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Chapter 3 Liability for Tax, Income Determination, and Administration of the Income Tax System

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Title: Chapter 3 Liability for Tax, Income Determination, and Administration of the Income Tax System


1
Chapter 3 Liability for Tax, Income
Determination, and Administration of the Income
Tax System
  • Primary source Income Tax Act
  • Other sources
  • Income tax regulations
  • Tax treaties
  • Tax cases
  • Bulletins, circulars, ruling, etc. published by
    CRA

2
The administrative process
  • Filing income tax return by taxpayers
  • Quick check by CRA and Notice of Assessment is
    issued
  • Filing Notice of Objection if taxpayers disagree
  • Taxpayers appeal to the Tax Court
  • Further appeal to the Federal Court
  • The Supreme Court is the ultimate arbiter

3
Structure of the Income Tax Act
  • Part I Income Tax
  • Division A liability
  • Division B computation of income
  • Division C taxable income
  • Division D non-residents
  • Division E tax credits
  • Division E.1 minimum tax

4
Division B - NIFTP
  • Employment income
  • Business income
  • Property income
  • Capital gains/losses
  • Other income/deductions

5
Income determination
  1. Aggregate income from employment, business,
    property and other sources
  2. Determine net taxable capital gains, i.e.,
    taxable capital gains net of allowable capital
    losses
  3. Sum up of (a) and (b), and net of other
    deductions
  4. Aggregate losses from employment, business, and
    property, and allowable business investment
    losses (ABIL), and subtracted from (c)

6
Example - income determination
  • A firm provides the following financial data
  • Business income 90,000
  • Gain on sale of land
  • and building 24,000
  • Loss on sale of shares (40,000)
  • Net income per
  • financial statement 74,000

7
Additional information
  • - Business income included accounting
    amortization of 37,000
  • - Capital cost allowance available as a tax
    deduction
  • Machinery 20,000
  • Equipments 12,000
  • Required Compute the net income for tax purpose
    (NIFTP).

8
Tax planning - all parties
  • Planner considers the implication of taxes to all
    related parties, employees, employers, creditors,
    suppliers, etc.

9
Tax planning - all costs
  • Taxes represent only one among many business
    costs.
  • Non-tax costs
  • - financial reporting
  • - capital and other regulations
  • - risk sharing
  • - incentive systems

10
Restriction to tax planning General
Anti-avoidance Rule (GAAR)
  • Intends to prevent abusive tax avoidance
    transactions arrangements but not interfere with
    legitimate commercial and family transactions
  • Tax benefits (tax reduction, avoidance, and
    deferral) from an avoidance transaction will be
    denied
  • Avoidance transaction a transaction with no bona
    fide purposes other than getting tax benefits
  • Transactions that comply with the Act read as a
    whole will not be affected

11
Whether GAAR should be applied
  • 1. Does any other provisions of the Act apply?
    (no GAAR if yes)
  • 2 and 3. Does the transaction result in tax
    benefits or is the transaction part of a series
    of transactions which result in tax benefits? (no
    GAAR if no)
  • 4. Can the transaction be considered to have been
    undertaken for bona fide purposes other than to
    obtain tax benefits? (no GAAR if yes)
  • 5. Does the transaction result in a misuse of the
    provision of the Act or an abuse of the Act read
    as a whole? (no GAAR if no)

12
Examples
  • An individual transfers his unincorporated
    business to a corporation primarily to obtain the
    benefit of the small business deduction.

13
Examples
  • The owner of land agrees to sell the property to
    a purchaser. The purchaser wants to buy the
    property for cash, but the owner does not want to
    have the profits recognized in the year of sale.
    The owner sells the land to an intermediary
    deferring receipt of the proceeds for several
    years after the date of sale (so reserve can be
    claimed). The intermediary sells the land to the
    purchaser for cash.

14
Tax liability
  • An income tax is paid on the taxable income for
    each taxation year of every person resident in
    Canada at any time in the year.
  • taxable income
  • income for the year special deductions

15
Full-time individual resident
  • Criterion (common law) a continuing state of
    relationship/ties with Canada.
  • the relationship/ties
  • - amount of time spent in Canada on a regular
    basis
  • - motives for being present or absent
  • - a dwelling
  • - a family
  • - personal property and social ties.

16
Deemed full-time
  • Sojourned in Canada in the year for an aggregate
    of 183 days or more.
  • Full-time resident will be taxed on his worldwide
    income for the whole year.

17
Part-time
  • A clean break or a fresh start
  • Transitional status
  • Part-time resident will be taxed on his worldwide
    income for the part of year while resident, and
    on his Canadian-source income for the part of
    year while non-resident.

18
Residence of corporation
  • Deemed resident
  • Incorporated in Canada after April 26, 1965,
  • or
  • Central management and control in Canada
  • Non-resident

19
Non-resident
  • Taxed on his income from
  • being employed in Canada,
  • carrying on business in Canada,
  • disposing of a taxable Canadian property, at any
    time in the year or a previous year

20
Chapter 4 Employment Income
  • Employee vs. self-employed/independent contractor
  • The courts consider the following tests
  • Economic reality or entrepreneur test
  • - control
  • - ownership of tools
  • - chance of profit/risk of loss
  • Integration or organization test
  • Specific result test

21
Structure
  • Basic inclusion
  • benefits and allowance
  • ESO benefit
  • - deductions allowed
  • Basic inclusion salary, wages, and other
    remuneration, including gratuities received

22
Example - payroll
  • Salary gross 78,000
  • Payroll deductions
  • RPP 2,000
  • CPP 2,163
  • EI 747
  • Income tax withheld 17,000
  • Union dues 590 (22,500)
  • ----------
  • Net salary 55,500

