Author: Jeff Kirshen

by Jeff Kirshen

John Scholz and RRSP Advantages

Have you recently received correspondence from the CRA regarding an audit or reassessment of your income tax returns for an alleged “strip” of a registered plan (such as an RRSP, RESP, RRIF or RDSP) resulting in an “advantage”?

The CRA is auditing taxpayers for “advantages” received from the transfer of their registered plan to Western Pacific Trust Company, the subsequent purchase of shares of Red Hill Capital Inc., and the direct repayment of the value of their registered plan from John Scholz of Northland Services Inc. following the purchase of the shares.

These audits are targeting taxpayers under a specific and technical provision of the Income Tax Act (the “Act”). In this blog post, which draws from Income Tax Folio S3-F10-C3, published by the CRA, we outline the meaning of these provisions and some of the reasons for their implementation. We also highlight another recent CRA publication regarding John Scholz.

 

Advantages

An “advantage” in relation to a registered plan is defined under subsection 207.01(1) as any of the following:

1. certain benefits or debt that are conditional on the existence of the plan, subject to listed exceptions;
2. an increase in the FMV of the property held in connection with the plan which increase is reasonably attributable to certain transactions or amounts;
3. income or a capital gain that is reasonably attributable to certain property or transactions in respect of the plan; or
4. a registered plan strip in respect of the plan.

The CRA considers the above series of transactions involving John Scholz to result in an “advantage” under subsection 207.01(1) of the Act.

Under subsection 207.05(1), the Act imposes a special tax for “advantages”. The tax is equal to the amount of the advantage and is payable by the annuitant, subscriber, or holder of the plan, unless the advantage is extended by the issuer, promoter, or carrier of the plan. In the latter case, the tax is payable by the issuer, promoter or carrier.

The person responsible for paying the tax is also required to file a special tax return. The CRA has discretion to waive all or part of the tax.

 

Registered Plan Strips

The CRA defines a “registered plan strip” as the amount of a reduction in the fair market value of property of a registered plan other than a TFSA.

The reduction may be considered a “strip” if the value is reduced as part of a transaction or event (or a series of transactions or events) one of the main purposes of which is to enable the controlling individual or any person who does not deal at arm’s length with the controlling individual to obtain a benefit in respect of the property of the plan or to obtain a benefit from the reduction.

The above definition involves a few technical terms:

• “Fair market value (FMV)” is generally considered to mean the highest price expressed in terms of money that can be obtained in an open and unrestricted market between informed and prudent parties who are dealing at arm’s length and under no compulsion to buy or sell.
• “Controlling individuals” of a registered plan is defined under subsection 207.01(1) of the Act as the annuitant of an RRSP or RRIF, the subscriber of an RESP or the holder of an RDSP or TFSA.
• The rules for determining whether persons deal with each other “at arm’s length” are set out under subsection 251(1) of the Act. The CRA does not view individuals as dealing at arm’s length with any of their registered plans.

The definition of a “registered plan strip” can apply even when no amount is traceably removed from a registered plan but where the value of the plan has still been reduced. For example, this could occur by way of transactions that dilute the equity of a corporation, trust, or partnership in which the plan is invested. It could also occur where a plan has directly or indirectly invested in a debt obligation and steps are taken to ensure that the debt cannot be repaid, or where no actions are taken to enforce repayment.

 

Advantages and the Reason for the Rules

The advantage rules originally applied only to TFSAs but were extended to cover RRSPs and RRIFs from March 23, 2011 and to RESPs and RDSPs from March 23, 2017.

The advantage rules target abusive tax planning arrangements that seek to artificially shift value into or out of a registered plan while avoiding the statutory limits for contributions or withdrawals. They also apply to benefits and loans that are conditional on a registered plan.

Normal investment activities and conventional incentive programs will generally be excepted from the application of the advantage rules. Amounts excepted from the rules may include amounts included in income, amounts withdrawn under the Home Buyers’ Plan or the Lifelong Learning Plan, direct transfers of funds that are permitted to be made on a tax-deferred basis, and the non-taxable portion of payments from RESPs or RDSPs relating to a return of contributions.

For the most part, the advantage rules do not impact the average investor. However, there has been a recent uptick in CRA audit activity surrounding advantages allegedly received by taxpayers following their dealings with John Scholz.

 

John Scholz

The CRA recently investigated the investment counselling business of John Scholz. The investigation revealed that Scholz did not report any of the commission fees he received from his clients for the 2011 to 2013 taxation years.

Scholz was found to have failed to report taxable income totalling $2,149,730 for these years, and to have evaded a total of $605,355 in federal income tax. Scholz also did not file GST/HST returns for the periods ending in 2011 to 2015, and he was found to have evaded the remittance of GST/HST totalling $445,789.

