DAVID WILKENFELD, CA, canadian tax CONSULTANT

Archive for September, 2009|Monthly archive page

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Non-Resident Investors In Canadian Real Estate

In Canadian Income Tax, Non-residents on September 29, 2009 at 5:20 pm

Maybe it’s the global warming thing, but Canada has suddenly become a very popular destination for non-residents (“NR”) investing in real estate. What are the tax rules for non-resident investors, and what investment vehicle should be used?

Non-Resident Investors

A NR investor is subject to withholding taxes under Part XIII of the Act. Generally, 25% of gross rents must be remitted to the CRA each month. An election under section 216 may be made. Under this election, the NR files a tax return and is eligible for the same deductions as Canadian residents including capital cost allowance. However, it does not entitle the NR to loss carryovers from prior years.

A survey of the tax rules would be advised prior to investing in Canadian real estate

A survey of the tax rules would be advised prior to investing in Canadian real estate

If form NR6 is filed, the NR undertakes to file a return within 6 months from the end of the year, and the tax withheld is reduced to 25% of the estimated income after deductions. Where no undertaking is filed, the tax withheld is 25% of the gross rent, but the deadline for filing a return is extended to 2 years.

Under certain circumstances a NR paying interest to another NR may also be subject to withholding taxes on the interest payments.

A NR corporation would be subject to further withholding requirements known as branch tax. This tax is intended to equal dividend withholding tax on profits repatriated out of Canada by the NR corporation. The branch tax rates are similar to withholding rates for dividends, subject to treaty reductions. NR corporations are also subject to tax on capital in certain provinces. Finally, an NR corporation may be subject to “thin capitalization” rules that restrict interest deductions.

A NR trust pays no branch tax or tax on capital. Losses of a trust , however, cannot be flowed out to beneficiaries.

Using a  Canadian Investment Vehicle

The two major choices for a Canadian investment vehicle is the Canadian resident trust or the Canadian corporation.

A Canadian corporation is subject to the full rates of tax on investment income. Unless it qualifies as a Canadian controlled private corporation, no part of the taxes payable will be refundable upon the payment of dividends. Dividend payments will be subject to withholding taxes of 25%, unless reduced by treaty. Further, in certain provinces, a Corporation is subject to tax on capital. Thin capitalization rules apply as well. These factors make this vehicle an unpopular choice for most NR investors.

A Canadian trust is not subject to tax on capital. Nor would the payments to beneficiaries of after-tax income be subject to any withholding taxes. Thus, the trust would be subject to tax only once, at the highest marginal tax rates for individuals. This rate could vary, depending on the province of residence of the trust.

Dispositions of Real Estate by Non-Residents

As taxable Canadian property, a gain on the disposition of real estate by a non-resident is generally subject to Canadian tax at Canadian rates for capital gains and recaptured capital cost allowance.

Withholding taxes must be remitted, and may be based on the gain on sale only where a withholding tax certificate is obtained under section 116 of the Act. If no certificate is requested by the due date (either before the sale, or within 10 days following the sale), then the purchaser is required to withhold based on the gross purchase price. The withholding rate is 25%. An additional 12% applies for the province of Quebec, which has its own certificate request procedure under Article 1097.

One common problem that arises when a NR disposes of Canadian real estate is that a 116 certificate will only be issued if all the withholding requirements have been met in the past. That is, if no returns were filed under section 216, then the CRA will require remittance of 25% of gross rents for the previous years plus interest. If the 2 year deadline has passed, the CRA will normally not accept late-filed 216 returns.

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What’s Your Tax Issue?

In Canadian Income Tax, Losses on September 25, 2009 at 12:41 pm

The Tax Issue:

I loaned some money to my son’s company and now he can’t pay me back. Is there a tax deduction I can claim?