23
Employee benefits
  • All benefits are taxable except
  • Employers contributions to retirement plans
    including RPP and DPSP
  • Employers contribution to group sickness or
    accident insurance plan, private health services
    plan, supplementary unemployment benefits plan
  • Employer pays counselling services of mental or
    physical health and the re-employment or
    retirement

24
Fringe benefits administrative practice
IT-470R
  • Employer-paid social club membership is not
    taxable if for employer advantage
  • Employer-paid financial counselling and tax
    return preparation are included
  • Non-cash holiday gifts (up to 2 gifts) not over
    500 are not taxable
  • Benefits from frequent-flyer accumulated through
    employer-paid trips are included

25
Taxable benefits
  • Special Benefit calculations apply to
  • Use of employer automobiles
  • Loans from employers
  • Relocation expenses
  • Stock option benefits

26
Automobiles
  • To the extent that an automobile is for personal
    use, a taxable benefit results.
  • There are two components
  • Standby charge, and
  • Operating cost benefit.

27
Standby charge
  • Employer owns the automobile, standby charge

Original Cost Number of the x 2 x of
Months Automobile Available
28
Standby charge
  • Employer leases the automobile, standby charge

Monthly Number Lease x 2/3 x of
Months Cost Available
29
Reduced standby charge
  • Reduced when the distance travelled is primarily
    for employment duties (defined as 50 or more)
  • Personal use must be less than 20,000kms for the
    year
  • Multiplying the standby charge by
  • non-employment km/1,667kms x of months

30
Operating cost benefit
  • Operating Costs Prescribed rate (0.24) x
    Personal kms
  • or
  • ½ of standby charge, if primarily for employment
    duties (defined as 50 or more)

31
Example
  • A car is leased by company for 6,000
  • Operating costs paid by company for 4,800
  • Business use of car 14,000km
  • Total use of car 24,000km
  • Calculate taxable benefit.

32
Employee loans
  • Low-interest or interest-free loans provided by
    employers are a taxable benefit
  • Taxable Benefit
  • Prescribed rate actual interest paid

33
Employee loans home purchase/relocation loans
  • Rate used to determine the deemed interest
    benefit is the lesser of
  • The prescribed rate in the quarter the loan was
    outstanding.
  • The prescribed rate in effect at the time the
    loan was granted.
  • If the prescribed rate declines, the lower rate
    can be used.

34
Employee loans - Example
  • Mr. Maple borrowed 70,000 from his employer on
    April 1,2010 at an annual rate of 2, to purchase
    common shares of a public co. Interest was
    payable monthly.
  • Note the prescribed rates are Q1 5, Q2 5, Q3
    4, Q4 7

35
Relocation expenses
  • Reimbursement of loss on sale of home
  • First 15,000 not taxable, but
  • one-half of any amount above 15,000 is taxable

36
Allowances
  • All allowances are taxable, subject to specific
    exceptions.
  • Allowance refers to
  • a fixed, specified amount that is paid on a
    regular basis
  • over and above a normal salary
  • to cover certain expenses incurred

37
Deductions
  • Rule no deductions allowed, unless specifically
    permitted
  • Most Common
  • Travelling Expenses
  • Salespersons Expenses
  • Professional and Union Dues
  • Works Space in Home
  • Contributions to RPP

38
Travel expenses
  • Travel expenses incurred in the course of
    work-related duties provided that the following
    circumstances exist
  • Ordinarily required to carry employment duties
    away from the employers place of business,
  • Employee is required to pay the travel costs, and
  • Has not received a non-taxable allowance designed
    to cover such costs.

39
Travel expenses
  • Travel expenses include
  • Transportation
  • Meals if away from the metropolitan area of the
    employer for at least 12 hours, and limited to
    50
  • Lodging

40
Travel expenses
  • Vehicle cost, subject to limitations, include
  • Gas and oil, repairs, insurance,
  • Financing costs (interest), and
  • Capital cost or lease costs
  • Limitations to Vehicle Costs
  • Vehicle cost limited to 30,000
  • Lease cost limited to 800 per month
  • Interest cost limited to 300 per month

41
Salespersons expenses
  • Deduct all amounts spent
  • Limited to commission earned
  • Items not limited to commission
  • CCA on an automobile
  • Automobile financing costs

42
Salespersons expenses
  • The following items are specifically not
    deductible
  • Payments for the use of a yacht, camp, lodge, or
    golf course
  • Membership fees or dues in a club
  • main purpose to provide dining, recreational, or
    sporting facilities to its members.
  • Capital expenditures that have a long-term benefit

43
Salespersons expenses
  • Deductible items include
  • Advertising and promotion
  • Telephone
  • Parking
  • Automobile
  • Supplies
  • Fees paid to assistants
  • Work space in home
  • Travel expenses

44
Work space in home
  • Permitted only when the work space is either
  • The principal place duties are performed, or
  • If first condition not met, then
  • Used exclusively for earning employment income,
    and
  • Used on a regular/continuous basis for meeting
    customers or clients

45
Work space in home allowable costs
  • Non-salesperson
  • Appropriate portion of maintenance and utility
    costs.
  • Salesperson
  • The preceding items, plus an appropriate
    percentage of property taxes and house insurance
    premiums.

46
Chapter 5 Business Income
  1. Business Income Defined
  2. General Rules for Determining Business Income
  3. Deductions denied and allowed

47
Business income defined
  • Can be earned by all three of the taxable
    entities
  • individuals, corporations, and trusts
  • Should be carried on with a reasonable
    expectation of profit.

