by Jeff KirshenAccommodation Sharing
Recently, many Canadians have been looking to get away from the city and enjoy more spacious living due to the imposed lockdowns. As such, individuals have been turning to accommodating sharing platforms to rent out cottages or bigger homes. For a small pocket of homeowners, this has created a boost in business and an opportunity to generate extra income. Indeed, accommodation sharing has become a lucrative business since the rising popularity of AirBnB. Whether you are operating AirBnB rental units full time as a business or just part time to generate side income, there are several tax implications that homeowners should be aware of.
Rental Income v. Business Income
First, many individuals are surprised to learn that revenue earned from AirBnB and accommodation sharing is taxable. For the most part, income generated through accommodation sharing will be classified as rental income. Homeowners generating rental income will need to report and file a T776 form – Statement of Real Estate Rentals. This form provides details on the income, expenses and capital cost allowance incurred from the property.
Alternatively, in some cases the revenue earned from accommodation sharing should be reported as business income. This is often the case if the homeowner operates multiple units or provides additional services. The CRA notes that in most cases, you are earning an income from your property (rental income) if you rent space and provide basic services only. Basic services include heat, lighting, parking and laundry facilities. However, if you provide additional services to tenants, such as cleaning, security and meals, you will most likely be considered carrying on a business. The more services you provide, the greater the chance that your rental operation is a business.
It is important to remember that anyone who operates a business is required to fill out a T2125 form – Statement of Business or Professional Activities. The T2125 form is a schedule that goes along with a tax return which details the taxpayer’s income, expenses and type of business it’s operating. The following is a more detailed analysis on the T2125 form and its requirements.
GST/HST Remittances and Accommodation Sharing
Another common question many AirBnb hosts have is whether they need to collect and remit sales tax (GST/HST). The first important factor the homeowner must consider is whether they are doing short term or long term rentals. If the homeowner rents out their unit on a long-term basis (more than 30 days), the income is exempt from GST/HST. The second factor is the income threshold. For short term rentals, the homeowner must register and collect GST/HST if their revenue exceeds over $30,000 in 4 consecutive quarters (12 months).
Deductions from Income
One advantage of operating an accommodation sharing rental unit is that you can deduct certain expenses used to operate the unit. The deductibility of an expense usually depends on whether the expense was incurred for the purpose of earning or producing income.
Expenses that are commonly deducted from accommodation sharing units include but are not limited to the following:
- Maintenance and repairs;
- Mortgage interest;
- Utilities;
- Insurance;
- Property taxes; and
- Advertising.
Homeowners should be cognizant of the fact that personal expenses cannot be deducted. In other words, if any of the above-mentioned expenses were incurred for personal use, it cannot be deducted. Similarly, the homeowner should calculate the portion of the expense that was used for business if some of the expense was incurred personally.
Accommodation sharing is expanding and many homeowners are looking at it as a new opportunity to generate income. However, it is critical that they navigate through their tax obligations to ensure they don’t get penalties and interest if mistakes are made. If you are looking to become an accommodation host and have any questions, contact a lawyer a Rosen Kirshen Tax Law 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 KirshenCRA Penalties and Interest: An Update
Many taxpayers are surprised to learn that the Canada Revenue Agency (“CRA”) can and does charge interest and penalties on the outstanding tax liabilities of Canadian taxpayers. Penalties and interest are often applied in concert and can quickly escalate what was originally a minor tax debt into a serious problem for the taxpayer. This post updates our first blog post about CRA penalties and interest. For that post please click here.
Interest Charges
If you owe funds to the CRA, your interest will start on the date that your tax filing was due. This results in taxpayers often receiving assessments or reassessments months or even years after the initial filing date with interest applied from the day that the taxpayer originally filed. For example, if a taxpayer filed a tax return on April 30th, 2018 and was reassessed on June 1st, 2020, compounding interest will be charges from the initial filing date (April 30th, 2018).
CRA compounds interest daily. The rate is available online here with it changing every three months. The current rate is 5%.If all of this interest wasn’t bad enough, the CRA even charges interest on any and all penalties that are assessed to a taxpayer.
Late Filing Penalties
Late filing penalties are charged by the CRA exactly when you expect they would be, when a taxpayer files a tax return past the prescribed filing deadline. If a taxpayer files a late return, CRA will charge an additional 5% on top of the balance owing. Additionally, they will charge 1% of the balance owing for each month late but only to a maximum of twelve months.
For this reason, even if a taxpayer cannot pay the anticipated taxes payable, it is still wise to file one’s return on time to avoid this penalty and subsequently pursue alternative measures of repayment for the outstanding tax liability.
