Accounting

by Jeff Kirshen

Should I Keep a Logbook for my Expenses?

Canadian Taxpayers can reduce their taxable income by claiming business expenses against the revenue they received. For individuals and businesses seeking these deductions, the Canada Revenue Agency (the “CRA”) allows you to claim any “reasonable” business expense.

Business expenses are defined as certain costs that are reasonable for a particular type of business, and that are incurred for the purposes of earning income. Business expenses can be deducted for tax purposes. However, personal, living, or other expenses not related to the business cannot be deducted for tax purposes.

For more information on business expenses and examples of expenses, click here.

Therefore, it is essential that taxpayers clearly distinguish between business expenses and personal expenses throughout the year. Some tips include keeping a separate bank account and following recognized accounting practices. However, one essential tip involves proper record keeping, and that is using a Logbook.

 

What is a Logbook?

Logbooks are used for keeping track of your expenses for work-related expenditures. Generally, the CRA has requirements that must be followed, which may vary depending on the type of expense.

For the purposes of this blog, we will explore three distinct expenses: Motor Vehicles, Gifts, and Meals and Entertainment.

 

Motor Vehicles

Businesses can generally claim travel expenses for the cost of driving a vehicle. Recording all of your driving in a mileage logbook is the best evidence to support claiming a deduction for your business travels.

Generally, for any trip to be logged as a business-related expense, you’ll need to note the following in your logbook:

• Date;
• Destination;
• Purpose; and
• Number of kilometers driven.

For added certainty, drivers may also take a picture of their odometer before and after their trip to substantiate the number of kilometers driven. You’ll also need to report the odometer reading at the start and end of the year. In the event that you changed vehicles, you will need to record the dates of the vehicle change and the odometer reading when the change occurred.

In addition, motor vehicle expenses can also be deducted if they are reasonable and there are receipts to support the expense. Some examples of Motor Vehicle Expenses include:

• License and registration costs;
• Fuel & oil;
• Insurance;
• Maintenance & repairs;
• Leasing costs; and
• Interest payments on money used to purchase the vehicle.

You can claim a deduction for these expenses in proportion to the use of the vehicle for business purposes. For example, if your vehicle is used 80% of the time for business purposes, then you can claim 80% of the expenses.

Lastly, if there are multiple business vehicles, a separate logbook must be kept for each vehicle.

 

Gifts

Sometimes gifts are provided and should be considered a business expense. For example, if someone refers you business, you may give them a gift and claim it is a business expense because that gift means they will continue to refer business to you.

Generally, for any Gift, you must log:

• The name and business address of the customer or employee receiving the gift;
• A description of the gift and the purpose it is for (or in the case of an award, the description of what the recipient did to obtain the award); and
• A receipt or other forms of documentation for the purchase.

 

Meals and Entertainment Expenses

Taxpayers and business owners can claim food, beverage, and entertainment expenses when these expenses are incurred for the purpose of earning income from a business or property.

Generally, for any Meals and Entertainment Expenses, you must log:

• The names and business addresses of the customers or persons being entertained;
• Contact details of the parties;
• A description of the client matter or income that the expense relates to; and
• A receipt or other forms of documentation for the purchase.

The maximum amount you can claim for food, beverages, and entertainment expenses is 50% of the lesser between the actual amount incurred for these expenses and the amount that is reasonable in the circumstances. This amount also applies to employees.

There are some circumstances where you’re allowed to claim 100% of your meal and entertainment expenses. Some examples include:

• Your meal and entertainment are included in the travel fee (for example, when you’re travelling by plane);
• You incurred meal and entertainment expenses for a work event, and you invite all of your employees (or all employees from a particular location). Note: you can only claim for six of such events per year; and
• Businesses that regularly provide food, beverages, or entertainment for compensation, such as restaurants or hotels, can claim 100% of such expenses.

 

For more information on why you should keep your receipts and records, click here. If you are being audited for your expenses, or CRA has already denied them, call us today! We can 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

What is Rental Income in Canada?