48
General rules for determining business income
  • The Act A taxpayers income for a taxation year
    from a business is the profit therefrom for the
    year
  • Business income for tax purposes is the profit
    determined in accordance with well-established
    business principles (such as IFRS/ GAAP).
  • IFRS/GAAP is good starting point adjustments
    are made where the Act specifies other
    requirements.

49
IFRS/GAAP and ITA
  • Similarities
  • Accrual
  • Net Concept
  • Major Differences
  • Amortization (Depreciation)
  • Other Allocations
  • Permanent Differences
  • Non-Arms Length Transactions

50
IFRS/GAAP and the ITA
  • Net IFRS/GAAP Income XXX
  • Add
  • Expenses not allowed
  • Disallowed deductions XXX
  • Unreasonable amounts XXX XXX
  • Deduct
  • Expenses specifically allowed (XXX)
  • Net income from a business for tax purposes XXX

51
General limitations
  • Expenses are deductible only if the following
    conditions are met
  • Income Earning Purpose Test
  • Capital Test
  • Exempt Income Test
  • Reserve Test
  • Personal Expense Test
  • Reasonableness Test

52
Examples
  • Charitable donation if not for producing income
  • Accounting depreciation on fixed assets
  • Major renovation of delivery vehicle to extend
    its useful life
  • Cost incurred for arrange a buy-sell agreement
    for shareholders
  • Appraisal fees to determine selling price of
    fixed assets
  • Premium for life insurance on the co. president,
    the proceeds of which are payable to the co.

53
Expenses denied
  • Use of recreational facilities and club dues
  • No deduction permitted for the use or maintenance
    of a yacht, a camp, a lodge, or a golf course,
    unless part of normal business
  • Also denies all expenses incurred as membership
    fees or dues in any club
  • Political contributions
  • No political contributions are deductible

54
Expenses denied
  • Work space in home
  • Deduction not permitted unless one of the
    following conditions is met
  • The space is the individuals principal place
    of business, or
  • If first condition not met,
  • used exclusively for the purpose of earning
    income from business, and
  • used on a regular or continuous basis for meeting
    clients, customers or patients of the individual.

55
Expenses denied
  • Work space in home
  • Permitted expenses include a proportionate amount
    of
  • Maintenance cost (heating, home insurance,
    electricity, cleaning material),
  • Mortgage interest,
  • Property taxes,
  • Capital Cost Allowance
  • Total expenses cannot exceed business income for
    the year.
  • Excess can be carried forward indefinitely.

56
Expenses denied
  • Meals and entertainment
  • Amount permitted is limited to 50 of actual
    costs
  • One of the exceptions (100 deduction)
  • cost of food, beverage, and entertainment events
    generally available to all employees (limited to
    six occasional events per year).

57
Expenses allowed
  • The Act lists approximately 40 specific items
    that are permitted as deductions even though,
    according to the six general limitations, they do
    not normally qualify.

58
Expenses allowed
  • Capital cost allowance
  • Interest on borrowed money used for earning
    business income
  • Financing Expenses
  • Expenses for issuing shares or borrowing money
  • Permitted as a deduction equally over five
    years
  • Printing and ad costs, filing fees, legal fees,
    transfer fees, commissions etc for issuing shares

59
Examples Financing Expenses
  • Legal and accounting fees related to the issuance
    of shares
  • Costs incurred regarding the renegotiation of the
    bank loans
  • Appraisal costs to determine value of the
    equipment for the bank

60
Expenses allowed
  • Reserves for doubtful debts
  • Can claim a reserve on amounts receivable if
  • it is anticipated that they wont be collected,
  • reserve is reasonable, and
  • that the debt, when established, created income
    for the taxpayer.

61
Expenses allowed
  • Reserves for delayed payment revenues
  • Reserve may be deducted when
  • inventory has been sold, and
  • all or part of payment not due until after two
    years.
  • Long-term payment schedule can be recognized over
    a period of time.
  • Utilized for no more than three years,
  • even if payment terms are longer.

62
Reserves
  • Whenever a reserve is allowed, the deduction must
    be added back to income the following year.
  • A new reserve can be deducted if it can still be
    justified.

63
Example
  • A firm sold its goods for 24,000 with cost of
    12,000. It received cash of 15,000 for the sale
    with the balance to be paid over the next 3 years
    at a rate of 3,000 per year.

64
Solution
  • Reserve profit unpaid revenue / total revenue
  • Profit revenue - COGS

65
Expenses allowed
  • Representation expenses
  • Representation to the government for license,
    permit, franchise or trade-mark relating to
    business
  • fully deductible
  • can elect to deduct equally over 10 years
  • Convention expenses
  • Limited to two conventions in a year

66
Expenses allowed
  • Employers contributions to RPP, DPSP,etc.
  • Expenses deductible on a cash basis
  • Landscaping
  • Site investigation fees
  • Utility service connections

67
Inventories
  • Inventory can be valued
  • 1. Value each item of inventory at LCM, OR
  • 2. Value all items of inventory at FMV
  • Cost of good sold are calculated by
  • 1. Specific identification, OR
  • 2. Average cost, OR
  • 3. FIFO

68
SRED
  • SRED carried on within Canada, the following
    special provisions apply
  • Expenditures (both current and capital) can be
    deducted in full in the year incurred
  • The business can choose not to deduct and carry
    forward indefinitely
  • A credit will be applied to the expenditures

68
69
Chapter 6 Acquisition, Use, and Disposal of
Depreciable Property
  • Depreciable Property and Capital Cost Allowance
    (CCA).
  • The Treatment of Eligible Capital Property
    (ECP).

70
Depreciable property and CCA
  • Calculation of the CCA
  • Start with opening balance (UCC).
  • Add any additional purchases.
  • Deduct any disposals.
  • Apply the appropriate CCA rate to the resulting
    balance.