If you know you have missed your filing deadline, you may be eligible for the CRA’s Voluntary Disclosure Program. Click Here for more information about RKTL’s Voluntary Disclosure Program Service.
Repeat Penalties
If you repeatedly make mistakes or file your tax returns late, the CRA can and will assess you for repeated penalties.
If you repeatedly file your tax returns late, the penalty mentioned above will increase up to 10% of the balance owing. Additionally, for each month you are late filing your taxes, the CRA will assess another 2% of the balance owing to a maximum of 20 months.
A “Failure to Report Income” penalty occurs where a taxpayer fails to declare income on a tax return, and also failed to report income in any of the previous three years’ returns. If a taxpayer did not report an amount of income of $500 or more for a taxation year, it will be considered by the CRA to be a failure to report income.
The federal and provincial or territorial penalties are each equal to the lesser of:
- 10% of the amount you failed to report on your return for 2019; or
- 50% of the difference between the understated tax (and/or overstated credits) related to the amount you failed to report and the amount of tax withheld related to the amount you failed to report.
A “Failure to Deduct” penalty relates to Canada Pension Plan, Employment Insurance or income tax remittances. Those who are required to remit these amounts to the CRA, but fail to, will be liable for a 10% penalty on the amount that you did not deduct. The repeated failure to deduct penalty increases this amount to 20%. This occurs where the penalty is charged to someone twice in the same year, or if gross negligence was involved.
Gross Negligence Penalties
The Income Tax Act allows the CRA to charge a penalty of 50% on tax amounts owing, where they believe the taxpayer committed gross negligence. The definition of gross negligence varies but basically, it is where a taxpayer purposefully hides income or over-inflates expenses to pay less taxes.
Trust Fund Penalties
The failure to properly remit penalty occurs where taxpayers do not remit the funds required or make remittance payments on time from the GST/HST and Payroll accounts of incorporated entities (corporations). The CRA views these funds as being held in trust for the CRA. Consequently, failure to remit the funds on time can create serious issues for the taxpayer. Penalties begin to accumulate after a period of just three days past the prescribed remittance date.
This is particularly complicated with respect to GST/HST accounts, due to the complexities of the GST/HST Self-Assessment Rules.
How to Tackle Penalties and Interest
In a perfect world all taxpayers would file their taxes correctly and on time and the CRA would never impose a penalty. However, the complexity of the Canadian taxation regime and the realities of modern life means that this ideal standard that is frequently breached.
The CRA has no remorse for taxpayers who did not receive their correspondences due to a change in address or phone number as the CRA views these changes as essential to report to their offices. Taxpayers can rack up significant debts, be completely unaware of any problem and be ineligible for any relief from the interest and penalties they have accrued. However, there are instances where taxpayers are granted relief from the penalties and interest accumulated by their outstanding tax liability.
One method of seeking relief from existing penalties and interest is to file a Taxpayer Relief Application with the CRA. While every taxpayer has the right to request taxpayer relief, the CRA’s decision to grant the relief is discretionary. Therefore, it is crucial to submit a strong argument that clearly states the reasons why one should be granted relief from the penalties and interest accumulated by one’s alleged failure to meet the CRA’s reporting requirements. For more information on the CRA’s Taxpayer Relief program, check out our blog post.
If you are drowning in debt with CRA, contact a tax lawyer at Rosen Kirshen Tax Law today! We can help deal with any of the above penalties and interest and more!
**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 KirshenDeducting Expenses from your Taxes
Income tax is nothing more than a tax on income. Income, on the other hand, is, for tax purposes, a complex concept that forms the basis of many tax disputes. Additionally, understanding what expenses are deductible and what are not deductible may be a difficult exercise come tax time.
The general rationale for the deductibility rules is that only expenses incurred for the purposes of earning or producing income should be deductible from a taxpayer’s income because only these expenses increase a taxpayer’s ability to pay. Expenses incurred for personal enjoyment, living, or savings, on the other hand, do not increase a taxpayer’s ability to pay and should therefore not be deductible.
Tax disputes often arise over where to draw the line between expenses incurred for the purposes of earning income and expenses incurred for the purposes of personal enjoyment, living, or savings. There are often two important factors to consider in resolving tax disputes of this kind. The first is whether the expense is deductible according to the deductibility rules. The second is whether the amount deducted was deducted at the appropriate time.
The Deductibility of Expenses
As mentioned above, the deductibility of an expense usually depends on whether the expense was incurred for the purpose of earning or producing income. The income for which the expense was incurred must be generated from a business or a property.
