts (s.56) – spousal support, pension Generally speaking courts have said if not listed in act and not enumerated then not taxable under the act When courts are unsure what something is classified as they will put it under business income Because different sources of income, does not adhere to horizontal equity Each of these sources has its own set of rules for calculating income, pursuant to section three income is to be calculated for each source distinctly from any othersIf multiple sources generate the same source of income its done on an activity by activity basisOnce each source is earned then the sources of income are combined to come up with total (or net ) income from which certain non0source specific deductions are taken to arrive at taxable incomeSection 3 includes “without restricting the generality of the forgoing” suggests that the legislation actually says in addition to five sources there can be unenumerated sources. But to his knowledge no court has every taxed an unenumerated sourceHigh Level Summary of the Calculation of (Net) Taxes PayableCalculate your net income (i.e. revenues minus deductible expenses) on a source by source basisRecall 5 Sources of income: there are different sets of rules for each e.g. employment – income – deductions = net income Each deduction is tied in with each specific source of income so cannot make it across different sources Aggregate (average) sources of income and claim non-source specific deductions (if any) Calculate taxes payable based on marginal tax rates Taxable income = 60,000 and made 20,000 RRSP 40,000 x .25 = 10,000 and 20,000 x 32% = 6,400 – therefore tax liability of 16,400Determine which tax credits you are entitled to, add them up and multiply them by the appropriate rate (usually the lowest marginal rate) Determine which tax credits entitled to, add them up and x by appropriate marginal tax rate Use this tax credit amount to reduce your tax liability and determine your net taxes payableTax Deductions Tax deductions: reduce a taxpayer’s taxable income, which in turn reduces the taxpayer’s tax liability (which is calculated by multiplying taxable income by the appropriate tax rates).Why do we allow deductions: encourage tax payer behaviour, costs money to make money (would inequitable to tax people the same if they incurred different expenses to earn the revenue), would not adequately reflect tax payers ability to pay, As tax deductions reduce the income of a tax payer, the benefit of a deduction is tax payer specific (aka will have different effects on different tax payers)Source vs. Non-Source Specific DeductionsAs alluded to in the text (see page 129), some deductions are “source-specific”; as the description suggests, this means that the deduction can only be claimed against a particular source of income (see for instance, section 8 for employment expenses and section 20 for business/property expenses)Other deductions are non-source specific. These deductions can be claimed against several or any source of incomeExample: RRSP contributionsThe Non-Deductibility of Personal and Living ExpensesQuestion: why does Canada generally not allow deductions for “personal and living” expenses in the calculation of “taxable income”?Answer: everyone has these, but then would have to increase tax rate as a result, but see basic personal credit, would encourage people to incur personal living expenses (don’t want to create an incentive), governments generally feel entitled to a portion of income before we are entitled to it, would be quite inefficient if we had to keep track of all of this. (administratively onerous)The Tax Benefits of Deductions – Basic CalculationsAnswer: Tax Payer #1: Taxable Income 40kDeductible RRSP contribution 10kPre-tax income x tax rate = tax liabilityWithout RRSP 40000 x .25 = 10000With RRSP 30000 x .25 = 7500Tax Savings/refund: 2500Way #2Take deduction amount x applicable tax rate = tax savings10000 x .25 = 2500Tax CreditsTax Credits: do not have any impact on a taxpayer’s income: Instead, tax credits are calculated separately from the calculation of taxable income (and taxes payable).The general rule is you take the value of the credit and multiply it by the lowest marginal rate (i.e. in Alberta, 25% I fed and prov tax credit). You then take that product and use it to reduce your tax liability. (10% if only alberta credit, 15% if only federal)Because these credits do not alter a taxpayer’s income (and are generally calculated at the same rate for all taxpayers), tax credits are generally taxpayer-neutralTax deductions comply with vertical equity but tax credits do not because treats everyone the same Some tax credits can only be used to reduce tax liability, therefore this benefit is lost because these tax credits are “non-refundable”That said, there are some exceptions where tax credits can be used by someone other than the taxpayer (i.e. tuition and education tax credits) or carried forward to a subsequent year (i.e. student loan interest).A few tax credits are also “refundable” (i.e. the GST credit)Example Fed and prov basic personal creditFederal: 11,327Prov18,214Effectively creates two more tax brackets118(1) contains many of the common tax creditsBasic credit 118.1.cMarried or common law partnerChild tax creditIf you transfer university tax credit to parent or grandparent, it is still taxed at lowest tax rate. The calculation of the tax savings or benefit is the same for everyone. Benefit is you can use tax credit in same year, and if parent is assisting you in your tuition costs, this is a way of thanking them.The Tax Benefits of Tax Credits – Basic CalculationsNo examples in my notes but pretty straight forwardCredit x applicable tax rate = for tax savingsTaxes due – tax credit savings = final taxes due (excuse my non-technical terms)A Brief Overview of the Unique Aspects of the Charitable Donation Tax Credit (and Associated Tax Planning)1st $200.00 of charitable donations – multiple amount of donations claimed by lowest marginal rate (25% in AB)BUT for any donations over and above $200.00 you multiple it by the highest marginal rate federally and 21% in AB for a total rate of 50%The defn of total charitable gift in s.118(1) – makes it possible to make donations and get receipts and hoard them up to 5 years and get them back all at once For those married or in CL, the CRA says you can pool the donations Common tax credits available to individuals located in s.118(1):Basic personal credit (s.118(1)(c)) Married or common law partner credit (s.118(1)(b) Child tax credit (s.118(1)(b.1) Refundable vs. Non-Refundable Tax CreditsA nonrefundable credit essentially means that the credit can’t be used to increase your tax refund or to create a tax refund when you wouldn’t have already had one. In other words, your savings cannot exceed the amount of tax you owe. For example, if the only credit you’re eligible for is a $500 Child and Dependent Care Expenses credit, and the tax you owe is only $200 -- the $300 excess is nonrefundable. This means that the credit will eliminate the entire $200 of tax, but you don’t receive a tax refund for the remaining $300Example basic personal creditRefundable tax credits, on the other hand, are treated as payments of tax you made during the year. When the total of these credits is greater than the tax you owe, the IRS sends you a tax refund for the difference.Example GSTUtilizing Tax Deductions and Tax CreditsIf tax deductions exceed taxable revenues to create a net loss in respect of a particular source of income (or activity), then that loss:In many cases may be used to offset taxable income from another source (or activity) in the current tax year (if any), andIn other cases, can be carried back up to 3 taxation years or carried forward to offset taxable income in those tax returns (see section 111).More specifically, if the loss is not a loss from the disposition of a capital asset, referred to as a “non-capital loss”, then it can be carried back up to 3 years and forward generally up to 20 years and offset against any other source of income in those years (paragraph 111(1)(a));However, if the loss is a loss from the disposition of a capital asset, referred to as a “net capital loss”, then the loss can still be carried back up to 3 taxation years and can be carried forward indefinitely (i.e. until the taxpayer dies), but can only be used to offset net taxable capital gains in those years (paragraph 111(1)(b)).Given this feature, the benefit of a deduction will generally be realized – either in the year that it is claimed or in a prior or subsequent year.In contrast, for the majority of tax credits, if they cannot be used in the current year to reduce an existing tax liability (including a tax liability that has been covered by source withholdings or instalment payments during the taxation year), then they are of no use for that taxation year (and are not applicable against future or prior taxation years)Put more simply, the benefit is lost (forever) An alternative (and common) way of stating this is that these tax credits are “non-refundable”.That said, there are some exceptions where tax credits can be used by someone other than the taxpayer (i.e. tuition and education tax credits) or carried forward to a subsequent year (i.e. student loan interest).A few tax credits are also “refundable”, meaning they can result in a tax benefit even if the taxpayer is not taxable (i.e. the GST credit).The Taxation Year for Individuals, Corporations and TrustsTwo possible definitions:For a corporation, the taxation year is its “fiscal period”, which generally cannot end more than 53 weeks from when the period began.Effectively, this allows a corporation to choose whatever 365 day period as its “fiscal period” – although once it selects this period, then generally speaking it is “stuck” with it unless it has a “good reason” to change it (i.e. amalgamated with another corporation)If an individual, a partnership, an inter vivos trust or a corporation = a calendar year (249(1)(b))if you are an individual earning business income you are allowed to report that business income on a non-calendar basis if you want (won’t test on this)estates within 90 days from the end of the yearkeep in mind it will take some time to settle the estateinter vivos trusts are taxed as if they are individuals, therefore they are taxed on a calendar yearEXCEPTION: Testamentary trusts: Any up to 12 months period ending after the date of deathA Brief Overview of the Issues Concerning Taxing Individuals vs. Family UnitsCanada ignores an individuals relationships status (generally) for purpose of calculating each ind. Tax liability but issue: two households, each containing at least 2 individuals and having the same total amount of household income, can pay different amounts of tax More detail?Carter Commission Recommendations (and Implications)Carter Commission expressed a strong concern about this result and, as a consequently, recommended the creation of a new family tax unit. = a husband, wife, and any minor dependent children would collectively report their income in a joint return and calculate their associated tax liability using a set of marginal tax brackets specifically created for family tax units. Don’t know what the implications are hereRecent Amendments to the Act to Move Canada towards Family Taxation3.Sources of the Income TaxA Brief Overview of the Contents of the Income Tax Act (Canada)Income tax act = primary source of income tax law in Canada Main sections of the ITA include:Table of Proposed Amendments (xiii): shows the status of budgetary amendments proposed by the HoC Valuable because tells us what the government intends to changeUsefully where govt has set date for implementation, or decided not to enact proposed lawTax Reference Tables (xxv): very useful for quick reference of tax rates, credits, etc.Tax reference tables? (we have in tax act) - check. Don’t duplicate on cheat sheet Ex: s 9 in practitioner’s act- related provisions section. Issue regarding calculation of business income. S 12 (10) p 60. Shaded sections- indicates that it has been introduced in house and is in process of becoming law but is not yet law.Detailed Table of Sections (lxxv): this can be a useful research starting point Legislative Provisions (page 1): always includes a related provision and notes section (gives case law/articles related to that section) While each publication differs slightly in form and in content, for each section of the Act, in addition to the actual provision, there will be a Related Provisions and Notes section. Notes contain summary of key cases, CRA publications, and articles. Index – along with the Detailed Table of Sections (p.g1229), this part of the ITA can be your best friend - often a starting point for research of the legislation - look for key terms and go from there...DTS-attempt to group together. Legislative ProvisionsSee aboveIncome Tax Application Rules (ITARs)Deal with capital gains and lossesPrior to 1972, capital gains and losses were not a recognized source under the Act; they were outside of the “tax base”. When the government changed its tax policy to make them taxable (on the recommendation of the Royal Commission (Carter Commision), the government also decided that it would not make the effect of this tax policy change prospective rather than retroactive.Put more simply, any increases in the value of a capital asset that occurred prior to 1972 would not (ever) be subject to tax.