Administration

by Jeff Kirshen

Am I Earning Business Income or Investment Income?

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

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

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

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

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

 

Investment Income vs. Business Income 

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

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

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

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

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

 

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

 

**Disclaimer

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

by Jeff Kirshen

Are Awards Taxable – A Tax Court of Canada Example

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

 

The Tax Court Case

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

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

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

 

The Tax Court Decision

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

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

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

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

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

 

Tax Court Comment – RKTL

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

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

 

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

 

**Disclaimer

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

by Jeff Kirshen

Canada’s 2021 Budget and its Impacts on Taxpayers

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

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

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

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

 

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

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

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

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

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

 

Canada’s 2021 Budget – Filing and Reporting Taxes

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

 

Canada’s 2021 Budget – Enhanced CRA Enforcement Budget

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

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

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

 

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

 

**Disclaimer

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

by Jeff Kirshen

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

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

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

 

What is a Change of Use?

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

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

 

Subsection 45(2) Election

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

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

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

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

 

What if I miss the Deadline to file the Election?

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

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

 

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

 

**Disclaimer

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

by Jason Rosen

Coinsquare and the CRA

On March 19, 2021, the Honourable Justice Pamel ordered CoinSquare, a major Canadian cryptocurrency exchange to provide a list of all Customer accounts, both active and inactive, either alone or jointly held with any other person(s) or business(es).

Customers are defined as the following:

• Accounts with a value of $20,000 CAD or more from December 31, 2014 to December 31, 2020;
• Customers who have cumulative deposits of $20,000 CAD or more since the account opening; and
• The 16,500 largest Customer accounts by trading volume in CAD dollars between 2014 and 2020, and if not already included, the 16,500 largest Customer accounts by number of trades between 2014 and 2020.

Additionally, the order also required CoinSquare to disclose the following:

• A detailed listing of all cryptocurrency and fiat currency transfers identifying the source and destination of all Customer’s deposits and withdrawals.
• A detailed listing of all trading activity of its Customers, including over the counter (OTC) or off-exchange trades and information indicating over-the-counter (OTC) or off-exchange trades and information indicating the trading pair, buy/sell order, date, time, amount, price per unit, fees, transaction identifier, which can include a list of all known cryptocurrency addresses that were, or may have been, used during the Period of its Customers, either alone or jointly with any other person(s) or business(es).

 

What Does this New Order Mean & How am I Affected?

In short, this new order means that Canadian policy makers are clamping down on taxpayers who are failing to properly report their assets, capital gains or income via crypto currencies. In effect, this will impact both taxpayers who both fail to report their crypto currencies intentionally or by accident. Many crypto trading platforms actively encourage their users to monitor and report their gains from crypto currencies. The CRA has broad powers to investigate and request information from both trading platforms such as CoinSquare as well as individual taxpayers.

If a taxpayer did not disclose their assets or gains from crypto currencies properly, they may still have a chance to come clean via the Voluntary Disclosure Program (“VDP”). You can read about our earliest post on the VDP here and here. Under the Canada Revenue Agency’s Voluntary Disclosure program, taxpayers can come forward to disclose past non-compliance, whether that be non-filing, over-claimed expenses, offshore reporting, or any of an almost limitless number of errors and omissions on Canadian taxes.

 

60 Day Order

CoinSquare has 60 days from receiving the March 19, 2021 order to comply and disclose the above-mentioned information. This will surely impact many taxpayers as the order means that CoinSquare will disclose information on approximately 5% to 10% of CoinSquare’s 400,000 customers to the CRA. More importantly, this may be a sign for further things to come as the CRA and Canadian policy makers actively seek to clamp down on non-compliance.

 

If you are having trouble navigating through the complex laws surrounding crypto currencies or need advice, contact a professional at Rosen Kirshen Tax Law 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 this article. If you have specific legal questions you should consult a lawyer.

 

Additional Resources

by Jeff Kirshen

Charitable Donations, Tax Shelters and the Sham Doctrine

Taxpayers can claim tax credits or deductions for charitable donations in certain circumstances. The Income Tax Act (“ITA”) proves a regime of charitable donation deductions and credits to encourage philanthropic and public service functions which benefit the community.

Tax deductions in respect to charitable donations first appeared in 1917 for Canadians who contributed to certain patriotic and war funds. The charitable deduction was increased following the Great Depression and continued to be prioritized following World War II. From 1948, the ITA required charitable organizations to issue receipts and register in prescribed form.