Expenses incurred in earning or producing income from a business or property might include, for example, employee wages, interest on money borrowed to finance operations, inventory or supplies costs, or rent and utilities costs for a business premises or rental property. Expenses incurred for personal enjoyment might include, for example, those incurred for the purchase of food, shelter, clothing, or personal entertainment.
Determining the purpose of an expense is fundamental for determining its deductibility. Determining the result of an expense, on the other hand, is irrelevant to determining its deductibility. Although the distinction between “purpose” and “result” may seem vague, it has at least one important consequence: expenses incurred for the purpose of earning or producing income from a business or property are deductible even if the result of incurring those expenses turns out to be a loss. This means, for example, that the expenses incurred in a given tax year for the purpose of starting a business may be deductible even if the business does not earn or produce income in that tax year.
The Timing of the Deduction
Expenses are generally categorized as current expenses or capital expenses (i.e., “capital expenditures”). Current expenses are fully deductible in the year in which they are incurred. Capital expenditures are deductible over a period of time during which the expense provides value to the business (click here for more information on the deduction of capital expenditures).
The general timing rule is that a taxpayer may deduct expenses in the year they are incurred (i.e., current expenses) only if the value of the expense is totally consumed in the year for the purpose of earning or producing income. The reason for this general rule is that, if the value of an expense is totally consumed in earning or producing income, then it cannot have been consumed for personal enjoyment, living, or savings.
On the other hand, if the value of a capital expenditure (e.g., the cost of purchasing a table saw used in a business) is not totally consumed in the year for the purpose of earning or producing income, the portion of the capital expenditure that is not yet consumed still has value. The remaining value is like the value of cash sitting in a bank account and waiting to be used for the purpose of earning or producing income. Just like cash sitting in a bank account, the remaining value of a capital expenditure could still be used for personal enjoyment, living, or savings rather than for the purpose of earning or producing income. This means that the “purpose” of the expenditure is still unknown, and so the portion of the value of the capital expenditure not yet consumed should not be deducted in the year.
It can be difficult to know where and when to draw the line between expenses incurred for the purposes of earning income and expenses incurred for the purposes of personal enjoyment, living, or savings. If you have questions regarding the deductibility of your expenses or when to deduct your expenses, 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.
by Jeff KirshenWhat is FAPI?
Foreign Accrual Property Income, or FAPI, are a set of rules in the Income Tax Act (the “ITA”) that treats property income the same as if accrued domestically or abroad. Where a Canadian resident has a substantial interest or level of control in a foreign corporation, the corporation will be treated as an extension of the Canadian shareholder. The FAPI regime is intended to prevent Canadian residents from avoiding Canadian income tax on passive investment income earned through a controlled foreign affiliate located in a low tax country or tax haven. In this way, income in a controlled foreign affiliate will be taxed in the hands of the Canadian shareholder, even if the shareholder has not yet received funds. The income is taxed in Canada as if it was earned directly. This eliminates any tax deferral advantage in investing offshore.
The FAPI rules only apply to passive income held in a corporation (which is a controlled foreign affiliate) off-shore. They do not apply to active business income earned by a corporation off-shore or to a corporation that is not a controlled foreign affiliate. Passive income includes income from rents, royalties, or taxable capital gains. Active business income includes most types of businesses, such as manufacturing, or other services which require active management.
Canadian resident shareholders to which FAPI can be imputed include individuals, corporations, partnerships, and trusts.
Controlled Foreign Affiliate and FAPI
The level of control that a shareholder exercises over an off-shore corporation is determinative of whether the FAPI rules will apply. If the shareholder owns more than 50% of the shares of the offshore corporation, then the corporation will be considered a controlled foreign affiliate. However, the definition of control is broad and the rules are designed to capture instances where the shareholder continues to control the foreign corporation indirectly.
Where the corporation is a controlled foreign affiliate, the ITA taxes the Canadian shareholders directly when the controlled foreign affiliate earns passive income, eliminating any tax deferral. Where passive income is earned by the controlled foreign affiliate, it is irrelevant whether the foreign country has a tax treaty with Canada.
FAPI is not applicable where the level of control exercised by the shareholder over the off-shore corporation is under 50%, or where the off-shore corporation is otherwise not considered a controlled foreign affiliate. However, there are other tax consequences applicable once a shareholder owns 10% or more of an off-shore corporation. These tax consequences fall under a different regime.
The control rules in the ITA are complex and situation based, and it is recommended a tax lawyer is consulted.