-still outside scope of tax base.The ITARs (page 1563) help taxpayers (and tax practitioners) deal with the introduction of capital gains as a source of income as of January 1, 1972, by setting out rules on how to calculate the “tax cost” of capital assets which were acquired prior to 1972 in order to be able to calculate the asset’s post-1971 gains. In the case of publicly-traded securities, this is very easy – the government recorded the ending trade values for all publicly-traded stock on December 31, 1971 – this is the “tax cost” for calculating post-1971 gainsIn other cases (where the asset was not publicly valued on December 31, 1971), the ITARs set out how to calculate the January 1, 1972 “tax cost”Particular to Farm property (or other types of property that is passed down) transfers on rollover basis. Where property passed down, may also have an ITAR issue. Allows the property to be transferred at the original owner’s cost so that no tax is triggered. Any capital property that has been transferred within family. Depends on type of land and to whom it is being transferred. General rule: taxable but exceptions through rollover provisions Provincial Tax Legislation and Administrationgenerally speaking, these are (typically) very short pieces of legislation which basically refer to and adopt the federal ITA calculations of “taxable income”.Two main exceptions – Alberta corporate income tax and Quebec personal and corporate income tax (separate substantive legislation)In addition to their own provincial acts, since the 1960s, the federal and provincial governments have entered into tax collection agreements. These agreements give the CRA the authority to collect and administer the provincial acts on behalf of the provinces. To be a party to these agreements, one of the requirements is that the definition of income be materially the same. (CRA doesn’t want to have to deal with different calculation of income. Most differences between the Federal and provincial ITAs concerns credits - which are fairly easy for the CRA to administer)Certain provinces have opted out of certain portions of the Tax Collection Agreement (i.e. Alberta corporate taxes and Quebec income taxes). Responsibilities for Taxationthere are three key players in the creation and administration of income tax law in Canada:The Department/ ministry of Finance: (creates tax law) who makes key tax policy decisions (of course, with input from the Prime Minister’s Office and Cabinet) and drafts the associated tax legislation,The Minister of National Revenue: (heads CRA- in charge of administering/ monitoring tax law and education- helps us comply. To the extent that the law is unclear or there are gaps in the law, will create administrative positions and state how they will apply the law (effectively becomes part of the law- but not law) who administers the Act through the Canada Revenue Agency (CRA), andThe Department of Justice: (provides legal advice to MNR DoF) who represents the Minister of National Revenue/CRA in court. Allegations have been made about lack of independence bw two bodies.A Brief Overview of the Legislative ProcessFormulation of federal tax policy beings with minister of finance delivering budget in HoCMinister of Finance formulates and implements the federal tax policy AND can amend tax legislation In past, fairly secretive process because concept of tax neutrality and tax efficiency. Kept changes quiet until announced at budget so that people didn’t start altering behavior. Harper was more transparent Tax notes explain why govt is implementing law etc. Government releases notice of ways and means motion to amend the act (drafted in ordinary language)DoF releases a draft of the proposed legislative changes with explanatory notesAfter budget debate on it in HoCGov’t releases bill to implement proposals from ways and means motionThe process of amendment is the House of commons senate Governor General to achieve royal assent Generally amendments are enacted retroactively back to the budget date when first announced Tax Neutrality and Efficiency: Prevents taxpayers from being able to plan into the existing rules of proposed amendments Don’t want tax payers to have opportunity to change behaviour & take advantage of existing law/ wait until new law comes into effect- no transitional period. Govt is free to specify date but absent specific language rule is that it is effective retroactive to budget date. Legislative amendments (draft legislation) are treated as current law, even if not technically soNB: If there is a change in government between when the amendment announced and when given royal assent, the draft legislation will still be enacted by the new government Tax Jurisprudence and the Tax Court of CanadaThe primary court of first instance for tax cases today is typically the Tax Court of Canada, which was created by the Tax Court of Canada Act (T-2) in 1983It has “exclusive original jurisdiction” to hear appeals with respect to various matters and statutes including, for our purposes, the Income Tax Act (section 12)Section 20 provides that the Tax Court has the ability to make its own Rules of Court (which it has – so make sure you consult it as the rules might be different than the Rules of Court within the province)Tax Matters not within the Scope of the Tax CourtTax matters can be heard by other courts:Unless the provincial income tax legislation gives the jurisdiction to the tax court, any question of provincial residency must be heard in QBIf you have an criminal offense (tax fraud)– then depending on the offense heard in either provincial court or QBApplication for judicial review in respect of CRA decisions where the act gives discretionary decision making powers (fairness applications) done in federal courtApplications in respect of the CRA’s audit and investigatory powers under the ITA (i.e. search and seizures, requests for information by 3rd parties, etc.) - again, must be done in Federal Court or a superior court in the provinceAppeals from CRA decisions with respect to the registration and deregistration of charities, pension plans and other entities under the ITA - appeals must be initiated at the FCA (without first having a hearing before a trial judge)The CRA has authority to grant relief (i.e if have tax liability cannot pay or it arose in sympathetic circumstances can apply to CRA to grant relief)When questioning audit or decision of the CRA it goes to court General and Informal Procedure HearingsInformal Procedure Create greater access to justice – faster, cheaper Tax payer can self-repNo examination or expert witnessesBUT only deals with simpler cases and do not have a general right of appeal Strictly speaking decisions do not have precedential value The amount of federal income tax and applicable penalties must be $25,000 or less per taxation year (s.18 Tax Court Act) – if slightly over can waive your rights to the extra amount General Procedure Analogous to Court of Queens Bench Includes examinations, full precedential weight, full rights of appealMust be represented by counsel if not self-repCostly and time consuming A Brief Overview of the Canada Revenue Agency’s (CRA’s) Major PublicationsAssist taxpayers and practitioners in complying with the act Income Tax Folios (replacing Interpretation Bulletins)(replacing interpretation bulletins): provide taxpayers with Summaries of the lawCRA’s interpretation of the law (where the law is uncertain) on a subject-area basis Main publication produced by CRADrawbacks?Just CRA interpretation NOT the law therefore it is possible for a taxpayer to comply with the folio and then have the courts say that the position is wrong CRA is not bound by these published interpretations nor are the courts The summaries do not distinguish between what is the CRA’s opinion and what is the laws opinion –BE CAREFUL NB: if rely on the opinion which is wrong the courts direct the CRA to waive any interests or penalties CRA acknowledged that 272 existing interpretation bulletins are out of date, Features of New Foliosnew ones have a 3-month comment period, pilot program to have folio chapters given to tax professionals in leading law firmsInformation Circulars(no substantive law but demonstrates process- ‘how to’ guides)Generally, provide information of the policies and procedures to comply with the Act (i.e. how to do a “fairness application”) rather than summaries and interpretations of substantive tax law.Advance Tax Rulings(part of educational component- demonstrates CRA’s interpretation and application)(ATRs): Rulings given by the CRA on a proposed (as opposed to completed) series of transactions as to what they believe the tax effects will be. CRA agrees to bind themselves to what they set out in the advanced tax ruling as long as set out all facts and carry out transaction as set out in rulingEg: ruling only holds if tax payer sticks exactly to the facts as set out, omission or misrep makes it non-bindingCRA does not have to issue an advance tax ruling IC70-6R5 para 15 sets out when the CRA may refuse to issue a ruling Paid serviceTechnical Interpretationssimilar to ATRs because asking the CRA for their interpretation/position BUT the interpretations are generally:are of a particular provision rather than to a proposed transactionare done on a “no-names” basis (as opposed to full disclosure) [anonymous]are not subject to any fees from the CRA, andthe CRA is not bound by the Technical Interpretation (although they likely would follow it - it would also have value in defending against possible gross negligence penalties)NB: evolved into a “light” version of an advanced tax ruling The Administration of Income Tax LawThe Legislative Requirements to File an Income Tax ReturnStarting point for administration of income tax law = section 150(1)Subject to s.150(1.1) taxpayers generally must prepare and file an income tax return for each taxation year w/ the CRA (self-assessing system)“Living individuals” s.150(1)(d) requires individuals to file their returns for the preceding tax year by April 30th Where April 30th falls on a weekend of statutory holiday then the deadline is extended to 11:59pm of the next business day “Deceased Individuals” General rule in 150(1)(d) applies UNLESS the ind. Passed away after October in which case the deceaseds legal rep gets at least 6 months after the deceased deaths in which to file final tax return Exceptions to the General Rules :Section 150(1.1): Individual does not have to file a tax return if they Do not have a tax liability ORHave not disposed of capital property;Do not have a positive balance in a Home Buyers Plan or Lifelong Learning Plan Section 150(2): An individual must file a tax return if furnished with a demand to do so by the Minister (even if the individual fits within the exceptions contained in subsection 150(1.1)) Why File a Tax return if you do not have to:Tax returns only need to be filed if: (1) taxes are owing to the government; (2) disposed of capital property in Canada; or (3) CRA sends a formal notice for a tax returnGenerally a good idea to file a return because:Can claim certain credits that are not dependant on income (e.g. GST credit)Even if you have a low income but that income is employment/business income will gain the ability to contribute to an RRSP- can utilize these later to lower tax liability down the road File a return starts the statutory clock ticking for limitation period of when CRA can look back at your past taxes (3 years income tax and 4 years GST) The Original/Desk Assessment and the CRA’s Ability to Audit and ReassessFile Tax Return:Section 