On April 13, 2019, Scholz was found guilty by a jury in the Hamilton Court House of one count of fraud over $5,000 under the Criminal Code for the evasion of GST/HST remittance.

On September 26, 2019, Scholz was sentenced to a conditional jail sentence of two years less a day, including 12 months of house arrest, curfew for the remainder of the sentence, and to 200 hours of community service. He also received a fine of $445,789, representing 100% of the amount of GST/HST that he evaded.

It is important to note that Scholz was not found guilty of anything having to do with the RRSP advantage issue.

 

If you have recently dealt with John Scholz and are concerned that you may be audited, or if you have recently received a notice of reassessment for an alleged “strip” of a registered plan resulting in an “advantage”, call us today. We are here to help!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

Am I Earning Business Income or Investment Income?

The COVID-19 pandemic has created novel socioeconomic conditions where many Canadians are in a state of professional flux. The prospect of earning supplementary income is tantalizing, and retail investing has never been more accessible to the taxpayer.

The advent of smartphone trading apps and low- or no-fee trading has provided many Canadians with the opportunity to purchase and sell securities without the interposition and cost of an investment broker. However, there may be tax implications and/or reporting requirements depending on the type of earnings garnered though retail investing.

While many investors believe that sheltering their investments under a tax-free savings account (TFSA) is the solution to the inclusion dividends or capital gains earned from the purchasing and/or selling of securities in their taxable income for a given taxation year, TFSAs do not offer categorical protection from paying taxes on investment earnings.

It is critical to discern whether the earnings garnered from a retail investor’s securities are “business income” or “investment income” under the Income Tax Act. If the Canada Revenue Agency (CRA) determines that the investment earnings are “business income”, the taxpayer must include those earnings in the taxpayer’s taxable income for that taxation year (regardless of the account in which the investment is being held).

So how does one determine whether investment earnings are “investment income” or “business income” under the Income Tax Act?

 

Investment Income vs. Business Income 

The distinction between “investment income” and “business income” stems from the motive of the taxpayer for purchasing the security. TFSAs are designed to protect “investment income” from taxation, so if a taxpayer is determined to be purchasing a financial instrument with the view of “investing” (as opposed to quickly profiting), this would be material in the CRA’s determination process to characterize the earnings as “investment income” versus “business income”. It is difficult to establish one’s motive for purchasing a security, so assessing this motive typically falls on viewing the activity of the taxpayer with respect to the security and the trading account in general.

The earnings garnered by retail investors could be characterized as business income where the trading undertaken resembles that of a “trader”. Essentially, where the level of trading activity engaged in by the retail investor during the course of the taxation year is analogous to what a trader would undertake, any earnings may be assessed by the CRA as “business income” and included in full in the taxpayer’s income, despite taking up valuable contribution room in the taxpayer’s TFSA.

What sort of activity would re-characterize what would otherwise be “investment income” as “business income”? If a retail investor is trading too frequently to the point where their activity could be labeled “day trading”, the CRA may assess earnings under the TFSA as business income. The exact number of transactions that would constitute “day trading” is not defined and is not the sole factor in determining whether earnings under a TFSA are “business income”. But frequent transactions that would lead a CRA agent to believe that the financial instruments were not purchased with a view to “invest” may be determinative in the CRA’s decision-making process.

The profession of the TFSA-holder would also be considered by the CRA. The CRA may assess what would otherwise be “investment income” as “business income” where the TFSA holder works in the financial sector or deals with securities regularly. This is because the motive of the retail investor may be coloured by his or her profession.

There is no definite method to protect oneself from having earnings under a TFSA (or other registered account) reassessed as “business income”. It is imperative to understand the eligibility requirements of financial instruments held under the TFSA and to be cautious with the type and number of transactions entered into as a TFSA-holder, as the assessment of earnings as business income could have significant tax consequences for the retail investor.

 

If you are concerned about unreported taxable income from your retail investing or wish to carefully plan your investment portfolio to ensure compliance with registered savings plan rules and eligibility requirements, contact a tax professional at Rosen Kirshen Tax Law today!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

What is Considered Non-Taxable Income in Canada?

Every April Canadians and non-resident taxpayers are forced to once again partake in the self-reporting Canadian taxation regime. Penalties for unreported income can be significant and with CRA interest rates on overdue taxes currently set at 5% (and retroactively applicable), what may have originally been a small income tax debt can quickly add up to a life-ruining outstanding balance with the CRA.