FAPI and Equality / Neutrality
The tax system is designed to be neutral with respect to an investor’s global tax; the Canadian investor’s worldwide tax payable to Canada will be the same whether they invest at home or abroad. The principal of capital export neutrality prevents a Canadian investor from avoiding taxes by moving investments to a tax haven. Income earned abroad is taxable in the country of residence. However, to alleviate double taxation, tax relief is provided to account for foreign taxes paid abroad.
Foreign Tax Credits and FAPI
Canada provides a foreign tax credit under section 126 of the ITA to alleviate any double taxation that may arise when taxes were paid in the foreign jurisdiction on the same income taxed by Canada. For shareholders whose controlled foreign affiliate received FAPI, foreign tax credits are generally applicable where foreign taxes were also paid.
Foreign tax credits are computed by country and must be applied to foreign tax paid on non-business income before being applied to foreign tax paid on business income.
You should know it is possible that your offshore corporation pays tax, and you do not receive tax credits for the taxes paid. A lawyer should be consulted so you are not double taxed.
The CRA also requires a corporation with off-shore affiliates to comply with certain foreign reporting requirements. The FAPI rules are complex and their application will differ on a case-by-case basis. You should speak with a qualified tax lawyer to discuss how FAPI may arise in estate planning or offshore investment planning. 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 KirshenThe Canada Emergency Wage Subsidy
Previously, we wrote about the initial emergency relief Canada Emergency Wage Subsidy (CEWS) implemented by the Government of Canada. As the changes implemented on November 19th build on the already existing CEWS, it is important to have a good understanding of the initial program. Our earlier blog posts on the COVID-19 Benefit Programs and CEWS and can be found here and here.
Essentially, the CEWS operates by subsidizing a percentage of the employee wages to Canadian employers who have seen a drop in their revenue due to the pandemic. The primary goal of the CEWS is to act as a financial crutch for businesses to re-hire workers, prevent further job losses and ease companies back into normal operations. This fundamental characteristic has not changed, and it continues to be the purpose which drives the CEWS.
Changes to the Canada Emergency Wage Subsidy
The following are some notable changes to the CEWS as of November 19, 2020.
- The CEWS has now been extended to June 30, 2021. Moreover, the deadline to apply for the CEWS has been extended to the later of:
- January 31, 2021; or
- 180 days after the end of the claim period.
- The maximum subsidy rates for periods 8 to 10 will remain at 65% (40% base rate + 25% top – up rate) up to the maximum weekly benefit of $734. To be eligible for the maximum 65% subsidy rate, there must be a revenue drop of 70% or more. The following is the dates for the eligible periods:
- Period 8 – September 27, 2020 to October 24, 2020;
- Period 9 – October 25, 2020 to November 21, 2020; and
- Period 10 – November 22 to December 19, 2020.
- Beginning in period 8, the calculation for the top-up rate is based on the higher revenue drop between the following:
- One – month revenue drop for the claim period month used to calculate the base rate; and
- The average revenue drop of the three months prior to claim period month.
Any employer who experiences a revenue drop less than 50% is not eligible for the addition of the top – up rate. Therefore, this change would only apply for employers who have experienced a revenue drop of more than 50%. Click here for the breakdown and calculation of the subsidy amount. The calculator has been updated to include the changes implemented on November 19th, 2020.
- The term “eligible employee” has now been narrowed down to include only those individuals who have been employed in Canada primarily throughout the relevant qualifying period. In other words, wages paid to employees that are not employed in Canada are no longer eligible to be subsidized.
The Canada Emergency Wage Subsidy – What to Watch For?
The changes to the CEWS should be welcomed by Canadian employers as they are ultimately made for their benefit. However, the added changes to the program also mean more calculations and moving parts to consider.
It is critical to remember that the CRA can and will audit taxpayers they suspect are not eligible for the CEWS. The CRA will likely start the audit process by issuing a questionnaire. These questionnaires would be sent to the taxpayer who applied for relief via one of these programs and notify them that the CRA is looking for further clarification with respect to their claim.
For the CEWS, the questionnaire would be concerned with how the employer calculated their payroll for the period for which the employer applied for relief and whether or not the employer had a valid business number and payroll account with the CRA.
Most importantly, the questionnaire would be concerned with how and on what basis the employer calculated their revenue declines. As shown above, the subsidy amount base rate and top up rate depends on the amount of revenue decline experienced by the employer. Therefore, it is imperative that the calculations are done properly.