152(1): CRA reviews an individual’s tax return once received and assesses tax payers tax, interest, penalties, tax refund, lossess etc for the year “with all due dispatch”.3rd parties (employer etc) send tax information to both you and the CRA (e.g T4’s) which are used to determine if you are filing a compliant returnThis information is communicated to the taxpayer by a Notice of Assessment (section 152(2)).Notice of Assessment (s.152(2))First/Initial assessment = desk/original assessment – typically done at CRA offices without any other information from the taxpayer except a completed return Once issued limitation period startsAssessment communicated to the taxpayer via the NOA (issuing NOA starts the limitation period)If this assessment differs from the return files then you generally will owe the CRA money Outstanding balances are subject to interest NB: the CRA need not wait for the taxpayers return to issue a NOA (s.152(7)) & it is not bound by the info contained in the taxpayers return CRA can determine your income through a net worth assessment (net worth = assets – liabilities): often go to financial institutions, LTO to get snapshot of incomeDo NWA assessment for now as well as a certain point in time and determine the differenceAssessment is considered to be correct unless the taxpayer disproves on a BOPShould keep all receipts supporting your return for up to 6 years otherwise cannot disprove the burdenPayment, Objection, Audit If taxpayer is satisfied with their assessment they pay the governmentIf the NOA differs from your return you can either 1) pay the return OR 2) object CRA may choose to audit the taxpayer after the initial NOA has been issued Question: what causes the CRA to audit a taxpayer (and his/her return(s))?Answer: encourages people to file honest tax returns (fear of audit), some of these people are just randomRed flags, drastic changes income and deductions, large amount of charitable donations, suspicious expenses, corporations (assess corporate tax payers on risk of tax behaviour), focus on people caught before, go for a tax preparer that has issues/errors other clients, look at businesses with a large cash componentThe Taxpayer’s General Duty to Assist (and Exceptions Thereto)Generally: The CRA derives its authority to audit from s.231.1Notice of reassessment: flows from an auditIn the event of a civil audit for compliance the taxpayer has a positive duty to assist the CRA in the audit per s.231.1(1)(d) BUT if the CRA is building a case for tax evasion pursuant to section 239 (or 238), which is a criminal offence, the duty to assist disappears and Charter protections kick in In Jarvis the SCC stipulated that if an auditor continues under the guise of a civil audit then that information will be thrown out if they know they will be seeking criminal charges BUT information obtained during a civil investigation that turned criminal can still be used so long as no further assistance was sought from the taxpayer once it turned criminal CRA has the power so assume information and make decisions based on those assumptions (no requirement of hard evidence – taxpayer bears burden of disproving assessment)Time Period to Conduct Audit: Three years to conduct an audit on an income tax return from the date of filing initial return Additional three years from the date of mailing the initial NOA to audit the client and issue notice of reassessment per s.152(1)(b)EXCEPTION: If the CRA suspects a taxpayer has made a mistake attributable to gross negligence OR intentional fraud then there is NO statute of limitations per Section 152(4)(a)The CRA bears the burden of proof of proving fraud (BRD) or negligence (BOP)Administrative AppealsOutcomes Following an AuditTax is acceptable and the desk assessment stands (no reassessment issued)Re-assessment issued and the taxpayer may either: Pay the taxes OR Challenge the reassessment by filing a Notice of Objection per Section 165(1))Notice of Objection No prescribed form, BUT the CRA has created a form T400A Generally should sets out the relevant facts and reasons for disputing the NORTo have valid reasons must set out the relevant law and the application of the law to the facts in issue Only three possible reasons for objection:The CRA got the law wrongThe CRA got the facts wrong The CRA made an error in applying the law to the facts Generally: Must file the notice within 90 days from the date the CRA mailed the NORThe NOO preserves your appeal rights AND tells the collection branch of the CRA to hold off The notice of objection then goes through the Appeals Division of the CRAAdministrative Appeal Once the taxpayer’s Notice of Objection is received by the CRA, it and the auditor’s files on the taxpayer then go to an Appeals officer within the Appeals Division of the CRAThe Appeals division of the CRA is separate department from the audit division but still connected to the CRAThe appeals officer has had no contact with the auditor If the assessment is the result of an audit, the auditors working papers will be included and the taxpayer is entitled to a copy The taxpayer is allowed to submit further evidence with respect to the assessment Generally: it is easier to appeal successfully when the appeal is the result of a personality conflict between the auditor & taxpayer [e.g. taxpayer refused to provide documents] OR is a matter of law (file a memo, provide facts) Benefits: Appeal helps narrow and define the issues in the event of litigation Settlement: Officially cannot settle a tax case at the appeals division BUT practically ITA disputes are usually about the application of facts to the law and thus are amenable to settlement (e.g. client is claiming a deduction on an expense but cannot remember if it is a business or personal expense) 92% of cases resolved at appeal levelTwo possible outcomes for filing a NOO:Notice of reassessment – which confirms the taxpayers initial returnNotice of Confirmation – confirms the auditors reassessment If this is the case the taxpayer may file a Notice of Appeal in a timely manner per Section 169(1) = equivalent of a SOCMust file within 90 days of receiving notice of confirmation As a general rule though the result is the same liability as the previous assessment or something lower, very exceptional case were appeals officer raises the tax liabilitySo little risk to going through the processAppeals to the Tax CourtIf the taxpayer is still not happy with the current status of his/her tax return, then the next step is to file a Notice of Appeal to the Tax Court of Canada in a timely fashion pursuant to subsection 169(1).Note: as set out in subsection 169(1), before a taxpayer can appeal to the Tax Court, he/she must first file a Notice of Objection (i.e. can’t go directly to Tax Court from assessment)General Rule: taxpayer has 90 days after the CRA mails a Notice of Reassessment or Notice of Confirmation to file his/her Notice of Appeal Timing of all these documents is critical. Failure to comply with a deadline could eliminate your client’s appeal rights and result in a professional negligence claim against you and your legal insurer.92% of all notices of objection are resolved or discontinued at the admin appeal levelRemained 8% only 3% actually make it to court, roughly 400 cases a few, of that over half decided in the tax payers favour10% of tax court decisions are appealed to the federal court of appeal, handful from there to SCCPitell (optional case): self-litigated, justice found for the tax payer, helped him out, para 42-45 access to justice problem in the tax courtLegal expenses incurred to dispute a assessment/reassessment are deductible (60.0)Tax Disputes and InterestInterest continues to accrue to unpaid taxes even though you file a NOO (to appeals division) or a Notice of Appeal (to tax court)If You win: then no interest accumulated BUT if you lose you must pay the interest from the date that the amount should have been paid (April 30th of the year after the taxation year) This rate is adjusted quarterly THUS to avoid interest liability commonly advised to pay interest with a letter stating that payment is solely for the purpose of stopping interest from accruing and not as an admission or acceptance of liability This way, if the taxpayer is successful, she will get the payment back plus interest (although the interest rate is lower) but if unsuccessful, will not have an increased bill.The Burden of Proof (and Overcoming the Burden)Legal Burden in Tax Cases is differentSection 152(1) & (4): The Minister of National Revenue is entitled to make an assessment pursuant to these sectionsThis assessment/reassessment sets out the taxpayers liability for the year and is based on:Info provided to the taxpayer on his return Info independently gathered by the minister Any assumptions made by the minister This assessment is presumed to be correct AND the taxpayer bears the burden of refuting it on a BOP Three Ways for the Taxpayer to Satisfy Their Legal Burden of Proof to Dispute the Assessment per NorthlandsChallenge the Ministers allegation of assumptions from which the assessment was based i.e. the assessment was not supported by the assumption - made an assumption but did not use it calculating the assessment Show that one or more of the assumptions were wrong i.e. Minister got the facts wrong (assumed 100K of income, but in fact less as shown by the taxpayer) Contend that even if the assumptions were justified, they still do not result in the calculation of the assessment i.e. improper application of the law to the facts NB: If the taxpayer proves one of these the will win appeal UNLESS the Minister shows that the assessment is otherwise valid (but here the burden would shift to the Minister to prove)Question: why does the taxpayer bear the initial legal burden?Answer: because tax payers have all the information to disprove it, as a matter of efficiency it makes more sense to put the burden on the tax payer to come up with the evidenceSettlementsMinister cannot enter into settlements (can only apply law to the facts on a principled basis)tax settlements may encourage people to be more aggressive and not comply with the income tax act Can possibly justify when there is uncertainty in the outcome such that settlement costs may be less than the trial costs It is possible to create a settlement offer position which conforms to this lettered principled approach – say assume these facts are true and then apply law to the facts to create a judgment – creative to make look like principled approachUS and UK administrator of tax law given the authority to settle cases on a non-principled basisBut justice lawyer given power to settle, may have more luck with that, but justice lawyer takes very strict instructions from the CRA 5. Employment IncomeCharacterizing a Service Provider for Income Tax PurposesTaxation of employment income important because (a) generates roughly 2/3rds of all income tax AND (b) each individual who earns employment income typically has the right to vote Always remember to ask if any receipts even fall within the scope of the actFour main sections of the ITA that cover income – Section 5-8Relevant Statutory DefinitionsSection 5-8 deal with taxation of income; 5+6 what is included in employment income, section 8 what can be deducted (don’t talk about 7)Section 5: Salary, Wages And other remuneration received by the TaxpayerGenerally per Section 5(1): A taxpayers employment income = salary, wages and other remunerations including gratuities received by the taxpayer during the year “Received by the taxpayer” (recognition event for employment income)= implies that employment income is included on a cash basis: i.e. when the monies are received as opposed to when the work was done Thus if you receive an advance on cash you must claim it in the year you receive it not the year the work was done for it Attempts at delaying income: When the taxpayer and employer attempt to artificially change the date of receipt, courts will deem you to have received the payment when you were supposed to receive it – constructive receipt.Section 248(7): Almost anything sent by first class mail is deemed to be received by the person on the date it was mailed NOTE: When you have an individual is both a employee and lender/shareholder of the corporation it is important to consider whether the earned the monies in the course of employment or in another capacity because there are different recognition eventsFor example: The recognition event for business income is based upon principals of accrual