Tax

by Jeff Kirshen

John Scholz and RRSP Advantages

Have you recently received correspondence from the CRA regarding an audit or reassessment of your income tax returns for an alleged “strip” of a registered plan (such as an RRSP, RESP, RRIF or RDSP) resulting in an “advantage”?

The CRA is auditing taxpayers for “advantages” received from the transfer of their registered plan to Western Pacific Trust Company, the subsequent purchase of shares of Red Hill Capital Inc., and the direct repayment of the value of their registered plan from John Scholz of Northland Services Inc. following the purchase of the shares.

These audits are targeting taxpayers under a specific and technical provision of the Income Tax Act (the “Act”). In this blog post, which draws from Income Tax Folio S3-F10-C3, published by the CRA, we outline the meaning of these provisions and some of the reasons for their implementation. We also highlight another recent CRA publication regarding John Scholz.

 

Advantages

An “advantage” in relation to a registered plan is defined under subsection 207.01(1) as any of the following:

1. certain benefits or debt that are conditional on the existence of the plan, subject to listed exceptions;
2. an increase in the FMV of the property held in connection with the plan which increase is reasonably attributable to certain transactions or amounts;
3. income or a capital gain that is reasonably attributable to certain property or transactions in respect of the plan; or
4. a registered plan strip in respect of the plan.

The CRA considers the above series of transactions involving John Scholz to result in an “advantage” under subsection 207.01(1) of the Act.

Under subsection 207.05(1), the Act imposes a special tax for “advantages”. The tax is equal to the amount of the advantage and is payable by the annuitant, subscriber, or holder of the plan, unless the advantage is extended by the issuer, promoter, or carrier of the plan. In the latter case, the tax is payable by the issuer, promoter or carrier.

The person responsible for paying the tax is also required to file a special tax return. The CRA has discretion to waive all or part of the tax.

 

Registered Plan Strips

The CRA defines a “registered plan strip” as the amount of a reduction in the fair market value of property of a registered plan other than a TFSA.

The reduction may be considered a “strip” if the value is reduced as part of a transaction or event (or a series of transactions or events) one of the main purposes of which is to enable the controlling individual or any person who does not deal at arm’s length with the controlling individual to obtain a benefit in respect of the property of the plan or to obtain a benefit from the reduction.

The above definition involves a few technical terms:

• “Fair market value (FMV)” is generally considered to mean the highest price expressed in terms of money that can be obtained in an open and unrestricted market between informed and prudent parties who are dealing at arm’s length and under no compulsion to buy or sell.
• “Controlling individuals” of a registered plan is defined under subsection 207.01(1) of the Act as the annuitant of an RRSP or RRIF, the subscriber of an RESP or the holder of an RDSP or TFSA.
• The rules for determining whether persons deal with each other “at arm’s length” are set out under subsection 251(1) of the Act. The CRA does not view individuals as dealing at arm’s length with any of their registered plans.

The definition of a “registered plan strip” can apply even when no amount is traceably removed from a registered plan but where the value of the plan has still been reduced. For example, this could occur by way of transactions that dilute the equity of a corporation, trust, or partnership in which the plan is invested. It could also occur where a plan has directly or indirectly invested in a debt obligation and steps are taken to ensure that the debt cannot be repaid, or where no actions are taken to enforce repayment.

 

Advantages and the Reason for the Rules

The advantage rules originally applied only to TFSAs but were extended to cover RRSPs and RRIFs from March 23, 2011 and to RESPs and RDSPs from March 23, 2017.

The advantage rules target abusive tax planning arrangements that seek to artificially shift value into or out of a registered plan while avoiding the statutory limits for contributions or withdrawals. They also apply to benefits and loans that are conditional on a registered plan.