Following our previous blog entry on the subject of “What is Considered Taxable Income in Canada?”, this edition will examine those few income sources that the CRA and Income Tax Act have defined as non-taxable sources of income.

 

Government Payments

The first category of income that does not have to be reported as earnings are certain payments from the provincial and federal governments.

Some benefits and credits paid by the provincial and federal governments are considered tax-exempt and do not have to be declared by one’s income tax filings. These include:

1. the GST/HST credit;
2. the Canada Child Benefit; and
3. in Quebec, child assistance payments.

It is not the case, however, that all benefits received from the provincial and federal governments are non-taxable. Notably, COVID-19 response benefits issued by the federal government to assist Canadians with financial strife stemming from the COVID-19 pandemic are to be reported as taxable income of their recipients.

Another governmental payment that is not taxed are some proceeds of litigation. Where a litigant successfully sues a provincial or territorial government and receives a financial award for criminal acts or motor vehicle accidents, the proceeds are generally, not taxable.

 

Tax-Free Savings Accounts (TFSAs) and Registered Savings Plans (RSPs)

Where a taxpayer earns dividend income, interest income or earns capital gains using funds held within a TFSA, the proceeds are not taxable or included in income for a given taxation year. There are, however, exceptions to this general rule as taxpayers who use the TFSA for purposes analogous to a securities trader may be deemed to have earned business income from these earnings.

Additionally, income earned from funds or investment vehicles held under some RSPs are not taxable until they are extracted from the account.

For both TFSAs and RSPs, contribution limits and procedural requirements are strictly enforced and could result in significant financial penalties if not appropriately met.

 

Lottery Winnings, Gifts, and Inheritances

Windfalls such as winnings from the lottery are typically not taxable in Canada unless they are considered to be annuity payments.

In most cases, gifts are not considered to be taxable income in Canada. There are exceptions to this rule, however. For example, where gifts are determined to be capital property, the donor (or gift giver) would have to report any income earned through capital gains on the capital property despite having transferred the donor’s beneficial interest in the asset to another party. Gifts from employers may also be deemed to be taxable where the gift can be construed as a “taxable benefit”.

Similar to gifts, inheritances are usually not taxable in Canada. Unlike the United States, for example, that imposes 18-40% in estate taxes for affluent taxpayers (prior to exemptions), the Canadian taxation regime only features tax consequences for testators who leave capital property to their beneficiaries or who have any tax debt owed to the government at the time of the testator’s death.

 

Other Non-Taxable Income Sources

The above-referenced non-taxable income sources are not an exhaustive list of non-taxable income sources in Canada. There are several statutory exemptions that apply to exempt certain sources of income from taxation in very tailored and specific circumstances. One such example, stemming from paragraph 81(1)(g.1) of the Income Tax Act which deals with compensation when employees pursue their employers for damages through litigation and identifies one source of non-taxable income as: “income for the year from any property acquired by or on behalf of a person as an award of, or pursuant to an action for, damages in respect of physical or mental injury to that person.”

However, it is not in all cases that damages from an employer be considered non-taxable, which was recently the subject of the Tax Court of Canada decision in Saunders v. The Queen.

While there are select provisions in the Income Tax Act that carve out specific statutory exceptions to taxable income inclusions, these provisions (like paragraph 81(1)(g.1)) are often very nuanced and applicable in very narrow circumstances.

 

If you are worried about potential unreported income or would like an opinion as to whether an income source is taxable or non-taxable, contact a tax professional at Rosen Kirshen Tax Law today!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer. 

by Jeff Kirshen

What are GST/HST Carousel Schemes?

A “missing trader scheme” or “carousel scheme” is a fake supply chain created by a group of GST/HST registrants who work in collusion by repeatedly reselling goods to each other. At one point during the purchase and sale of these goods, at least one of the registrants collects GST/HST but does not remit it to the government. This registrant is the “missing trader” who gives the scheme its name. The following is a step-by-step explanation of missing trader/carousel schemes adapted from the CRA’s 2016-2017 Departmental Results Report:

1. First, a GST/HST registrant (Company X) purports to import goods, usually operating within a supply chain; no GST/HST is paid;
2. The goods do not exist, but Company X claims them to be intangible (film rights) or intangible (computer chips);
3. Company X creates fictitious invoices and bank statements to give the appearance that transactions are occurring and that it is charging GST/HST;
4. Company X disappears without remitting the GST/HST collected from the phoney transactions (the “Missing Trader”);
5. The last company in the supply chain claims to export the goods to offshore companies at 0% GST/HST;
6. Each company in the supply chain network files requests for GST/HST refunds (often for millions of dollars) for taxes “paid” to Company X; and
7. Stages (1)-(6) can repeat indefinitely.

