by Jeff KirshenThe Small Business Deduction and the New Passive Investment Rules
In 2017, the Federal Government announced its intention to make sweeping changes towards small business taxation in Canada. The government initially targeted hallmarks of tax planning strategies for small and medium-sized business owners under the ostensibly stated goal of bringing fairness to the Income Tax Act. Tax planning tools chosen for tightening included limiting the use of income sprinkling to family members and increasing taxation of passive investment income held by corporations.
The Small Business Deduction and the New Passive Investment Rules
At first, the proposed changes, released by the Minister in July of 2017, would have taxed passive income essentially at a rate equal to the top marginal rate for individuals. The changes proposed in July would have a drastic impact on corporations across Canada with a particular sting felt by small and medium-size companies that generate passive investment income. After a torrent of negative responses from business owners and entrepreneurs, the Liberal government balked and pivoted course. Finance Minister Morneau promised to lessen the impact of their initial proposal; mainly abandoning the harshest changes on the taxation of passive-investment income.
With the tabling of the Trudeau Government’s third budget on February 27, 2018, in the House of Commons (the 2018 Budget), we now have a clearer picture of the passive investment income changes. The 2018 Budget should somewhat alleviate the anxiety of small business owners regarding the passive-income proposal. Although the 2018 Budget includes measures to reduce the tax deferral benefits presented by passive investments made by private corporations, the method of doing so is less jarring than what was initially announced.
What has Changed?
The method proposed by the federal government is to reduce access to the small business tax deduction for corporations earning considerable passive investment income on a straight-line basis. In Canada, a lower tax rate is available for Canadian-controlled private corporations (CCPCs) on the first $500,000 of income it actively earns from a business source (i.e. excluding investment income). The small business deduction currently provides an effective federal tax rate of 10% on $500,000 of qualifying business income. Some welcome news, the 2018 Budget will see the small business rate deduction will be lowered further to 9% by 2019.
The proposed changes in the 2018 Budget will affect CCPC’s earning more than $50,000 of passive investment income. A CCPC making more than $50,000 in passive investment income will now see the amount of active business income eligible for the lower small business rate deduction decrease by $5 for every dollar of investment income above $50,000. Accordingly, the effect of the change will see the small business rate entirely unavailable for corporations once $150,000 of passive investment income is earned.
To determine what income will be considered “investment income” to reduce access to the small business deduction, the proposed changes introduce a new term: “adjusted aggregate investment income (AAII)”. AAII excludes specific forms of passive income from the calculation. Importantly, capital gains generated from selling active business assets will be excluded from the determination.
The changes in the 2018 Budget are a welcome backtrack from what the Federal Government proposed in July of 2017. However, the changes must be considered by business owners earning passive investment income and taken into account to ensure access to the small business deduction is not impaired. If you are an owner of a corporation earning passive investment income, please contact Rosen Kirshen Tax Law to learn about how the proposed changes may be affecting you and your business.
**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 KirshenRecent Changes to the Voluntary Disclosures Program (Part 1)
Under the Canada Revenue Agency’s Voluntary Disclosures 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. We help Canadians voluntarily disclose issues like this on a daily basis, and it forms a large part of our practice.
Recent Changes to the Voluntary Disclosures Program
Recently, the CRA has made some substantial changes to the program. Included among these changes are fundamental changes to the procedures for making the disclosure, as well as changes to eligibility criteria. However, two changes in particular make it more important than ever to seek legal representation before making a disclosure: “Payment up front” & the Limited Disclosures Program.
Payment Up Front
CRA now expects taxpayers to make a payment of the estimated taxes owing when they make a disclosure. Previously, our clients could just disclose first and sort out the tax payment later; now, they have send money with their application (although we are happy to discuss methods for easing this burden).
Alternatively, Canadians making disclosures can claim that they do not have the funds to pay now, but request that the CRA’s collections division contact them to arrange a payment plan. We highly recommend seeking legal advice from Canadian tax lawyers with experience handling both collections and disclosures.
First, we know the ins and outs of the collections process, and have a firm understanding of their protocols and tactics. We know what they like and dislike, and how best to coordinate workable payment plans.
Second, we know what financials the CRA will request from you, and we can help you put them together and communicate any mitigating circumstances. While the process is fundamentally about full disclosure, you will be required to pass along a wide range of information to collectors. What this means is that your discussions with tax lawyers, which are subject to solicitor-client privilege, are now more important then ever. This protects you from attempts to force you to divulge your strategy or information.