Normal investment activities and conventional incentive programs will generally be excepted from the application of the advantage rules. Amounts excepted from the rules may include amounts included in income, amounts withdrawn under the Home Buyers’ Plan or the Lifelong Learning Plan, direct transfers of funds that are permitted to be made on a tax-deferred basis, and the non-taxable portion of payments from RESPs or RDSPs relating to a return of contributions.

For the most part, the advantage rules do not impact the average investor. However, there has been a recent uptick in CRA audit activity surrounding advantages allegedly received by taxpayers following their dealings with John Scholz.

 

John Scholz

The CRA recently investigated the investment counselling business of John Scholz. The investigation revealed that Scholz did not report any of the commission fees he received from his clients for the 2011 to 2013 taxation years.

Scholz was found to have failed to report taxable income totalling $2,149,730 for these years, and to have evaded a total of $605,355 in federal income tax. Scholz also did not file GST/HST returns for the periods ending in 2011 to 2015, and he was found to have evaded the remittance of GST/HST totalling $445,789.

On April 13, 2019, Scholz was found guilty by a jury in the Hamilton Court House of one count of fraud over $5,000 under the Criminal Code for the evasion of GST/HST remittance.

On September 26, 2019, Scholz was sentenced to a conditional jail sentence of two years less a day, including 12 months of house arrest, curfew for the remainder of the sentence, and to 200 hours of community service. He also received a fine of $445,789, representing 100% of the amount of GST/HST that he evaded.

It is important to note that Scholz was not found guilty of anything having to do with the RRSP advantage issue.

 

If you have recently dealt with John Scholz and are concerned that you may be audited, or if you have recently received a notice of reassessment for an alleged “strip” of a registered plan resulting in an “advantage”, call us today. We are here to help!

 

**Disclaimer

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

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

What is Considered Non-Taxable Income in Canada?

Every April Canadians and non-resident taxpayers are forced to once again partake in the self-reporting Canadian taxation regime. Penalties for unreported income can be significant and with CRA interest rates on overdue taxes currently set at 5% (and retroactively applicable), what may have originally been a small income tax debt can quickly add up to a life-ruining outstanding balance with the CRA.

Following our previous blog entry on the subject of “What is Considered Taxable Income in Canada?”, this edition will examine those few income sources that the CRA and Income Tax Act have defined as non-taxable sources of income.

 

Government Payments

The first category of income that does not have to be reported as earnings are certain payments from the provincial and federal governments.

Some benefits and credits paid by the provincial and federal governments are considered tax-exempt and do not have to be declared by one’s income tax filings. These include:

1. the GST/HST credit;
2. the Canada Child Benefit; and
3. in Quebec, child assistance payments.

It is not the case, however, that all benefits received from the provincial and federal governments are non-taxable. Notably, COVID-19 response benefits issued by the federal government to assist Canadians with financial strife stemming from the COVID-19 pandemic are to be reported as taxable income of their recipients.

Another governmental payment that is not taxed are some proceeds of litigation. Where a litigant successfully sues a provincial or territorial government and receives a financial award for criminal acts or motor vehicle accidents, the proceeds are generally, not taxable.

 

Tax-Free Savings Accounts (TFSAs) and Registered Savings Plans (RSPs)

Where a taxpayer earns dividend income, interest income or earns capital gains using funds held within a TFSA, the proceeds are not taxable or included in income for a given taxation year. There are, however, exceptions to this general rule as taxpayers who use the TFSA for purposes analogous to a securities trader may be deemed to have earned business income from these earnings.

Additionally, income earned from funds or investment vehicles held under some RSPs are not taxable until they are extracted from the account.

For both TFSAs and RSPs, contribution limits and procedural requirements are strictly enforced and could result in significant financial penalties if not appropriately met.

 

Lottery Winnings, Gifts, and Inheritances

Windfalls such as winnings from the lottery are typically not taxable in Canada unless they are considered to be annuity payments.