What initially may seem like a lifeboat can turn out to be a financial and emotional setback if the CRA comes knocking. If you have questions about CEWS or your business is being audited, 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.
by Jeff KirshenWhat is a Taxable Benefit – Part 2
It may come as a surprise to some Canadian taxpayers when they receive a Notice of Assessment with reported income reassessed to be significantly higher than what their reported take-home pay was. This may be because of the inclusion of a “taxable benefit” in the taxpayer’s income. The Canada Revenue Agency (CRA) is within their rights to tax purported benefits received by taxpayers from their employer by virtue of their employment. Many taxpayers are aware that work perks that provide a financial benefit to the employee are usually taxable by the CRA and do report some amount of taxable benefit on their return. For part 1 of our taxable benefit blog post where we discuss what a taxable benefit is, and what can be done if you disagree about receiving taxable benefits, please click here.
However, not all work-related benefits are taxable. So, how can you tell if a benefit you receive by virtue of your employment is taxable? The answer to this question is determined by evaluating whether the benefit falls within the scope of the meaning of “taxable benefit” under the Income Tax Act. When filing their taxes, Canadian taxpayers must examine (1) the “character” of the alleged benefit; (2) the nexus between the alleged benefit and the taxpayer’s employment; and (3) the valuation of the benefit to be included in the taxpayer’s income.
How do I Identify a Taxable Benefit?
Paragraph 6(1)(a) of the Income Tax Act creates a baseline from which employment benefits are determined to be taxable, taxable in part, or non-taxable. Paragraph 6(1)(a) specifically outlines benefits that may be subject to tax as:
“[T]he value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer, or by a person who does not deal at arm’s length with the taxpayer, in the year in respect of, in the course of, or by virtue of the taxpayer’s office of employment.”
Notably, this definition is sufficiently broad to theoretically capture any benefits earned in the course of employment. It becomes necessary to examine how this provision has been interpreted by the courts in order to properly characterize benefits received by virtue of a taxpayer’s employment as either taxable or non-taxable.
Benefits are not restricted to benefits that replace traditional remuneration for employment services. In R. v. Savage, a 1983 Supreme Court of Canada decision, the scope of taxable benefits was explained to include “material acquisition[s] which [confer] an economic benefit on the taxpayer.” Justice Dickson (as he was then) held that material facts determine whether or not the benefit conferred by virtue of employment is “taxable” or “non-taxable”.
The determinative factor is whether or not “something of value” was conveyed by the workplace to the employee. This has taken many forms in Canadian case law including life insurance benefits, health coverage, and even business trips where there is significant personal benefit (usually in the form of “enjoyment”) to the taxpayer.
How do I Determine if the Benefit was Sufficiently Connected to my Employment?
The words in paragraph 6(1)(a) of the Income Tax Act, “in respect of, in the course of, or by virtue of the taxpayer’s office of employment” are sufficiently broad to cover a wide range of direct and indirect benefits received from one’s workplace. In particular, the words “in respect of” have been determined by the Supreme Court of Canada in Nowegijick v The Queen, to be words of the “widest possible scope” and to “import such meanings as ‘in relation to,’ ‘with reference to’ or ‘in connection with’.”
The determinative factor is whether there was any discernable nexus between the benefit conferred to a taxpayer and the taxpayer’s working relationship with the party providing said benefit.
How Much of the Benefit do I Report as Part of my Taxable Income?
There may be some cases where less than the whole of the value of the taxable benefit received by the taxpayer should be included in the taxpayer’s taxable income. The Federal Court of Appeal traditionally held that the value to be included in taxable income should be limited to the cost to the employer. This method was abandoned by the Federal Court of Appeal in Spence v. Canada.
In Spence v. Canada, the court held that the fair market value of the benefit conferred to the taxpayer should be the metric to determine what percentage of the benefit should be included in the taxpayer’s income.
Are Any Employment Benefits Exempt from Taxation?
There are exceptions to the inclusion of employment benefits in taxable income, though they may be susceptible to assessment under other provisions of the Income Tax Act. For example, subparagraph 6(1)(a)(vi) of the Income Tax Act excludes education benefits received by those other than the taxpayer with an employment nexus to the benefit, though this amount may be included as a “scholarship” under paragraph 56(1)(n) of the Income Tax Act.
There are also some prescribed statutory exclusions to the rule in subsection 6(1) of the Income Tax Act. For example, subsection 6(6) excludes any benefits incurred that stem from a “special work site” (typically a remote location that the requires that the taxpayer leave his or her principal place of residence for 36 hours at a time).