Lastly, having people negotiate on your behalf puts someone between you and the collector. Dealing with CRA’s collectors is extremely stressful, and people can grow understandably emotional when handling these disputes themselves. But often, animus between taxpayers and their collectors can prevent reasonable solutions.
If you and the collector do not come to an agreement, CRA could yank the protections of the disclosure program right out from under you. Not coming to an agreement is even more risky in the disclosure context.
In short, having tax lawyers on your side protects you throughout the process, and if you don’t have the funds to pay immediately, trying to cut costs by going it alone can open you up to a stressful and risky dispute with CRA’s collections arm. Have additional questions or want to discuss the Voluntary Disclosures Program? 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 the articles. If you have specific legal questions you should consult a lawyer.
by Jeff KirshenA Canadian’s Guide To U.S. Tax Changes
Throughout 2017, the Trudeau government’s proposed changes to Canadian business taxation often dominated headlines. However, their gradual rollout and ponderous process resulted in something of a slow burn of coverage, which, however much Canadians discussed it, cannot hold a candle to the coverage of changes to the tax code south of the border. Rather then taking all year, changes to the American tax code were completed in about a month, and rather than being driven by the hopes of closing opportunities for tax planning to save sophisticated taxpayers money, they appear to be motivated by the opposite, creating particularly wide loopholes for business owners to squeeze through.
For Canadian taxpayers, it would be entirely understandable to want to avoid adding an additional layer of complexity overtop of the Canadian tax code. However, if you had heard changes to the American code mentioned on the news and have wondered how we do things differently, here is a basic discussion of one of the changes, what we do differently, and some ways the changes to the American system can be gamed.
SALT Deductions in the United States
Prior to the recent changes in the form of the Tax Cuts and Jobs Act, residents of American states could claim a deduction from their income at the federal level for state and local property taxes, as well as either state income taxes or state sales taxes. This reduced their income in calculating their federal taxes, and so residents of states with higher taxes tended to have lower federal tax rates.
Under the recently passed Republican tax plan, the SALT deduction is now capped at $10,000 USD wherever you are in the country. Through the SALT deduction, the American system offset federal revenue from states willing to increase their own taxes, essentially subsidizing taxes at lower levels. Because taxes are considered a business expense, this change to the code affects businesses less than individuals, as businesses do not require specific authority to deduct state and local taxes. Provided that property tax is for a business property, for example, businesses can expense it anyways. The change will primarily affect relatively well-off individuals in high-tax states such as New York or California.
State and Local taxes tend to be more regressive (affect people who make less money more for each dollar they earn) than federal income taxes in the US, as they are more likely to be based on consumption or property values.
However, only relatively well-off people tend to pay enough income tax, or more than $10,000 in state taxes, and so the move is less likely to affect them. Less wealthy Americans are also more likely to claim a “standard deduction”, reducing their income by a specific amount rather than individual deductions, which this change to the code will not affect.
Available Loopholes
There are, however, some possibilities for avoidance. On the individual end, wealthier individuals who would opt to itemize their state and local taxes may find yet another incentive to claim themselves to be “independent contractors” or to provide services (such as legal or medical services) through their own personal corporation. In this case, they may be able to claim deductions for some of their SALTs as a business expense.
In this case, many of the opportunities for tax avoidance come at the state level. If states still want to save their own residents taxes at the expense of the federal government, there are options available for them. Under one means of avoiding the change proposed by a group of American tax experts, a state could require businesses to collect income tax as a payroll tax, rather than have employees themselves file. In this way, the business can still deduct the tax, passing on the cost to their employees. In this way, the result can be very similar to that prior to the change in the tax code.
A Canadian Perspective
In eliminating the SALT deduction, the American tax system takes one step towards building a tax system like Canada’s. Canadian employees, who cannot claim deductions for most things unless specifically permitted to, cannot deduct provincial and local taxes. Provincial and local governments simply have to account for the full effect of their own taxes on their residents. As for American businesses, Canadian businesses can deduct taxes as expenses. This includes most local and provincial taxes, except for income/profit taxes.
Instead of generally deductible state and local taxes, we use “equalization”, which you have likely already heard of, and certainly will have if you live in the prairies. Through equalization, the Canadian federal government passes out money it earns at the federal level to provincial government depending on how much money they could raise. This depends on what the provincial budget would look like if the province had average revenues from five different sources (personal income taxes, business income taxes, GST/HST, natural resource revenue, and property taxes). While it is a common misconception, provinces do not pay equalization per se; people from provinces do, resulting in an outflow of cash from some provinces and an inflow to others, but it is not directly dependent on provincial taxes or budget balances.