These schemes are prevalent in Canada, and the CRA continues to improve its processes to detect and prevent GST/HST refund arrangements that bear a resemblance to them.

 

Carousel Schemes and Precious Metals

The CRA has identified the precious and scrap metals industries as a particularly high-risk target for missing trader/carousel schemes. Taxpayers involved in this industry may participate in these schemes by buying pure gold bullion from commercial suppliers (which is not subject to GST/HST) or by buying scrap metal containing gold (which is subject to GST/HST) and from which pure gold bullion can be refined.

Taxpayers who buy pure gold bullion from commercial suppliers utilize missing trader/carousel schemes by melting the bullion down and adding low levels of impurity. After impurities are added, the formerly pure gold can be sold as scrap metal. Once the scrap metal is sold, the seller will charge, but not remit, and often abscond with, GST/HST. The purchaser of the scrap metal will then claim a refund (such as Input Tax Credits) on the GST/HST paid to the seller.

The purchaser of the scrap metal will then melt the scrap metal down and refine and reshape it back into pure gold bullion. Other bullion purchasers down the supply chain will then purchase the bullion, and the cycle can continue indefinitely.

 

Carousel Schemes and CRA Issues

It is not uncommon for taxpayers involved in missing trader/carousel schemes within the precious and scrap metals industries to receive reassessments for tens of millions of dollars in unremitted GST/HST and/or disallowed Input Tax Credits. In 2011, for example, Metaux Kitco, one of Quebec’s most prominent gold-trading companies, was reassessed for $85 million in disallowed Input Tax Credits, and was alleged to be one of approximately 125 companies involved in the scheme alleged to defraud the Canadian government of approximately $350 million (see Cody Kessler, Taxpayer Non-Compliance with Input Tax Credit Rules: Data and Policy Options for Canada, Canadian Tax Journal (2020) 68:3, p 784).

Importantly, the “director’s liability” and “derivative assessment” provisions of the Excise Tax Act can place corporate tax liability on the corporate directors personally. This presents a significant risk for individuals involved in missing trader/carousel schemes.

 

If you or your business are at risk of being involved in a missing trader scheme or carousel scheme, call us today. We are here to help!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

Are Awards Taxable – A Tax Court of Canada Example

In 2020, the Tax Court of Canada published its decision for Saunders v The Queen (2020 TCC 114). The issue in this case is whether monetary awards received by employees following a successful grievance against their employer is taxable as employment income. The following provides a summary and brief comment.

 

The Tax Court Case

The Appellants, who were, at the time, experienced team leaders in the Revenue Collections Division of the CRA, made successful grievances to the Public Service Labour Relations and Employment Board. The grievances addressed an arbitrary overtime policy implemented by Terry Harder, the incoming assistant director of the Calgary Tax Services Office. Under this policy, overtime hours were no longer available to all Collections team leaders, and they were instead only available to team leaders already stationed at a particular section of Collections.

Before the Board, the Appellants successfully argued that the policy breached a clause of their collective agreement with their employer, which stated that the employer was to make every reasonable effort to offer overtime work on an equitable basis. Despite numerous inquiries about the policy change, and despite repeated expressions of interest in working overtime, Mr. Harder denied the appellants access to overtime work. They also described his behaviour toward them as bullying, aggressive, and harassing.

The Board left the parties to negotiate the appropriate amount of monetary compensation for the Appellants’ losses. Mr. Harder, with typical hostility, then sought to negotiate the compensation award himself despite the Appellants’ request for him to delegate the task. He intended to ensure that the compensation would be taxable as income. The parties settled despite the Appellants’ wish to word the settlement agreement to receive the compensation as non-taxable damages for personal injury rather than as taxable income.

 

The Tax Court Decision

The Honourable Justice Susan Wong of the Tax Court of Canada decided that the compensation did not meet the exception under paragraph 81(1)(g.1) of the Income Tax Act, which provides that “income for the year from any property acquired by or on behalf of a person as an award of, or pursuant to an action for, damages in respect of physical or mental injury to that person” is not taxable. The compensation was therefore employment income and not damages for personal injury.

Wong J relied on the two questions posed by the Supreme Court of Canada in Tsiaprailis v Canada (2005 SCC 8):

• (1) What was the payment intended to replace?
• (2) Would the replaced amount have been taxable in the recipient’s hands?

The compensation replaced the remuneration the Appellants would have received had they been offered, and accepted, overtime work. While Wong J acknowledged the Appellants’ distinguishing missed overtime, the remuneration for which ought to be taxable, from missed offers of overtime, which ought to be compensated with damages, she did not agree that it was appropriate in the circumstances. The compensation, which was calculated according to the approximate number of overtime hours that the appellants would have worked, replaced remuneration despite breach of the collective employment agreement.

