by Jeff KirshenRetail Investing and the Tax Implications in Canada
The COVID-19 pandemic has created novel economic conditions for Canadian investors. Many Canadians were laid off or let go completely from their place of employment. Stay-at-home orders have also resulted in many Canadians spending much of their winter indoors in order to comply with provincial regulations to curb the spread of the disease. The pandemic’s effect on the economy has also created an investment climate where there is tremendous potential upswing for the changing needs of our society. Stocks like Amazon, Shopify and, most notably, Tesla have seen record gains on the stock market leading to significant gains for their shareholders in turn.
These factors have led to many Canadians pursuing income-earning alternatives to try to mitigate financial damage. This has contributed to the increasing popularity of “retail investing” as a potential means of planning for one’s financial future. While retail investing may provide an opportunity for some to supplement their earnings, it is important to consider the tax implications of the addition of investment income to one’s existing income sources.
Some retail investors may believe that sheltering their securities under their Tax-Free Savings Account (TFSA) will protect their earnings from any tax liability. However, there are limitations as to what earnings are protected from inclusion in taxable income, even under a TFSA.
What is Retail Investing?
“Retail investing” is the term for non-professional individuals buying and selling financial instruments or securities. Retail investors open investment accounts and procure securities with or without the direct aid of a broker.
Retail investing is increasingly accessible to Canadians, with a wide range of trading accounts now offered by major Canadian financial institutions. Another arena of growth has been the development low-cost trading applications like Wealthsimple Trade and Questrade that allow for Canadians to purchase securities on the go.
Retail Investing and the Tax Implications
Retail investing can trigger earnings in several ways, all of which are taxable (unless eligibly positioned in a registered savings account that shelters the earnings from taxation, like an RRSP or TFSA). However, the amount of the earnings that is included in a retail investor’s taxable income depends on source of the earnings. With retail investing, earnings usually stem from one of three main sources: interest income, dividend income, or capital gains.
Interest income can be earned on investments that have a rate of return on the principal amounts invested. Typically, this is a low percentage of guaranteed earnings such as the interest return on a savings account principal, bond interest or interest earning from a Guaranteed Investment Certificate (GIC). Any interest income earned during a calendar year is to be included in full in the taxable income of the taxpayer.
Dividend income is earned when a corporation elects to pay out a portion of its profit during a specific time period to its shareholders. These earnings vary depending on the security and are to be included in full in the taxable income of the taxpayer during the taxation year in which they were accrued.
When a security appreciates in value and is sold by a taxpayer, any gains or profit earned by the taxpayer upon the sale of the security are determined to be “capital gains” (with some exceptions, e.g. where the taxpayer meets the definition of a “trader”). Half (50%) of the value of all capital gains earned by the taxpayer during a given taxation year are to be included in the taxpayer’s taxable income during a taxation year.
There is a legitimate means of avoiding taxable income inclusions with respect to earnings from these three sources for the individual: placing the financial instruments in a registered savings account such as a TFSA or RRSP (each with their own set of advantages for savings). However, this sheltering requires careful adhesion to the rules and eligibility criteria for investments to be protected under the registered savings plan.
Retail Investing and the TFSA
A TFSA can be a great tool to avoid income tax inclusions on qualifying earnings of eligible securities. However, there are eligibility requirements for what sort of investment earnings garnered under a TFSA are sheltered from taxation.
A consideration to keep in mind is whether the TFSA account holder has already exceeded his or her TFSA contribution limit. The contribution limit is prescribed by the federal government and additional contribution room has been provided each year since 2009. Contributing in excess of the allowable contribution limit can result in serious penalties levied by the CRA against the taxpayer, so in almost all circumstances it would be unadvisable to exceed this limit.
Another key consideration is the nature of the security being held under the TFSA. Retail investors are able to keep mutual funds, registered stocks, bonds, ETFs and GICs among other types of investments in their TFSA. The eligible placement of these securities will protect the interest income, dividend income and capital gains earned from the securities from inclusion in the taxpayer’s taxable income for that taxation year, so long as several requirements are met.