 

Claiming Charitable Donations

Under the current regime, individuals may claim a tax credit against their tax payable and corporations may claim a deduction for eligible charitable donations. The former reduces the tax owed, at prescribed rates, providing a dollar-for-dollar reduction of tax payable. The latter reduces the corporate income subject to taxes for up to 75% of net income.

The charitable tax credit for individual donors is a non-refundable tax credit that can be carried forward five years or ten years for ecological gifts. Individuals can only claim the amount that is eligible.

Corporations can claim a deduction for the eligible amount of their charitable gifts for up to 75% of net income for the year. Donations that exceed the 75% net income can generally be carried forward five years.

 

Charitable Donation Requirements

There are certain requirements to be met for the charitable donation tax credit or deduction to be claimed. Donations must be made to qualifying donnees, there must be a valid gift, the value of the gift must be for an eligible amount, and the donor must comply with requirements for filing of receipts.

 

Qualified Donees

For the purposes of charitable donations, only certain organizations or entities will be eligible to issue charitable receipts. These include, but are not limited to: registered charities in Canada; registered Canadian amateur athletic associations; Canadian municipalities; United Nations agencies; and certain universities outside of Canada

 

Valid Gift

For a gift to be valid, there must be a charitable intent or absence of receiving something in return. Generally, the donor must own the gifted property, gift same voluntarily and without receiving any benefit in return. The gift must be property and not services.

 

Value of Gift

The amount eligible for the gift is the excess of the value of the gift over any advantage received. Any advantage can include broad benefits conferred to the taxpayer. For instance, in the case of dual secular and religious private schools, despite older guidelines providing otherwise, the child’s private education is considered a benefit to the donor.

 

Issuing Receipts

The qualified organizations can only issue a receipt for the amount of the contribution that exceeds any advantage received by the donor.

 

Tax Shelters and the Sham Doctrine

In certain cases, tax shelter programs may provide substantial tax benefits far above the actual contribution amount. Given the significant cost to the federal and provincial treasuries of these shelters, tax shelters involving charitable donations will be highly monitored and subject to CRA scrutiny. Programs which are found to be tax shelters will be subject to additional reporting and compliance requirements. These additional reporting requirements are also extended to individuals who participate in the program. 

In circumstances where there is evidence showing the legal effect of a transaction was to achieve a tax benefit that would otherwise be denied, the court may arrive at a finding of a sham. Essentially, the sham doctrine states that: “…acts done or documents executed by the parties to the “sham” which are intended by them to give third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create..”

In cases of an alleged sham, the court will examine the objective reality of the situation, and will determine what actually happened. In the case of many tax shelters, the Courts are only willing to provide a donation credit for the actual cash contribution. There are even times where the actual cash contribution is denied if the tax shelter was considered extremely abusive.

 

The CRA continues to conduct routine mass audits of tax shelters and charitable programs to ensure compliance. What is considered an eligible gift for the purposes of obtaining a charitable donation depends on a case-by-case basis. In findings of a sham transaction, the CRA will deny the credit or deduction with applicable interest and or penalties, even where the participant was unaware of the sham. If you are experiencing any issues regarding your charitable donations, or a tax shelter you have been involved with, speak with a qualified tax lawyer today! We can help discuss the eligibility of your charitable donation tax credit or deduction and if a charitable donation tax shelter or sham applies to you.

 

**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

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 Jason Rosen

T1135 Discretionary Penalties

Over the past decade, the Tax Court of Canada (TCC) has gradually carved a role for itself to decide whether to penalize Canadians who fail to file their Foreign Income Verification Statement (T1135 form) on time. A T1135 form must be filled out by any Canadian who, at any time during the year, owns foreign property valued at more than $100,000.00 CAD. Failure to file a T1135 form normally results in a strict penalty being levied against the taxpayer. A “strict” penalty is practically automatic; the circumstances that resulted in the late filing are not examined by the CRA when they’re applied.

 

T1135 Penalties and the Tax Court of Canada

The courts have gradually decided that there are circumstances where the strict T1135 penalty should not be applied. In Douglas v HMQ, 2012 TCC 73, the TCC accepted the Appellant’s argument that the penalty imposed under subsection 162(7) of the Income Tax Act should be waived for the late-filing of a T1135 form.