Wong J distinguished the facts in this case from Schwartz v Canada ([1996] SCR 254), which decided on the question whether compensation paid for losses arising from the retraction of an employment offer could be characterized as a retiring allowance and therefore taxable. The employment relationship, the breach of the collective employment agreement, and the lack of any issue concerning retiring allowances, were facts sufficient to depart from Schwartz.

 

Tax Court Comment – RKTL

With respect, it is questionable whether these facts are sufficient to distinguish Schwartz. In that case, the compensation was not characterized as a retiring allowance since the taxpayer was never “in the service” of the offeror and could not therefore be considered an employee under subsection 248(1) of the Act. While, in this case, the compensation may have replaced remuneration otherwise unearned in the service of the employer, this construal overlooks the context in which such remuneration went unearned.

In reaching a settlement, the Appellants referred to the approximate amount of otherwise unearned overtime hours to quantify the awardable compensation, but they would never have been compelled to do so without first suffering Mr. Harder’s un-admirable qualities and the subsequent breach of their collective employment agreement. This leaves open the possibility that the compensation was not paid as foregone earnings “in the service” of their employer but awarded as damages for earnings foregone because of the breach of their employment agreement.

 

If you are receiving an award, and want to know whether it is taxable or not, contact us today!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

Canada’s 2021 Budget and its Impacts on Taxpayers

On April 19^th, 2021, the Deputy Prime Minister and Minister of Finance, the Honourable Chrystia Freeland presented “Budget 2021”, the first federal budget announced by Parliament in more than two years. Subtitled “A Recovery Plan for Jobs, Growth, and Resilience”, Budget 2021 addresses many key concerns of Canadians arising from the pandemic and proposes to invest in Canadians now to incentivize future economic growth.

Budget 2021 sets out to invest in Canadians by including new initiatives like the “National Early Learning and Child Care Plan”, a national program designed to reduce the national average childcare cost by 50% by 2022 with further cost reductions in following years.

Due to the pervasive effect COVID-19 has had on the Canadian economy, it is unsurprising that Budget 2021 projects significant deficits for the foreseeable future (including a projected $354 billion dollar shortfall for this coming fiscal year-end).

In order to support these new expenditures during a period of economic uncertainty and offset these projected shortfalls, the federal government has proposed modifications to Canada’s income tax regime. Some of these implementations will have significant impacts on the Canadian consumer and individual taxpayer.

 

Canada’s 2021 Budget – Excise Tax Act (GST/HST)

Canadian consumers will now be paying a bit more their streaming services. As previously proposed by the federal government, non-resident digital vendors of online services such as Netflix and Spotify will begin to collect GST/HST on the products and services they offer to Canadians, which could see an increase in federal tax revenue in the billions over next five years.

There will also be additional excise duties levied on luxury products like private planes and yachts that exceed cost thresholds outlined by Budget 2021. These luxury taxes will be applied at a rate of the lesser of 10% of the full value of the aircraft or watercraft or 20% of the value that exceeds the federal government’s prescribed thresholds ($100,000 for aircraft and vehicles; $250,000 for watercraft) and will be in addition to the existing sales taxes and purchase prices of these products.

For example: If a consumer purchases a boat in Ontario for $160,000, the lesser of 10% of the total value ($16,000) and 20% of the value that exceeds the federal government’s prescribed threshold (20% of $60,000; $12,000) would be added to the cost of the boat. Assuming all ancillary fees were included with the boat’s purchase price, the boat would cost:

$160,000 + Ontario HST (13%; $20,800) + luxury taxes of $12,000 totalling $192,800.

 

Canada’s 2021 Budget – Filing and Reporting Taxes

A major objective of Budget 2021 surrounds the improved compliance of Canadian taxpayers with respect to filing. The federal government will be incentivizing taxpayers to file their returns electronically by lowering or eliminating return quantum thresholds of taxpayers and their tax preparers, allowing businesses to issue only electronic copies of T4As and T5s, and have eliminated the existing requirements for written signatures on prescribed forms. Some taxpayers that have registered for digital filing will also only receive some notices electronically from the CRA.

 

Canada’s 2021 Budget – Enhanced CRA Enforcement Budget

Budget 2021 will also be boosting the CRA’s existing budget for enforcement in order to capture funds that otherwise may have slipped through the CRA’s current enforcement framework. More than $500 million will be allocated to the CRA’s collections department and aggressive tax planning division and towards new programs to combat tax evasion.