The Answer:

Unfortunately, I get this question quite frequently after it’s too late -  a loan has already been made and gone bad. Often, a loan is made from a parent to a child’s company with no interest charged. Under the rules of the Income Tax Act, any loss on a loan made for no consideration is not deductible for tax purposes. So if you are thinking of helping out a family member, don’t be so generous as to deny yourself a tax deduction of you don’t get paid back. Always check with a professional before making a business loan.

If interest was charged, or if you are also a shareholder of the company to which you loaned the funds, 50% of the loss is considered  an allowable  capital loss. Such a loss may be claimed only against taxable capital gains. Unused losses can be carried back three years and forward indefinitely.

Under certain circumstances, the allowable capital loss may qualify as an allowable business investment loss, in which case it is deductible against any income for the year. The company would have to meet certain tests in order to establish that it meets the definition of a small business corporation. Essentially, this is a corporation that uses all or substantially all of its assets in an active business carried on in Canada.

Before any loss can be claimed, the debt must be established to be uncollectible. According to the CRA you must have exhausted all legal means of collecting the debt and/or the company is insolvent. The courts have taken a more lenient view and require only that the debt be uncollectible in the eyes of the creditor, without the need to exhaust all legal means of collection. If a debt is established to have gone bad in a year, then you must make an election in your income tax return to establish it as a bad debt and claim whatever loss you are entitled to based on the above criteria.

Registered Disability Savings Plans

In Uncategorized on September 22, 2009 at 9:04 am

One of the more interesting proposals from the 2007 federal budget may have escaped detailed analysis by many commentators…until now. For younger taxpayers qualifying for the Disability Tax Credit (“DTC”), the new Registered Disability Savings Plan (“RDSP”) should be considered as an important part of a financial plan.

In 1986, an expert panel produced a report to the Minister of Finance outlining its recommendations for a savings plan designed in a similar manner to the Registered Education Savings Plan, that would assist families in providing long term financial security for severely disabled children. The result was the introduction of the RDSP, which came into existence in 2008.

The plan is available to taxpayers under the age of 60 years who are eligible for the DTC. A plan is set up by its “Director” – generally the parent or guardian of a minor child. A competent adult would be the Director of his own plan.

Contributions and Government Grants

Like an RESP, contributions to the plan are not tax deductible, but income accruing is not taxed. Contributions can only be made by the plan’s Director, and there is a lifetime contribution limit of $200,000.

When a contribution is made to a plan, the government will pay a Canada Disability Savings Grant (“CDSG”) equal to a specified percentage into the plan to augment the contributions. The amount of the CDSG depends on the family income of the Director and is limited to a lifetime total of $70,000.

For families with net income equal to or less than $74,357, the government will provide:

  • $3 for every $1 on the first $500 of contributions; and
  • $2 for every $1 on the next $1,000 of contributions.

For families with net income over $74,357:

  • $1 for every $1 on the first $1,000 of contributions.

A further amount of $1,000, called a Canada Disability Savings Bond (“CDSB”) is paid where family income is below $20,883, and is gradually decreased until such income reaches $37,178.

The income thresholds are to be indexed and apply to the family income of the parents where a minor child is the beneficiary, and to the beneficiary and his spouse in any other case.

The CDSG’s and CDSB’s are available only until the end of the year in which beneficiary turns 49 years of age.

The provisions are intended to promote long-term savings for young people who are disabled. As such, there is a fairly strict rule that provides for the repayment of all grants/bonds paid into the plan in the ten years prior to one of the following events:

  • A withdrawal from the plan;
  • The death of the beneficiary; or
  • The beneficiary is no longer DTC eligible

Withdrawals

Payments from the plan must begin at age 60. Payments received will be made up of a repayment of capital (non-taxable) and a combination of income earned, CDSG’s and CDSB’s, which are taxed in the hands of the beneficiary.

Payments out of the plan are limited to a maximum annual amount based on the life expectancy of the beneficiary.