Rental income is the money or value you receive when you rent out property that you either own, or have the use of. The property may be yours wholly, or owned with someone else. Essentially, if you are earning income (money, value of goods received, etc.) from renting out a house, room, office, apartment, or any other property whatsoever, you are earning rental income.

 

Is it classified as Rental Income or Business Income?

To determine this, you will need to take into account the types of services you provide for your tenants. If the only service you provide is renting the space out, it is likely you are earning rental income. However, if you provide additional services to tenants, such as routine security checks/security systems, cleaning or meals, you are likely to be deemed to carry on a business. Generally speaking, the more services you provide to the tenant, the greater the likelihood the CRA will deem you to be running a business. As an example, a bed and breakfast may be considered business income because the work being expended is much more than just renting out a room.

The Canada Revenue Agency takes a hard look at those earning income from rentals while claiming it as business income. So be sure you check with a tax professional before making this determination.

 

Calculating your Rental Income or Loss

If at any point during the year you received rental income, you must file a statement of income and expense along with your tax returns. This is done by completing CRA form T776 which provides space to input rent, expenses and any capital cost allowance (CCA).

When filing out the form, the fiscal period will always be January 1 to December 31, except if it is the first year of your rental operation, in which case the start date will be the date you began renting the property out.

Generally you will need to report rental income for the fiscal period you earn it, regardless of when you actually receive the rent payments (the same goes for calculating your expenses).

In most circumstances, if you have rental income or rental losses, that amount must be reported by the person who owns the rental property.

 

Uncollectible Rent

If you can prove that you have uncollectible rent from a tenant, that amount can be deducted from your gross rental income. To prove rental is uncollectible, you must demonstrate that the debt is:

• Owing to you at the end of the tax year;
• Uncollectible during the tax year; and
• Included or deemed to have been included in your income for the year or a previous tax year.

Be sure to have proof of this, as the CRA will always ask for it when reviewing if a debt is uncollectible.

 

Rental Expenses

As a property renter, you are able to deduct any expenses you incur to earn rental income that are reasonable. The two basic types of expenses are:

• Current expenses; and
• Capital expenses.

Current expenses are recurring expenses that provide a short-term benefit. You can deduct current expenses from your gross rental income in the year you incur them.

As for capital expenses, they provide a benefit that usually lasts for several years. Generally, you cannot deduct the full amount of these expenses in the year you incur them. You will deduct these types of expenses over a period of several years (this is where the CCA mentioned earlier comes into play).

Personal Portion

If you live in the same building/unit that you are also renting out, you can claim the amount of the expenses that relate to the area that is being rented out.

For items that relate 100% to the rented rooms only, such as repairs and maintenance, you can deduct the total amount of the expenses.

For items such as insurance and taxes that relate to the whole building, you can only deduct the portion that relates to the rented rooms/units.

Lastly, there are some expenses that cannot be deducted no matter the situation and those include:

• Land transfer taxes;
• Mortgage principal; and
• Value of your own labour.

 

Overall, knowing how to calculate gross rental income, and which expenses are deductible, and which are not, seems straightforward, but if not executed correctly, can bring about unwanted tax consequences. If you have any questions or need any assistance regarding your rental property, or any tax matter, please feel free to contact us!

 

**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

Allowable Business Investment Loss Claims

An allowable business investment loss (“ABIL”) is a special type of capital loss that is deductible against all sources of income. This is different from capital losses that can only be deducted against capital gains. An ABIL can be carried back 3 years and carried forward 10 years. After 10 years, the unused ABIL will be treated as net capital loss and carried forward to be deductible against taxable gains indefinitely.

 

Business Investment Loss

An ABIL is 50% of a business investment loss.  A business investment loss can be incurred in the following scenarios:

1. Actual Disposition

When there is a capital loss from an actual disposition of a share of capital stock of a small business corporation or debt in a Canadian-controlled private corporation (“CCPC”) to an arm’s length individual, a business investment loss occurs. An arms-length person is a party not related to you or does not share a common interest with you.