If you have questions about taxable benefits, or you’ve been assessed with a benefit that you do not agree with, 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.
by Jeff KirshenTax Residency and Avoiding Double Taxation
Canadian residents are responsible for taxes on their worldwide income. Please see our other article for more information about residency status. A non-resident of Canada for tax purposes will only be responsible for taxes on income received from sources in Canada. However, due to Canada’s source-based taxation rules, Canadian residents who pay non-residents money or transfer property to non-residents may be subject to withholding tax, to be reduced by an application tax treaty. Persons who immigrate or emigrate in the year are taxed when they are considered a resident of Canada for that part of the year. Residency for tax purposes differs from residency in the immigration sense. Tax residency is a question of fact and depends on the specific facts of each case. Knowing what country you are a tax resident of is extremely important so that you are not subject to double taxation.
Tax Treaties and Avoiding Double Taxation
Tax treaties are conventions, agreements, and arrangements Canada negotiates with other countries for the purpose of avoiding double taxation for taxpayers who would otherwise be subject to taxation in both Canada and the foreign country. Another purpose of tax treaties is to prevent tax evasion.
While some countries may tax persons similar to Canada, that is, on their worldwide income based on residency, other countries may levy taxes based on citizenship (United States), or on a territorial basis for income from a source (such as France and Hong Kong).
As a result, a tax treaty is necessary to resolve situations where a single citizen is liable to tax in two or three different countries (if they are resident of one country, a citizen of another, and/or have income generated from another country). An analysis must be completed to determine where a taxpayer is actually resident so that he or she knows what country they are liable to pay tax in.
Tax Residency and Tax Treaties
Tax treaties contain a number of tests that are used to determine what country a person is a tax resident of.
The tie-breaker rules are found in paragraph 2 of the Resident Articles of most of Canada’s income tax treaties. They provide several tests for determining which country can levy its taxes in cases where the person may be liable to tax in two or three different countries. Subsection 250(5) of Canada’s Income Tax Act provides that if a person is considered a Canadian resident, then that person will be deemed to be a non-resident if a tie-breaker rule in the applicable tax treaty treats them as being a resident of the other country.
For breaking the “tie” between residencies, the tie-breaker rules generally provide a permanent home test. Where a permanent home (a permanent dwelling place the individual retains either owned or rented) is available to the individual in one country but not the other, the individual will be considered a resident where that permanent home is available. Therefore, if a dual resident only has a permanent home in one country, the individual will be deemed a resident of that country with the permanent home for the purposes of the tax treaty. The other tie-breaker rules will not have to be considered. If an individual has two permanent homes, one in Canada and abroad, then the next-tie breaker rule will need to be considered.
The Centre of Vital Interests test requires examining the individual’s personal and economic ties with each country to determine which is closest. They are similar to the common law test in determining Canadian residency for tax purposes. Significant primary ties include property ownership, where the common-law partner or spouse resides, and where dependants reside. Significant secondary residential ties include but are not limited to which country the individual’s bank accounts, social clubs, gym memberships, personal property are located. Other considerations are whether the individual has permanently severed ties with Canada (such as by cancelling provincial health coverage by advising of change of address) and the regularity and length of visits to Canada.
Tax Credits for Avoiding Double Taxation
In cases where double taxation may result from having the same income taxed at both the source and the country of residence, Canadian residents can receive a tax credit or exemption depending on the circumstances.
The tax situations involving dual residency can be complex and a taxpayer may need to speak with a tax specialist or lawyer to confirm their residency status. If you have questions about tax residency, double taxation, or tax treaties, 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 KirshenIs Interest Paid on my Investments Deductible?
There is a proverbial expression that goes, “It takes money to make money”. When taken literally, this expression could be interpreted as the act of borrowing and using leverage to help increase income. Of course, this would also mean that a business or individual is increasing their risk in the pursuit of higher returns.
However, what is often overlooked in this endeavour is the room for effective tax planning and restructuring. Mainly, s.20(1)(c)(i) the Canadian Income Tax Act states that in computing a taxpayer’s income for the year, interest paid on borrowed money which is used for the purpose of earning income from a business or property can be deductible. This deductibility allows the individual or business to greatly increase their after-tax rate of return on their investment.
There are several criteria that must be met in order for interest expense to be deductible.
The Conditions of Interest Deductibility
First, it must be established that the money borrowed is used for the purpose of earning business or property income. Examples of property income include rent, dividends and royalties. Share appreciation through capital gains is not considered income. Therefore, if an individual or business purchased shares of a business, they must demonstrate that they expect to receive dividends.
Second, the interest on the borrowed money must be paid in the year or be payable during the year you are claiming the deduction. Lastly, you must be under a legal obligation to pay the interest and the interest expense amount must be reasonable.