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WHAT’S YOUR TAX ISSUE?: OFFSHORE EMPLOYMENT

In Canadian Income Tax, Tax Avoidance on September 17, 2009 at 5:26 pm

The Tax Issue:

I was wondering If I earn money offshore and do not repatriate any of it back to Canada do I have to pay tax on it. (i.e. Work, Investments, etc…)?

The Answer:

The short answer is YES!

With all the talk recently about UBS, offshore bank accounts and tax evasion, this question comes at a crucial time for any Canadian taxpayer with funds offshore.

Generally, if you are a Canadian resident, you are obligated to declare and pay tax on your world income. So, if you go off to Dubai and earn revenue as a systems consultant there for a few weeks, deposit the funds in a Swiss bank account and never bring the money into Canada, you are still obligated to report the income earned on your Canadian income tax return for the year.

Similarly, any investment income earned while that money sits in an offshore account is taxable in Canada as it is earned.

If the income is from employment, and you meet certain criteria, you may be eligible for an overseas employment tax credit to be deducted on your return. You should consult your tax advisor if you were employed on a long-term project offshore at any time in the year.

The Canadian system operates on the basis of residency alone. So, if you leave Canada permanently, you will no longer be subject to Canadian income tax from the time of departure. As a non-resident you will generally not be subject to tax in Canada, even if you are a Canadian citizen.

So, if you’ve read my previous post on the UBS affair and how it affects us here in Canada, you should be aware that any funds deposited in any offshore account that contains proceeds from taxable earnings you derived while a resident of Canada is subject to the scrutiny of the CRA at any time.

Update: See the case of Bensouilah v. MNR (2009 DTC 1327) for an illustration of Canadian resident taxpayer failing to report employment income earned in Saudi Arabia.

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Canadian Tax on the Entertainer

In Canadian Income Tax, Non-residents on September 16, 2009 at 12:16 pm

Like most people, while enjoying a live concert or watching a movie, my mind inevitably begins to wander away from the performers on stage towards the Canadian income tax rules that apply to them. They are truly talented and unique, these non-residents of Canada, and as such, special tax rules apply to them.

General Rule for Services Rendered in Canada

In my August 31 post you will recall that we dealt then with Regulation 105 withholding requirements. When a non-resident enters Canada to perform services, he is subject to a 15% levy (plus an additional 9% in Quebec) on account of income tax payable in Canada. This charge applies similarly to musicians, and other performing artists. According to the CRA, these performers are carrying on business in Canada and are subject to tax on their income earned in this country.

In many cases, however, services rendered by a resident of a treaty country, such as the US would be exempt from Canadian taxes. Business income is exempt under most treaties unless the taxpayer has a “fixed base regularly available to him” in this country.

Artistes and Athletes

A special section found in most of Canada’s treaties deals specifically with “Artistes and Athletes”. This provision essentially provides that the above treaty exemption for business income does not apply to income of more that $15,000 in a year, derived as an entertainer such as a movie, theatre, radio or television artiste, a musician or an athlete. Accordingly, these talented people have to “pay to play”, so to speak.

Requirement to File a Tax Return

Whether or not a person is exempt from Canadian tax under a treaty provision, he must file a Canadian income tax return. The 15% tax withheld does not relieve a non-resident of this duty. If the income is exempt under a treaty, then the full amount withheld would be claimed as a refund. If the taxpayer is not exempt, he must report his net income earned in Canada, and the 15% tax withheld is applied as a credit against taxes owing. Failure to file a Canadian return would result in penalties.

Like Me, Some People Are Not Artistic Enough

Billy Joel in Montreal - Must file a Canadian tax return

Billy Joel in Montreal - Must file a Canadian tax return

The question of whether a taxpayer is an “artiste or athlete” can be difficult to answer at times. In the case of Thomas F. Cheek v. The Queen, Toronto Blue Jays announcer Tom Cheek was held not to be a “radio artiste”, because he was simply reporting on the games and was not attracting his own audience by virtue of his talents as a radio personality. The court found he was exempt under the Canada –US Treaty.