71
CCA rates
  • The Act assigns various types of assets to
    specific classes.
  • Each class has a specific rate attached to it.
  • signifies the maximum deductible in any year.
  • No requirement to claim this maximum
  • can choose to claim any amount up to the max.
  • Unclaimed portions is available for deduction in
    future years.

72
Common classes
  • Class 1 4
  • Buildings After 1987
  • Class 8 20
  • Miscellaneous Tangible (equipment, office
    furniture etc.)

73
Common classes
  • Class 10 30
  • Vehicles
  • Movable equipment
  • Class 10.1 30
  • Vehicles With Cost Greater Than 30,000

74
Common classes
  • Class 12 100
  • Small Tools
  • Computer Software
  • Dishes
  • Books

75
Common classes
  • Class 43 30
  • Manufacturing Equipment
  • Class 44
  • Patents after April 26, 1993
  • Can choose to use class 14
  • Class 52 - 100
  • Computers acquired after Jan 27, 2009 and before
    Feb 2011

76
Pooling assets of the same class
  • Assets of the same class are placed in a common
    pool,
  • provided all used in the same business.
  • A purchase will add that pool of assets.
  • A sale of an asset will remove it from the pool.

77
Pooling assets of the same class
  • The one-half rule applies only on net additions.
  • If disposals exceed purchases, no one-half rule.
  • When assets are sold, the CCA pool is reduced by
    lower of
  • Original cost, or
  • Proceeds of disposition.

78
Example Class 8
Undepreciated Cost of Capital
  • UCC beginning of year 70,000
  • Additions 60,000
  • Disposals (50,000) 10,000
  • 80,000
  • CCA
  • 20 x 70,000 14,000
  • 20 x 10,000 x ½ 1,000 (15,000)
  • UCC 65,000

79
Gains/losses on disposition
  • Gains/losses can occur at three points
  • Terminal Loss
  • All assets in pool are disposed of, and
  • Positive balance in the pool.
  • Recapture
  • Negative balance left in a pool
  • Regardless of whether there are assets left.
  • Capital Gain
  • The selling price exceeds the original cost.

80
Special treatment of passenger vehicles luxury
  • Passenger vehicles costing more than 30,000.
  • Class 10.1 limits the tax deduction for luxury
    cars.
  • Maximum claim is 30,000 regardless of cost.
  • Assets are not pooled.
  • No recapture or terminal loss
  • One-half rule
  • Applies in the year of acquisition
  • Is claimable in disposal year.

81
Exceptions to declining balance
  • Leasehold improvement (class 13)
  • Tenant is responsible for the cost of making the
    rented space suitable to their needs.
  • Expenditures are
  • tangible improvements to the rental property,
    and
  • at the end of the lease, cannot be removed.
  • Allocated using the straight-line method over the
    life of the lease plus one renewable option
    period.

82
Exceptions to declining balance
  • Franchises and licences ( class 14)
  • a limited legal life
  • CCA is determined separately for each item
  • The annual CCA
  • straight-line basis based on number of days owned
    in the year divided by the total number of days
    in the life of the asset.

83
Eligible capital property
  • Intangible nature with unlimited life
  • Some common types
  • Goodwill (purchased).
  • Franchises, licences, and concessions with no
    legal limited life.
  • Trademarks.
  • Customer lists.
  • Incorporation costs.

84
Rules for eligible capital property
  • All assets are pooled together.
  • Additions and disposals are recorded at 75.
  • Annual rate of 7.
  • No one-half rule

85
Example
  • In 2009, a firm purchased an existing business
    and acquired a franchise (unlimited life) for
    10,000 and goodwill for 30,000. In 2011, the
    franchise was sold for 60,000 but the business
    continues.

86
Chapter 7 Income from Property
  1. Income from Property Defined
  2. General Rules
  3. The Unique Features of Property Income

87
Income from property
  • An annual or regular return received for allowing
    another party to use ones property.
  • Property income includes
  • Dividends shares
  • Interest loans, deposits, etc.
  • Rental income real estate
  • Royalties patents, etc.

88
General Rules
  • Net amount
  • Deduction of expenses which are incurred for
    earning property income

89
Interest income
  • Interest income the compensation received for
    the use of borrowed funds.
  • Corporations on an accrual basis
  • Include as income on a daily basis,
  • even though not received or receivable until some
    future time.
  • Individuals -
  • The cash method
  • The annual accrual method

90
Annual Accrual Method
Required method so cannot defer for long periods
Loans 100,000 on February 1, 20X1. Loan must be
repaid in two years. Interest is charged at 12,
compounded annually and is payable at the end of
two years.
  • Cash Method
  • Year Income
  • 20X1 0
  • 20X2 0
  • 20X3 25,440
  • Total 25,440
  • Annual Accrual Method
  • Year Income
  • 20X1 0
  • 20X2 12,000
  • 20X3 13,440
  • Total 25,440

Yr 1 100,000 x 12 12,000 Yr 2 112,000 x 12
13,440 25,440
91
Foreign interest
  • Gross amount is included
  • amount received plus foreign taxes withheld.
  • If foreign tax is withheld may receive a
    foreign tax credit

92
Dividend income
  • Corporate ownership

Individual
Individual
Dividend
Dividend
Corporation
Dividend
Corporation
Corporation
93
Dividends received by individuals
  • Dividends from taxable Canadian corporate shares
    are included when received
  • Grossed Up
  • Received from Private Corporations
  • 125 - if eligible for special low-tax rates.
  • 144 - if not eligible for special low-tax rates.
  • Received from Public Corporations
  • 144
  • A dividend tax credit (DTC) is available