In most cases, gifts are not considered to be taxable income in Canada. There are exceptions to this rule, however. For example, where gifts are determined to be capital property, the donor (or gift giver) would have to report any income earned through capital gains on the capital property despite having transferred the donor’s beneficial interest in the asset to another party. Gifts from employers may also be deemed to be taxable where the gift can be construed as a “taxable benefit”.

Similar to gifts, inheritances are usually not taxable in Canada. Unlike the United States, for example, that imposes 18-40% in estate taxes for affluent taxpayers (prior to exemptions), the Canadian taxation regime only features tax consequences for testators who leave capital property to their beneficiaries or who have any tax debt owed to the government at the time of the testator’s death.

 

Other Non-Taxable Income Sources

The above-referenced non-taxable income sources are not an exhaustive list of non-taxable income sources in Canada. There are several statutory exemptions that apply to exempt certain sources of income from taxation in very tailored and specific circumstances. One such example, stemming from paragraph 81(1)(g.1) of the Income Tax Act which deals with compensation when employees pursue their employers for damages through litigation and identifies one source of non-taxable income as: “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.”

However, it is not in all cases that damages from an employer be considered non-taxable, which was recently the subject of the Tax Court of Canada decision in Saunders v. The Queen.

While there are select provisions in the Income Tax Act that carve out specific statutory exceptions to taxable income inclusions, these provisions (like paragraph 81(1)(g.1)) are often very nuanced and applicable in very narrow circumstances.

 

If you are worried about potential unreported income or would like an opinion as to whether an income source is taxable or non-taxable, 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

What are GST/HST Carousel Schemes?

A “missing trader scheme” or “carousel scheme” is a fake supply chain created by a group of GST/HST registrants who work in collusion by repeatedly reselling goods to each other. At one point during the purchase and sale of these goods, at least one of the registrants collects GST/HST but does not remit it to the government. This registrant is the “missing trader” who gives the scheme its name. The following is a step-by-step explanation of missing trader/carousel schemes adapted from the CRA’s 2016-2017 Departmental Results Report:

1. First, a GST/HST registrant (Company X) purports to import goods, usually operating within a supply chain; no GST/HST is paid;
2. The goods do not exist, but Company X claims them to be intangible (film rights) or intangible (computer chips);
3. Company X creates fictitious invoices and bank statements to give the appearance that transactions are occurring and that it is charging GST/HST;
4. Company X disappears without remitting the GST/HST collected from the phoney transactions (the “Missing Trader”);
5. The last company in the supply chain claims to export the goods to offshore companies at 0% GST/HST;
6. Each company in the supply chain network files requests for GST/HST refunds (often for millions of dollars) for taxes “paid” to Company X; and
7. Stages (1)-(6) can repeat indefinitely.

These schemes are prevalent in Canada, and the CRA continues to improve its processes to detect and prevent GST/HST refund arrangements that bear a resemblance to them.

 

Carousel Schemes and Precious Metals

The CRA has identified the precious and scrap metals industries as a particularly high-risk target for missing trader/carousel schemes. Taxpayers involved in this industry may participate in these schemes by buying pure gold bullion from commercial suppliers (which is not subject to GST/HST) or by buying scrap metal containing gold (which is subject to GST/HST) and from which pure gold bullion can be refined.

Taxpayers who buy pure gold bullion from commercial suppliers utilize missing trader/carousel schemes by melting the bullion down and adding low levels of impurity. After impurities are added, the formerly pure gold can be sold as scrap metal. Once the scrap metal is sold, the seller will charge, but not remit, and often abscond with, GST/HST. The purchaser of the scrap metal will then claim a refund (such as Input Tax Credits) on the GST/HST paid to the seller.

The purchaser of the scrap metal will then melt the scrap metal down and refine and reshape it back into pure gold bullion. Other bullion purchasers down the supply chain will then purchase the bullion, and the cycle can continue indefinitely.