In that case, the Appellant knowingly filed his T1 income tax return along with his T1135 nine months late. He assumed that his failure to file on time would not attract a penalty as he did not owe any taxes for the year. However, the Minister imposed the maximum penalty of $2,500.00 for the late-filed T1135.

The TCC noted that the facts of that case justified such application to waive the T1135 penalty. The Court found that the Appellant acted reasonably in believing that there would be no penalty since no taxes were owing. Notwithstanding that subsection 162(7) imposes a strict penalty, the TCC held that it would be unfair to penalize the Appellant in these circumstances.

This decision suggests that a taxpayer may have recourse through the TCC for late-filed T1135 penalties when the taxpayer has exercised “all reasonable measures” to comply with the Income Tax Act.

In Fiset v R, 2017 TCC 63 (Informal Procedure), the Tax Court confirmed the judgement of the Court in Douglas. In that case, the Minister’s counsel (the CRA) decided to agree to cancel the penalties over the course of the proceedings. Justice Fournier stated that had the agreement not been reached, he would have done so himself. Justice Fournier explained:

“It is important to recognize that the Minister of National Revenue (or his delegate) has the discretion to waive any penalty or interest imposed under the Act (subsection 220(3.1)). This is a fairness provision. In my opinion, to insist that the appellant suffer the consequences of an honest mistake would neither benefit the public administration nor enhance confidence in the CRA.” (paragraph 10)

In other words, it is not the Act’s purpose to punish an individual who makes a reasonable mistake in good faith, nor would it generate greater confidence in the CRA. The fact that a Justice of the Tax Court of Canada is considering these appeals demonstrates that these matters are within their purview. Their impact on decisions from the Appeals Division of the CRA are less certain as Appeals Officers are not bound by Informal Procedure decisions.

 

T1135 Penalties and the Federal Court

In Biswal v Canada, 2017 FC 529, the Federal Court was not able to accept the Appellant’s use of Douglas because it found that it does not have similar jurisdiction of the Tax Court of Canada. This, in essence, confirms that matters of cancelling penalties can be within the jurisdiction of the Tax Court of Canada. The Federal Court judge even encouraged the Appellant to file an appeal to the Tax Court, to access the remedy that she sought.

 

T1135 Penalties and the Voluntary Disclosure Program

In Leclerc v R, 2010 TCC 99, the Court concluded that Canadians could not be expected to know that T1135 late filing penalties would only be waived by the CRA if they formally applied under its Voluntary Disclosure Program, since these information forms do not involve fraud or non-disclosure of income. The Court’s point in Leclerc was taken further in Moore v the Queen, 2019 TCC 141, where the Court criticized the Tax Guide available to taxpayers, and found that it is unreasonable to punish ordinary Canadians with penalties for honest mistakes.

The Court in Moore cited Leclerc, stating at paragraph 17, “Justice Favreau’s comments are also relevant to, and highlight, the fact that Mr. Moore may have voluntarily disclosed to CRA his late filing, but was unaware that would have had to be done under CRA’s formal voluntary Disclosure Program if he wanted to avoid coming to Court”. He proceeded to cancel the penalties imposed on the Appellant.

If you are considering a voluntary disclosure, please give us a call.

 

T1135 Discretionary Penalties

The evolving case law underscores the more active role that the Tax Court of Canada is taking in providing oversight for the CRA’s more severe penalties and procedures. The Court is chiefly interested in whether the taxpayer exercised due diligence in trying to meet their obligation to file a T1135.  While the Court admits that relief should be granted sparingly, it also seems quite willing to consider the remedy in a broad range of circumstances.

However, the Court’s newfound discretion has only been confirmed in judgements rendered under the Informal Procedure. It has not yet been heard in a proceeding under the General Procedure.

The distinction between these two Tax Court procedures is crucial. While officers in the CRA’s internal appeal process can consider judgements rendered through the Informal Procedure, they are only bound by ones rendered in the General Procedure. Until T1135 penalty cases are heard under the General Procedure, these new developments are less likely to have an impact on decisions made by officers in the CRA’s internal appeal process. This unfortunately means that Canadian taxpayers who are unfairly subject to T1135 penalties cannot benefit from the CRA’s internal appeal process; they will have to undergo a costly appeal to the Tax Court or pin their hopes on a taxpayer relief request.