Even still, earnings from these securities that are eligible for protection under the TFSA may be viewed by Canada Revenue Agency (the CRA) as taxable income depending on the nature of the activity undertaken by the TFSA holder. The key distinction lies with whether or not the earnings stem from “investment income” or “business income” in the eyes of the CRA, the latter of which is not protected from inclusions in taxable income.
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 KirshenWhat is a Taxable Benefit – Part 2
It may come as a surprise to some Canadian taxpayers when they receive a Notice of Assessment with reported income reassessed to be significantly higher than what their reported take-home pay was. This may be because of the inclusion of a “taxable benefit” in the taxpayer’s income. The Canada Revenue Agency (CRA) is within their rights to tax purported benefits received by taxpayers from their employer by virtue of their employment. Many taxpayers are aware that work perks that provide a financial benefit to the employee are usually taxable by the CRA and do report some amount of taxable benefit on their return. For part 1 of our taxable benefit blog post where we discuss what a taxable benefit is, and what can be done if you disagree about receiving taxable benefits, please click here.
However, not all work-related benefits are taxable. So, how can you tell if a benefit you receive by virtue of your employment is taxable? The answer to this question is determined by evaluating whether the benefit falls within the scope of the meaning of “taxable benefit” under the Income Tax Act. When filing their taxes, Canadian taxpayers must examine (1) the “character” of the alleged benefit; (2) the nexus between the alleged benefit and the taxpayer’s employment; and (3) the valuation of the benefit to be included in the taxpayer’s income.
How do I Identify a Taxable Benefit?
Paragraph 6(1)(a) of the Income Tax Act creates a baseline from which employment benefits are determined to be taxable, taxable in part, or non-taxable. Paragraph 6(1)(a) specifically outlines benefits that may be subject to tax as:
“[T]he value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer, or by a person who does not deal at arm’s length with the taxpayer, in the year in respect of, in the course of, or by virtue of the taxpayer’s office of employment.”
Notably, this definition is sufficiently broad to theoretically capture any benefits earned in the course of employment. It becomes necessary to examine how this provision has been interpreted by the courts in order to properly characterize benefits received by virtue of a taxpayer’s employment as either taxable or non-taxable.
Benefits are not restricted to benefits that replace traditional remuneration for employment services. In R. v. Savage, a 1983 Supreme Court of Canada decision, the scope of taxable benefits was explained to include “material acquisition[s] which [confer] an economic benefit on the taxpayer.” Justice Dickson (as he was then) held that material facts determine whether or not the benefit conferred by virtue of employment is “taxable” or “non-taxable”.
The determinative factor is whether or not “something of value” was conveyed by the workplace to the employee. This has taken many forms in Canadian case law including life insurance benefits, health coverage, and even business trips where there is significant personal benefit (usually in the form of “enjoyment”) to the taxpayer.
How do I Determine if the Benefit was Sufficiently Connected to my Employment?
The words in paragraph 6(1)(a) of the Income Tax Act, “in respect of, in the course of, or by virtue of the taxpayer’s office of employment” are sufficiently broad to cover a wide range of direct and indirect benefits received from one’s workplace. In particular, the words “in respect of” have been determined by the Supreme Court of Canada in Nowegijick v The Queen, to be words of the “widest possible scope” and to “import such meanings as ‘in relation to,’ ‘with reference to’ or ‘in connection with’.”
The determinative factor is whether there was any discernable nexus between the benefit conferred to a taxpayer and the taxpayer’s working relationship with the party providing said benefit.
How Much of the Benefit do I Report as Part of my Taxable Income?
There may be some cases where less than the whole of the value of the taxable benefit received by the taxpayer should be included in the taxpayer’s taxable income. The Federal Court of Appeal traditionally held that the value to be included in taxable income should be limited to the cost to the employer. This method was abandoned by the Federal Court of Appeal in Spence v. Canada.