accounting Report the income once you have done everything to become entitled to payment of the income (even if you will receive the cash later) [i.e. satisfied all the terms of the contract]To recognize and conduct expenses for a business must satisfy two requirements:Taxpayer must be legally liable for the amount of the expense The expense can be estimated with reasonable accuracy Section 6: What is characterized as employment IncomeSection 6 expands what is taxable under s.5 by refining what is considered to be employment income Generally: The value of board, lodging and other benefits of the kind received or enjoyed by a taxpayer in respect of an office or employment shall be included in the taxpayers employment income This has been given a BROAD interpretation to mean that if an employee or anyone related to an employee receives or enjoys a benefit that is connected to the employment relationship that it is taxable (Savage) UNLESS you can find an exception Benefit need not flow from the employer to the employee (s.6(1)(a)) e.g. if client gives you a trip this is a benefit because flowed from employment Section 8: Employment DeductionsGeneral Rule: Section 8(2): An employee cannot deduct anything against employment income for tax purposes UNLESS it is specifically provided for in s.8 Allowable expenses will be deductible in the year they are paid as opposed to the years to which they pertain [follows cash basis approach]***The ability to deduct expenses calculating business income and the requirement to recognize employment income when received creates a tax planning opportunity for owner-managed businesses (see Cliffe ):If a company pays a “salary” to the sole shareholder of a owner managed than the company is not taxed but the individual is (higher tax liability). BUT if instead the company pays dividends to the shareholder then the company is taxed but not the shareholder [lower tax liability because taxed at corporate tax rate]EXCEPTION: Section 78(4): If the corporation has not paid out the entire salary that it has dedicated for tax purposes for calculating business income within 179 days of its year end the corporation has to amend it tax return and does not get a deduction for the amount that is unpaid Characterization of Employment vs. Business relationship Important to determine in what capacity a person is providing services for another person (i.e. business or employment relationship)The Key Implications of Each CharacterizationEmployment (i.e. service provider = employee)Business Relationship (i.e. service provider = independent contractor) This characterization determines how a person will be taxed under the ITA and have non-tax implications Tax implications:By virtue of s.8 an employee is very limited in the kinds of deductions they may claim BUT if running a business they broad spectrum of deductions possible: Section 18(1)(a) – if the expense was incurred for the purpose of earning business income (But For Test) then it will be deductible for tax purposes Employment insurance:If employment relationship then both employer and employee are subject to the EI premiums BUT if independent contractor then service recipient will not have to pay EI premiums Vicarious Liability:Employer VL for acts of employeePayment and withholding of tax:Section 153(1)(a): Employer has responsibility of calculating, withholding and remitting source deductions for employment income Generally no withholding requirements for business income Basic of Measurement:Employment income calculated on a cash basis Business income calculated on accrual basis Canada Pension Plan:If employment relationship then generally speaking both employer and employee will have to pay CPP premiumsParticipation in Employer Benefits/Plans: independent contractors are not entitled to supplementary health care benefits and participation in the employers pension planDetermining CharacterizationITA has unhelpful definitions (overly broad)Example: Section 248(1): Employment is defined as “the position of an individual in the service of some other person… and “servant” and “employee” mean a person holding such position”for our purposes officers (ex judge) and employees can be grouped togetherDefinition of a business is a bit more helpful: Business is defined as “includ[ing] a profession, calling, trade, manufacture or undertaking of any kind whatever and… an adventure in the nature of trade, but does not include an office or employment” (drafted broadly to be a catchall)**NB: if determined to be an employee continue within this unit to determine income. If determine to be IC then go to unit 6 for calculating business income Common Law TestCommon Law Determination For Status of A Service Provider: Wiebe Door Services v Minister of National Revenue Generally: The determination is a question of fact. Must look at the entire relationship and all of the facts surrounding it to determine if the SP is in business of himself or in a master-servant relationship ASK: Is there a contract of service (employment) or a contract FOR services (IC)Utilize comprehensive factual analysis (see steps 1-6)Control Test:Most important test If the control is less extensive (service recipient is only controlling what is done rather then what AND how things should be done) then likely an ICIf controlling what and how things should be done then more likely employee Issue with test: breaks down when the service provider has a high level of expertiseThe Wiebe Door IndiciaOther Indicia of control:Subcontracting Where the SP that initially contracts must perform those services this is more likely employment Where the employee does not have to do work themselves this is more likely business relationship Mode and Time of Payment Regular payment = more likely employment Payment upon completion = business Evaluation of workDoes the SR get to evaluate the work being performed – if yes more likely employmentIn a business relationship there is generally no provision for evaluating work other than at the end of the contract Suspending and terminating relationshipIf the SR can terminate the relationship at any point without notice severance or cause, more likely IC Can have situations where person has lots of control but still business relationship (pro tennis player saying how their racket should be strung)Can have situations where not a lot of control, or not telling how done (in house counsel) that’s an employee (say where service provider has much more technical competence than recipientOwnership of Tools TestLeast important Generally you hire a business person to do work for you, the business person will have their own tools to provide that service to you If the SR is providing the tools then more likely employment Problem with test: expensive or specialized equipment involved then the SR may possess it and the SP is just providing their skills Chance of Profit/Risk of Loss (Entrepreneurial Test)Second most important test ASK: does the SP have the ability to profit or potentially sustain a loss in providing services? If YES then likely an IC (courts care more about risk of loss)If remuneration is NOT tied to performance then likely employeeCertainty/guarantee in the short term? Likely employee Integration TestTest MUST be applied from the SERVICE PROVIDERS perspective (person doing the work)ASKS: how important is the service recipient to the service providers business?If they are crucial then more likely employment (e.g. SP only has one client)If less important more indicative of IC (e.g. if the SP has a lot of clients) Problem: it is possible for the SP to have only one client and still be in a business relationship The Role of the Parties’ Mutual IntentionNB: Potential sixth criteria (not discussed in Wiebe): What are the parties’ objective intentions as manifested by their actions with respect to the relationship? What did the parties intend when they were structuring their relationship (principals of contract law) (wiebe obiter somewhat interpreted to make intention irrelevant1392644 Ontario Inc v Minister of National Revenue, 2013 FCA 85Facts: Contract for services tried to construe things so as to make service provider an independent contractorIssue: where they IC or employee? Result: FCA stated that starting point is to look at the parties mutual understanding or common intention. If there is a common intent, Wiebe Door tests are to be applied by considering relevant facors in light of mutual intent to determine if the facts are consistent with the common intent. But mutual intention is not legally determinative, actions must be consistent with intentionDistinguishes between parties setting out the terms of their relationship (duties, finances etc) and the legal effect of such terms/contract (parties cant decide the second one, especially given power imbalances)Wiebe Door Services Ltd Facts: Wiebe was in the business of installing and repairing doors in Calgary. WDS had contracts with a number of door installers and repairers, each of whom had the understanding that they would be running their own business with all of its implications (i.e. no unemployment insurance, responsible for WCB premiums, taxes, etc.)Issue: were these door installers and repair persons employees or independent contractors for tax purposes?Analysis: Look at the whole relationship of the parties to determine if the service provider is in business for himself/herself or a servant of the service recipient -is there a contract of service (i.e. an employment relationship) or a contract for services (i.e. a business relationship)?Comprehensive factual analysis – see test Practical Tips for Assisting Your Clients Achieve their Desired Characterization Use a Written Contract at the beginning of the relationshipUsing the words “business relationship” is not indicative BUT can signal intentions of parties When it is close this statement can break a tie Add a clause about sick days, no medical insurance, no pension plan etc Advise The Service Provider to IncorporateSimply incorporating will not in of itself automatically create a business relationship The legislation stipulates that when you have a corporation providing services to a 3rd party you ignore the corporation and ask what the relationship is between the SP and recipient?If the answer is an employment relationship then this is a personal service business and the corporation will be ineligible for tax breaks found in s.18(1)(p) and restricted to deducting only employee expensesGo Through Wiebe Test and Think of if the CRA would lean toward a business relationshipHave service providers give estimates to the service recipient before doing the work and have recipient approve work Set as few rules as how work is done within parameters of business needs and commercial realities To extent possible require them to provide their own tools If the service provier is going to use their equipment – have a separate agreement for that To extent possible do not want to preclude service provider from going out and getting other clients Incorporated EmployeesCan you change an employee’s characterization by having the service provider incorporate a company who will then contract and provide services to a service recipient?Short Answer: NO – legislation depletes the benefits if found to be a personal service business (see below)A service business carried on by a corporation where, (has to be a purely service business)Statutory Definition of a Personal Services BusinessTo combat inappropriate tax planning (SP incorporating), in 1981, the federal government created the definition of a “personal service business” in subsection 125(7)= A service business carried on by a corp where, the individual who provides the services on the corps behalf or anyone related the individual is a specified shareholder (person who owns not less than 10% of issued shares) and would reasonably considered an employee of the service recipient but for the existence of the corporation UNLESS the corporation employs in its business throughout the year more than 5 fulltime employees ImplicationsUnder this section if a corporation is found to be carrying on a personal services business then two consequences flow from that result:Personal service income earned by MyCorp is not eligible for the low corp tax rate Personal service business income will be taxed at full corporate rates which are much closer to personal income tax rates and then MyCorp dividends being paid out to employees will also be taxed making taxes actually higher S. 18(1)(p) is engaged and states