Equalization, with the federal government taking in revenue to distribute to the provinces, is in part how Canadian provincial governments spend so much, allowing Canada to be the developed world country with the greatest share of revenue spent at the sub-federal level.
In contrast to the American approach, the Canadian system provides less of a subsidy to specific fiscal choices of lower-level governments, and instead allocates similar dollars on the basis of the recipients’ actual capacity. In the American contexts, the states that benefit from the SALT deductions tend to be relatively wealthy. Not only are individuals for whom it is worth claiming SALT relatively well-off, but the states that charge relatively high taxes (particularly, non-property taxes) tend to be better off as well.
If you are thinking about the implications of changes to the United States’ tax code and how it affects your Canadian business, or if you are thinking of disclosing funds held in the States, consider reaching out to one of our tax lawyers for a consultation!
**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 KirshenNew Income Sprinkling Rules
On December 13, 2017, the Department of Finance re-released its draft legislation regarding income splitting rules and provided guidance to the revised legislation. The Government’s stated objective for changing the income splitting rules is to limit the ability of owners of private corporations to lower their personal income taxes by sprinkling income to family members who do not contribute to the business.
According to the Department of Finance, the legislation is proposed to apply immediately on January 1, 2018.
What are the New Income Sprinkling Rules?
The revised income splitting rules ostensibly simplify the original proposal to amend the income sprinkling rules, originally announced on July 18, 2017, after considerable blowback from Canadian business owners. The revised rules claim to provide clarification to the process of determining whether a family member is significantly involved in the business.
A family member determined to be involved substantially in the business will not be taxed at the highest marginal tax rate (i.e. the “tax on split income”) on income received from the business. Currently, the highest marginal federal tax rate is 33%.
The revised rules now include specific bright-line tests to automatically exclude individual members of a business owner’s family from the tax on split income. The following individuals are automatically excluded from the tax on split income that they receive from a family business:
- The business owner’s spouse if the spouse meaningfully contributed to the business and is aged 65 or over;
- Adults aged 18 or over who have made a substantial labour contribution to the business during the year, or during any five previous years;
- Adults aged 25 or over who own 10 per cent or more of a corporation that earns less than 90 per cent of its income from providing services and is not a professional corporation; or
- Individuals who receive capital gains from qualified small business corporation shares and qualified farm or fishing property.
The associated technical notes provided by the Department of Finance expand on how the Canada Revenue Agency will consider a family member’s labour contribution as substantial. Generally, an individual who works an average of 20 hours per week during a business year will be deemed to be actively engaged on a regular, continuous, and substantial basis for the year.
In the event an individual does not work an average of 20 hours per week, it will become a question of fact whether the individual is actively engaged in the business.
Reasonableness Tests
The revised rules retain the reasonable return test for individuals aged 25 or older who do not meet any of the bright-line exclusions discussed above. The reasonableness test will be used to determine what amount, if any, of the income, would be subjected to the highest marginal federal tax rate.
The proposed income sprinkling amendments define “reasonable return” as “an amount that is reasonable having regard to the contributions of the specified adult individual to the related business relative to other family members who have contributed to the business”.
Adults between the age of 18 and 24 who contribute their capital to a family business, but do not meet the substantial labour contribution threshold, may also be able to use the reasonableness test on income earned from the business.
The revised income sprinkling rules also provided specific exclusions for income earned by related individuals who derive income from “excluded shares”, which the individual owns. The tax on split income will not apply to income received from a share provided the following conditions are satisfied:
(a) The individual is over 25 years of age;
(b) The individual owns a minimum of 10% of the outstanding shares of the corporation, both
in voting shares and in value; and
(c) the corporation meets the following additional conditions:
- it earns less than 90% of its income from providing services;
- it is not a professional corporation; and
- all or substantially all of the corporation’s income is not obtained from a related business of the individual.
Again, where an individual is over 25 years of age, but the income earned is not from excluded shares as discussed above, the tax on income splitting will apply only to income earned from the shares that is deemed unreasonable.
Despite the Department of Finance’s stated intention for “simplified income splitting rules”, the new rules continue to add complexity and ambiguity to Canadian business owners. How the CRA interprets and applies the subjective terms such as “meaningful contribution to the business” and “substantial labour contribution” remains a mystery.
