Accounting

by Jeff Kirshen

RRSPs Explained

The Registered Retirement Saving’s Plan, also known as an RRSP, is a retirement account that was introduced by the Government of Canada in 1957. The primary purpose of the RRSP is to promote and incentive taxpayers to save for retirement by providing specific tax benefits to those who contribute to their account. Indeed, having many Canadians reach old age with no savings, no ability to work and relying on government assistance to make ends meet would be a national concern. As such, the RRSP was designed to prevent the same by promoting a lifestyle that financially rewards saving during a taxpayer’s working years.

This blog post will briefly examine the various advantages and functions of the Registered Retirement Saving’s Plan.

 

How Does it Work?

As mentioned earlier, the RRSP is a retirement savings account where taxpayers can contribute funds into and hold various investments including cash, GIC’s, stocks (equities), bonds, ETF’s and others. The primary tax advantage of the RRSP is that any contributions are made pre-tax and are allowed to grow tax free until withdrawal. In other words, any money you contribute to the RRSP will be deducted from your taxable income for that year, and will only be taxed in whichever later year the funds are ultimately withdrawn.

 

RRSP Tax Advantages

RRSPs present a tremendous opportunity for savings via tax-deferral. For one, we know that the Canadian tax system operates under progressive rates meaning that higher earned income pays a higher tax (for every dollar earned in that bracket) than the lower-earned income. The idea of the RRSP is to deduct as much taxable income as possible during your working years, presumably when you would be earning in the highest tax bracket, and subsequently pay the deferred tax during your retirement years when you would likely be in the lowest tax bracket.

For example, if Taxpayer A earns $100,000 but contributes $18,000 to their RRSP, his/her taxable income would effectively be $82,000 for that year. If the Taxpayer subsequently withdraws the same amount years later after they retired (assuming $0 income), they would be paying 15% on that amount as opposed to the higher 20.5% and 29% tax brackets.

More importantly, the taxpayer gets to immediately recognize the tax advantage of decreasing their tax burden at present and deferring payment until years later. This is arguably the key differentiating factor between RRSP’s and the Tax-Free Savings Account (“TFSA”), another savings account promoted by the Government of Canada.  Despite TFSA withdrawals being ultimately tax free, any contributions made to the TFSA do not reduce the taxpayer’s income by the same amount. Alternatively, RRSP’s withdrawals are considered taxable income, but contributions are considered a tax deduction and effectively will lower the taxpayer’s income.

The other main tax advantage of the RRSP is that investments can grow tax-free until withdrawal. Using the example above, if the taxpayer purchases $18,000 worth of equites which issue quarterly dividends, both the capital gain and dividend income will not be taxed until the withdrawal date.  This means that the taxpayer can capture the whole dividend income and use it to purchase more equities or other growth-type investments rather than pay a portion to the CRA. Indeed, by allowing the gains to be tax-deferred, this allows investments inside the RRSP to compound and grow at a much faster compared to just investing in a normal brokerage account.

 

RRSP Contribution and Deduction Limits

Naturally, there is a limit to how much a taxpayer can contribute to the RRSP annually. The Canada Revenue Agency (“CRA”) typically calculates a taxpayer’s RRSP deduction limit as the following:

• The Lesser of
  • 18% of your earned income in the previous year; or
  • RRSP limit ($27,830 as of 2020).

Importantly, any unused contribution amounts from preceding years carry forward to the contribution limit. That said, unused amounts do not carry over for deduction limits and the maximum amount is capped at 18% of your income or the RRSP limit. Taxpayers must be careful not to overcontribute as there is tax penalty of 1% per month on contributions that exceed their RRSP deduction limit by more than $2,000.

 

Additional Factors Regarding Contributions and Withdrawals

The RRSP contribution age limit is 71. After that, the RRSP will either convert to a Registered Retirement Income Fund (“RRIF”) or the full amount must be withdrawn and taxed that year. Taxpayer’s can also withdraw from their RRSP anytime before 71, but the withdrawals will be considered taxable income for that year.

One exception to the above rule is the Home Buyer’s Plan (“HBP”). This program allows eligible taxpayers to withdraw up to $35,000 tax-free from their RRSP to help purchase their first home ($25,000 limit for withdraws before March 2019). This incentive aligns with another one of Canada’s policy objectives of promoting home buying for taxpayers. Nevertheless, any amounts taken out from the RRSP via the HBP must be eventually paid back. In effect, taxpayers looking to purchase a new home can view the $35,000 amount in their RRSP as an interest free loan.

 

Conclusion

The RRSP is truly one of the few great tax saving accounts the Government of Canada promotes and provides to taxpayers. However, there are complex rules surrounding the application of the RRSP and taxpayers must ensure they do not fall into any pitfalls causing unnecessary financial damage to their accounts. If done correctly, taxpayers will benefit greatly from contributing to the RRSP and even get ahead in purchasing their first new home.

