DAVID WILKENFELD, CA, canadian tax CONSULTANT

Archive for November, 2009|Monthly archive page

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New Business Number, After All These Years?

In Canadian Income Tax on November 26, 2009 at 2:14 pm

Today I received an interesting early Christmas gift from the CRA – a new business number! If you’ve been following my Twitter Tweets (and who isn’t?), you should know that starting January 1, 2010, anyone who files information returns with more than 50 slips attached will be required to file their returns electronically.

These new rules apply to all information returns that require slips, some of the most common being T4, T5, T4A, RRSP contributions and TFSA reports.

For those who file 50 slips or less, the electronic filing system is voluntary.

In order to file electronically, you need to have a web access code and a business number.

Business numbers with the new “RZ” suffix have been automatically issued to many corporations and filers of information returns. The RZ suffix is to be used when filing information returns (other than T4′s where the existing payroll account suffix “RP” applies).  So, if you’ve received what looks like a new business number in the mail and were wondering why, you’re business number hasn’t changed  – you’ve simply been automatically registered to file electronic information returns and your business number will have a suffix of , say, RZ0001 attached to it.

There are four different program account types, as follows:

  • T5, RRSP, T5007, T5008, SAFER
  • TFSA (tax-Free Savings Account)
  • T5013 (Partnership Return)
  • T5018 (Construction contract payments)

If you are filing returns for different program file types, you will need a different suffix for each type. For example, for filing t5′s your number may end with RZ0001, and your T5013 filing number may end with RZ0002.

If you have not automatically received these new business numbers, you must apply for them by filing the new special business number application form RC257.

If you need more information, you can call the CRA at 800-959-5525

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What’s Your Tax Issue? Gift or Sale to Kids

In Canadian Income Tax, Personal Tax on November 19, 2009 at 6:11 pm

The Tax Issue:

I am a partner in a Canadian co-ownership of real estate rental property and my siblings and my mother are also part owners. I would like to make a gift of my share to my children. Can this be done tax-free? Could I sell the property to them for a dollar?

The Answer:

In Canada, we don’t have a gift tax. However, when a gift is made between family members there is a deemed disposition at fair market value. So any gain that has accrued on your share of the co-ownership will be realized and you will be taxed. I’m not sure of your particular situation, but you might want to check your 1994 income tax return (if you can find it). That’s the year that the $100,000 general capital gains exemption was repealed. A special election was available to make one final use of the exemption and “bump up” the cost base of capital assets. If  you made the election on your real  estate venture, that could shelter part of the tax on a future disposition.

Special rules would also apply to your kids if you make this gift to them. Their cost amount for depreciation purposes could be reduced by the amount of your proceeds that results in the non-taxable portion of a capital  gain.

One of my pet peeves is when people make the mistake of thinking that a sale for a dollar is the same as a gift. It isn’t. A sale at an amount less than fair market value is not a gift, and different, much harsher rules apply. Your proceeds will still be equal to fair market value, but the cost base to the purchasers will be equal to exactly what they pay, i.e. one dollar. Then, when they decide to sell, they would be paying tax again on the full amount of proceeds. This “double tax” is the penalty for making a sale to a related person at an amount less than fair market value.

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Don’t Get Trapped With Vacant Land

In Canadian Income Tax on November 17, 2009 at 10:22 am

The deductibility of interest and taxes on vacant land is a topic that invariably causes confusion for many people, myself included. So, since I felt the need to brush up on the issue, I thought I’d subject you to the same torture.

To quote Maria von-Trapp, let’s start at the very beginning. That would be subsection 18(2), a very fine place to start. In its simplest application, it provides that interest and taxes on vacant land are not deductible. That’s a pretty well-known concept.

Income tax rules: Someday there will be a musical

OK, let’s jump ahead now to paragraph 53(1)(h). That’s the provision that allows us to add these disallowed expenses to the adjusted cost base of the land. Again, a simple concept.

So why the whole Tax Issue treatment? Well, for one thing, I’ve got space to fill; for another, it gets a bit more complicated.

Let’s jump back for a minute to 18(2). There are a few exceptions to the rule, whereby the expenses will be deductible. The provision does not apply at all, if the land was used in the course of a business at any time during the year. So, for example, if a piece of land was used at any time to store inventory, such as scrap metal, as part of a business, 18(2) would not apply and the expenses would be fully deductible. Note that the rule applies to a business. This means that rental use is not likely to qualify. Further, the exception does not apply to developers, who are subject to their own set of rules.