Debt in a CCPC also includes:

• • A small business corporation,
  • A small business corporation at the time it became bankrupt, or
  • An insolvent corporation and a small business corporation at the time winding-up order was made in respect of the corporation.

Under s.125(7) of the Income Tax Act, a CCPC is defined generally as a Canadian private corporation, not controlled by a non-resident or public corporations.

To qualify as a small business corporation, at least 90% of the fair market value of the assets of the CCPC must be attributable to (1) assets primarily used in an active business carried on largely in Canada by the CCPC or a related corporation, or (2) shares or debt obligations of other small business corporations in respect of which the holding corporation owns more than 10% of the shares.

If the corporation meets these criteria at any time in the 12 months preceding the disposition of the shares or debt, it can qualify as a small business corporation.

Another way a business investment loss can occur is if the taxpayer has to repay a corporation debt from a previously made guarantee.

2. Deemed Disposition

Under s.50(1) of the Income Tax Act, a deemed disposition can occur when a taxpayer is deemed to have disposed of the share or debt at the end of the taxation year for no proceeds as well as immediately reacquired the property for zero or nil. In other words, a deemed disposition can occur if a debt owing to you at the end of a taxation year is considered “bad debt” (meaning uncollectible) or a share in a corporation owned at the end of the year, where the corporation has become bankrupt, or insolvent, and a winding-up order has been made in the year.

 

How to Claim ABIL?

To claim ABIL on your 2021 income tax return, you enter the business investment loss amount on line 21699 of your income tax benefit return. If you claimed a capital gains deduction in a previous year, you have to reduce your business investment loss. To determine the reduction, the Canada Revenue Agency (“CRA”) provided a formula to complete the calculation.

Also, you should include a note on your income tax and benefit return that states the following:

• name of the small business corporation;
• number and class of shares, or the type of debt you disposed of;
• insolvency, bankruptcy, or wind-up date;
• the date you bought the shares or the date you acquired the debt;
• amount of the proceeds of disposition;
• adjusted cost base of the shares or debt;
• outlays and expenses on the disposition; and
• amount of the loss.

The CRA tends to audit ABILs regularly, so it is important to keep supporting documents.

 

If you have questions about the above, have attempted to claim a business investment loss, or an allowable business investment loss and the CRA is auditing your loss claim, give us a call 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 Happens to an RRSP Upon Death?

To put it rather simply, a Registered Retirement Savings Plan (“RRSP”), is a tool created by the Government of Canada designed to help individuals invest and/or save for their inevitable retirement. The RRSP program provides incentives to individuals who contribute to it in the form of tax advantages, in order to encourage individuals to save. For a detailed breakdown of what an RRSP is and all its advantages, please refer to the hyperlink above.

 

What is an RRSP Annuitant?

As defined by the Government of Canada, a registered retirement savings plan (RRSP) annuitant is the person for whom a retirement plan provides retirement income.

 

What happens to the RRSP funds upon death?

The Canada Revenue Agency (“CRA”) has attempted, over the years, to clarify this matter for individuals to adequately prepare for death’s financial consequences. Generally, upon death of the annuitant, the RRSP issuer (usually a bank or trust company) will prepare a slip to describe how the funds from the RRSP account are to be paid out.

There are three distinct periods that matter for our purposes:

1. The day the annuitant died;
2. From the day after death until December 31 of the year after the year of death; and
3. From January 1 of the year after the period described in #2 to the date the RRSP property is distributed.

These periods are used to calculate which individual will be reporting the RRSP value on their tax return and will determine which slip the RRSP issuer issues to the individual.

 

Day the Annuitant Died

The amount of the RRSP for the purpose of this section will be deemed to be the Fair Market Value (“FMV”) of the RRSP account. The CRA considers that the annuitant received the amount at the time of death, so the amount will be reported in box 34 of a T4RSP slip issued by the issuer. The annuitant will be the individual who must report the amount on their final tax return for the purposes of this section.