that if the corp is earning personal service business income the corp is extremely limited in the expenses it can deduct in the business income What is Included in Employment Income (and When)What is Included in Employment Income?Starting Point is section 5.Answers two questionsWhat is to be included in employment income for tax purposes?5(1) provides that a taxpayers income from an office or employment is the salary, wages and other remuneration, including gratuities received by tax payer during the yearNeither 5(1) nor 6 says these things must come from the employer (ex tips)When such income is to be included?Recognition event as per 5(1) is receipt during the year this is commonly referred to as the “cash basis” of income recognition Includes the time you receive signing bonus and when you receive severance paymentThis recognition event (receipt of cash) for employment income, coupled with the recognition event for business expenses (when legally liable for the expense and it can be estimated with reasonable accuracy), creates a “tax deferral” opportunity that is often enjoyed by small businesses.This is different then the calculation of business income. When have you done everything legally necessary to get paid. This is accrual accounting. Legal entitlement to be paid as opposed to when it is legally received. To recognize expense under accrual method. Must be legally liable for expense and be able to estimate it with reasonable accuracy. Sets up a tax deferral opportunity. Corporations where employees are also shareholders. On dec 31 declare a bonus for key people. (get a deduction for this generally)Legally obliged to pay can estimate with reasonable accuracyIf they wait till 2016 to actually pay the bonus: that’s the year the employee must report. But see s.76.4 (provides that the company has 180 days from the end of the corporations taxation year to pay out bonus) If not corporations loses in year declared. The Taxation of Employment Benefits: s.6(1)(a) – include in employment income value of benefitsEmployment Benefit = an economic advantage or material acquisition, measurable in monetary terms, that one confers on an employee in his capacity as an employee General RULE per s.6(1)(a): an employee to include in his/her employment income “the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer or by a person who does not deal at arm’s length with the taxpayer, in the year in respect of, in the course of, or by virtue of the taxpayer’s office or employment”To trigger requires three things:1: must receive or enjoy a benefit2: that is in respect of, in the course of, or by virtue of the taxpayer’s office or employment3. Is not excluded by a statute, jurisprudence, CRA’s administrative policies. What is an Employment Benefit?What is an Employment Benefit for Tax Purposes?an economic advantage or material acquisition (small stuff like a company t-shirt isn’t really a material acquisition), measured in monetary terms, that one confers on an employee in his capacity as an employee”CRA position that a 5-7 isn’t a benefit – after hour eventsReimbursement generally seen as a non-taxable benefitAllowances as a taxable benefit (see below)Section 6(1)(b) also provides that as a general rule “allowances” provided by an employer to an employee will be taxable as employment income Allowance (as defined in case law) = a financial amount given for a specific purpose for which the employee does not have to account back to his employer (e.g. gym membership allowance)EXCEPTION: Mileage per Regulation 7306: an employer can pay the employee a tax-free mileage allowance in respect of the employees use of their personal vehicle for employment purposes at a rate of 0.54 cents for the 1st 5000km and 0.48 cents for each additional kilometer.NB: does not include travel to and from work Three potential results for allowances:Not taxable by virtue of an exception under s.6(1)(b)Allowance taxable but employee able to claim an associated employment expense per s.8 which reduces net tax effect of unused amountAllowance fully taxable with no opportunity to claim an associated expense Alternative Approach to giving allowances: Employer reimburses an employee for work related expenses incurred by the employee on the employers behalf Here there is no increase in net worth thus not taxable and the employer can deduct the expense using more generous deductions for calculating business incomeReimbursement policy only works in respect of true expenses (e.g. cannot reimburse for a yoga class) 2. When is a benefit in respect of, in the course of or by virtue of employment? R v Savage: words in respect of are words of the widest possible scope (mean in relation to , with reference to in connection with). Courts don’t have a difficulty finding a relationshipBut for test (but for job would they have enjoyed this)Common law definitionWhat constitutes an “economic advantage” to an employee? Not well defined or applied by the courts (lots of variability with, in some cases, very irrational support – i.e. putting (new) money into one’s pocket vs saving money already in his/her pocket) – making room for creative arguments (and uncertainty in outcome)Reimbursements vs AllowancesReimbursement generally seen as a non-taxable benefitAllowances as a taxable benefit (see below)Section 6(1)(b) also provides that as a general rule “allowances” provided by an employer to an employee will be taxable as employment income Allowance (as defined in case law) = a financial amount given for a specific purpose for which the employee does not have to account back to his employer (e.g. gym membership allowance)EXCEPTION: Mileage per Regulation 7306: an employer can pay the employee a tax-free mileage allowance in respect of the employees use of their personal vehicle for employment purposes at a rate of 0.54 cents for the 1st 5000km and 0.48 cents for each additional kilometer.NB: does not include travel to and from work Three potential results for allowances:Not taxable by virtue of an exception under s.6(1)(b)Allowance taxable but employee able to claim an associated employment expense per s.8 which reduces net tax effect of unused amountAllowance fully taxable with no opportunity to claim an associated expense Alternative Approach to giving allowances: Employer reimburses an employee for work related expenses incurred by the employee on the employers behalf Here there is no increase in net worth thus not taxable and the employer can deduct the expense using more generous deductions for calculating business incomeReimbursement policy only works in respect of true expenses (e.g. cannot reimburse for a yoga class) When is a benefit in respect of, in the course of or by virtue of employment? R v Savage: words in respect of are words of the widest possible scope (mean in relation to , with reference to in connection with). Courts don’t have a difficulty finding a relationshipBut for test (but for job would they have enjoyed this)A Brief Overview of Non-Taxable Employment BenefitsStatutory Statutory Exception - The Act specifically excludes the amount from the employees income Example benefits derived from contributions from employer to a registered pension plan, insurance plan etc. Here there is no immediate taxable amount NB: Pension plans are taxable when they become due Certain scholarship programs are also not taxable if the scholarship is from K-12 it will be taxable because the parent has an obligation to provide for their minor child Section 6(1)(a)(i) - employer payments to certain types of plans excluded Section 6(1)(a)(iii) automobile benefits benefit will not be taxable where an employer provides a company vehicle that will be exclusively used for work (other parts of section 6 set out auto benefits)Section 6(1)(a)(iv) - counselling services in respect of: (a) mental/physical health of the taxpayer or someone related to the taxpayer, and (b) the re-employment or retirement of the taxpayer non taxable benefit to the employeeSection 6(1)(a)(vi) – certain scholarship programs provided by the employer to the employee’s children – if are a current or retired worker of an organization and have children attending post-secondary those children would be eligible for a scholarship program Common Law The Principled and Subjective Applications of the Primary Beneficiary TestThe courts have judicially interpreted the Act to exclude or not apply the amount from the employee’s income Here there are two main exceptions:Principal exception: If the expenditure is primarily for the employers benefit, then it will be non-taxable to the employee (read into s.6(1)(a))E.g. Continuing education is a benefit to employerA gym membership is only beneficial to the employee UNLESS there is a physical component to the job Factual Exception: Even in cases where the employee is primary beneficiary, the benefit will be Taxable ONLY if the employee actually (subjectively) benefit from the expenditure Example: Parking spot that employee does not use Generally: Expenses in the form of yachts, camps, lodges, golf courses, dining memberships provide no deduction to employer (s.18(1)(i))May result in double tax: E.g. employer incurring golf fees and no deduction provided (thus paying tax on this), and if employee has to include this as a taxable benefit then double taxation R v Lowe: employee and wife given trip, part of trip is business, part pleasureTwo Steps: 1. Was an economic advantage provided that is measurable in monetary terms?2. If a benefit was provided was the primary beneficiary the employer or employee? (recently judges apply this objectively and subjectively)Result: where primary purpose of expenditure is business related its not taxable even if there is some non-business benefit to the employeeR v Rackfalowski: got golf membership from employers, doesn’t actually golfCourt, non-taxable benefit, (objectively benefit, but subjectively facts suggest not a benefit)AdministrativeCRA has taken position that certain expenses received by an employee shall not be taxable”Where it is unclear where there has been a benefit to the employeeWhere it is unclear who the primary beneficiary is Where it is very difficult to quantify the benefit (e.g. frequent flyer points from work related trips) Retail establishment staff discountSubsidized mealsUniforms and special clothingRecreational facilities (only if employer has there own, giving outside ones doesn’t count)Professional membership feesValuationOnce you have determined that an employee has received or enjoyed a taxable benefit the next step is to value that benefit to determine the income inclusion there is no bright line test for this Many different methods to calculate as per exampleCases of private schools that provide free education of children of staff: how do we treat these benefits. But its private not public. Sometimes required to send kids or it would look bad on school. Generally the courts have said it’s a taxable employment benefit. Primary beneficiary is employee. What is the valuation? Possibility: full tuition priceCost of attending private school vs public school (hard to determine cost of public school) still have to pay school taxes Incremental cost to the school of additional studentFree: its freely provided since we already have to go to school. Different decisions, have resulted in judges picking all these different optionsA Brief Overview of the Challenges of Valuing Taxable Employment BenefitsTo fully appreciate the taxation of employment income and benefits to the employee, it is necessary to also have a basic understanding of the taxation/deductibility of employment expenses to the employerGeneral Rules/Scenarios Concerning the Deductibility of Expenses to the Employer and Inclusion of Employment Income to the EmployeeParagraph 18(1)(a): If an expense is incurred for the purpose of earning business (or property) income, then generally deductible unless there is another provision which limits this ruleParagraph 18(1)(h): Personal and living expenses are generally not deductible for tax purposes Paragraph 67: Only the “reasonable” amount of an expense will be deductible for tax purposes Reasonableness is assessed in the circumstances (contextual test – what is reasonable will be broader for a large corp rather then a small corp)In the context of employment expenses/income three possible scenarios:The typical scenario is that the amount will be deductible to the employer (as a business expense) and taxable to the employee (as employment income).In contrast, a “bad” situation (from a