More Issues for Athletes

For athletes, questions can become even more complex. US athletes playing for Canadian sports teams might be considered resident in Canada depending on their circumstances, and vise versa. Non-resident employees of sports teams might benefit from treaty protection if they are not present in Canada for more than 183 days in a year. However, self-employed athletes, such as tennis players would likely have no treaty protection.

Special Rules for Film Actors

Finally, a completely separate set of overriding rules applies to actors who provide acting services in a film or video production. These taxpayers, whether they provide services directly or through a corporation, are subject to a flat 23% withholding tax under Part XIII of the Act. This rate applies to income from acting services, including residuals and contingent compensation. Further, these taxpayers are not required to file Canadian income tax returns.

However, a special election is available to actors who choose to file a tax return. Under this election the 23% withholding tax does not apply, and they will be taxed under Part I on their net income earned in Canada. To be valid, this election must accompany a Canadian income tax return filed by the person’s filing due date.

Note that these special rules do not apply, for example, to stage actors or radio artistes. They do not apply to other income earned by the actor, such as from services as a producer or director. Nor do they apply to other personnel working behind the scenes in the film industry. All these other services are subject to the normal 15% Reg. 105 withholding and the requirement to file a return.

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Friends in Low Places

In Canadian Income Tax, Personal Tax on September 13, 2009 at 11:08 pm

CRA prescribed interest rates were announced this week and, for the third quarter in a row, they have been pegged at a very slim 1%. What better time to pull out a couple of tried and true income splitting strategies designed to take advantage of these rates.

Strategy #1 – Loan To Spouse

Whenever prescribed rates dip, tax planners suggest this strategy, but with rates this low, I’m not just suggesting, I’m urging. If you have investments earning income on which you are paying tax at high marginal rates, and your spouse pays tax at lower rates, this strategy is for you. Making a gift of funds to your spouse to have him earn the investment income might sound like a good idea, but, of course, this would trigger the income attribution rules. Essentially, the income earned by your spouse would be attributed back to you and taxed in your hands.

A bona fide loan to your spouse would not create the same attribution problem; but it is subject to other restrictions. Essentially, you must charge interest on a loan to your spouse at the prescribed rate in effect at the time the loan was made. Any income earned by your spouse over and above this rate will be taxed at his lower rate.

With prescribed interest  rates at 1%, and equity investments moving up, this strategy has never been more attractive.

Strategy #2 – Corporate Freeze

If you are a business owner and you’ve been contemplating allotting shares of the business to your spouse or minor child, the time is now.

If you shares have a value, you cannot simply issue new shares to your family members without triggering tax. The normal course of action would be to freeze the value of your shares and issuing new common shares in the desired proportions. This will generally trigger the “corporate attribution” rules. Essentially, the company would have to pay you an annual dividend based on the value of your shares at the time of the freeze. What’s the rate of the dividend? That’s right – the prescribed rate. So a corporate estate freeze should now be considered for anyone who has a company with value and wants to bring family members into the fold.

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WHAT’S YOUR TAX ISSUE?

In Canadian Income Tax, Personal Tax on September 10, 2009 at 8:35 pm

This is the first instalment of a regular feature on The Tax Issue where you ask the questions and I offer an incredibly coherent and entertaining answer. This week, the topic is marriage  breakdown and the equivalent-to-spouse credit.

The Tax Issue:

Upon the breakdown of a marriage, who is eligible to claim an equivalent-to-spouse credit for a child that lives with both parents on a regular basis throughout the year?

The Answer:

This is a question that comes up on a regular basis, and the answer is a bit complicated.

First, let’s look at who can claim the equivalent-to-spouse credit. You must fall into one of the following categories at any time in the year:

  1. You must be unmarried and not in a common-law relationship; or
  2. You are married or in a common-law relationship, but did not support or live with your spouse or partner and your spouse or partner did not support you.