 

Day after Death until December 31 of the Year after the Year of Death

This section will depend highly on whether the RRSP is matured or unmatured. A matured RRSP is one that is actively paying out income to the annuitant, whereas an unmatured RRSP has not yet started to pay a retirement income. For both matured and unmatured accounts, the amount to claim will be the income earned in the RRSP during the subject period. If the RRSP is unmatured, the income paid to the beneficiary is reported in box 18 of the issuer’s T4RSP slip, whereas if the RRSP is matured, the income is reported in box 28 of the T4RSP issued to the beneficiary.

For the purpose of this section, the beneficiary of the RRSP is the individual who will have to report this amount on their tax return (that being the income earned in the RRSP during the subject period).

 

January 1 of the year after the period described in #2 to the date the RRSP is Distributed

The RRSP amount is calculated the same way as above, that being the income earned in the RRSP during the subject period. Once again, the beneficiary is the individual who will have to report this amount on their tax return.

 

General Rules applying to a deceased annuitant’s RRSP

When the annuitant of an unmatured RRSP dies, the CRA considers that the annuitant received, immediately before death, an amount equal to the fair market value of all the property held in the RRSP at the time of death. This amount and all other amounts the annuitant received from the RRSP in the year must be reported on the annuitant’s income tax and benefit return for the year of death. However, a beneficiary will not have to pay tax on any amount if it can be reasonably regarded as having been included in the deceased annuitant’s income (this is done to avoid double taxation on both the deceased annuitant, and the beneficiary).

However, amounts paid from the RRSP, which represent income earned in the RRSP after the date the annuitant died, must be reported by the beneficiaries (given that these amounts would not have been claimed on the deceased annuitant’s final tax return, someone must pay taxes on that money).

 

Overall, the next steps following the death of an RRSP annuitant are complicated, and if not executed correctly, can bring about unwanted tax consequences. If you have any questions or need any assistance regarding RRSPs, or any tax matter, please feel free to call us toll free at 877-921-8423 or email us at info@rktaxlaw.com.

 

**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 New Canada Recovery Hiring Program

The Federal Government recently announced a new program to assist businesses that have been impacted financially by the Covid-19 pandemic. The Canada Recovery Hiring Program (“CRHP”) offers eligible employers who have experienced a declined in revenue as a result of the pandemic, a subsidy of up to 50 per cent of eligible salary or wages. The goal of the new program is to help businesses increase their hiring and employment practices during a financially difficult time.

Eligible Employers can apply for CRHP support through the Canada Revenue Agency (CRA) for June 6, 2021 (retroactively), through to November 20, 2021.The CRHP will overlap with the Canada Emergency Wage Subsidy (“CEWS”) and eligible employers can choose to claim wage support from either program. Employers can choose the subsidy of whichever program provides them with the greater amount, but they will not be able to use both within the same claim period. CEWS will automatically be applied if both amounts are equal.

 

What is the Difference Between CEWS and CRHP?

The main difference between the two programs is the way that the subsidies are calculated. Please refer to the CRA website for a breakdown of the similarities and differences between the calculation.

 

Who is Eligible?

Most of the eligibility criteria for CRHP and CEWS are the same, including payroll account requirements and required revenue drops.

Most types of employers who are eligible for the CEWS will also be eligible for the CRHP. However, there are some additional requirements for “for-profit” corporations and partnerships to be eligible for the CRHP.

For-profit corporations are eligible only if they are a Canadian-controlled private corporation, and are also eligible for the small business deduction, or are a partnership where at least 50% of interest are help by employers eligible for the CRHP.

You should note that if your employees are eligible for CEWS, then they are also eligible under CRHP. However, employees who were on paid leave are not eligible to be included in the CRHP calculation.

 

How Claim Periods Work

The claim periods for the hiring subsidy match the claim periods for CEWS. Each claim period is a specific period of 4 weeks, beginning on a Sunday.