It is also important to note that the Income Tax Act explicitly states that the interest expense deductibility is not intended for life insurance policies.
Interest Deductibility – An Example
One application of the interest expense deductibility for taxpayers is to deduct the mortgage on their house. More specifically, one can take out a home equity line of credit on their home and use those funds to invest in dividend yielding stocks or other investments. The interest rate on the home equity line of credit, which is often prime rate or a few points above, would be deductible when computing income.
Similarly, a taxpayer could restructure their borrowings in order to be eligible to deduct their interest expense. Consider the scenario where a taxpayer already owns 1000 shares of a corporation and a personal use condominium that was purchased through borrowed money. At this point, the mortgage paid on the condominium cannot be deducted as it was not borrowed for the purpose of earning income.
However, the taxpayer’s borrowing could be restructured and interest expense deductible if he/she does the following:
- Taxpayer decides to sell the 1000 shares of the Corporation and use that money to pay off the mortgage on the condominium; and
- Taxpayer now takes out a home equity line of credit or borrow money to re-purchase the 1000 shares of the Corporation.
By doing this, the taxpayer has now demonstrated that the new borrowed money was specifically for the purpose of earning income through purchasing shares of the corporation. As previously mentioned, the shares of the corporation must yield a return on capital and cannot be just capital gains. Examples of return on capital include but are not limited to dividend yielding stocks, mutual funds and Real Estate Investment Trusts.
Interest Deductibility – Tax Planning
If carefully planned and managed, individuals and businesses can use the interest expense deductibility provision of the Income Tax Act to greatly increase their after-tax returns on investment. With that in mind, the deductibility of interest continues to very contentious in tax courts and the meanings of “use”, “purpose of earning income” have been highly litigated.
If you need assistance with tax restructuring or have any inquiries regarding interest expenses, contact us today. Professionals at Rosen Kirshen Tax Law have years of experience developing effective tax strategies for both businesses and individuals.
**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 KirshenThe CRA and Automatic Tax Filings
In her 2020 Speech from the Throne, Right Honourable Julie Payette, Governor General of Canada, addressed many potential changes that may be adopted by the Canadian government to address the revenue shortfalls precipitated by the COVID-19 pandemic. One potential new program mentioned by the Governor General would be a new tax filing system whereby individuals will have their income tax returns automatically filed on their behalf with the Canada Revenue Agency each year.
While at first glance this may seem like a long-overdue addition to our self-filing income tax system, the interposition of “automatic” returns could see benefits for some and have unforeseen consequences for others.
The CRA and Automatic Tax Filings
The addition of “automatic” returns to the income tax filing framework of the Canada Revenue Agency (CRA) would allow for the filing of millions of individual tax returns each year that otherwise go unrecorded. The CRA already has access to most of the requisite taxpayer information and receives much of what would be required to file simple returns from employers and institutions. While the idea of an “automatic” filing program may seem radical to some, if Canada were to allow for “automatic” returns today, we would be the 37th nation to do so.
Right now, the CRA offers “File My Return” services, whereby low-income taxpayers can receive income tax refunds and benefits simply by sharing personal information. Taxpayers do not have to complete any calculations or fill out any paper forms. However, as of now not every taxpayer is permitted to file using this service.
Those who are eligible receive confirmation via mail of their eligibility for the File My Return services. Taxpayers must complete this process via telephone after receiving their eligibility letter in the mail. “Automatic” returns would be different from this process as, presumably, no action would have to be taken on the part of the taxpayer in terms of filing. For example, in the UK, taxpayers who meet all of their income tax remittance requirements at the source (usually having their taxes deducted directly from income earned) and are not required to make any self-assessment for any other reason, still qualify for benefits and refunds despite never having personally filed a return on their own behalf or having shared additional information with the UK tax collection service.
Automatic Tax Filings – Who Benefits?
Many Canadians do not file their tax returns each year. For example, in Ontario approximately 16% of adults do not file an annual tax return. This could be for a host of reasons, one of the main reasons being that in situations where taxpayers do not believe that they owe anything to the government, they do not file a return. The program could abridge this gap and provide for millions of additional returns each year.
Ultimately, it will be the federal government who decides what the eligibility thresholds for the “automatic” return program would be. These standards would determine to whom the program would apply.
The “automatic” returns are reportedly slated to be free for all citizens. Citizens who previously did not have access to certain benefits because due to non-filing would have the potential to have their filings up-to-date and consequently become eligible for federal tax benefits, such as the Disability Tax Credit or the Canada Child Benefit. Thus, “automatic” returns have the potential to improve access to federal programs among marginalized members of the citizenry, whether their lack of access to proper filing is the result of financial bars or a low degree of financial sophistication.