If you have questions or concerns about how your business may be impacted by the proposed changes and wish to take proactive steps to protect your company and your family, please contact 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 KirshenIncome Sprinkling and Reasonableness
In the recently announced changes to the Income Tax Act, “reasonableness” takes centre stage. Taxpayers running businesses who pay money out to their family members in the form of dividends or salary, can currently “spread” that money around, distributing it to those with lower incomes so that the family unit as a whole pays less in taxes. This is what is known as income sprinkling. The proposed changes force taxpayers to consider whether or not these payments (salary or dividends) are “reasonable in the circumstances”. If the Canada Revenue Agency states that they are not reasonable in the circumstances, the recipient of the payment would be forced to pay the highest possible tax rate on the income received.
What is Reasonable in the Circumstances?
Given the similarity between compensating a family member for their contribution through salary and through dividends, the test for reasonableness in the context of salary payments could be a useful guide.
Manchester v The Queen provides an example of a family that elected a number of its adult children as directors of a corporation, which was run by their parents. While it paid the children a salary, as opposed to dividends, the facts of this case and the children’s’ role is similar to many arrangements involving dividends.
Simply because they were directors, the children did have some obligations, and the shareholders had elected them, even if they were motivated by tax concerns. As such, the children had contributed something-they still had to show up to the occasional meeting, after all, even if they did not contribute much. The fees paid to the children, rather than being based on their contribution to the business, were instead based on their expenses in the year. The Tax Court determined the absolute maximum that could be reasonably to pay the children, simply on the basis of being directors and opening themselves up to director’s liability, to have been $11,500 annually, and denied the rest of the deductions, increasing the businesses income. This suggests that the final interpretation of the changes may still provide some opportunities for family businesses, particularly relatively small ones, to income spread where adult children take on a limited role in the management of the businesses, such as by being named as directors.
Income Sprinkling and Reasonableness
A test that would disallow income spreading benefits where the value of dividend payments “markedly departs” from the value of the recipient’s contributions, or where “no reasonable businessperson” would have paid the value of those dividends to the recipient as a salary in exchange for their services, would be in line with constraints on deductions for salaries paid to family members.
Here, the details will matter a lot. How Parliament and the Courts hammer out the technical points of the new rules will make a large difference. Because the money must flow through the corporation before it is paid out, there are more moving parts than just dealing with salaries. There is also the conceptual issue that “reasonableness” does not apply as cleanly to what a business does with its profits as it does with whether a given expense is cost-justified. For another, the fact that income paid out in unreasonable dividends defaults to the highest rate may mean that for families where the owner of the business is below the top tax bracket, paying out too much in dividends could result in a higher tax bill than just having the primary earner keep the money themselves.
Reasonableness Tax Tests
As with reasonableness in general, the most likely end point is that the test will end up involving a mix of factors that, while they may make sense to the person on the street, make it hard to know exactly where you stand.
On paper, a bona fide family businesses where all family members are making reasonable contributions would still be able to structure itself in more or less the same way. But this does not take into account the fact that reasonableness is challenging to determine in advance. Especially before the legal approach to determining what is reasonable is hammered out, it is likely that many such small businesses will be faced with audits, leading to objections, and even Tax Court appeals to prove that their income sprinkling is reasonable.
If you are concerned about the impact of the proposed tax changes for your businesses, or are considering reorganizing your finances to adapt them, consider speaking with one of the Tax Lawyers at Rosen Kirshen Tax Law, whose advice is always reasonable in the 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 Jeff KirshenWhat are Reasonable Business Expenses?
In a tax context, an expense or a write-off is another word for a deduction. Canadian corporations are taxed on their profits, that is, the income that they earn less the cost of earning that income. Costs that you legitimately incur in earning your income can be “written-off”, that is, used to reduce your income by that amount. So, while the business still needs to pay the actual cost of the thing in question, the purchase reduces its tax bill.
For example, if you run your own unincorporated furniture-making business in Ontario and make $60,000 a year, your marginal tax rate is 29.65%. After receiving a call for new chairs, you run out to a new supplier in town to get $100 of wood. When you get back, however, you realize that you have been duped; the supplier was a fly-by-night wood-salesman, and what you thought was fine Nordic cherry is warped and bug-ridden pine. It is unfortunate that you lost $100 on the wood. However, because you can claim the cost of the wood as a write-off, the total hit to your wallet after tax is only $70.35, because the loss reduces your profits from your business.
Reasonable Limits on Deducting Business Expenses
Businesses cannot make any deductions that are unreasonable, and the Canada Revenue Agency and Tax Court may deny expenses that are partly reasonable, and partly not. However, in the past, this raised many issues; some expenses may be incurred in good faith, but simply be unwise. Can you deduct for expenses incurred as a result of poor business decisions?