The subsidy does not renew automatically. Each period, you must confirm that you’re eligible and calculate your amount according to that period’s rules before you apply.

There is a deadline to apply or increase your claim for each period.

 

How to Apply

Unlike CEWS, you only submit one CRHP application for each claim period you are eligible for, even if you have more than one payroll (RP) account. Using the online calculator, you can enter your revenue and employee pay information to see whether your CRHP or CEWS claim would be higher and therefore which subsidy is best to apply for.

There are three ways to apply:

(1) Through your My Business Account, you can find the CRHP application under “Payroll” on the main menu;

(2) Business representatives may apply using the Represent a Client feature. However, note that only representatives authorized at Level 2 or 3 will be able to apply; or

(3)  If you are not able to apply with either of the options mentioned, you can use the Web Forms application by using your web access code (WAC).

 

What Happens After I Apply?

If you are registered for direct deposit, you can expect your payment within 3 to 8 days, and the same for time frame applies for cheques but you also must add mailing time. Each claim period deadline is 180 days after the end of the claim period. There is no availability to change or cancel online yet, however if you need to change from CRHP to CEWS, you can simply submit an application for CEWS that will then replace your CRHP application.

After your application, you will receive a Notice of Determination to know if your claim was accepted, and how much you will receive.

 

If you have any questions or concerns, speak with a tax lawyer to discuss if the CRHP or any other benefits apply to your particular circumstances. 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 Jason Rosen

What is a CRA Net Worth Audit?

Has your CRA auditor informed you that your audit will be a Net Worth Audit? Are you wondering what that means? We previously wrote about Net Worth Audits and Assessments which you can find here. This blog provides more information about net worth audits, what they are, why they occur, and what can be done to fight them.

 

Net Worth Audit

Generally, a standard audit consists of reviewing a taxpayer’s accounting records (i.e., bank statements) as well as other related records. However, in cases where the CRA finds the taxpayer’s records insufficient, the CRA may initiate a Net Worth Audit. Once initiated, the CRA will consider a multitude of factors to arrive at a taxpayer’s taxable income. This can include a review of bank records, assets, and liabilities, along with accounting records. In a way, the CRA is assuming the taxpayer’s unreported income when utilizing a Net Worth Audit. The CRA justifies this type of audit when they claim there is any indication of irregularity or insufficiency in the financial affairs and records of the taxpayer.

The auditor may even increase taxable income if they feel that a taxpayer’s respective tax returns do not support his or her lifestyle (also referred to as a CRA lifestyle audit). This can result in a financial gift from a parent turning into taxable income, or even unidentified bank deposits being termed income. The overall goal of a CRA Net Worth Audit is to increase a taxpayer’s taxable income. If the taxpayer’s books and records are in poor shape, it will be much easier for them to do so.

 

When will CRA use the Net Worth Audit Method?

The CRA refers to a Net Worth Audit as an indirect verification of income. The CRA may rely on the Net Worth Method, if:

• Your books and records are inadequate and indicate potential errors;
• You mix personal and business income into one bank account. For instance, one account may be used for both personal and business transactions;
• The income you reported does not support your lifestyle;
• If the business you are in is in an industry where tax evasion is common; and/or
• If comparable businesses report higher income then your business.

These are all factors that the CRA may rely on to initiate a Net Worth Audit.

 

How do you challenge a Net Worth Audit Tax Assessment?

CRA auditors have immense discretion. Additionally, there is a reverse onus in tax law, meaning that it is on the taxpayer to prove his or her income (as the Canadian tax systems is a self-reporting system). In practice, auditors are allowed to assume facts that a taxpayer must then rebut.

A taxpayer can successfully challenge a net worth assessment by preparing detailed responses and explanations to each assumption of the auditor. The taxpayer’s goal is to demolish the auditor’s assumptions. This is normally done with explanations and documentation rebutting each assumption.