 

If you have any questions about Form T1135, “Foreign Income Verification Statement”, or you are late filing it, or simply don’t know whether you need to file it or not, 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

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 CRA Audit Process

Canada has a self-reporting tax regime, meaning that Canadians are responsible for accurately reporting their taxes payable to the federal government by certain prescribed filing deadlines. In order to properly police this self-reporting tax regime, Canada Revenue Agency (the CRA) requires tools at its disposal to investigate and verify the accuracy of amounts reported by taxpayers. Audits are an effective way for the CRA to assess the legitimacy of amounts claimed by taxpayers on tax filings.

In 2021, the audit process may become increasingly relevant for the average Canadian due to the possibility of COVID-19 related pandemic response audits.

 

CRA Audit Basics

Any “person” as defined by the Income Tax Act can be audited (notably, this definition includes corporations and trusts). The CRA chooses the subject of audits through risk assessments of the returns filed by taxpayers. Risk assessments look at the number of errors on the tax filings of a taxpayer and/or anything reported by the taxpayer that may indicate non-compliance or suggest a misrepresentation. Taxpayers are deemed responsible for misrepresentations advanced on their behalf by tax preparers.

Most Canadian taxpayers are familiar with what the process of an audit entails—a CRA agent (an auditor) contacting a taxpayer and asking a series of questions to determine the candidacy of the taxpayer for an audit. Establishing proof of the claims of the taxpayer requires that the auditor probe through troves of taxpayer records for lengthy periods and at great inconvenience to the taxpayer.

Most Canadian taxpayers would ideally prefer to avoid this process at all costs. While a taxpayer may believe that after receiving an income tax refund that the taxpayer is in the clear, that is not always the case. The CRA has variable discretion to reassess years after the income tax filing has been made and investigate through the taxpayer’s records from years prior to the filing.

 

How Long does the CRA have to Initiate Audit Proceedings?

If the CRA deems that a taxpayer meets the eligibility requirements of an audit, the CRA has a statutory limit of three years for reassessing tax liability. For example, if a Notice of Assessment is issued to a taxpayer on May 14^th, 2021, the CRA can adjust that tax year by issuing a notice of reassessment until May 13^th, 2024. However, if the CRA suspects that a taxpayer perpetrated a misrepresentation akin to fraud on the taxpayer’s filing, this time limit is extended.

Depending on the nature of the taxpayer’s returns (individual, corporate, etc.), this process could mean combing through a significant volume of documents. How far exactly the auditor can look back is subjective and depends on what is uncovered during the initial review of the first two to three taxation years.

If the auditor finds an error that sparks interest in a prior taxation year, the auditor then has cause to extend the period under scrutiny and open up other taxation years for review. Again, if the auditor uncovers what the auditor thinks is a misrepresentation tantamount to fraud, the auditor can look back as far as he or she wants into records from prior taxation years.

 

How Long does the CRA want me to keep my Records?

There is actually no time limit with respect to CRA requesting the production of tax records (notably in Ghermezian v. Canada, the CRA was permitted to peruse records from 21 years prior), but taxpayers are not expected to retain the records they relied on to file their returns indefinitely.

Subsections 230(4) and 230(4.1) of the Income Tax Act mandate that most tax records be kept for six taxation years following the date of filing of the taxation year. For example, if a taxpayer filed its annual income tax return on June 30th, 2020, its tax records from the 2020 taxation year should not be destroyed until June 30th, 2026 (if at all). This includes electronic records that must be kept in an “electronically readable” format of the document(s) for the same six-year period.

Where the taxpayer files its return late, the taxpayer must retain records for six years from the original date of late filing. Using the same example as above, if the taxpayer filed its 2020 income tax return on September 27, 2020, the corporation must retain its records from this reporting period until September 27, 2026.

 

The audit process can result in findings that cause life-changing adjustments to a taxpayer’s returns. Few taxpayers are aware that in lieu of having the audit conducted at their home or place of business, it is the taxpayer’s right to have the audit conducted at the office of their authorized representative. Conducting an audit at the office of a tax lawyer allows the taxpayer to protect their rights by having their lawyer present for the duration of the audit process. If you are being audited or fear you may be, having legal support can make all the difference in a successful audit defense. Contact a tax lawyer at Rosen Kirshen Tax Law today. We are here to help!

 

**Disclaimer

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