Additionally, low-income Canadians with simple income tax returns may be able to avoid filing costs altogether, as in lieu of paying a tax professional to file their returns, the CRA would be completing their returns free of charge.
Automatic Tax Filings – Who Loses?
If a taxpayer’s returns do not fall into the “simple” category, the taxpayer may be under a mistaken belief that the automatic filing system would cover the taxpayer’s filing requirements. This may be the case where a taxpayer qualifies in one taxation year, but the filing circumstances of the taxpayer change in a subsequent year such that the taxpayer no longer meets the program’s eligibility requirements. There can be stark penalties and interest applied to Canadian taxpayers who fail to meet their income tax filing requirements. This could create a potential risk to taxpayers under the mistaken belief that their returns have been adequately filed through the “automatic” return program.
All of this information is also speculative, as no details of the “automatic” return program were announced during 2020’s Speech to the Throne. Careful planning and administration of the program would be central to its success. While an “automatic” return program could pose potential risks to Canadian taxpayers, to many Canadians it could finally provide much needed access to tax refunds and federal programs and services. If you need help with filing your taxes, 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.
by Jeff KirshenWhat is Capital Cost Allowance?
Capital expenditures are distinct from current expenses. While both may be incurred for the purpose of earning income, only the latter is immediately deductible under the Income Tax Act. The former is only deductible pursuant to an exception under paragraph 20(1)(a), which allows for regulations to determine the amount of a capital expenditure that is deductible in a given tax year. This amount is called the “capital cost allowance” (CCA).
What is Depreciable Property?
The property for which capital cost allowance may be claimed is called “depreciable property”. The idea behind this is that the property may be used year after year, while slightly declining in value.
There are prescribed classes of depreciable property listed in Schedule II to the Income Tax Act, the most common of which are listed here. Examples include motor vehicles, tools, or goodwill.
What is Undepreciated Capital Cost?
Regulation 1100(1) sets out the percentage amount of CCA that applies to the “undepreciated capital cost” (UCC) of a class of depreciable property. UCC can be thought of as the cost that a taxpayer estimates to incur in acquiring and keeping depreciable property, which includes not only the purchase price, but also maintenance, legal, accounting, and/or other similar fees. The legal definition of UCC is found under subsection 13(21).
The CCA system allows for taxpayers to recover UCC by deducting it from their income. For example, a professional carpenter who purchases a new power saw for his business can expect for the saw to have the highest possible UCC at the moment of purchase, but he can expect for its UCC to be increasingly used up as it approaches the end of its life. This is because he has been using the depreciation yearly, which continues to lower the UCC of the saw eventually getting down to zero.
Capital Cost Allowance Calculation
The CCA that may be deducted for a class of depreciable property is calculated as follows under Regulation 1100(1):
CCA = CCA % amount x UCC at the end of the tax year
Capital Cost Allowance – Limitations
CCA deductibility may be limited. For instance, since Regulation 1100(1) mandates a determination of the UCC of a class of property at the end of the tax year, no CCA amount, subject to certain exceptions, may be deducted in a tax year if the class of depreciable property has no UCC left over at the end of that tax year and even if UCC was outstanding prior to the end of that tax year. Similarly, for depreciable property acquired during a tax year, only half of the CCA amount is deductible. This is known as the “half year rule”.
The Sale of Capital Assets
If a depreciable property is sold for more than its UCC, the value of the property according to the price for which it is sold will be greater than the value of the property according to its UCC. Under these circumstances, subsection 13(1) provides for a “recapture” by adding the difference in value to the seller’s income. This means that the provision effectively looks back to prior tax years in which too great a CCA amount was deducted, and then reduces the deduction. This ensures that the seller does not deduct from income any CCA that exceeds the actual decline in value of the property.
If a depreciable property is sold for less than its UCC, the value of the property according to the price for which it is sold will be less than the value of the property according to its UCC. Under these circumstances, subsection 20(16) provides for a “terminal loss” by allowing the seller to deduct from income the difference in value.
The possibility of claiming a “terminal loss” does not mean that taxpayers are free to create losses that shelter income but that do not reflect the economic reality of their circumstances. Rental property investments, for example, may present an attractive means of using the CCA system to shelter income, but the Act’s “stop-loss rules” restrict such use. For our blog post further discussing the relationship between rental properties and the CCA system, click here.
If you have questions regarding the capital cost allowance system, or if you are interested in learning how to use it 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.