 

If you need assistance with structuring your RRSP or have any general inquiries, contact us today. Professionals at Rosen Kirshen Tax Law have years of experience developing effective tax planning structures specifically tailored to each individual taxpayer. We’re 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

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.

by Jeff Kirshen

Shareholder Loans and the CRA

Many independent business owners dedicate a significant part of their time and effort into managing the operations of their business. Naturally, it is difficult for business owners to separate their personal life and the time spent managing their business. A common consequence from these set of circumstances is that owners start using their corporate account or credit cards to fund personal purchases and vice versa. This may be better known as “shareholder loans” and “shareholder benefits”.

The Government of Canada recognizes that this is relatively a common phenomenon and has provisions in the Income Tax Act to ensure that they are dealt with effectively and fairly. This post will briefly highlight the main tax consequences of shareholder benefits/loans and what business owners should be aware of. For a previous blog post overview of shareholder loans in general, please see here.

 

Shareholder Loans and Benefits

A shareholder benefit is money given by a corporation to one of its shareholder, or to a person or partnership who does not deal at arm’s length with the shareholder. It is intended to capture economic advantages a shareholder may receive which are derived from the corporation. More specifically, s.15(1) of the Income Tax Act ensures that the value of any such “benefits” conferred on a shareholder of a corporation are included in income of the shareholder, and taxed.

The term “benefit” however is not explicitly defined in the Income Tax Act and can compass several meanings. As a result, some benefits are easier to recognize than others. For example, a business owner withdrawing cash from their corporate account would be considered a benefit conferred. A more subtle yet just as equally a benefit conferred would be purchasing an item for personal use such as a MacBook with corporate funds. In this case, the value of the MacBook would be attributed as income to the shareholder.

 

How do I Manage Shareholder Loans?

Typically, the balance sheets of corporate accounts have an account called “shareholder loans” to oversee what is owed and paid to the business. For example, if the shareholder deposited excess personal funds to the business, the shareholder loan account would be in the liability section as the business owes the shareholder.

Alternatively, if the shareholder withdrew excess funds from the business, the shareholder loan account would appear on the asset section as the shareholder owes the business money.

 

Shareholder Benefits – Are there any Workarounds?

It is important to note that dividends or capital distributions are not included as shareholder benefits. This is because when income is extracted from the corporation in the form of a taxable dividend, the amount of the taxable dividend is already fully included in the income of a taxpayer.

Furthermore, s.15(2) of the Income Tax Act allows loans paid to the shareholder not to be deemed a benefit conferred as long as the loan amount is repaid within one taxation year after the end of the taxation year in which the loan was given. The purpose of this rule is to prevent business owners from unfairly providing themselves or other shareholders long term loans that effectively allow them to use corporate funds for personal purchases while deferring their tax obligations.

The Courts have also grappled with the issue of whether or not a benefit is actually conferred when there is an accounting oversight. For example, what happens when an accountant erroneously posts a personal home purchase as a corporate expense rather than debiting the shareholder loan account. In this situation, the Courts determined that an erroneous failure to adjust a loan account does not create tax liability.

 

If used properly, shareholder loans can be an extremely powerful tool for business owners to leverage their corporate accounts. However, improper use of shareholder loans can result in double taxation and audits from the CRA. If your business is being audit or have further questions regarding shareholder loans and benefits, contact a professional at RKTL today! We’re 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 the articles. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

GST/HST Rules for the Supply of Digital Products or Services

The Government of Canada has proposed new measures surrounding the registration and collection and remittance of the goods and services tax / harmonized sales tax (“GST/HST”) for cross-border digital products and services. This comes at a time of accelerated digital shopping and growth in e-commerce as public health measures surrounding COVID-19 remain in place.

 

Current Rules for the Supply of Digital Products or Services

Under the current rules in Canada, any business or company is required to register, collect, and remit the GST/HST on their sales when they exceed $30,000.00 over a 12-month period, are selling taxable supplies, and are carrying on a business in Canada.

Currently, non-resident vendors who are not considered to be “carrying on business” in Canada but are supplying digital products or services to consumers in Canada, are not required to register for the GST/HST and collect and remit GST/HST.

Whether a taxpayer is “carrying on business” in Canada is a factual test. Factors include whether the company is located in Canada, whether the activity is continuous, whether the company has some physical presence, or uses Canadian warehouses or other infrastructure to hold its assets.  Currently, a non-resident online marketplace with only a place of contract, solicitation and payment would not be considered to be carrying on business in Canada despite exceeding the sales threshold.

The current rules place Canadian vendors at a disadvantage since large scale non-resident vendors do not have to charge the GST/HST if they do not carry on business in Canada.  This allows non-resident vendors to provide competitive pricings since the inclusion of tax does not pass to the consumer.

 

Proposed New Rules for the Supply of Digital Products or Services

On November 30, 2020, Minister of Finance, Chrystia Freeland, tabled the Fall Economic Statement 2020, with proposed amendments and draft legislation for new GST/HST registration requirements for non-residents of Canada who do not carry-on commercial activities in Canada. The proposals are effective July 1, 2021. The government consultation period ended February 1, 2021.

Under the proposed legislation, non-resident vendors that supply digital products or services to consumers in Canada would be required to register for the GST/HST and be responsible for collecting and remitting same.