While this upfront cost may seem considerable, the CRA is projected to return billions of dollars from these increased enforcement expenditures.

Budget 2021 also announced that the federal government is also planning to revisit (among others) the existing anti-avoidance rules, transfer-pricing rules and foreign affiliate dumping rules under the Income Tax Act in short order. These revisions could make aggressive tax planning increasingly risky for Canadian taxpayers; what was once strategic tax planning may soon fall under the new revisions to the Income Tax Act anti-avoidance provisions. 

 

If you are concerned about your current tax planning strategy or the impact of any of the new implementations from Budget 2021, contact a tax professional at Rosen Kirshen Tax Law today!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

The Taxation of Trusts in Canada

Trusts receive special tax treatment under Canadian income tax laws. Corporations are taxed as entities separate from the individuals controlling them, and partnerships are taxed such that income earned by the partnership is taxed in the hands of the partners. However, the taxation of trusts is somewhat of a mixture of both: trusts may be taxed either at the level of the trust itself, separate from the beneficiaries entitled to the property it holds, or at the level of the beneficiaries. The dual nature of trust taxation makes trusts a very useful tool for estate planning and tax planning.

Taxpayers will usually find themselves dealing with a trust when the management and control of property in which they have an interest is vested in one person or persons (the “trustee” or “trustees”) and the enjoyment of the property is vested in another person or persons (the “beneficiary” or “beneficiaries”).

 

Types of Trusts in Canada

There are two kinds of trusts: those created by a living person (a “settlor”), which is called an inter vivos (i.e. “between the living”) trust, and those created in consequence of death, which is called a testamentary trust. The most common example of a testamentary trust is a trust created by a will. In estate law, the person who drafted the will is called the “testator”. In the case of a testamentary trust, the testator’s will creates a trust in consequence of the death of the testator.

The Income Tax Act makes no distinction between “trust” and “estate”, and instead refers to both these terms as a “trust”. This means that, for the purposes of income taxation, a “trustee” can refer to either a trustee dealing with the estate (i.e. all the assets and liabilities) of a deceased person (an “estate trustee”) or a trustee dealing with the property of living persons (a “non-estate trustee”).

Other terms of note — “personal representative”, “executor”, and “administrator” – refer to the person(s) to whom the deceased’s estate passes on death. Under the Income Tax Act, the personal representative is referred to as the “legal representative”.  “Personal representative”, “executor”, “administrator”, and “estate trustee” are, for the purposes of taxation, interchangeable terms because the trust under which the property in question is being administered will be taxed in the same way regardless of whether the settlor or testator is alive or deceased.

 

Trusts and their Tax Rules

Sections 104-108 of the Income Tax Act provide the rules of taxation of the income of trusts and beneficiaries. Trusts are, like corporations, individuals for tax purposes, which means that they are taxed like individual taxpayers. Any property transferred to or from a trust is therefore considered a disposition of that property attracting tax on any taxable capital gains arising from that disposition. Avoiding capital gains tax can be a key driver in the way in which trusts are set up.

Capital gains tax on the disposition of property transferred to a trust is commonly incurred in the testamentary situation. Under the Income Tax Act, all capital property of a deceased taxpayer is deemed to have been disposed of, immediately before death, for proceeds of disposition equal to the fair market value of the property. The deceased is then liable to pay, on a “terminal return” for the tax period up to the date of death, tax on any taxable capital gains arising from the disposition of that property. Conversely, the deceased’s estate is deemed to acquire the property of the deceased at a cost equal to the fair market value of the property.

Poor estate planning can sometimes leave trusts or their beneficiaries needlessly liable to pay capital gains tax. However, testamentary and inter vivos trusts can use rollovers to avoid the deemed disposition of capital property as described above, and to thus avoid capital gains tax. “Rollovers” deem property transferred to or from a trust to have been disposed of for proceeds equal to the adjusted cost base (i.e. the original acquisition cost) of the property rather than its fair market value. This prevents the transfer of the property from incurring any capital gain or loss at the time of transfer. Any tax liability is instead deferred until the beneficiaries die (triggering the deemed disposition immediately before death as described above) or until the trust disposes of the property.

 

There are numerous estate planning techniques that rely on the unique tax treatment of trusts. If you have questions regarding your estate planning, trusts, or the taxation of trusts, call us today! We are here to help.

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

The Toronto Vacancy Tax

On December 16, 2020, the City of Toronto approved the implementation of the new tax on vacant Toronto homes. The new tax is expected to generate at least $55 million to $66 million in tax revenue per year. The vacant home tax will be effective in 2022.