94
Dividends received by individuals
Corporation Income 100 Tax _at_ 20
(20) Net earnings 80
  • Individual Shareholder
  • Dividend from Corporation 80
  • Taxable dividend (80 x 1.25) 100
  • Tax _at_ 45 45
  • less DTC (20)
  • Net personal tax 25
  • Total tax paid on Corporate profits
  • Paid by corporation 20
  • Paid by individual 25 45

95
Rental Income
  • Rental Income Rent Expenses
  • Interest expenses, costs incurred to obtain loan
    financing
  • Insurance, property taxes, utility costs
  • Repairs, maintenance costs
  • Landscaping costs around a building
  • CCA
  • Salaries and wages, property management fees
  • Accounting costs, costs incurred to collect rents

96
Special Rules for CCA
  • Apply only to rental property
  • CCA claimed on rental properties cannot incur a
    rental loss
  • Separate classes for each rental building costing
    50,000 or more

97
Shareholder-manager remuneration package
  • Salary vs. dividends
  • Paying dividends
  • reduces shareholders tax payable
  • not tax deductible for the corporation.
  • Paying salary
  • tax deductible for the corporation
  • taxed in the employees hand
  • Which is best - dividend or salary, or a
    combination?
  • A mix of dividend and salary is best when the
    corporate tax rate is less than 20
  • Paying salary is best when the corporate tax rate
    is above 20

98
Salary vs.dividend
  • Other considerations
  • Paying salary will be qualified for contributing
    to RRSP and RPP because salary income is used to
    calculate the contribution limit. Dividends are
    not qualified
  • Paying salary may incur payroll tax

99
Tax-planning
  1. Evaluating investment choices based on after-tax
    return
  2. Use excess cash to purchase personal assets use
    borrowed funds to purchase investment assets
    maintain clear records

100
Example
  • An individual borrows 10,000 at 10 to
    purchase either a cottage or an investment.
    Individual has a tax rate of 45.
  • Cottage personal use
  • Interest paid 1,000
  • Tax saving 0
  • Cost of loan 1,000
  • Investments
  • Interest paid 1,000
  • Tax saving (450)
  • Cost of loan 550

101
Chapter 8 Capital Gains and Losses
  1. CG/CL Defined
  2. Determining CG/CL General Rules
  3. Specific Capital Properties

102
Determining CG/CL
  • Proceeds of disposition xxx
  • less adjusted cost base (ACB) (xxx)
  • less disposition expenses (xxx)
  • net amount xxx
  • less reserve (xxx)
  • CG/CL xxx
  • TCG/ACL ½CG/CL

103
Deferred Proceeds
  • Maximum reserve in any year is equal to the
    lesser of
  • (i) deferred proceeds / total proceeds x net
    amount, and
  • (ii) 80 of the gain in year 1, 60 in year 2,
    40 in year 3 20 in year 4 and 0 in year 5

104
Reserves an example
  • Selling a piece of land with ACB of 130,000 for
    200,000 in 2009, he receives 80,000 in cash at
    time of sale, 30,000 in 2010 and 90,000 in
    2011.
  • Net amount 70,000
  • Reserve claimed in 2009
  • 70,000 x 120,000/200,000 42,000, or
  • 4/5 x 70,000 56,000 (42,000)
  • Capital Gain recognized in 2009 28,000
  • Taxable Capital Gain 1/2x28,000 14,000

105
Small business corporation (SBC)
  • a private corporation that is Canadian-controlled
    (CCPC), and
  • that uses all or substantially all of its assets
    (at least 90) to conduct an active business.

106
Small business corporation (SBC)
  • Up to 250,000 taxable capital gains from QSBCS
    are exempted.
  • Qualified small business corporation shares
    (QSBCS)
  • (a) a share of SBC at the time of disposition
  • (b) held throughout 24 months and
  • (c) the share for the past 24-month was a share
    of CCPC and more than 50 assets were used in an
    active business
  • Allowable business investment loss (ABIL)
    incurred on the disposition of
  • a loan to a small business corporation, or
  • shares of that corporation
  • An ABIL can offset against all other sources of
    income

107
Superficial Losses (denied)
  • No intention of disposing of the asset,
  • disposed of and then reacquired within 30 days.
  • The actual loss is added to the ACB of the
    reacquired asset

108
Superficial loss example
  • Taxpayer sold 500 shares in Corp X for 8,000 on
    Dec. 31, 2010 with an ACB of 10,000. On Jan 5,
    2011 he reacquires 500 shares of Corp X for
    7,500.
  • Shares sold on December 31, 2010
  • POD 8,000
  • ACB ( 10,000)
  • Actual loss ( 2,000)
  • Superficial loss deemed to be nil nil
  • ACB of shares purchased on Jan 5, 2011
  • Original POD 7,500
  • Denied loss 2,000
  • New ACB 9,500

109
Personal Use Property (PUP)
  • Gains Taxed
  • Losses Non-Deductible
  • This restriction is applied to each item of
    personal property.
  • Minimum POD 1,000
  • Minimum ACB 1,000

110
Listed Personal Property (LPP)
  • PUP that has some element of investment value
  • A print, etching, drawing, painting, or
  • sculpture, or other similar works of art
  • Jewellery
  • A rare folio, rare manuscript, or rare book
  • A stamp
  • A coin
  • Losses recognized, but only deductible against
    gains on LPP.
  • Unused losses
  • Carried back 3 years, or forward 7 years
  • Remember
  • Minimum POD 1,000
  • Minimum ACB 1,000

111
Identical properties
  • The ACB of each identical property acquired is
    the weighted average cost of all the identical
    properties acquired