In Spence v. Canada, the court held that the fair market value of the benefit conferred to the taxpayer should be the metric to determine what percentage of the benefit should be included in the taxpayer’s income.
Are Any Employment Benefits Exempt from Taxation?
There are exceptions to the inclusion of employment benefits in taxable income, though they may be susceptible to assessment under other provisions of the Income Tax Act. For example, subparagraph 6(1)(a)(vi) of the Income Tax Act excludes education benefits received by those other than the taxpayer with an employment nexus to the benefit, though this amount may be included as a “scholarship” under paragraph 56(1)(n) of the Income Tax Act.
There are also some prescribed statutory exclusions to the rule in subsection 6(1) of the Income Tax Act. For example, subsection 6(6) excludes any benefits incurred that stem from a “special work site” (typically a remote location that the requires that the taxpayer leave his or her principal place of residence for 36 hours at a time).
If you have questions about taxable benefits, or you’ve been assessed with a benefit that you do not agree with, call us today!
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.
by Jeff KirshenCOVID-19 and Taxpayer Relief
In certain circumstances, the Minister of National Revenue may grant relief to a taxpayer where they cannot meet their tax obligations. Relief is discretionary. The Minister has broad discretion to provide relief. For instance, The Minister can provide for the waiver or cancellation of all or part of the penalties and interest payable by the taxpayer. The Minister can also allow an extension of the filing-due date for making certain elections or to amend or grant permission to amend or revoke certain elections. Furthermore, the Minister can authorize a reassessment resulting in a refund of tax or a refund of tax alone to an individual (not applicable for trusts) or certain estates even if an income tax return is filed beyond three years.
A taxpayer must apply for relief under the provisions of the Income Tax Act (the “ITA”) or the Excise Tax Act ( the “ETA”). Relief will be determined by a delegated Canada Revenue Agency (“CRA”) official on a case-by-case basis and depends on the relevant facts and circumstances of the taxpayer’s situation.
CRA Penalties and Interest
The COVID-19 administrative changes extended the filing of returns, forms, elections, and designations to June 1, 2020. No interest or penalties were applied during the extension period. However, interests and penalties were charged if the new deadlines were not met. Taxpayers who filed past the extended deadline would need to apply to the Minister for a waiver of interest and or penalties.
Subsection 220(3.1) of the ITA and section 281.1 of the ETA allow the Minister, through the discretion of the CRA, to cancel or waive all or a portion of the penalties and interest payable by a taxpayer.
CRA Taxpayer Relief – Individuals and Corporations
The ITA and ETA recognize several grounds for relief for individuals. These circumstances include extraordinary factors outside the taxpayer’s control, financial hardship, or actions of the CRA. Applicable extraordinary factors include natural or man-made disasters, disturbances or disruptions in service, serious illness or accident, and or serious mental distress.
Penalties or interest in respect to a failure to file a corporate tax return or to make payment may be waived if the reason was beyond the corporations’ control. These circumstances outside the taxpayer’s control include, floods or fires, civil disturbances, postal strikes, serious illness or accident, the corporation received the incorrect information from the CRA, and natural or human-made disasters. The CRA will also consider relief when a business is experiencing extreme financial difficultly. Where enforcement of penalties would imperil the continuity of operations, result in job loss for employees and significantly impact the community as a whole, the CRA may waive or cancel penalties and or interest even without extraordinary circumstances.
CRA Penalties and Interest
Any penalty calculated on an annual rate is compounded daily. For instance, a nominal annual rate of 3% would be an effective annual rate of 3.045326%. Penalties paid under both the GST/HST legislation and the ITA are non-deductible. The Minister can waive any penalty incurred under the ITA, with the exception of penalties that are enacted as taxes such as Part III tax on excessive capital dividends.
The CRA charges compound daily interest on any late payments. The total owing increases each day and the interest rate applies to the increased balance. The rate changes quarterly as prescribed by the Interest Rates Regulations in both the ITA and ETA.