 

Carousel Schemes and CRA Issues

It is not uncommon for taxpayers involved in missing trader/carousel schemes within the precious and scrap metals industries to receive reassessments for tens of millions of dollars in unremitted GST/HST and/or disallowed Input Tax Credits. In 2011, for example, Metaux Kitco, one of Quebec’s most prominent gold-trading companies, was reassessed for $85 million in disallowed Input Tax Credits, and was alleged to be one of approximately 125 companies involved in the scheme alleged to defraud the Canadian government of approximately $350 million (see Cody Kessler, Taxpayer Non-Compliance with Input Tax Credit Rules: Data and Policy Options for Canada, Canadian Tax Journal (2020) 68:3, p 784).

Importantly, the “director’s liability” and “derivative assessment” provisions of the Excise Tax Act can place corporate tax liability on the corporate directors personally. This presents a significant risk for individuals involved in missing trader/carousel schemes.

 

If you or your business are at risk of being involved in a missing trader scheme or carousel scheme, call us today. We are here to help!

 

**Disclaimer

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

The Taxation of Trusts in Canada

Trusts receive special tax treatment under Canadian income tax laws. Corporations are taxed as entities separate from the individuals controlling them, and partnerships are taxed such that income earned by the partnership is taxed in the hands of the partners. However, the taxation of trusts is somewhat of a mixture of both: trusts may be taxed either at the level of the trust itself, separate from the beneficiaries entitled to the property it holds, or at the level of the beneficiaries. The dual nature of trust taxation makes trusts a very useful tool for estate planning and tax planning.

Taxpayers will usually find themselves dealing with a trust when the management and control of property in which they have an interest is vested in one person or persons (the “trustee” or “trustees”) and the enjoyment of the property is vested in another person or persons (the “beneficiary” or “beneficiaries”).

 

Types of Trusts in Canada

There are two kinds of trusts: those created by a living person (a “settlor”), which is called an inter vivos (i.e. “between the living”) trust, and those created in consequence of death, which is called a testamentary trust. The most common example of a testamentary trust is a trust created by a will. In estate law, the person who drafted the will is called the “testator”. In the case of a testamentary trust, the testator’s will creates a trust in consequence of the death of the testator.

The Income Tax Act makes no distinction between “trust” and “estate”, and instead refers to both these terms as a “trust”. This means that, for the purposes of income taxation, a “trustee” can refer to either a trustee dealing with the estate (i.e. all the assets and liabilities) of a deceased person (an “estate trustee”) or a trustee dealing with the property of living persons (a “non-estate trustee”).

Other terms of note — “personal representative”, “executor”, and “administrator” – refer to the person(s) to whom the deceased’s estate passes on death. Under the Income Tax Act, the personal representative is referred to as the “legal representative”.  “Personal representative”, “executor”, “administrator”, and “estate trustee” are, for the purposes of taxation, interchangeable terms because the trust under which the property in question is being administered will be taxed in the same way regardless of whether the settlor or testator is alive or deceased.

 

Trusts and their Tax Rules

Sections 104-108 of the Income Tax Act provide the rules of taxation of the income of trusts and beneficiaries. Trusts are, like corporations, individuals for tax purposes, which means that they are taxed like individual taxpayers. Any property transferred to or from a trust is therefore considered a disposition of that property attracting tax on any taxable capital gains arising from that disposition. Avoiding capital gains tax can be a key driver in the way in which trusts are set up.

Capital gains tax on the disposition of property transferred to a trust is commonly incurred in the testamentary situation. Under the Income Tax Act, all capital property of a deceased taxpayer is deemed to have been disposed of, immediately before death, for proceeds of disposition equal to the fair market value of the property. The deceased is then liable to pay, on a “terminal return” for the tax period up to the date of death, tax on any taxable capital gains arising from the disposition of that property. Conversely, the deceased’s estate is deemed to acquire the property of the deceased at a cost equal to the fair market value of the property.