112
ACB Identical properties
  • Acquire shares as follows
  • Year of Shares Cost per share Total
  • 20X6 100 6 600
  • 20X7 200 8 1,600
  • 20X8 80 10 800
  • 380 3,000
  • ACB per share (3,00/380) 7.89
  • Sale Proceeds ( 150 x 9) 1,350
  • ACB (150 x 7.89) ( 1,183)
  • Capital Gain 167

113
Principal residence
  • Owned and ordinarily inhabited for personal use,
    one principal residence per family unit,
    designation at sale
  • Claim exemption against capital gains

114
Principal residence
  • exemption
  • The 1 is included to cover the year in which
    two houses are owned as a result of the normal
    process of selling one house and acquiring a new
    one

1 Yrs. Designated Principal Residence X
Gain Number of Years Owned
115
Principal residence an example
  • A taxpayer acquired a house in 2006 for
    100,000. In 2008 he acquired a vacation home for
    50,000. In 2010 both properties were sold the
    house for 150,000 and the vacation home for
    95,000

116
Comprehensive example
  • Properties proceeds cost
  • Shares of co.X 60,000 40,000
  • Shares of co.P 17,000 41,000
  • Art 8,000 6,000
  • Boat 9,000 12,000
  • Grand piano 11,000 10,000
  • Stamp collection 18,000 21,000
  • Shares of small
  • business corp. 8,000 20,000

117
Chapter 9 Other Income/Deductions, and Special
Rules for NIFTP
  1. Other Income
  2. Other Deductions
  3. Special Rules for NIFTP

118
Other income
  • RRSP and RRIF benefits
  • Pension benefits from employers pension plan
  • OAS, CPP, EI
  • DPSP benefits
  • Foreign pension benefits
  • Retiring allowances
  • Scholarship, fellowships, bursaries
  • Support payments

119
Other deductions
  • Major items
  • RRSP contributions
  • Support payments to a former spouse, if
  • Periodic and
  • By virtue of a court order.
  • Fees/expenses for objection or appeal of a tax
    assessment
  • Moving expenses
  • Child care expenses lower income spouse

120
Moving expenses
  • Deductible if
  • incurred for relocation to commence a business or
    employment
  • attend a university or other post-secondary
    school
  • to the extent of income earned in the new
    location
  • Moving Income in
  • expense gt new location
  • Then
  • Carry forward unclaimed portion and deduct in
    following year.

121
Moving expenses
  • Deductible expenses include
  • Travel costs in moving to new place (meal 51 per
    day w/o receipt),
  • Transportation and storage of belongings,
  • Temporary board and lodging (up to 15 days),
  • Costs of cancelling a lease for the old
    residence,
  • Selling costs of the old residence,
  • Legal fees and land transfer taxes,
  • Cost of maintaining a vacant former residence
    within limits (up to 5,000),
  • Cost of revising legal documents

122
Child care expenses
  • Includes
  • the cost of babysitting, day care, or lodging at
    a boarding school,
  • children 16 years of age or less,
  • If incurred so taxpayer could pursue employment,
    business, or research activities.
  • Limits
  • 4,000 per child 7 to 16, 7,000 per child under
    7, or
  • 2/3 of the taxpayers earned income for the year.
  • Lower income spouse claims

123
Example
  • Marge and Homer have 3 kids, aged 8,6, and 1. In
    the year, Marge earned 40,000 and Homer earned
    15,000. Marge paid 250/week for the three
    children for 52 weeks in the year, which were
    qualified as child care expenses. What is the
    amount deductible for tax purposes?

124
NAL transactions
  • Non-arms length (NAL)
  • special rules prevent the elimination or
    reduction of tax by selling at a price other than
    fair market value.
  • Taxpayers are considered not to be dealing at
    arms length if they are related to each other.

125
Non-Arms Length (NAL)
  • Sell Price lt FMV
  • Vendor deemed to have sold at FMV
  • Purchaser no adjustment
  • Sell Price gt FMV
  • Vendor no adjustment
  • Purchaser ACB is deemed equal to FMV
  • Gifting
  • Vendor sales price FMV
  • Purchaser ACB FMV

126
Non-Arms Length (NAL)
  • 1. Individuals are related if they are
    direct-line descendents
  • 2. Individual is related to a corporation if
  • controls the corporation,
  • a member of a related group that controls the
    corporation, or
  • is related to an individual who controls the
    corporation
  • 3. Corporations are related if control

127
Property transferred to spouse or child
  • Transferred to spouse
  • Deemed to have been sold at cost automatic.
  • Can choose to recognize a gain on spousal
    transfer
  • Transferred to child
  • whether by gift or sale, is deemed for tax
    purposes to have been sold at FMV per NAL rules
    described.

128
Attributions
  • Subsequent income received by spouse/child on
    transferred property is attributed back to
    original owner
  • Exceptions
  • if property is transferred to a spouse at FMV
  • Income on property transferred to child
  • If over 18
  • If capital gains or losses
  • Second-generation income

129
Example
  • Ms. Martel has 6000 shares with ACB of 35 per
    share. She is thinking of transfer the shares
    equally to her spouse and two sons (one is 15 and
    the other is 21),
  • by gifting
  • selling at 20 per share
  • Discuss the tax consequences.