As a rule, yes. Generally, deductions end up being denied where there is a substantial personal component, or where it is spent on someone with whom you have a personal relationship, rather than because a Court thinks business owners make poor decisions. The furniture salesman above is likely safe in claiming this loss as a deduction, even if he could have been more careful about his supplier.
However, Courts can attack “outrageous choices”. For example, in considering whether a given advertising deduction is reasonable, Courts consider factors such as the size of the business, the support the advertising is expected to generate, the form of the advertising, the locality where the advertising was broadcast, and the size of the population reached to determine whether any reasonable businessperson could have spent that amount.
For a business expense to be denied a deduction, it must be such a poor exercise in judgment that no reasonable businessperson would have incurred that expense at the time. Just because it worked out poorly, with the benefit of hindsight, does not mean that it was an unreasonable expense at the time. It is genuinely difficult to meet this threshold; in the case of Ankrah v The Queen, a taxpayer operating a multi-level marketing business took losses year after year after year, and while the Tax Court did not allow him to deduct expenses that were clearly personal, they would not step in to second-guess his business judgment, despite him having spent several thousand dollars on advertising, conventions, and office space (none of which worked out particularly well).
Whether or not a deduction is reasonable often gives rise to disputes between the CRA and taxpayers. Because it can be hard to determine in advance whether or not a given deduction or expense is reasonable, you may not know whether you are in the clear or whether you are risking an audit.
Reasonableness when Deducting Food and Entertainment Expenses
If you see corporate boxes while watching a game on television or walk past restaurants filled with people eating steaks in suits, you may be wondering how these people afford it. In many cases, the answer is that these meals or boxes may be tax “write-offs” for the businesses footing the bill. Businesses are taxed on the profits they make; in determining these profits, they are allowed to subtract what they spend making them, reducing their tax bill at the end of the day. However, businesses are only allowed to deduct amounts that are “reasonable” in the circumstances. What this ends up meaning, though, will vary a lot depending on the context.
Businesses cannot deduct expenses that are purely personal. For example, people require food, whether or not they run a business, so business owners cannot deduct the cost of their own food. (However, there are several exceptions, including one particularly interesting one: in jobs where the taxpayer is using food like fuel in a car, as with say, a bike courier, this extra food is deductible!)
However, where businesses claim deductions for expenses that may help them earn income, but also may be fun for the owners, there are potential tax savings, which has been reflected in Canada’s tax codes. So, while dinner at home may not be deductible, dinner to woo clients may well be.
The government, not wanting to haggle over every hot dog and scotch on the rocks, eventually determined the share of food and entertainment expenses that businesses could deduct would be capped at 50% of what the business spent, or 50% of what is reasonable, whichever is less.
As some businesses pay very generous dues at places like golf clubs, businesses are general unable to deduct for memberships in recreation facilities, or for tickets to sporting events. However, because of the way the legislation was written, you can deduct the cost of private boxes at sporting events, which plays a role in the growth of corporate boxes.
If you are faced with an audit of your expenses, if you are thinking about whether a given deduction is reasonable, or if you are hoping to structure your affairs to make the most out of Canada’s tax laws, contact Rosen Kirshen Tax Law to see what we can do for you and your business.
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.
by Jeff KirshenWhat does ‘Reasonableness’ Mean in Canadian Tax Law?
When Canadians think of taxes, they likely think of strict rules that come out of the Income Tax Act. Parts of the Act, however, do not really work that way, and rather turn on less clearly defined concepts, such as “reasonableness” or what is “reasonable” in the circumstances. Many protracted disputes between taxpayers and the Canada Revenue Agency, as well as much of what Tax Lawyers do, involves laws that depend on “reasonable” amounts.
What is Reasonable or Reasonableness?
The Canada Revenue Agency often uses reasonableness tests to signal that they would prefer to delegate decisions to what is reasonable, rather than devise their own strict rules and regulations. Reasonableness language is often used where a given practice is very context dependant, and bright lines in the sand would be unhelpful. When a law is framed in terms of reasonableness, in effect, it allows the courts to define “tests”, the factors that will help determine whether a given case is reasonable or not. This extends all across Canadian law, from lawyers’ bills to employment disputes to family law.