In the case of rental use, a second exception allows a deduction of interest and taxes to the extent of income for the year from the land; income may be offset, but no loss can be generated by these expenses.

Lets go back now to paragraph 53(1)(h) because the ACB adjustment may not be so clear cut. What many practitioners are surprised to discover (and often only find out during an audit) is that the non-deductible interest and taxes on vacant land is not automatically added to the ACB. In order for the ACB adjustment to apply, the expenses must have been disallowed by virtue of subsection 18(2). Flipping back there, we find that the expenses are disallowed in the calculation of net income from business or property. Therefore, the land must be part of a business or property income earning endeavour. If not, there is no ACB adjustment.

Typically this problem comes up in cases such as Bauerle v. MNR, where the taxpayer purchased a parcel of land in 1957, held it until 1981, and reported a capital gain on disposition. In calculating the ACB of the property, he added the interest and taxes for all the years he owned it. The tax court held that paragraph 53(1)(h) did not apply to increase the ACB because the land was not used or held in connection with the earning of income from a business or property. In such cases, the expenses are simply non-deductible capital expenses, and are lost.

Alternatively, an adjustment to the cost of land inventory may be available under subsection 10(1.1). The owner must hold the land as inventory, either as a developer or dealer. Any gain or loss on the sale of the land would, of course, be treated as ordinary income of the taxpayer.

This begs the question as to the treatment of an isolated purchase of land as an adventure or concern in the nature of trade. Such a purchase would classify the land as inventory and the disallowed expenses would be available as addition to the cost of inventory under 10(1.1). Again, any gain would be fully taxable as business income. Furthermore, whether a purchase of land is an adventure or concern in the nature of trade is a question of fact, and must be analyzed based on the circumstances. These factors include: (a) the taxpayer’s conduct; (b) the nature of the property; and (c) the taxpayer’s intention.

So the problem with vacant land is not as easy as A-B-C or even Do Re Mi. Blindly assuming that interest and taxes may be added to ACB could become a costly trap in the end

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The Tax Treatment of Legal Fees (And Other Important Lessons)

In Canadian Income Tax, Personal Tax on November 12, 2009 at 4:00 pm

Did you ever get yourself into a bad relationship? How about a lousy business venture? How about a bad relationship, three lousy business ventures, a few lawsuits and a tax court case? Consider the case of John G. Dalfort v. Her Majesty the Queen (2009 DTC 1278), and the relationship from hell. Apparently, while they were together, John and his ex, Karen Conquergood, attempted a few enterprises that didn’t quite pan out. The first was an escort service. Then they tried a pyramid scheme, and finally a crab-fishing business. Well, you can’t say they didn’t diversify! They also received cash from two separate lawsuits brought, first against an insurance company and then a physician.

John and Karen - Even crabs couldn't keep them together

After they split up (yes, somehow they were not destined to last), she sued him for spousal support, her share of the take from the aforementioned ventures, as well as for her share of the proceeds from the sale of their house and a 45-foot sailboat. Finally, there was the small matter of the damages she sought for assault.

Ms. Conquergood was only mildly successful in her claims, but poor John then tried to deduct the legal fees he paid to defend himself. And so, The Tax Issue must now discuss the mundane topic of legal fees and their tax treatment.

The CRA has summarized their position on legal fees in their bulletin IT-99R5. First, there is nothing in the law that allows for the general deduction of legal fees. Apart from a few specific provisions which we discuss below, legal fees are only deductible if they are non-capital expenses incurred to earn income from a business or property.

Examples of deductible legal fees for business purposes include:

  • Preparation of general sales contracts
  • Obtaining security for trade debts
  • Preparation of annual minutes and corporate filings

Legal fees for obtaining financing or issuing shares are capital in nature, but under a special rule, they may be amortized over five years.

Other legal fees that are capital in nature may be added to the cost of capital assets acquired or to cumulative eligible capital.

Apart from the above, specific sections of the law allow you to deduct legal fees incurred for:

  • Enforcing or establishing a right to salaries and wages
  • Enforcing or establishing a right to pension benefits or a retiring allowance (including damages for wrongful dismissal)
  • Preparing an appeal to a tax assessment
  • Making representations to a government body
  • Establishing a right to child support
  • Enforcing a pre-existing right to spousal support or child support

Legal fees incurred to establish a right to spousal support are not deductible.