tax perspective) is where an amount is NOT deductible to the employer but is still taxable to the employeeThe third possible scenario – which is the best from a taxpayer perspective, is where the amount is deductible to the employer but non-taxable the employee (because of a statutory, case law or administrative exception/exclusion) – which I refer to as a “win-win situation”A Brief Overview of Employment DeductionsGenerally, two types of deductions that employees are entitled to:Deductions from employment income (as set out in s.8) = source specific deductionsDeductions claimed when calculating income from a particular source Other Deductions: RRSP, alimony = non-source specific deductions Can be claimed against multiple or any source of income Starting Point (Section 8(2)): Unless the deduction is specifically provided for in s.8, an employee cannot claim the deduction in calculating employment income Complete opposite to business expenses set ut in s.18(1)9a)Things people can deduct: legal 18(1)(b) legal expenses (but lots of rules)(f) Sales expenses (where person remunerated in part by commission and required to incur expenses associate with selling as part of employment)(h)Travel: not to or from work but during work(I) Dues: but not if employer pays them(m) employee contribution to an employer run pension plan8.13: home office, only in very specific circumstancesTo reduce discrepancy Parliament has enacted a non-refundable Canadian employment tax credit per s.118(1):Purpose of the credit is to acknowledge certain expenses that Canadian employees incur in the course of providing their employment services without requiring them to itemize or provide supporting documentation Credit is based on the lesser of the employees income for the year and a base amount and is multiples by the lowest federal marginal rate (15%)Assuming that an employee has at least $1,117 of employment income for the 2013 taxation year, then he/she will receive a tax reduction of $168 (which is typically much less than the tax benefits if the service provider can calculate his/her income using the business income rules)Alberta has a refundable family employment credit for Alberta residents with children under the age of 18 who meet the income eligibility criteria (A family net income of less than $53,725 for families with one child, $70,275 for families with two children, $80,200 for families with three children, and $83,500 for families with four or more children6.Business and Property IncomeWhat is a Business (and What Isn’t)?Statutory and Common Law Definitions SEQ CHAPTER \h \r 1Section 248(1): Business includes a profession, calling, trade, manufacture or undertaking of any kind whatever and adventure in the nature of trade BUT does not include an office or employmentWhat is a business is not easily answeredIn Smith v Anderson (1880), referred to favourably in the SCC decision Stewart (at para 51), a “business” was described as “anything which occupies the time and attention and labour of a man for the pursuit of profit”.As there are only 5 classes of income under the ITA, business income has been given a broad definition (“catch-all category”)Why characterize something as business activity?If the taxpayer loses a significant amount of money from an activity – having that activity be classified as a business allows for the taxpayer to deduct those losses from other sources of income Hallmarks of a BusinessHallmarks:The sale of goods or the provision of services (as opposed to passive ownership of property and economic rent therefrom)The intention to make a profit from a person’s activities (as opposed to doing an activity for personal reasons); andActive ownership as opposed to passive ownership of propertyAn element of risk (but also system to minimize or manage such risk).NB: courts reluctant to find that gambling is a business Adventure in the Nature of TradeAdventure in the nature of tradeAn isolated transaction (which lacks the frequency of a trade) in which the taxpayer buys property with the intention of selling it at a profit and then sells it (normally at a profit but sometimes a loss) Example: if decide to flip a house, not in the business of doing this, but would still constitute an adventure in the nature of trade Requires a scheme for profit making (generally if successful, it will not take much for the court to find this scheme) Non-Business ActivitiesThings that Might not be a Business:Non-competition payments (court said non-taxable but feds passed legislation to make taxableA hobby is not a business, but rather a personal activity (something done purely or primarily for personal enjoymentCommon Law Test: StewartDrawing the line between hobby and business (Stewart)Overturned bad Moldowan ruling (dentist losing money on horse raising) here SCC said to be a source of income must have profit or reasonable chance of profitDecision: to determine if an activity constitutes a source of income ask: did the taxpayer intend to carry on the particular activity in question in pursuit of profit and is there objective evidence to support that intention?Purely Commercial EndeavoursIf unqualified yes: activity constitutes a source of income for tax purposesFrom here decide if its business or property/investment activityThen apply relevant legislative provisions (9,12,18,20,67)Debt as an indicia (some judges say means its for a business, others borrowing for personal expenses)Indicia of business in real estate: who is customer going to be? Family or stranger?Is this something that people do for profit or not?Business planning/forecasts of the market Taxpayers expertise/knowledge is it in the area?Hybrid (Business and Personal) ActivitiesIf qualified yes: if carried out partially in pursuit of profitTo be a source of income must have “sufficient indicia of commerciality”This includes its financial history, forecastsCRA will consider reasonable expectation of profit along with other stuffIf it meets the threshold then personal expenses can still be denied via 18.1.a and hIf threshold met continue as described above with determing whether it is business or propertyPurely Personal Activities If No: then it’s a personal activity, does not constitute a source of income under the act and expesnes are not deductible, revenue is not taxableExample: gamblingGambling CasesCan gambling constitute a source of incomeIt depends: Leblanc v RSince in this case it was a lottery, and impossible to create a system, or have skill which could influence winning percentage not a source of incomeCohen v RQuit to pay poker fulltimeCase law says gambling has a personal component even if you practice, play a lot and studySo applied stewart: sufficient indica of commercialityLook steps to minimize risk (working on imporving skills etc) Court found training undertaken not sufficient for professional gamblerDecided not a businessSo gambling not generally a commercial activity (CRA says so in folios) but acknowledges that it might be under some circumstancesCRA will consider: degree of organization present in pursuit of activity by taxpayerExistence of special knowledge or inside info that enables taxpayer to reduce element of chanceIntention to gamble for pleasure vs for profit as means of gaining livelihoodExtent of gambling activitiesAdministrative GuidanceIn Folio S3-F9-C1: generally speaking, gambling “is something that by its nature is not generally regarded as a commercial activity except under very exceptional circumstances” (To be clear, the operation of a gambling establishment (i.e. horseracing track, casino, etc.) is clearly a business and taxable under the Act.)That acknowledged, in determining whether such an “exceptional circumstance” exists the CRA states that it will consider:1)The degree of organization that is present in the pursuit of this activity by the taxpayer;2) The existence of special knowledge or inside information that enables the taxpayer to reduce the element of chance;4) The taxpayer’s intention to gamble for pleasure as compared with any intention to gamble for profit as a means of gaining a livelihood; and5) The extent of the taxpayer’s gambling activities, including the number and frequency of bets.Business Income Distinguished from Property Income Property Income: Income arising from the mere ownership of the asset Business Income: Where operating a business or selling goods (or combo), something more then just mere ownership must be generating the income Example: owning an apartment, renting it out, cleaning it, providing food (likely business) as opposed to just renting it out RULE: Where the activity of the owner is very low than generally the income from dividends, rents, royalties, interest will be characterized as property BUT if the level of activity is high then courts have said this is more like a business Where the individual is a passive investorWhen this Distinction is ImportantGenerally: Rules for calculating business income and property income are the same Section 9: Taxpayers income for a taxation year from a business or property is the taxpayers profit from that business or property Therefore in most cases do not need to distinguish between the two types BUT Exceptions where distinction is importantCommon EXCEPTIONS:Access to Small Business DeductionOnly available to the corporation – individuals cannot claim Canadian Controlled Private Corporations (CCPC) which is earning Active Business Income – the first 500K if active business income is eligible for small business deductions (brings tax rate down to 14% from 30%)BUT if the CCPC is earning specified investment business income (from property) no deduction Income Splitting and Attribution RulesMarried couples are separate and distinct persons for the purpose of the ITAITA contains attribution rules which prevent one spouse from shifting their income to their spouse etcThese rules primarily apply to investment income – business income is NOT subject to these rules Registered Retirement Savings Plans:In order to be able to contribute to an RRSP you have to earn the eligibility by earning certain types of income in prior years Employment and business income will earn you eligibility BUT property income will not EXCEPT where the property income is rent from real property or royalties from an invention you created The Four Main Categories of Property Income: Interest, Dividends, Rents and RoyaltiesFour main categories of property income: 1) interest; 2) dividends; 3) rents; 4) royalties Where individual earns one (or more) of these types of income, often be characterized as property/investment incomeHowever, very contextual and will depend on the level of activity that is required/expended to generate the income (taxpayer specific characterization).if Royal Bank and employ tons of people to sell mortgages and even though they earn interest then it’s considered a business.High level of activity likely business incomeLow level of activity likely property incomeexamples: landlord vs. hotel operator, purchasing a Canada Savings Bond vs. selling/managing millions of dollars of mortgages Business Income Distinguished from Capital GainsGenerally: More beneficial to earn business income than employment income or property income BUTIt is More beneficial to generate capital gains then business income due to a 50% inclusion rate for capital gains Means only 50% of capital gains are required to be included in an individuals tax return, the other 50% is tax free In contrast, if you realize the gain from the disposition of property and it is characterized as a business gain, 100% of that must be realized on the taxpayers return BUT while the characterization favour capital gains in the event of a gain IF there is actually a loss it is better to be characterized as business incomeIf You Profited From the Sale of An Asset If you Lost on the Sale of an Asset Business Gain: 100% of the gain goes toward income ( pay full tax)Capital Gain: 50% of the gain is included in income (reduces tax bill by half) Business Loss: 100% of that loss can be used to offset ANY source of incomeGenerally utilize loss to offset gains from the year the loss occurred BUT can apply the losses to three years prior or carry forward 20 years if you are an individual Capital Loss: 50% of the loss is calculated into your income and can only be used to offset against positive taxable capital gainsIf there are no capital gains to offset those losses, you can carry losses back three years or forward indefinitely (until dead) THUS taxpayers much rather it be a business loss, because