130
Chapter 10 Individuals Taxable Income And Taxes
Payable
  1. Taxable income
  2. Calculation of Tax for Individuals

131
Taxable income
  • A taxpayers taxable income for a taxation year
    is
  • The special reductions are grouped together in
    Division C of The Act.
  • Stock options
  • Losses not utilized in other years
  • Lifetime capital gain deduction

Taxable income Net Income Special Reductions
132
Taxable income
  • Net income for tax purposes
  • a) Employment Income
  • Business Income
  • Property Income
  • Other items
  • Plus
  • b) Net Taxable Capital Gains
  • Less
  • Other items of deductions
  • Less
  • Aggregate of losses from Employment
  • Business, Property and ABILS
  • Net Income for tax purposes (NIFTP)

133
Taxable income
  • Net income for tax purposes XXX
  • Less
  • Special Reductions
  • Stock Options (XXX)
  • Losses not utilized in other years (XXX)
  • Lifetime capital gain deduction (XXX)
  • Taxable Income

134
Loss carryovers
  • Net capital loss
  • Non capital loss
  • Farm loss and restricted farm loss

135
Net capital losses
  • Net Capital Losses
  • Allowable capital losses incurred in current
    year but cannot be utilized,
  • can be carried back three years, and
  • forward indefinitely,
  • only deductible against capital gains.
  • Exception upon the death,
  • unused losses may be deducted against any type of
    income earned in the year of death or in the
    preceding year.

136
Non-capital losses
  • Unused business, property and employment losses
    and ABILs
  • Can be carried back three years and forward
    twenty against any source of income.

137
ABIL - special treatment
  • ABIL unused after twenty-years
  • reclassified as a net capital loss, and
  • can be carried forward indefinitely
  • to be used only against future capital gains.

138
Farm losses
  • Farm losses chief source of income is farming
    or fishing.
  • Farm losses are treated the same as business
    losses.

139
Restricted farm losses
  • Part-time farming
  • Unused losses classified as restricted farm
    losses.
  • Unused losses can be
  • carried back three years, and
  • forward twenty years,
  • only be deducted against farming losses

140
Capital gain deduction
  • Lifetime Capital Gain Deduction is available only
    for
  • Qualified small business corporation shares, and
  • qualified farm property.
  • Deduction is 1/2 of 500,000 (250,000)

141
Calculation of tax for individuals
  • Income tax is imposed by the federal and
    provincial governments
  • Federal tax - of taxable income
  • Provincial tax - of taxable income

142
Determination of Tax for an Individual
143
Primary Federal Tax
Taxable Income Range (2006) Rate
Up to 40,970 15
40,971 - 81,941 22
81,942 - 127,021 26
Over 127,021 29
144
First category of credits
  • Dividend tax credit Type A Corporations
  • Equal to 25.9 of the taxable amount of dividends
    received from Canadian corporations.
  • Dividend tax credit Type B Corporations
  • Equal to 16 2/3 of the taxable amount of
    dividends received from Canadian corporations.

145
Dividend tax credit
  • Type A Corporations
  • Canadian Public Corporations
  • Canadian Private Corporations not Canadian
    controlled
  • CCPC not eligible for SBD
  • Type B Corporations
  • CCPC eligible for SBD
  • CCPC earning investment income

146
First category of credits
  • Basic
  • 15 x 10,382
  • Spouse or equivalent to spouse
  • 15 x
  • 10,382, reduced by spouses net income

147
First category of credits
  • Infirm dependants
  • Individuals supporting a
  • related person,
  • over the age of 18, and
  • dependent by reason of physical or mental
    infirmity.
  • Tax credit 15x4,223
  • reduced by 15 of dependants net income in
    excess of 5,992.
  • necessary for dependant to be living with
    supporting individual.

148
First category of credits
  • Caregiver
  • Provide in-home care for
  • a parent or grandparent who is 65 or older, or
  • dependent relative who is infirm.
  • 633 tax credit against federal tax.
  • Reduced by 15 of the dependents income in
    excess of 14,422.

149
Personal credits - summary
  • Every taxpayer will take either the married,
    equivalent to married, or single credit
  • A dependent credit can only be claimed if the
    dependent is 18 or older and mentally or
    physically infirm
  • The same dependent person cannot be used for both
    equivalent to married and the dependent credit
  • The same dependent person cannot be used for both
    dependent and caregiver credit

150
Planning for personal credits
  • If you have a single dependent who qualifies
    infirm dependent (and therefore also equivalent
    to married), you will generally want to take
    equivalent to married
  • If you have a second dependent, who would not
    meet infirm dependent but meet equivalent to
    married status (e.g., a child of the taxpayer
    under 18), use the second dependent to claim
    equivalent to married and the first to claim the
    dependent credit

151
First category of credits
  • Age amount 65 years of age or older.
  • Disability a severe prolonged mental or
    physical impairment.
  • Can be transferred to spouse
  • CPP and EI
  • 15 x CPP and EI contributions

152
First category of credits
  • Pension
  • 15 on first 2,000
  • qualified pension income received in a year.
  • Charitable donations
  • 15 x first 200 of annual contributions
  • 29 x the remainder.
  • Annual donations cannot exceed 75 net income.
  • Unused Donations can be carried forward for 5
    years.

153
First category of credits
  • Medical expenses
  • 15 x qualified medical expenses exceeding
  • either 3 of the taxpayers net income, or
  • 2,024, whichever is less. Tax planning
  • Choose the 12 month period to maximize the
    credit, i.e., group the maximum amount together
    in the 12 month period
  • As the credit depends on the income in the year,
    this may affect the year you take the credit in
    (the period you choose)

154
First category of credits
  • Tuition fees
  • attend a university, college, or other certified
    post-secondary institution.
  • 15 x tuition fees paid.
  • Education amount and textbook credit
  • Full-time students 15 x 465 x each month of
    full-time attendance.
  • Part-time education 15 x 140 x each month of
    part-time attendance.