The proposed legislation applies regardless if the non-resident vendor carries on business in Canada or has a permanent establishment in Canada.

Furthermore, digital distribution platform operators, such as the online marketplace which facilitate the sales of the non-resident vendors, would also be required to register for and collect and remit the GST/HST on the sales of goods located in Canadian fulfilment warehouses if the sales to Canadians exceed a certain threshold.

These non-resident vendors and distribution platform operators can register under a new simplified registration system. However, the option to register for the normal GST/HST system remains open.

 

Input Tax Credits

Input tax credits (“ITCs”) allow GST/HST registrations to recover the GST/HST paid on business expenses. However, ITCs can only be claimed under the normal GST/HST system and not the simplified GST/HST system.

The simplified GST/HST system provided in the proposals do not allow for registrants to claim ITCs.

Whether a non-resident vendor should register under the normal or simplified system depends on a variety of factors. A qualified tax lawyer or professional should be consulted prior to the July 1, 2021 effective date to determine a compliance plan accordingly.

 

The new rules surrounding the supply of digital products or services are among some of the new amendments proposed by the Government of Canada in late 2020. Given the complexity of the GST/HST rules and amendments in light of a changing economic landscape, speaking with a qualified tax lawyer or tax professional can assist in ensuring compliance with new or continuing business operations in Canada. Contact us today to learn 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 Kirshen

The Taxation of Electric Vehicles

In recent years, Canada has experienced a significant increase in the adoption rate of ZEV (zero emission vehicle). According to Statistics Canada, electric and plug-in hybrid sales grew from two percent in 2018, to 2.7 percent in 2019, and 3.3 percent in 2020.  While a large reason for the increase in ZEV adoption can be credited to the improvements of battery technology and subsequently a better selection of electric vehicles, the Government of Canada has also implemented many incentives to help lower the costs of ZEVs for Canadian consumers. This post will briefly highlight the main potential ZEV tax incentives Canadians should be aware of.

 

What is a Zero Emission Vehicle?

Before diving into the various types and forms of incentives, taxpayers must first ensure that the vehicle they are looking to purchase qualifies as a ZEV. Transport Canada defines zero emission vehicles (ZEV) as vehicles that has the potential to produce zero tailpipe emissions. They can still have a conventional internal combustion engine but must also be able to operate without using it.

Examples of ZEV’s include the following:

• Battery-electric;
• Plug-in hybrid electric; and
• Hydrogen fuel-cells.

Among others, popular vehicles that qualifies as a ZEV include Tesla Model 3, Audi A3 e-Tron and Chevrolet Volt.

 

Purchase and Lease Incentives

The first incentive offered by the Government of Canada for consumers looking to buy or lease a ZEV is the point of sale incentive. Essentially, the Government of Canada will pay for $5,000 of the final price of an eligible battery-electric, hydrogen fuel cell and longer-range plug-in hybrid vehicles. Alternatively, shorter range plug-in hybrid electronic vehicles are eligible for $2,500. The purchase incentive will be applied at point-of-sale directly on the sale or lease agreement. As a result, the dealership will be responsible for completing the documentation required to receive the incentive.

It is important to note that in order to be eligible for the ZEV program, the vehicle must have either:

• Manufacturer’s Suggested Retail Price (MSRP) of less than $45,000 if vehicle has six seats or lower; or
• Manufacturer’s Suggested Retail Price (MSRP) of less than $55,000 if vehicle has seven seats or greater.

The reasoning for the cap in MSRP is so that the incentive helps overall ZEV adoption rather than just subsidize the purchase price for luxury vehicles.

 

Capital Cost Allowance and Zero Emission Vehicles

In addition to the point of sale incentive, the Government of Canada also introduced two new Capital Cost Allowance (CCA) classes specifically for businesses looking to adopt ZEVs. As mentioned earlier in the previous blog post about CCAs, capital expenditures are distinct from current expenses in that while both may be incurred for the purposes of earning income, only the latter is immediately deductible under the Income Tax Act.

Class 54 now captures ZEV excluding taxicabs and automobiles used for lease and rent. The CCA rate for this class is 30%. Meanwhile, class 55 captures ZEV for leasing/renting taxicabs and the CCA rate for this class is 40%.

Importantly, businesses can now write off 100% of the purchase price of eligible class 54 and class 55 vehicles, up to $55,000, in the year the car becomes available for use. However, the Government of Canada has also implemented the following phase out period:

• 100% after March 18, 2019 and before 2024;
• 75% after 2023 and before 2026;
• 55% after 2025 and before 2028; and
• 0% after 2028.

 

As the world strives for a greener future, electronic vehicles will become increasingly more common place. If your business is looking to purchase ZEV’s and capitalize on the current tax incentives, or you have general questions regarding the deductibility of business expenses, contact a professional at RKTL 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 the articles. If you have specific legal questions you should consult a lawyer.

by Jeff Kirshen

CRA 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 30^th, 2018 and was reassessed on June 1^st, 2020, compounding interest will be charges from the initial filing date (April 30^th, 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 Kirshen

Deducting 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 Kirshen

What 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 Kirshen

What 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 Kirshen

Is 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.