While further details of the tax development process will be provided in 2021, it is expected Toronto’s vacant home tax will be styled after Vancouver’s vacancy tax. The latter was introduced in 2016 by the British Columbia provincial government and became effective in 2017.

 

British Columbia Vacancy Tax

Under British Columbia’s Vacancy Tax Bylaw No. 11674, certain vacant properties in the city of Vancouver are subject to a 1%-1.25% tax of the assessed value of the property. A 5% penalty applies for unpaid amounts related to the vacancy tax.

Vancouver’s vacancy tax applies to all taxable property as defined in the provincial bylaw. Taxable property is residential property that is vacant property that is not exempt from taxation and not exempt from the vacancy tax. Residential property is defined as class 1 property such as single-family residences, duplexes, multi-family residences, apartments and condominiums. Vacant property is further defined as residential property that has been unoccupied for more than 180 days from January 1 to December 31 of the year (“Period”) or otherwise deemed by the rules. A property that is the principal residence of the occupier or is being rented out for at least 30 consecutive days will not be considered unoccupied.

Uninhabitable properties that do not meet the enumerated exemptions are generally taxable.

Since the vacancy tax became effective on January 1, 2017, all homeowners in Vancouver are required to submit a property tax declaration each year.  If the homeowner fails to make a declaration, or makes a false declaration, then the property will be deemed vacant under the rules and possibly subject to the vacancy tax if the other criteria apply.

 

Vacancy Tax Exemptions

Exemptions from the vacancy tax are available.  Homeowners who are away from the property for more than 180 days due to death, property renovations, hospitalization or court order will not be required to pay the vacancy tax under the Vancouver bylaw. Further exemptions apply for certain strata units and land that is limited in its lawful use. Homeowners are further exempt from the vacancy tax if title was transferred during the Period. Furthermore, even if the property is not the homeowner’s principal residence, the vacancy tax will not apply if the homeowner occupies the home for a minimum of 180 days during the Period.

 

Vacancy Tax Audits

During the pandemic, audits continued to be conducted in respect to the vacancy tax. An estimated 4% of Vancouver homes were audited. With the introduction of the vacancy tax on Toronto properties to be implemented in 2022, it is expected similar audits will be conducted. Taxpayers who own commercial properties, vacant land, property of which a portion is uninhabitable, or property which will undergoing lengthy renovations should consider the application of the vacancy tax in their planning. Evidentiary issues relating to the use of different mailing addresses or lack of tenancy documentation should also be considered.

 

The vacant home tax is expected to generate significant tax revenues and increase the Toronto housing supply. However, the tax changes will impact taxpayers in Toronto should the new rules apply to them. If you have questions, or want to look into a tax plan to ensure you don’t run afoul of the vacancy tax, speak with a qualified tax lawyer today!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

S.45(2) Election and the Changes in Use of Property

Many Canadian taxpayers are aware that the disposition of a property typically triggers a capital gain. In other words, the taxpayer is required to pay a tax on the profit realized from selling the property at a price higher than in which they purchased it. One exception to this rule is if the property in question was the taxpayer’s principal residence. Indeed, if a property qualifies as a taxpayer’s principal residence, he or she can use the principal residence exemption to reduce or eliminate any capital gain otherwise occurring, for income tax purposes.

However, what happens if the property changes its “use” during ownership? For example, what happens if a taxpayer resides in a property but later decides he or she wants to starting renting it out or vice versa? We first discussed changes of use in this blog post, and now, the current post will briefly explain the Income Tax Act rules regarding the change of “use” in properties and the s.45(2) late election request.

 

What is a Change of Use?

The Income Tax Act (“ITA”) deems a taxpayer to have disposed of, and immediately reacquired the property (at the cost equal to fair market value), when the taxpayer changes the “use” of a property from income-earning to personal use or vice versa. This means that anytime a taxpayer changes its property from a rental property to principal residence (or vice versa), the taxpayer will have to pay a capital gain tax on the fair market value minus the purchase cost of the house.

Taxpayers must be very watchful for deemed disposition rules because they may not have the requisite funds to pay for the tax owing. Consider the normal scenario where the taxpayer owes capital gain tax after selling his or her property. The taxpayer would be able to use the funds received from the sale of the home to pay for the tax owing. In contrast, a deemed disposition would require the taxpayer to owe the same amount of tax but not have the actual profits from selling the home.

 

Subsection 45(2) Election

S.45(2) of the ITA carves out a way that allows taxpayers to be deemed not to have made the change in “use” of the property. This means that taxpayers can elect not to be considered as having started to use the property as income producing, and subsequently not report any capital gain. This election is done in the year that the change of use occurs.