155
Tuition and education credits
  • The student may not have sufficient income to
    utilize the above credits.
  • The unused portion is transferable up 750 (15
    x 5,000) annually to a spouse, parent, or
    grandparent.
  • Alternatively, the student may keep the unused
    credit and carry it forward indefinitely.

156
Second category of credits
  • Foreign tax credit
  • Political contributions
  • Based on a graduated scale.
  • The annual credit is
  • 75 of the first 400,
  • 50 of the next 350, and
  • 33 1/3 of contributions over 750.
  • Maximum of 650 annually
  • Investment tax credits

157
Chapter 11 Corporations An Introduction
  1. Determination of Taxable Income
  2. Calculation of Corporate Tax
  3. The Integration of Corporate and Individual
    Taxation

158
Determination of taxable income
  • A corporations taxable income is
  • Net income for tax purposes
  • less special deductions
  • Donations to charitable organizations
  • Loss carryovers
  • Inter-corporation dividends

159
Calculation of corporate tax
  • Two basic categories for tax purposes
  • Public corporations
  • Canadian residence and shares are traded on a
    stock exchange.
  • Canadian-controlled private corporations (CCPCs)
  • Canadian residence
  • Not a public corporation, and
  • Not controlled by non-residents of Canada.

160
Determination of Tax for Corporations
161
Tax Rates
  • Basic federal tax rate 38
  • Federal abatement for provincial tax (10)
  • Net federal tax 28
  • General rate reduction (10)
  • Total federal tax 18
  • Provincial tax (assume) 13
  • Effective total tax 31

162
Corporate taxation in Europe
  • Countries Tax rates
  • Austria 34
  • Belgium 40
  • France 35
  • Germany 39
  • Ireland 16
  • Italy 40
  • Netherland 35
  • Spain 35
  • UK 30

163
Multi-provincial tax
  • A corporation carries on business in a province
    through a permanent establishment such as an
    office, branch, warehouse, or factory
  • The profits attributable to that province are
    based on the ratio of
  • sales in the province to total sales, and
  • wages paid in the province to total wages,

164
Example
  • Ontario Alberta U.S.
  • Salary 40,000 (40) 30,000 (30) 30,000 (30)
  • Sales 100,000 (20) 200,000 (40)200,000 (40)
  • Average30 (4020)/2 35 (3040) 35
  • Taxable income earned in a province is 65
  • Income tax paid to Ontario taxable income ? 30
    ? Ontario tax rate
  • Income tax paid to Alberta taxable income ? 35
    ? Alberta tax rate

165
Refundable tax on investment income (ART)
  • Applies only to the investment income of a CCPC.
  • Additional tax is 6 2/3 of investment income
    and
  • Fully refundable to the corporation when
    dividends are paid.

166
General rate reduction
  • Public corporations
  • 10 x taxable income not subject to manufacturing
    and processing activities
  • CCPC
  • 10 x active business income
  • Above the annual small business limit, and
  • Not eligible for the MP reduction

167
Small business deduction (SBD)
  • Available only to CCPCs
  • 17 x the first 500,000 of annual active
    business income of the corporation, or
  • Taxable income, whichever is lower

168
Manufacturing and processing deduction
  • Profits from manufacturing and processing (MP)
    activities
  • Public corporation - 10 of MP profits
  • CCPCs 10
  • only on annual manufacturing profits in excess of
    the SBD amount

169
The integration of corporate and individual
taxation
  • Corporations are taxed on their profits separate
    from their shareholders.
  • After-tax corporate profits are distributed in
    the form of a dividend,
  • tax is again payable on the dividends received.
  • Two-tier system creates the possibility of double
    taxation.

170
Chapter 13 CCPC
  1. Taxation of Income Earned by a CCPC
  2. Overall Tax Calculation for a CCPC

171
Taxation of income earned by a CCPC
  • Net income for tax purposes must be allocated
    into five areas before taxes can be computed
  • Active business income
  • Specified investment business income
  • Capital gains
  • Dividends

172
Active Business Income (ABI)
  • ABI is business income from any business carried
    on by the corporation other than
  • a specified investment business, and
  • a personal services business.
  • ABI includes property income closely related or
    incidental to business activities
  • i.e. interest income earned on overdue A/R.

173
Tax Treatment of ABI
  • First 500,000 x 17 (federal tax)
  • Referred to as the small business deduction
    (SBD).
  • The 500,000 SBD limit is an annual amount
  • if unused, cannot be carried over to other years.

174
Specified Investment Business Income
  • A business with a primary purpose to earn
    property income which includes
  • interest,
  • rents,
  • royalties, and
  • dividends from non-affiliated foreign
    corporations.
  • Dividends from other Canadian corporations and
    foreign affiliates are excluded from this
    definition since these dividends are not taxable.

175
Tax Treatment of Specified Investment Business
Income
  • Disqualified as ABI
  • is not entitled to the SBD
  • In addition a special refundable tax of 6 2/3
    must be paid.
  • This special refundable tax is fully refundable
    to the corporation upon payment of dividends.

176
Capital Gains
  • Taxable capital gains treated the same as
    specified investment business income.
  • Capital Dividend
  • a mechanism to avoid double taxation on capital
    gains
  • distributes the tax-free portion of the gain to
    the shareholders
  • an election is required

177
Dividends
  • Taxable Canadian dividends received by a CCPC are
    subject to special tax treatment.
  • This special treatment depends on the degree of
    ownership that the corporation has in the
    corporation paying the dividend.

178
Dividends Received from Non-Connected
Corporations
  • Non-connected if
  • Non-Connected Dividends received are taxed at 33
    1/3 (Part IV tax) of actual dividends received
    but this tax is fully refundable upon the payment
    of
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