If your audit has been concluded, you may continue to fight the assessment by filing a Notice of Objection and/or appealing to the Tax Court of Canada. The best method to dispute the Net Worth Audit is have your books and records reconstructed to show the difference between the CRA auditor’s accounting and factual assumptions. Providing detailed and accurate records of your finances is key.

 

At Rosen Kirshen Tax Law, we have represented several clients during and after a Net Worth Audit. If a taxpayer wants to appeal a Net Worth Audit tax assessment, we can file a Notice of Objection, challenging the assessment before a CRA Appeals Officer. If you are going through a CRA Net Worth Audit, or have had one completed that you disagre with, and you need assistance, contact us today! We are here to help!

 

**Disclaimer

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

by Jeff Kirshen

Why you Should Keep your Receipts

Keeping your receipts, regardless of the field it pertains to, is a prudent and highly advisable practice. In the area of tax, this practice becomes even more important. In the event you should be audited, reassessed, or be the subject of a processing review, the Canada Revenue Agency (“CRA”) will request (and frankly demand) that the appropriate receipts be provided to verify the information you filed on your tax return is accurate. Keeping your record books accurate will help to ensure the process is as painless as possible.

 

Where do I Keep my Records?

The CRA has stated that you must keep your records at either your place of business (for any business records) or at your residence, unless the CRA has given you express permission to keep them elsewhere. If you would like to obtain the CRA’s permission to keep your records elsewhere, you will need to write to your local tax services office.

 

How long do I have to keep records for?

The record keeping requirement stems from paragraph 230(4)(b) of the Income Tax Act. This section states that every person carrying on business and/or every person who is required to pay taxes shall keep all records and books that are necessary to verify the information until the expiration of six years from the end of the last taxation year. In theory, if you are filing your 2020 return, you should keep the documents until 2026. However, this rule does have some caveats. The six-year requirement for keeping documents relates not only to the original tax year in which you file, but also relates to the tax year in which you are claiming a certain expense/deduction, etc.

Looking at our previous example, when filing your 2020 tax return, the minimum requirement for keeping the relevant documents is 2026. However, if you plan on carrying a business loss forward to use in a future year (say 2030), then the relevant documents to prove the business loss must be kept until 2036. The six-year requirement not only relates to the original year the return was filed, but more importantly, it relates to the year in which the taxpayer plans to use that document.

 

Can I Destroy the Records before the Six-year period Expires?

If you want to destroy the records prior to the retention period expiring, you must request permission from the CRA to do so. In order to obtain this written permission, either yourself or your authorized representative must do one of two things:

• Complete the Form T137 (Request for Destruction of Records); or
• Apply in writing to your local Tax Services Office.

 

In what Situations does the Six-year limitation Period not Apply?

The six-year limitation period does not apply to all possible situations. Some situations in which a different limitation period applies includes:

• When your records and supporting documents concern long-term acquisitions and disposal of property, the share registry, or other historical information that would have an effect on the sale, liquidation or wind‑up of the business, you have to keep them indefinitely.
• If the CRA wants you to keep records for a period longer than six years, a CRA official will let you know how long to keep them either in person or by registered mail.
• If you file an income tax return late, you must keep your records for six years from the date you file that return.
• If you filed an objection or an appeal, you must keep all necessary records until the latest of the following dates:
  • the date the objection or appeal is resolved;
  • the date for filing any further appeal has passed; or
  • the six-year record keeping period has passed.

 

What if I don’t have my Receipts?

All is not lost if you did not keep all of your receipts. That being said, it does make proving your expenses much more challenging. You may attempt to use other methods of proving the expenses, such as bank and credit card statements. The CRA, however, will likely have a hard time accepting your expenses claims. In these types of situations, you should seek the assistance of a professional.