Poor estate planning can sometimes leave trusts or their beneficiaries needlessly liable to pay capital gains tax. However, testamentary and inter vivos trusts can use rollovers to avoid the deemed disposition of capital property as described above, and to thus avoid capital gains tax. “Rollovers” deem property transferred to or from a trust to have been disposed of for proceeds equal to the adjusted cost base (i.e. the original acquisition cost) of the property rather than its fair market value. This prevents the transfer of the property from incurring any capital gain or loss at the time of transfer. Any tax liability is instead deferred until the beneficiaries die (triggering the deemed disposition immediately before death as described above) or until the trust disposes of the property.

 

There are numerous estate planning techniques that rely on the unique tax treatment of trusts. If you have questions regarding your estate planning, trusts, or the taxation of trusts, call us today! We are here to help.

 

**Disclaimer

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

The Taxation of Cryptocurrency

For the past decade, the rise of Bitcoin and other cryptocurrencies has taken Canadians by storm. However, through the lens of legal policy making, cryptocurrencies are still considered a relatively new phenomenon. That said, Canadian policy makers have recently taken a stronger stance in the regulation and monitoring of crypto purchases. This blog post seeks to summarize the general rules surrounding crypto currencies as well as the main changes Canadians should be aware of.

 

What are Crypto Currencies?

Generally, the Canada Revenue Agency (“CRA”) considers crypto currencies to be a taxable form of commodity equivalent to stocks and investments. It follows that any gains or losses arising from a taxpayer’s purchase and subsequent disposition of Crypto will be subject to tax.

Irrespective of whether the disposition is from crypto to fiat or coin to coin, the disposition constitutes a taxable event.

 

Capital Gains vs. Business Income?

Typically, the sale of cryptocurrencies would be categorized as a capital gain and result in only 50% of the gross capital gain being taxable. On the same “token”, this means that only 50% of any losses derived from the sale of crypto currencies would be considered a taxable capital loss. Furthermore, capital losses are “quarantined”, in that it can only be applied to offset capital gains and not other sources of income (such as from business nor employment).

However, in some circumstances, the CRA may determine that this trading activity constitutes income on account of business. When this happens, the proceeds of disposition arising from the transaction is captured in full (100%) and taxed accordingly. This usually occurs when the CRA determines that the taxpayer is actively trading crypto currencies or is in the business of speculating price changes of crypto currencies.

Other factors the CRA considers when determining if the taxpayer’s profit in selling crypto is capital or business income includes but not limited to:

• The intention of the Taxpayer;
• The length of time the crypto currency is held;
• The frequency in which the taxpayer buys/sells crypto currencies; and
• The taxpayer’s knowledge and expertise .

It is important to note that each case is very fact-dependent on the taxpayer, their trading activity and other material circumstances.

 

How do I Calculate my Gains and Losses?

Taxpayers must also be very attentive of the constantly changing adjusting cost base (“ACB”) of their crypto currencies. In short, ACB is the measure of what the taxpayer paid to receive the coins. Naturally, the ACB is subject to change then if the taxpayer purchases and sells their coins throughout the year at different prices.

The following example clarifies this concept. Suppose the following transactions occurred:

• Taxpayer purchased 1 coin of X for $100 on January 1^st;
• Taxpayer purchased an additional 1 coin of X for $200 on May 1^st;
• Taxpayer sold 1.5 coins of X for $300 on June 1^st; and
• Taxpayer purchased an additional 1 coin of X for $400 on August 1^st.

In this example, the Taxpayer’s ACB after transaction 1 would be $100. However, after transaction 2, the taxpayer’s ACB for coin X would increase to $150. As a result, the taxpayer’s proceeds from the disposition in transaction 3 would be $150 ($300 – $150). After transaction 4, the taxpayer’s ACB of coin X would rise to $275. This example assumes there are not transaction fees for each purchase and sale.