From a payer’s point of view, fees to contest a claim for support payments or to reduce pre-existing support amounts are not deductible.

But let’s get back to our hero, John. The Tax Court ruled that his legal fees were incurred to defend against claims which were either personal in nature, or involved business activities which had been, but were no longer carried on. His claim was dismissed.

I think there are many lessons to be learned from this case, the tax treatment of legal fees being probably the least important.

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What’s Your Tax Issue? Tuition Fees

In Canadian Income Tax, Personal Tax on November 6, 2009 at 5:43 pm

The Tax Issue:

I am enrolled in a university course on an audit basis. I’m allowed to attend the lectures, and receive course material, but I do not write any exams and I get no mark. It’s half the regular fee for a course, and I’m wondering if the fee can be deducted?

The Answer:

The general rule for the tuition fee credit is that the fee must be paid to a university (or a certified post-secondary institution), must be over $100 and must cover a period of not more than 12 months. Provided these requirements are met, the CRA takes the view that fees for auditing courses are eligible for the tuition credit.

Another question arises as to whether the time spent in auditing a course would qualify  for the education credit – $400 per month for full-time and $120 per month for part-time attendance. That would probably depend on the structure of the course, and whether you would be considered to be a student attending the class. It would seem that if the tuition qualifies, then the course would also qualify for the education tax credit if your time is actually spent attending the class.

Interestingly, the tuition fee credits require hat you be enrolled in a Canadian university. The rules are a bit different for foreign universities.  Here, you must attend the university and the course must lead to a degree.

Recently, the question of attendance in a university has been the focus of some commentary. The question is, are you “attending” a university if you are taking a correspondence or online course. In the case of Valente (2006 DTC 2685) the Tax Court ruled full-time attendance can be done through the internet.

The CRA has recently published an opinion stating that a student enrolled in a university outside Canada and taking courses over the internet may be able to claim a tuition tax credit provided that student is able to demonstrate that their attendance over the internet constituted “full-time attendance”.

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Offshore Trusts – Is The Sun Setting?

In Canadian Income Tax, Tax Avoidance on November 3, 2009 at 1:27 pm

So often, I see tax strategies fall short, not due to faulty planning, but faulty execution. It is so easy to fall into complacency with regard to documentation. But I’m not going to ask you to take my word for it. I’ll let you read a great excerpt from the Tax Court of Canada in the case of Antle (2009 TCC 465). This case, by the way is one of the two recent “Barbados trust” cases involving the use of offshore trusts to escape tax on large capital gains.

Parenthetically, the other case, Garron Family Trust, (2009 TCC 465) calls into question the long-standing notion that a trust is resident in the jurisdiction where the majority of the trustees reside. This absolute certainty, like the shape of our globe, once considered to be flat, has given way to the reality that the residence of a trust should be determined based on the set of circumstances in question, and that the place where management and control takes place is now the overriding factor.

But I digress. I want to get to this great quotation, because the lawyers involved in this case must be pulling out their hair. When Mr. Antle was about to sell his shares, he decided he could avoid the capital gains tax by following a few simple tax planning steps, as follows:

Step 1: Set up a spouse trust with a trustee resident in Barbados.

Step 2: Transfer shares to a spouse trust (tax free under Canadian law)

Step 3: Trust sells shares to Mrs. Antle (tax-free under Barbados law and Canadian-Barbados tax treaty)

Step 4: Mrs. Antle sells shares with stepped-up cost base

Forget the fact that GAAR also applies to this transaction. The court, in fact made another fun statement in this regard, calling the strategy “a classic law school model of what GAAR was intended to capture”.

But again, I digress. The point is, don’t lose your case for a client before it gets out of the starting block through sloppy paperwork and poor execution. In Antle, the court stated:

“With certainty of intention and certainty of subject matter in question and, more significantly, no actual transfer of shares, there is no properly constituted trust: the Trust never came into existence. This conclusion emphasizes how important it is, in implementing strategies with no purpose other than avoidance of tax, that meticulous and scrupulous regard be had to timing and execution. Backdating of documents, fuzzy intentions, lack of transfer documents, lack of discretion, lack of commercial purpose, delivery of signed documents distributing capital from the trust prior to its purported settlement, all frankly miss the mark — by a long shot. They leave an impression of elaborate window dressing. In short, if you are going to play the avoidance game, it is not enough to have brilliant strategy, you must have brilliant execution.”

So true. Both the Garron and Antle cases are being appealed.