 

Overall, the CRA requirements for record keeping seem simple, but are quite complex. Failure to retain your records for the appropriate period can have a detrimental impact on the successful defence of any audit, processing review, etc. If you are going through a CRA review, and you need assistance with proving your receipts and expenses, 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

Bill C-208 – New Rules for Intergenerational Wealth Transfers

On June 29, 2021, Bill C-208 received Royal Assent. It represents a significant change to the Income Tax Act (“ITA”) for intergenerational wealth transfers. The private member’s bill amended sections 84.1 and 55 of the ITA, providing more flexibility to intergenerational transfers of small businesses, family farms or fishing corporations. For business owners, Bill C-208 may allow access to new tax-efficient strategies when the time comes to pass down the torch to the next generation.

 

Basics of Wealth Transfer

There are two main ways for business owners to pay themselves out: by selling equity (capital gains) or issuing dividends. In Canada, taxpayers may obtain more favourable tax treatment on capital gains than on dividends. They may also be eligible to claim the lifetime capital gains exemption to reduce some or all the tax payable on the sale of qualified businesses.

 

Section 84.1

Section 84.1 of the ITA is a specific anti-avoidance rule intended to prevent surplus stripping, a tax strategy where business owners pull out their earnings as capital gains rather than dividends. The law deems certain transactions involving related parties (a non-arm’s length transaction) as a dividend instead of a capital gain.

One popular method of passing on a business is through the use of a holding corporation. For example, parents sell their shares of a qualified small business corporation to a holding corporation owned by a child or a grandchild. Under the old rules, the transaction would be classified as a non-arm’s length transaction and would be captured by the s.84.1 anti-avoidance provision. The parents would have to pay dividends tax and lose the advantages associated with capital gains. In contrast, had the parents sold to a holding company owned by third parties, the sale would’ve been classified as an arm’s length (unrelated) transaction and deemed a capital gain.

The amendments in Bill C-208 intended to address the application of s. 84.1 on transactions between parents and their children or grandchildren. It effectively provides an exemption to section 84.1 of the ITA where three criteria are met:

1. The business is a qualified small business corporation or a family farm or fishing corporation within the meaning of s. 110.6(1) of the ITA;
2. The purchaser corporation is controlled by one or more children or grandchildren of the taxpayer who are 19 years of age or older; and
3. The purchaser corporation does not dispose of the subject shares within 60 months of the transaction (other than for reasons due to death).

If the transaction meets the three criteria, the transaction would be assessed as a capital gain rather than a dividend and allow the parents to tap into significant tax savings.

Bill C-208 also include additional rules such as limiting a business owner’s access to the lifetime capital gains deductions for corporations with taxable capital employed in Canada over $10 million. Furthermore, the rules also require the business owner to obtain an independent assessment of the business’s fair market value. In the end, there remain many uncertainties in the wording of the new bill, and taxpayers should be vigilant when planning the sale of their family business.

 

Section 55

Subsection 55(2) of the ITA is a specific anti-avoidance rule that would apply to certain transactions involving the transfer of a corporation’s cash or property. Before the amendment, the rule converts tax-free inter-corporate dividends into a capital gain in some circumstances. There were exceptions to this rule for related persons, but it did not apply to siblings. However, Bill C-208 effectively expanded the related person exception to provide additional tax savings to transactions involving siblings.

 

Summary

Bill C-208 introduced new amendments to the ITA to provide small business owners with new tax-efficient strategies for passing on their business to the next generation. Under the new rules, parents may be eligible to report the transaction as a capital gain, as opposed to the transaction being deemed a dividend under the old rules. Furthermore, the amendments relaxed transactions between siblings, adding greater flexibility for transactions within the family.

However, on July 29, 2021, the Department of Finance also indicated its intentions to release further legislative amendments that “honour the spirit of Bill C-208 while safeguarding against any unintended tax avoidance loopholes”. Taxpayers should be wary as these new amendments may change the applicability of Bill C-208.

 

Are you seeking to transfer your small business to your children? Contact us today to schedule an appointment with our team of experts! Rosen Kirshen Tax Law will provide you with the expert advice you need to minimize your tax exposure!

 

**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

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.