Now, let’s look at who would be the subject of the claim. The person must be someone who lives with you and is:

  1. Resident in Canada (except in the case of your child)
  2. Wholly dependent on you for support
  3. Related to you (we’re talking immediate family)
  4. Except in the case of a parent or grandparent, under 18 years of age, or dependent on you by reason of mental or physical infirmity.

Now that we’ve covered the basics, let’s get down to the actual question. Let’s assume we are talking about a child under 18, the parents separate in the year and the father immediately begins making non-deductible support payments pursuant to a court order or written agreement.

Essentially, the answer depends on whether we are in the year of the breakup or a subsequent year.

In the year of breakup:

In this year, either parent who qualifies can claim the deduction in respect of the child, but they cannot share the credit. So, if the child normally lives with both parents (shared custody), then they must agree as to who will take the credit in respect of the child. If they can’t agree, then neither one gets the claim.

If there are two children, and each spouse wishes to make a claim for one child, this might be possible, but each parent would have to prove that their respective child lived with them and was wholly dependent on them for support at some time in the year.

After the year of breakup:

In any subsequent year, the person required to make child support payments (whether or not the payments are actually made) is not entitled to the claim. So, in our example, the mother would be the only person eligible to make the equivalent-to-spouse claim in respect of the child.

If no support payments are being made, or they are paid but are not required under a written agreement or court order, then the above restriction does not apply, and either parent can make the claim, as long as they meet the criteria set out above.

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Brian Mulroney and the CRA – Part 2

In Canadian Income Tax, Tax Avoidance on September 9, 2009 at 5:41 pm

This is a continuation of my Mulroney rant from last post.

While Mr. Mulroney admits to collecting $225,000 as a retainer for services to be rendered to Karlheinz Schreiber, he claims he did not report the amounts as income for tax purposes because he didn’t feel they were earned yet.

Muroney with Reagan - happier days

Mulroney with Reagan in happier days

Fast forward to 1999, when the amount was finally reported as income. First of all, the event that triggered the reporting was not the fact that anything was earned, it was the fact that Mr. Mulroney was feeling threatened that Schreiber was going to report him to the tax authorities. So, if Mulroney was complying with the tax law as he claimed, why would he worry about such a threat?

Next, if all was above board with this amount of income, why would Mulroney not simply add  it to his tax return for 1999? Here’s a fact: the voluntary disclosures route taken by Mr. Mulroney is only available to taxpayers where negligence penalties are involved.

And why, for heaven’s sake, would he not insist on reporting the full amount when his lawyers came to him with the deal they negotiated with the CRA that allowed him to escape tax on half the cash? That’s what I would do if I were a former Prime Minister conscious of my appearance in the public view.

When asked these very questions, Mr. Mulroney simply blamed it all on his lawyers. Trust me when I say that pleading ignorance and relying on professionals never works with the CRA or the courts. Taxpayers, especially sophisticated taxpayers are always assumed to have knowledge of the contents of the tax returns as evidenced by their signatures and are held responsible for them. For someone like Mr. Mulroney to reply to a direct question concerning his taxes with the statement that he “gave it to (his) tax advisers” is the epitome of brazenness.

Mulroney was followed immediately by Wayne Adams of the CRA who tried to explain to the committee much of what I’ve just said. At the end, Commissioner Oliphant said “I listened to Mr. Mulroney for six hours and I find myself more tired listening to an hour and a half of tax law here”.

Charisma. Mulroney’s got it. Tax nerds like me, not so much.

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Brian Mulroney and the CRA – Part 1

In Canadian Income Tax, Tax Avoidance on September 7, 2009 at 10:42 pm

Now that I’ve got a Blog, I’ve got a platform to whine, to vent, and to set the record straight on whatever I choose.  So, even though it’s a bit late, I’d like to clear up a few of the tax issues brought up during Brian Mulroney’s testimony at the Oliphant commission last May.