can be offset against any source of income and 100% deductible Taxpayer PreferencesCommon Law Test: Primary and Secondary IntentionsThere is a difference between the income earned while holding an asset and the income earned upon disposition of an asset Disposition (sale) of an Asset (Business Gain or Capital Gain)Use Primary and secondary Intention test If determined to be a capital asset this DOES NOT mean that the rental income from the property will be taxed as a capital gain Income Generated by the AssetBusiness income/investment (property) income Business Asset = an asset the taxpayer acquires with the intention of selling for a profit E.g. inventory – staples purchases printers to sellCapital Asset = an asset that is purchased not with the intention of selling it for a profit but for using that asset to generate income E.g: printers purchased by staples are used to print documents for paying customers RULE: An asset can be a capital or business asset – the characterization depends on the taxpayers intention at the time of acquisition of the asset TestTest is applied at the time of acquisition of the Asset NOT the time of sale of asset Characterization is based on the objective intention of the taxpayer at the time of acquisition of the asset Primary Intention Test: At the time of the acquisition of the asset was the taxpayers intention to:Sell the asset? If YES then is a business gain/loss and when dispose of gain/loss any subsequent gain/loss on the sale will be business income Make use of the asset for either a) income earning or personal purposes?If YES then appears to be a capital asset BUT move to secondary intention test Secondary Intention Test Did the taxpayer have a secondary intention to sell the asset for a profit if the primary intention was frustrated and the secondary intention to sell was a motivating factor at time of acquisition?Therefore need both A) Secondary intention to sell and B) Was a motivating factor at time of acquisition Example: buying something to use it but know that you can flip is quickly to make a profit If YES then characterized as a business asset and will be a business gain or loss. If NO then is a capital asset NB: a mere intention to sell the asset for a profit if the initial intention does not work out is merely a prudent investment decision and does not imply a secondary intention to engage in business or an adventure in the nature of trade BUT there is a difference between a taxpayer who responds to a changing investment climate and a taxpayer who actively contemplates the potential of profit on resale at the time of the investment. Where the potential of profit from a quick sale is a motivating consideration, it suggests a secondary intention to engage in an adventure in the nature of trade (and hence business income treatment)To determine if taxpayer’s primary or secondary intentions courts will look at taxpayers Actions AND Conduct for example”Number of Similar Transactions: The more a person does this type of activity the more likely they are a business person and not an investor Increased transactions = more likely business income BUT Caution because “adventure in the nature of trade” only requires one transaction and still constitutes business activity Nature of Asset: Where the property being disposed of is shares in a corporation the courts will presumptively (rebuttable) that the shares were acquired for the purpose of earning income (dividends) and thus are a capital asset Exception: If the person is a broker then the presumption is that the acquisition is a business asset Raw land (undeveloped) is presumed to be a business asset (presumption that intend to flip land for profit)Return on Investment:Ask: How could a reasonable person have expected to make money through the acquisition and ownership of the property?If answer is only through resale of property then likely on account of business (“trading assets”)BUT if assets have the potential to generate income (even if remote) then) it will treated as a capital asset (e.g shares that have little expectation of dividend return) Example: If buy raw land and try to dress it up as a parking lot the Court will still infer a business asset because the only reasonable way to make money off it is to sell it because putting in a seizable investment just to get a small revenue (return low compared to investment)How does this Transaction Relate to the Taxpayer’s Business? A taxpayer’s profits from transactions that are closely related to his other ordinary business activities are usually characterized as business income. Strong presumption that if transaction is connected in any way with taxpayers usual business it is intrinsically part of business Degree of Organization: Basically how professional the taxpayer was in the activity – if they acted as a business person then more likely a business asset Where a taxpayer deals with property in much the same way as a dealer would with similar property, then any resulting profit is likely to be characterized as business income. Length of Ownership: For some assets, the longer the asset is held, the more likely that a Court (and CRA) will consider the gain to be on account of capital. Shorter hold = business (more likely to sell for profit)Longer hold = capital (doesn’t really go the other way though) Not as strong of an indicia as the others NB: not just duration of ownership but what you did with the asset in that period Income from Capital and Business AssetsMust ask 2 questions to get full income tax picture:What type of asset does the taxpayer ownThis question determines how to characterize the gain or loss on dispositionWhat type of income is generating while owner (if any)Determine how to report the income generated by the asset while owned Example: Purchase a condo. If purchased to sell for a profit, then when the condo is sold, the gain will a 100% includable business gain BUT if purchased with no secondary intention to flip, then when condo is sold: the gain will be a 50% capital gain If condo rented during period of ownership then rental income is either:Property - low level activityBusiness income – high level activity THUS even though by virtue of the primary and secondary intention tests, an asset may be properly characterized as a capital asset, such a capital asset may generate business or property income while it is owned and being used.The Election for Capital Gains TreatmentTo relieve uncertainty with respect of purchase and sale of Canadian securities, it is possible for an individual or a corporation who is not a stock broker or day trader to make a onetime lifetime election to deem all of the acquisitions of Canadian securities to be on account of capital per Section 39(4) Once you make that election – from that year for the rest of your life, all of your purchases and sales of Canadian securities will be capital transactions, capital gain or loss treatment.T123 election form must be filed. Cannot go back on this. Once you make the election that precludes you in the future from being able to take the position that a stock you used for business you can you that loss as against other sources of income. Many taxpayers will wait until have a really big gain to elect to give notice. An Overview of the Calculation of Business Income/ProfitCalculation of Business/Investment IncomeStep 1. Is there a Source of income at all (section 3)Stewart Analysis: 1. Done for the pursuit of profit? With objective evidence to supportIf unclear, look to sufficient indica of commercialityGambling cases – making money isn’t the same as a pursuit of profitStep 2: Non-tax calculation of income (section 9)Would the expense (or revenue) be included in the calculation of profit using well accepted principles of business or accounting practice? (Tonn) must be an intention to make profitGambling cases: intention to win or make money not enough to always satisfy intention componentCapital Expenses excluded: expenses generally incurred for the purpose of bringing into existence an asset of enduring benefit (building, computer etc)These expenses are capitalized (reported on balance sheet as a capital assetStep 3: Apply Section 12 to Increase income for tax purposes (Section 12)12(1)(b): accrual basis for recognition of revenue:Recognize revenue when you have done everything necessary to become entitled to payment (even if that payment might come later)Expenses: Don’t generally need to record an expense until (a) you are legally liable for expense (b) you can estimate expense amount with reasonable accuracy (c) principle of matchingPrinciple of Matching: We want to match expenses to the period in which the revenue association with these expenses is realized. Even if the two criteria above are met if you are paying for the spring clothing line in November you want to hold off on including it since you wont realize the revenue till the next period12(1)(a):recognize an amount received in respect of services to be rendered or goods to be delivered in the future 12(1)(g): recognize amounts dependent on the use or production from property whether or not it was an instalment on sale price of property (besides agricultural land)If sale price for land is dependent on production or use of land (gravel extracted, widgets produced) this is reported as a business gain (even if it might otherwise be a capital gain)Step 4: Prohibited Expenses (Section 18)18(1)(a): limitation against deductibility of expenses unless expense incurred for purpose of gaining or producing income from a business or propertyRequires a business or property earning intention (subjectively)Intention does not care about results (whether or not income actually earned)Must be the primary intention (test doesn’t care about other intentions)18(1)(h): restriction against deductibility of personal or living expensesPersonal in nature is an objective test248(1): Defines Personal and living expenses: includes expenses of properties maintained by any person for the use or benefit of taxpayer (or any connected person) and not maintained in connection with a businessBusiness vs Personal expesnesMain Test: primary purposeSecondary tests: Whether the expense would be incurred (and to the same extent) regardless of the business activity?What “specific business need” does the expense satisfy (and is this need intrinsic to the business)?Does the expense make the taxpayer available to the business or is it part of the business?Historically, how has this particular expense been treated for tax purposes?18(1)(b): can’t deduct for an outlay, loss or replacement of capitalNon-deductibility of capital expensesInterest incurred to acquire capital asset rather than produce income is denied18(1)(I): cannot deduct use of recreational facilitiesStep 5: Allowable Expenses (Section 20)20(1)(a): Capital Cost Allowance20(1)(c): interest paid or payable pursuant to a legal obligation to pay interest on money borrowed for the purpose of earning income from a business or propertyMust connect interest to business earning purposeStep 6: Reasonability Limitation (Section 67)No deduction shall be made in respect of an outlay or expense unless it was reasonable in the circumstancesQuantitative requirement: how does magnitude of expense compare to associated revenue (more common)Qualitative requirement: was it reasonable to incur this type of expense?7. Capital Gains and LossesHistory: Capital gains/losses are only subject to tax if they occurred after January 1, 1972Before this time they were exempt as sources of income (thus excluded from the tax base)Recognition Event: Disposition of the asset Inclusion Rate: Capital gains are taxed at the same marginal rate (if an individual) as other sources of income BUT only has a 50% inclusion rate = only 50% of capital gains are taxable as capital gainsTHUS some people factor this into the marginal rates and say that at the highest tax bracket, capital gains are taxed at 19.5% (i.e. 39% x 50%)Statutory Definition of Capital PropertySection 54: (a) any depreciable property and (b) any other property the gain or loss from the disposition thereof would constitute a capital gain or lossDepreciable property is property that declines in value over time by virtue of its use or time (vs non-depreciable property (land, shares of a corp)Statutory Definition/Calculation of Capital Gains and LossesFormula for Calculating Capital Gains: (s.40):Capital Gain = Proceeds on the disposition of property – Adjusted Cost Base (ACB) – Selling Expenses If negative number then = capital loss (ACB and