So where does “reasonable” pop up in the Income Tax Act? One of the most important places is with business deductions, as the Canada Revenue Agency can deny or limit deductions from business income they consider unreasonable, including excessive spending on advertising or flashy meals. In the newly proposed changes to the tax code, in an effort to avoid “income splitting”, Parliament has proposed placing an explicit “reasonableness” test on dividends paid to the family members of business owners. This change hopes to prevent owners limiting their tax bill by compensating their children or spouses in amounts unreasonably exceeding the contribution they make to the business.
As a general rule, all deductions taken by taxpayers must be reasonable under the circumstances.
What is a Reasonable Expectation of Profit?
Distinguishing businesses from hobbies, and thus whether income is taxable and losses deductible, considers whether the activity was undertaken with a Reasonable Expectation of Profit. Alongside other considerations, the Courts consider whether your activities could reasonably be expected to make money on the basis of your training, profit and loss over past years, and your plans may determine whether or not you need to pay taxes if you make money from a given activity. This forms part of the basis for hobby gambling winnings being non-taxable.
If you lose money in a business venture, you can deduct it against your other income in a year. In a recent case, a man in Thornhill, Ontario started two ventures he claimed to be businesses, one as a “real estate consultant”, and one as a personal trainer. He was, frankly, not particularly good at either of them; he took a bath on both ventures, and they soon folded. In his real estate “business”, he would essentially ask people if they could use advise on real estate transactions, even though he lacked any formal training. As a personal trainer, he would invite clients into his condominium’s recreational area to work out and critique them. He then tried to deduct the money he lost in these schemes from his income to reduce his tax bill. It may have been tough for Mr. X to read the judgement, as the court is extremely critical of his capacity as a businessman. As he was untrained, did not seek to minimize his risks, and the Court generally thought his plan was bad, they did not consider him to have been running businesses, and so also not to have been generating business losses. This is a good example of a reasonableness test in action; a person of good judgment would likely agree that he could not reasonably have expected to profit off of these activities, but the court did not apply rigid rules in coming to its conclusion. Multi-level marketing schemes have often been deemed not to be businesses on a similar basis.
Employees and What is Reasonable
While many of the “reasonableness” provisions relate to business income, some also apply to employees. Generally, employees of other business cannot deduct expenses incurred in earning their income. However, there are some exceptions, including reasonable expenses for an office or assistant if required by the employee’s contract. In Morgan v The Queen, a taxpayer ended up in hot water because as an employee he used a tactic more frequently employed by businesses: he hired his wife as an assistant. He paid her quite well ($35,000 and $52,500), and the Canada Revenue Agency argued that this was not reasonable, and that on the basis of the services received, a more reasonable deduction would have been about $25,000. The Court dismissed their case for other reasons, but in the end said that he would have considered these deductions to be excessive. The Judge considered that the most a reasonable business person would have paid would have averaged about $25,000 per year, which he arrived at by comparing wages on Workopolis.com with the amount she worked over the year.
Reasonableness and the Income Tax Act
The above are only a few examples- as of writing, “reasonable” and “reasonably” show up 1219 times in the Income Tax Act, without looking at any tax regulations, provincial acts, or other kinds of taxes. Rosen Kirshen Tax Law also deals with gross negligence penalties imposed by the CRA when it considers taxpayers to have made unreasonable errors.
On the one hand, these kinds of provisions allow for a flexible legal system, and provides judges (or auditors), with all of the information in front of them, the ability to make context-sensitive decisions. On the flip side, however, “reasonableness” provisions decrease certainty. When a given factor only plays a limited role in a broader determination of reasonableness, it can often be hard to know where you stand. For example, a taxpayer required to limit deductions to those that are “reasonable” may need to choose between claiming expenses cautiously in an attempt to avoid being audited and claiming them boldly to avoid leaving money on the table. Once something gets to Court, reasonableness may help make decisions that accord with common sense, but it is less helpful at letting you know what to do during tax season. This uncertainty means that reasonableness rules can result in complicated legal disputes, and that policymakers should be conscious of this inherent trade-off between flexibility and certainty.
Lawyers, and particularly lawyers whose practice involves litigation, are used to dealing with reasonableness, and whether the CRA is questioning the reasonableness of part of your return or you are wondering if you can reasonable make a given claim, a tax lawyer may be the right person to call. Rosen Kirshen Tax Law has the experience and skill necessary to resolve your dispute about reasonableness or what is reasonable in the circumstances. Don’t wait, call us today!