Don’t get me wrong. I’ve got nothing personal against Mr. Mulroney. Apart from Pierre Elliott Trudeau, I consider him to be the most charismatic prime minister I’ve seen.

But his tax knowledge is weak, and the news reports about when and how he paid taxes on the payments he received are somewhat misleading. So it’s my job to try to clear things up.

Brian Mulroney - Charisma : Yes - Tax Expertise: NoBrian Mulroney – Charisma : Yes;  Tax Expertise: No

It’s old news now, but just to refresh our memories, Mulroney admitted to receiving cash payments totaling $225,000 from German businessman Karlheinz Schreiber. The payments were received in 1995, just after Mulroney left office.

When asked about reporting this amount on his income tax return, Mulroney suggested that he did not report the amounts because he considered them to be “retainers”, and had every intention of reporting the income at such time as he felt they were earned. This, he stated was according to the rules of the Income Tax Act, and I have yet to see any news reports that challenge this view.

Assuming the amounts received were retainers for services to be rendered in the future, the law does not allow for a taxpayer to simply report the amounts when they are earned. There’s a mechanism in place that allows the CRA to keep tabs on us.

Section 12 of the Act requires any amount on account of future services to be reported as income in the year received. Then if the services have not been rendered by year-end, section 20 allows for a reserve to be deducted.

So, if we accept that Mulroney intended to comply with the law from the start, we should have seen an income inclusion of $225,000 in his 1995  tax return, and a deduction for the same amount as a reserve. Each year thereafter, the reserve is brought into income and another reserve claimed if the services have not yet been rendered.

No, I don’t work for the CRA. It’s just that of all people, a former PM should be very careful to actually report income that he says he intends to report.  It would have set such a good example for the rest of us, wouldn’t you say?

This rant is not over. There’s even more to come next time.

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Canada’s Quieter Campaign

In Canadian Income Tax, Tax Avoidance on September 2, 2009 at 6:31 pm

With the UBS ordeal making loud news across the border, Canada , in addition to continuing to piggy-back on the success of the IRS, quietly pursues its own ongoing campaign against off-shore tax evasion. While some may see the CRA’s efforts as slow to the point of non-existent, it is real, and it is progressing.

The Minister of Finance announced last week that it has signed its first Tax Information Exchange Agreement (TIEA) with a non-treaty tax jurisdiction. The sharing of tax information is normally included in Canada’s treaties, but this is different – it applies to non-treaty, traditionally low tax jurisdictions such as Bahamas, Caymen Islands, Jersey and the like. Last week’s agreement with the Netherlands-Antilles is the first in a long list of agreements that will be signed over the next five years.

The bad news, of course, is that these countries will now be happy to turn over information to the CRA that is necessary to help enforce Canadian tax law. Anyone doing business in these jurisdictions would be well advised to start thinking about the future and ensure that they have, in fact been complying with the rules.

The good news is that these countries will become more attractive jurisdictions for foreign business operations from a Canadian tax point of view. Any country that has signed a TIEA with Canada will be eligible for favourable treatment with respect to dividends coming back to Canada. The current rule is that any dividend paid from a non-treaty country is not eligible for exemption under our foreign-affiliate system. Now, any country that has a TIEA with Canada will also qualify for this treatment. So, earnings from active business in these countries can be repatriated to a Canadian parent company on a tax-deferred basis.

Now, back to the bad news. For those countries that do not sign a TIEA with Canada within five years from the day that Canada invites negotiations, active business earnings will not only fail to qualify for tax exempt repatriation, it will also become subject to Canada’s Foreign Accrual Property rules, better known as “FAPI”.

The bottom line? Expect Canada to put the pressure on many tax haven jurisdictions to sign these agreements, allowing the CRA to quietly cast its net over an ever-increasing area of the tax world.