It is important to note that taxpayers can only make the s.45(2) election if they satisfy the following:

• You must report the net rental or business income you earn; and
• You cannot claim any capital cost allowance (CCA) on the property

Additionally, a property can qualify as a taxpayer’s principal residence for up to 4 years during which a subsection 45(2) election remains in force, even if the housing unit is not ordinarily inhabited during those years by the taxpayer or by his/her spouse. However, the taxpayer must be a resident or deemed to be a resident, in Canada during those years for the full benefit of the principal residence exemptions to apply.

 

What if I miss the Deadline to file the Election?

While the CRA may allow late elections requests even after the change in use of property has already occurred, penalties may apply. Specifically, s.220(3) of the ITA requires taxpayers to pay the lesser of the following:

• $8,000; or
• $100 for each complete month from the election’s original due date to the date the application is made in a form satisfactory to the CRA.

 

Further to the above, if you miss the deadline for the election, technically you have income taxes to pay because the change in use means there is a deemed sale. This can be a very complex matter and professional assistance is recommended. If you have questions regarding the s.45(2) election request, want to file one, or you’re late in filing one already, contact a professional at Rosen Kirshen Tax Law today! We are help to help.

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

Employee Stock Options

Employee stock options give employees the right to purchase a specified number of shares of a company at a specified price. Employees can derive financial and tax benefits from these stock options if they exercise their options when the market purchase price of the stock is greater than the purchase price specified by the option. They can then sell the stocks they own. However, there are important tax rules that must be understood when an employee exercises their options, and also when those stocks are sold.

 

Employee Stock Option – Public Companies and Tax Benefits

The following analysis is for stock options granted by public companies.

Under paragraph 7(1)(a) of the Income Tax Act, employees are taxed on the difference between the amount they pay to purchase their option and the fair market value of the stock at the time they exercise the option. The way in which employees are taxed on employee stock options is similar to the way in which they would be taxed on a bonus.

For example, if an employee is given an option to purchase stock for $1,000 and, at the time the employee exercises the option, the fair market value of the stock is $2,000, then the employee will be taxed on the $1,000 difference between the exercise price and the fair market value. This will be counted as employment income in the year the option is exercised.

The way in which employees are taxed on the exercise of their stock options creates the possibility for double taxation. Usually, when an employee sells stock purchased with an employee stock option, the gain incurred from the sale is taxed as a capital gain. In this case, and using the above example, the $1,000 option purchase price would be the cost base for the stock, while the $2,000 fair market value of the stock would be the price of disposition (assuming that the stock is sold for fair market value). The $1,000 difference would be the taxable capital gain. Double taxation can arise here because the employee could be taxed twice: once when the employee exercises the option, and again when the employee sells the stock.

Fortunately, paragraph 53(1)(j) of the Act provides that the difference between the exercise price and the fair market value is to be added to the cost base for the stock. This means that, for the above example, the $1,000 difference between the employee’s exercise price and the stock’s fair market value would be added to the $1,000 cost base on the sale of the stock. Now, with a $2,000 cost base, there would be a $0 difference between the cost base and the price of disposition. The employee’s taxable capital gain would be cancelled out.

 

Employee Stock Option – Canadian Controlled Private Corporations

If options are provided by a Canadian-controlled private corporation (“CCPC”), and those options are exercised, the taxable benefit mentioned above will only be added to the employee’s income when the stock is actually sold. This is the benefit of exercising options that were granted by a CCPC, you don’t pay any of the taxes until you actually sell.

These shares may also be eligible for the lifetime capital gains exemption. There are specific rules and conditions that must be met before being eligible for this exemption so please consult a tax lawyer.

 

Employee Stock Options – Tax Deferral

The Income Tax Act provides other mechanisms for the preferential treatment of employee stock options. Under paragraphs 110(1)(d) and (d.1), only half of the difference between the exercise price and the fair market value is taxable. This preferential treatment is, however, limited to certain circumstances: employees must deal at arm’s length with their employer, must generally receive prescribed stock on the exercise of options (rather than generally receiving cash), and, on the date the option is granted, the purchase price specified by the option must be greater than or equal to the fair market value of the stock. Also, if the employer granting the option is a CCPC, the employee must hold the stock for at least two years.

 

Employee stock options are useful for attracting and retaining employees. For CCPCs especially, employee stock options can act as tax subsidies because they can offer potential employees tax-deferred compensation in exchange for cash investment in the stock of the corporation. If a CCPC is strapped for cash, and if markets are rising, employee stock options can be an ideal means of taking advantage of such circumstances. If you have questions regarding employee stock options, or if you are interested in learning how to use them to your advantage, call us today!

 

**Disclaimer

This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.