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.
by Jeff KirshenChanges to the Voluntary Disclosures Program
Do you have unfiled tax returns, or have you incorrectly reported income? If so, you may be eligible for the Voluntary Disclosures Program. The Voluntary Disclosures Program incentivizes taxpayers to correct previous non-compliance by offering relief from penalties, a reduction of interest, and a promise that the taxpayer will not be referred for criminal prosecution. However, the Canada Revenue Agency is proposing changes that threaten the viability of the Voluntary Disclosures Program altogether.
Changes to the Voluntary Disclosures Program
The Federal government has announced that broad changes will be implemented to the Voluntary Disclosures Program. The first will be restrictions on who is eligible to qualify for the program. The second change to the Voluntary Disclosures Program is that the Canada Revenue Agency will have the power to revoke the acceptance of the disclosure, and the power to audit information coming through the Voluntary Disclosures Program. The third change is that the amount of relief for certain situations will be limited. Finally, the Canada Revenue Agency will want up front payment of the taxes owed.
Please see below for a more detailed discussion of the changes to the Voluntary Disclosures Program.
Restrictions on Eligibility
Under the new Voluntary Disclosures Program, applications reporting proceeds from a crime will no longer qualify. The new program would also exclude applications that involve transfer pricing and applications from corporations with gross revenue in excess of $250 million. To restrict eligibility from proceeds from crime will mean that illegal income, and those who earn illegal income have no real chance to become compliant with our tax laws. This change to the Voluntary Disclosures Program will force taxpayers to continue to hide from the Canada Revenue Agency as they have no incentive in coming forward. The penalty will be the same whether they disclose under the Voluntary Disclosures Program, or get caught.
Power to Revoke, and Power to Audit
The Canada Revenue Agency reserves the right to audit any information provided in the Voluntary Disclosures Program application, and to reassess any tax year – not just the years involved in the disclosure. If implemented, the new Voluntary Disclosures Program would also give the CRA power to cancel Voluntary Disclosures Program Relief if they discover misrepresentations attributed to wilful default even if the misrepresentation has nothing to do with the disclosure.
Limited Relief for Severe Non-Compliance
The CRA has also proposed a “Limited Program,” that limits the scope of Voluntary Disclosures Program relief in cases of “severe non-compliance.” In its draft Information Circular, the CRA provides a non-exhaustive list of ‘severe’ cases:
- Those who actively attempted to avoid being caught, including through offshore corporations, trusts, or other entities;
- High dollar amounts;
- A large number of years of non-compliance;
- Anyone who the CRA considers to be a sophisticated taxpayer;
- A Voluntary Disclosure being made by a taxpayer where the taxpayer is employed in an area currently being targeted by the CRA for enforcement; and
- Any other circumstances where the taxpayer actively attempted to evade taxes.
Frequently, failing to file in one year causes a spiral effect whereby taxpayers become too anxious to file in subsequent years. These are often taxpayers with modest incomes who have little knowledge of Canadian tax laws. For these taxpayers, penalties can account for a large portion of their tax liability.
Another peculiar proposal is to make “large amounts” eligible under only the Limited Program. This will arguably have the effect of decreasing revenue from the Voluntary Disclosures Program, in that only taxpayers with small tax debts will come forward.
Up Front Payments
Under the current Voluntary Disclosures Program, disclosures must meet four criteria in order to be valid: the disclosure must be voluntary, complete, be more than one year past due, and involve the imposition of a penalty. The CRA is proposing a fifth criterion that taxpayers make payment of the estimated taxes owing at the time of filing the application.
The new Voluntary Disclosures Program provides the opportunity for a payment arrangement with the CRA where taxpayers are unable to pay the entire amount at once. However, taxpayers must present “adequate security” in order to qualify, making it harder for low-income taxpayers with few assets to qualify for Relief from the Voluntary Disclosures Program.
If either of these changes are implemented, the Voluntary Disclosures Program will no longer be a viable program for those looking to become compliant with the Canada Revenue Agency. These changes will force taxpayers to continue hiding and will have the effect of destroying the entire Voluntary Disclosures Program.
If implemented, the proposed changes will take effect on January 1, 2018. If you are considering filing under the Voluntary Disclosures Program, do so before the proposed changes take effect by contacting a tax lawyer 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 the articles. If you have specific legal questions you should consult a lawyer.
by Jeff KirshenOntario Real Estate Agents and Professional Corporations
Realtors in Ontario have traditionally been left out in the cold when it comes to taking advantage of the tax benefits of professional corporations. Under the definition section of the Real Estate Brokers Act, real estate brokers and salespersons are required to be individuals. The effect is to prevent real estate brokers and salespersons, unlike lawyers, health care workers, insurance agents, and architects, from forming a professional corporation (i.e.personal real estate corporations (“PREC”)).