Due to delays surrounding the measures relating to COVID-19, it is expected that processing times for taxpayer relief requests will be extended. In usual times, it takes approximately 6 to 8 months for a reviewing agent to be assigned to the file and to contact the taxpayer for further details in respect of their application. Once an officer is assigned for review, it takes an approximate 1-3 months for a decision to be rendered.
Even when a taxpayer makes a request for relief, the CRA will continue to charge compound daily interest. Given the current circumstances, processing requests may take over a year. Should relief be granted and the penalties and interests cancelled, the CRA will refund the interest on the penalty and interest amounts.
CRA Taxpayer Relief – 10 Year Limitation Period
The taxpayer has 10 years from the end of a calendar year in which the tax year ended to request relief from penalties. The 10-year limitation also applies for requests to the Minister to accept a late, amended or revoked income tax election, or to request that the Minister issue a refund or make an adjustment beyond the normal three-year assessment period.
For a request to waive or cancel interest under subsection 220(3.1) of the ITA, the Minister may grant relief from accrued interest for the 10 years before the year the request is made for any tax year in which the tax liability arose. This legislative amendment, applicable for requests made on or after June 2, 2011, followed the Federal Court of Appeal decision in Bozzer v Cananda, 2011 FCA 186.
Taxpayer relief requests are processed on a priority basis. Processing delays exacerbated by the measures surrounding COVID-19 may mean greater interest and penalties on any unpaid balances that continue to be compounded daily. However, if relief is granted, a refund of the interest will be issued to the taxpayer.
If you are feeling overwhelmed by the amount of interest and penalties charged to you by the Canada Revenue Agency, we can help! Call us today to learn how we can get them removed!
**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 KirshenParticipating Debt Interest
Participating debt interest and regular interest are treated differently by the Income Tax Act here in Canada. Whether interest is considered to be participating or regular depends on whether certain factors are present in the the repayment of such debt. For example, if money was loaned to someone so that they could go out and buy a rental property, participating debt interest would allow the creditor to make the amount of the interest payments dependent on something, say the profit from the rental property or the cash flow moving through it. It may also be tied to revenue, prices, or a variety of other factors.
Regular interest is when there is a set amount payable to a creditor based on how much was loaned.
Participating Debt Interest and International Taxation
In today’s fast-paced and competitive market economy, many people look past the Canadian border to produce and generate personal and corporate income. This is especially true for both Canadian and U.S residents alike. However, taxpayers often question what tax implications are imposed on income generated outside of the country. For example, many Canadian residents choose to conduct and run their business in the U.S. As such, cross-border business or investment activities could potentially have both U.S and Canadian tax implications.
Normally, when interest payments are made to a resident of another Country, taxes are withheld. Each tax treaty Canada has with other countries must be examined to determine whether withholding is necessary. The type of interest being paid matters for withholding purposes as well.
Participating Debt Interest and the Income Tax Act
Section 212(3) of the Income Tax Act defines Participating Debt Interest as interest (other than certain amounts which are “fully exempt interest”) that is “paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholder of any class of shares of the capital stock of a corporation. Over the course of the years, the Income Tax Act has undergone many amendments and as a result, withholding from most interest payments to non-residents has been eliminated. However, it is important to note that a taxpayer may subject to withholding tax on interest payments that fall under “participating debt-interest”.
Participating Debt Interest and Withholding Taxes
As of today, if you are earning participating debt interest from another country, that other country will very likely have to withhold taxes before sending you any funds. Under the current rules in Canada, certain payments including standby and guarantee fees are treated for purposes of the Canadian non-resident withholding tax provisions as interest on the related debt that would be, or is, issued. Further, pursuant to the new rules, these payments will also be exempt from Canadian non-resident withholding tax, provided that the recipient deals at arm’s length with the borrower and, where applicable, the amounts are not participating debt interest.
If you are a Canadian tax resident, and you are earning participating debt interest or are thinking about lending funds overseas, call us today! We can assist with putting together a plan to minimize taxation and/or withholding, and we ensure that you fully understand your tax withholding obligations.
**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.