Taxpayer’s should also be aware that the ACB of each type of coin should be calculated and monitored. For instance, the cost basis of Bitcoin, Ethereum, Litecoin and others must be calculated separately and adjusted after each corresponding transaction. Intuitively, this is akin to calculating the ACB for different stocks. The ACB of a taxpayer’s Apple shares should not be affected by a subsequent purchase or sale of RBC shares or any other stock except Apple.

 

If you have questions about the taxation of crypto currencies, call us today! We are here to help!

 

**Disclaimer

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

Employee Stock Options

Employee stock options give employees the right to purchase a specified number of shares of a company at a specified price. Employees can derive financial and tax benefits from these stock options if they exercise their options when the market purchase price of the stock is greater than the purchase price specified by the option. They can then sell the stocks they own. However, there are important tax rules that must be understood when an employee exercises their options, and also when those stocks are sold.

 

Employee Stock Option – Public Companies and Tax Benefits

The following analysis is for stock options granted by public companies.

Under paragraph 7(1)(a) of the Income Tax Act, employees are taxed on the difference between the amount they pay to purchase their option and the fair market value of the stock at the time they exercise the option. The way in which employees are taxed on employee stock options is similar to the way in which they would be taxed on a bonus.

For example, if an employee is given an option to purchase stock for $1,000 and, at the time the employee exercises the option, the fair market value of the stock is $2,000, then the employee will be taxed on the $1,000 difference between the exercise price and the fair market value. This will be counted as employment income in the year the option is exercised.

The way in which employees are taxed on the exercise of their stock options creates the possibility for double taxation. Usually, when an employee sells stock purchased with an employee stock option, the gain incurred from the sale is taxed as a capital gain. In this case, and using the above example, the $1,000 option purchase price would be the cost base for the stock, while the $2,000 fair market value of the stock would be the price of disposition (assuming that the stock is sold for fair market value). The $1,000 difference would be the taxable capital gain. Double taxation can arise here because the employee could be taxed twice: once when the employee exercises the option, and again when the employee sells the stock.

Fortunately, paragraph 53(1)(j) of the Act provides that the difference between the exercise price and the fair market value is to be added to the cost base for the stock. This means that, for the above example, the $1,000 difference between the employee’s exercise price and the stock’s fair market value would be added to the $1,000 cost base on the sale of the stock. Now, with a $2,000 cost base, there would be a $0 difference between the cost base and the price of disposition. The employee’s taxable capital gain would be cancelled out.

 

Employee Stock Option – Canadian Controlled Private Corporations

If options are provided by a Canadian-controlled private corporation (“CCPC”), and those options are exercised, the taxable benefit mentioned above will only be added to the employee’s income when the stock is actually sold. This is the benefit of exercising options that were granted by a CCPC, you don’t pay any of the taxes until you actually sell.

These shares may also be eligible for the lifetime capital gains exemption. There are specific rules and conditions that must be met before being eligible for this exemption so please consult a tax lawyer.

 

Employee Stock Options – Tax Deferral

The Income Tax Act provides other mechanisms for the preferential treatment of employee stock options. Under paragraphs 110(1)(d) and (d.1), only half of the difference between the exercise price and the fair market value is taxable. This preferential treatment is, however, limited to certain circumstances: employees must deal at arm’s length with their employer, must generally receive prescribed stock on the exercise of options (rather than generally receiving cash), and, on the date the option is granted, the purchase price specified by the option must be greater than or equal to the fair market value of the stock. Also, if the employer granting the option is a CCPC, the employee must hold the stock for at least two years.

 

Employee stock options are useful for attracting and retaining employees. For CCPCs especially, employee stock options can act as tax subsidies because they can offer potential employees tax-deferred compensation in exchange for cash investment in the stock of the corporation. If a CCPC is strapped for cash, and if markets are rising, employee stock options can be an ideal means of taking advantage of such circumstances. If you have questions regarding employee stock options, or if you are interested in learning how to use them to your advantage, call us today!

 

**Disclaimer

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