selling expenses exceed proceeds on disposition)if positive = capital gain (proceeds of disposition exceed ABC and selling expenses)Allowable Capital Loss/ Net Capital Loss (Taxable Capital Gain) = Capital Gain x 50% (inclusion rate)In order to calculate a capital gain or loss by the above formula four main questions must be answered:What constitutes a disposition (and when does a disposition occur) for tax purposes?What are the proceeds of disposition (and how are they calculated)?What is the adjusted cost base (ACB) (and how is it calculated)?What is included in the associated selling expenses of a disposition?Policy Reasons for Giving a Tax PreferenceTo encourage investment. Also encourages in capital investment by foreign investorsInflation IssueCapital assets people hold for a long time often increase in value due to inflationSince we tax inflationary gains, supports not having them taxed as much (50%)Not what you would normally think of as income (no work done)Hagg + Simon income = consumption + changes in net worth (this would make it income but this isn’t the only view)Not calculated yearlyRecognition event is disposition so many years of increased income could be paid for at one point in timeEspecially in progressive tax regime this large one time payment can but them into a high bracket when yearly would have been in lower bracketsNot having it may create a disincentive against disposing of property to redeploy in proper formHigh capital gains inclusion rate would encourage people to keep money where it is, even if more profitable long term elsewhereWhat is a Disposition for Income Tax Purposes and When Does It Occur?Dispositions are the recognition event for capital gains/lossesSection 248(1)(a): Defines disposition as “any transaction or event entitling a taxpayer to proceeds of disposition of the property”The most common form of disposition = Voluntary sale of property for valuable considerationBUT: Dispositions do not have to be voluntary/for consideration they can also be:involuntary (e.g. expropriation/theft)ANDFor no consideration (e.g. gift) Example: GiftsOften no consideration given in the disposition of a gift Section 69(1)(b) deems the taxpayer to have received the fair market value (FMV) of the gift as proceeds of disposition For monetary or non-monetary consideration (barter transaction)Determine value of both items for purpose of calculating gains and losses (if arms lengths party doesn’t need to be equal)Valuation doesn’t have to be exactly the same.Transactions of non-arms length parties: general rule is gifts take place at FMVIf its not a gift (consideration flowing back to other person) want to make sure transaction occurs at FMV69.1.b, 69.1.A CRA can make one sided adjustments to transactions that don’t occur at FMB effectively double tax both sides have to pay (want to avoid this)There are also deemed dispositions under the ITA which deem property to be disposed of even if there is no actual change in legal title When a person dies (70.5.6), for income tax purposes, immediately prior to death the taxpayer is deemed to have disposed of all capital property despite there being no change in legal title If have capital property which using for personal use (e.g. residential home) and then convert it into income earning property (rent out house), then despite their being no legal change in title, there is deemed to a disposition and reacquisition of property Prior to the acquisition of Canadian residency or severing Canadian residency there is a deemed disposition of all or a persons capital property In canada you dispose of and reacquire proprety immediately prior to becoming a resident (not taxed but increased ACB)Section 248(1): Non-dispositions:Transfers of property to secure a loanBailmentsLeasesGranting of an option Licences THUS if selling a home which has increased in value (thus triggering tax liability), can instead put up the increased value as security for a loan – does not trigger recognition event because no disposition When has a Disposition Occurred:General rule: When the vendor has an absolute but not necessarily immediate right to be paid the sales proceeds (e.g. all condition precedents have been satisfied even if proceeds are paid in installments) No bright line test and can be arbitrary as to when a Court will make a finding of when disposition occursOther Tests:Where there has been a transfer to another party, the disposition occurs when the attributes of ownership passes to the recipient (duties, responsibilities and charges of ownership + profits, benefits and incidents of ownership)Some cases legal title has not yet changed but the person is getting all the benefits from it At the time of transfer contemplated in the contractIn the case of a sale of shares of a corporation, the disposition date is not the trade date (i.e. date sale goes through exchange) it is the settlement date (date seller required to deliver the share certificates and purchaser required to pay for shares) NB: The settlement date can be a few days after the trade date important because if selling unsuccessful stocks to offset gains from other stocks at the end of the year be wary of settlement date so it does not push you into the following year (thus not allowing you to offset gains) Proceeds of DispositionWhat are the Proceeds of Disposition:Per Section 54: The proceeds of disposition are generally the amount of the sale price of the property sold (excluding GST) for an arm length sale (not colluding with purchaser) BUT if there is collusion (e.g. buyer and seller are family members which try to manipulate sale price for one parties benefit), the CRA can re-determine the proceeds of disposition based on Adjusted Cost Base of the Disposition - see belowThe proceeds of disposition generally include any and all consideration flowing to the former capital property owner THUS both monetary consideration and non-monetary consideration (e.g. tangible property) will constitute a proceed for the disposition Example: Barter transactions (where no cash involved –e.g. goods for goods/service for goods/service for service) constitute proceeds of disposition In these types of transactions the CRA will assign the fair market value for what you are giving up so you cannot get around tax liability Gifts: With gifts, s. 69(1)(b) deems the taxpayer to have received FMV for the gift as proceeds of disposition.Ex. if grandma gives her grandchild the house b/c grandma has to report the FMV on her tax return so if Grandma doesn’t have the primary residence tax break can be a big problem. Adjusted Cost BaseAdjusted Cost Base (per Section 54) = Original cost of capital asset (including associated costs [i.e. legal fees] + costs required to get asset into a usable condition (delivery charges, installation, set up charges)Includes: Improvements made to the capital These will be characterized as capital expenditures and added to the ACB of the asset Does NOT include: Repairs and maintenance expenses in respect of the capital asset Taxpayer can deduct these expenses (as business/property expenses) in the year they are incurred NB: this difference in treatment creates an incentive for a taxpayer to try and characterize all expenses incurred in respect of capital assets as repairsCapital Improvements vs. Repairs and Maintenance ExpensesTest for Determining For Characterizing the Capital Asset Expenditure (Improvement vs Repair):Central Question: Per Minister of National Revenue v AlgomaWas the expenditure made with a view to bring into existence an advantage for the enduring benefit of the taxpayer’s business?IF YES, then it is a capital improvement (aka capital expenditure) (and will be added to the ACB)IF NO, then it is a repair and maintenance expense, and there is an immediate deduction in the year incurredAdditional Factors used in answering central question per Central Amusement:Is the expenditure annual, recurring, or continuous (something you are doing all the time)?The more frequently you conduct the expense the more it looks like repairs (and is deductible)If unusual then more likely to be capital expense (improvement) Is the purpose of the outlay to provide a temporary advantage?If yes, more likely repair and maintenanceIf provides a more lasting advantage then improvement What is the magnitude of the expense in relation to the value of the asset as a whole?If small, likely repairs and maintenanceIf large, likely capital improvementWhat is the useful life of the expenditureLonger, likely it is a capital improvementCS: ITA requires the improvement to be made with cash or some equivalent assetNB: When dealing with assets purchased prior to 1972, it is only the gains/losses of the value of capital property post 1971 which constitute a source of income under the Act. Example: If purchased house in 1930s, on dispositon any increases in value prior to 1972 will not be taxed BUT the ACB will be taxed after 1972NB: When dealing with property which is passed down through families (e.g. farms) special rules in the ITA allow this to occur without cause ACBAdjusted Cost BaseNOTE: Generally when a person acquires a capital asset there is no deduction or tax credit, its value is determine by the adjusted cost base. BUT if the property acquired is depreciable capital property (e.g. property that deteriorates over time or through its use) you may claim that depreciation as an expense against the capital property (capital cost allowance) Section 47: where a tax payer acquires identical properties (ex shares of a corporation) at different costs the taxpayer is required to average the costs among all of the propertyMagnitude of the Expenses: (Atco Electric)Atco had a policy that they would replace certain transformers/generators within their gridIndividually these were expensive upgrades but not expensive from perspective of entire gridCRA challenged this as a capital expenditureFCA: ATCO is right and can deduct the repairs as business expensesExpenses on DispositionDefinition: Actual selling costs (realtor fees, mortgage break fee), and those expenses incurred to bring the property to a saleable condition (ie. fix the deck, paint the house, clean the house) are deducting in calculating the capital gain/lossBUT issue as to exactly what expenses are properly deductible under this category. No bright line test Court has generally said that if you incur expenses for the purpose of disposing of the property than you can deduct those in calculating your capital gains/loses (Avis Immobilien GmbH v Canada)Court Distinguished Between:Expenses “incurred or made directly for the purposes of making the disposition”Which are deductibleExpenses “which may have merely facilitated the making of the disposition or which were entered into on the occasion of the disposition” Which are NOT deductible Examples of deductible expensesFixing up expenses, finders fees, sales commissions, brokers fees, surveyors fees, transfer taxes, legal expenses relating to dispositionA Brief Overview of Capital Gains Reserves RULE per Section 40(1): Taxpayer is required to calculate their capital gain/loss in the taxation year in which the taxpayer disposes of capital property and include 50% of it in their tax returnWhen the disposition is in the form of a sale for FMV and the taxpayer receives full consideration in the year of sale it is easy to pay this tax (b/c have cash in hand) BUT when the sale price is to be paid over a period of years there is a cash flow problem will have to pay taxes on the entire gain without the necessary cash from the sale to do soSolution per s.40(1)(a)(iii): Taxapyer can claim a reasonable reserve (usually 5 years) defers the recognition event of a portion of the gain to a future yearTo utilize this provision the taxpayer must recognize the greater of 20% of the total gain ORProportion of the proceeds actually received in the yearPersonal Use Capital PropertyPersonal use capital property (section 54) capital property that is primarily used for personal enjoyment of the taxpayer or someone related to the taxpayerEx. Your home (principle residence), your clothes, toys etcPUP is still capital property it follows the same rules in the Act with two main exceptions1. If taxpayer suffers a loss from disposition of PUP that loss is deemed to be nil by virtue of 40(2)(g)Garage Sale Rule: if taxpayer realizes a gain from the disposition of PUP its taxable only if both the proceeds of disposition and the ACB are greater than 1000$ 46(1) ................
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