However, a light may be appearing at the end of the tunnel for Ontario Realtors. Bill 104, titled the Tax Fairness for Realtors Act, 2017, passed the second reading on March 23, 2017, and is currently under review by the Standing Committee on General Government. After the third-reading at the Standing Committee, the Committee will provide commentary to the legislature and propose potential amendments at which time the legislature will vote. If Bill 104 passes, Ontario real estate professionals stand to reap many tax advantages.
Bill 104
Bill 104 would permit a PREC to register as a real estate broker or salesperson, provided the individual professional/equity shareholder of the PREC has the necessary qualifications to be registered.
The Bill would require PREC’s to be a corporation under the Ontario Business Corporations Act (“OBCA”). The Act mimics other professional corporate statutes by restricting the corporation’s activities to trading real estate and requiring an individual to own the equity shares.
Tax Benefits
Real estate professionals conducting their business through a PREC could potentially reduce their tax burden significantly and gain the ability to defer their tax liabilities. Real estate professionals using PRECs would be accessing Ontario’s 15% tax rate for Canadian controlled small businesses on the initial $500,000 of their taxable income. Corporate income above $500,000 would then taxed at $26.5%. Compared with Ontario’s top marginal tax rate for individuals of 53.53%.
Real estate professionals would also gain the ability to keep their earned income in their PREC. This option creates a deferral opportunity by delaying taxation on the income until it is removed from the corporation, allowing for more advantageous tax planning.
Bill 104, if enacted in its current form, would also allow “income sprinkling” by allowing immediate family members to own non-equity shares in the corporation and therefore receive dividends. However, the Bill was drafted before the Federal Government proposed plans to limit this form of tax planning.
If Bill 104 becomes law, real estate professionals in Ontario should speak with their legal advisors about carrying on their trade through a PREC to utilize the numerous tax benefits. Rosen Kirshen offers a suite of tax and corporate advisory services to professionals in Ontario, and we would be thrilled to help you capitalize on this potentially exciting opportunity. Kindly 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 KirshenTax Planning Using Private Corporations – 2017 Changes
The Federal Government has announced that they are looking into making changes to what they perceive as unfair tax advantages provided to individuals who own their own corporations. The changes focus on three major areas: income sprinkling, holding passive investments inside corporations, and attempting to turn business income into capital gains.
The justification for these changes is that an employee who earns the same amount as a self-employed individual should not be paying more in tax simply because they do not have access to certain tax planning measures that are done through private corporations.
Income Sprinkling
Income sprinkling is a tax planning manoeuvre where corporate profits are “sprinkled” on many members of a family unit. The purpose behind this income sprinkling is to lower the overall tax burden of the family. The common example is that a self-employed person, and an employee who earn the same income, likely pay two different tax rates. The reason for this is because the self-employed individual can have his or her income claimed by others in the family unit who are in a lower tax bracket.
The Federal Government has announced that they are considering a “reasonableness” test to determine whether the compensation paid to someone is justified by their contribution to the private corporation. There are both pros and cons with this approach. The definition of reasonableness is different to everyone, and how will the government decide the value provided to a corporation by a non-working spouse, who allows the working spouse to spend 16 hours at their office, while the non working spouse runs the household.
Passive Investments Inside a Private Corporation
The purpose behind a lower corporate tax rate is so corporations can reinvest in the economy by growing their business, and hiring more employees. What the government has seen is that this is not always the case. Sometimes private corporations simply invest their surplus, which is then taxed at a lower rate then an individual who invests the same amount of money. Essentially the government is trying to level the playing field when it comes to passive investments. Their current proposals are very difficult to implement, and this will very likely lead to a large increase in corporate audits where passive investments are being made by the private corporation.
Converting a Private Corporation’s Regular Income into Capital Gains
This is typically known as surplus stripping, and the Income Tax Act already has many rules aimed at preventing this. The government is attempting to further tighten these rules so that regular income cannot be changed into capital gains, which is done because of the preferential tax rates provided to capital gains. Successive governments have implemented similar rules with mixed results. It remains to be seen how these new rules will affect tax planning for private corporations.
In case you missed it, one of our partners, Jeff Kirshen, appeared on CTV Your Morning to discuss the changes. You can see it here:
These new changes are going to create large tax issues for some private corporations and the families that run them. However, the changes also create new tax planning opportunities. If you have questions about the changes, or how best to prepare yourself please 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.