DAVID WILKENFELD, CA, canadian tax CONSULTANT

Archive for January, 2010|Monthly archive page

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Selling Low

In Canadian Income Tax on January 22, 2010 at 10:57 pm

I am often asked during the course of a year whether a taxpayer, for whatever reason, can make a sale of property at a price lower than fair market value, transfer an asset for no consideration, make a gift to a relative or friend, either personally or through a corporation, etc. You get the idea.

The Income Tax Act (“the Act”), being the complex animal that it is, contains many provisions that deal with these questions, and, depending upon the circumstances, any one or more of them could apply. And we won’t even get into the General Anti-Avoidance Rule. What follows is a general discussion of some of these provisions.

Subsection 69(1) – Inadequate consideration

Subsection 69(1) of the Act provides rules that apply where any consideration other than fair market value is provided in any transaction between people who are not dealing at arm’s length. Generally, the provision provides a one-sided adjustment to the selling price. If the proceeds are too high, then the purchaser’s cost amount will be adjusted downwards. If the price is too low, then the seller’s proceeds will be adjusted upwards. If there are no proceeds at all (i.e., a gift) then the transfer will be deemed to have been made at fair market value for both parties.

Subsection 15(1) – Shareholder Benefits

Subsection 15(1) of the Act is a broad provision that taxes shareholders (and future shareholders) on the value of any benefit conferred on them by a corporation. This subsection would cover such transactions as the issuance of treasury stock at less than fair market value, and the forgiveness of shareholder debt.

Some exceptions apply, such as stock dividends, and treasury shares where identical offers are made to all existing shareholders.

Subsection 56(2) – Indirect payments

Subsection 56(2) of the Act applies to “indirect payments”. It deals with situations where a benefit is conferred on a person, where that benefit would, if it were paid to the taxpayer, be taxed in the taxpayer’s hands. The effect of the provision is to tax the person who confers the benefit.

According to the CRA, there are four conditions that must be met for this provision to apply:

(a) there is a payment or transfer of property to a person other than the taxpayer;
(b) the payment or transfer is pursuant to the direction of, or with the concurrence of, the taxpayer;
(c) there is a benefit to the taxpayer or a benefit the taxpayer wishes to confer on the other person;
(d) the taxpayer would have been taxable on the amount under some other section of the Act if the payment or transfer had been made directly to the taxpayer.

A simple example is where a director of a corporation makes a payment to a person who is a non-shareholder of the corporation at the request of a shareholder.

It has been held that subsection 56(2) cannot be applied to dividends paid to one shareholder to exclusion of another at the discretion of the directors of a corporation (i.e., discretionary dividends).

Subsection 246(1) – Benefit Conferred On A Person

Subsection 246(1) of the Act is another broad rule that provides that where a person confers a benefit on a taxpayer, the amount of the benefit must be included in income of the taxpayer.

Subsection 246(2), however, provides an “arm’s length” exception, where all of the following four conditions are met:

(a) The person and the taxpayer are dealing at arm’s length;
(b) The transaction is bona fide;
(c) The transaction is not pursuant to, or part of any other transaction; and
(d) The transaction was not entered into to effect payment of an obligation.

There is very little jurisprudence with respect to the saving provision in subsection 246(2). The only case involving this provision is Pelletier et al v. the Queen. In that case, a shareholder sold his shares to the other arm’s length shareholders of the same corporation for less than fair market value. The exception was held to apply.

Generally, the CRA likes transactions to occur at market value. Any deviation could invoke any one of the above provisions, so as always, be cautious.

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Rollover of RRSP’s and RRIF’s on Death – Don’t Take It For Granted

In Canadian Income Tax, Personal Tax on January 12, 2010 at 11:14 am

If you are the executor of an estate, or you are perhaps advising your client on his will, you should be aware of the rules regarding RRSP’s and RRIF’s on death.

I’m surprised at the number of people, executors and plan administrators alike, who work on the often erroneous assumption that these plans simply roll over tax-free when the surviving spouse is named as the beneficiary.

In fact, the opposite is true. While capital property automatically rolls over tax-free to a spouse on death, a RRSP/RRIF does not. The general rule is that it is taxable in the hands of the deceased annuitant. From there, a number of possibilities can occur.

If the spouse is named as the “successor annuitant”, then the capital in the plan is not paid out. The plan simply continues and the spouse replaces the deceased as the annuitant. There is no tax to the estate and no reporting is required. The successor annuitant can be named in the plan itself or in the will. The successor annuitant can also be established in other cases if the executor and the plan administrator agree.

If there is no successor annuitant, then the proceeds of the plan are realized and they are taxed either in the hands of the surviving spouse or the estate, depending on the circumstances. If the spouse is designated as the plan beneficiary in the contract, the payment of funds is made to the spouse upon death of the annuitant, and the spouse adds the amount to income. The spouse then has until 60 days after the end of the year to transfer the funds to his or her own RRSP/RRIF to obtain an offsetting deduction.

If the spouse is named as a beneficiary in the will alone (which will likely be the case in Quebec), then the payment of funds is made to the estate. The executor and the spouse must then agree and file an election (form T2019 for RRSP’s  or T1090 for RRIF’s) to have the proceeds added to the spouse’s income, and be eligible for rollover into his or her plan.

What if the spouse refuses to sign the election?

Take the case where a deceased man is survived by his second wife, has children from a former marriage and the leaves a RRIF to the spouse in the will, with no clear instructions regarding the taxes. The residue from the estate goes to the children. The executor must receive the funds from the RRIF and pay them to the spouse under the terms of the will. No taxes are deducted from this amount. The spouse can then choose not to make the election. She will receive the entire amount of untaxed capital from the RRIF and she will not have to roll it into her own plan, thus avoiding future taxes on withdrawal. The taxes will be borne by the deceased, and be taken from the residue of the estate, thus providing a possible unintended benefit to the spouse, and most likely some very disgruntled children.

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Wright is Wrong….Again!!!

In Canadian Income Tax, Non-residents on January 5, 2010 at 4:04 pm

Once again, I am personally forced to swallow a tough court decision, as the case of Pechet v. The Queen (2009 DTC 5189) has been dismissed by the Federal Court of Appeal. This case overturned the informal procedure Tax Court decision of Wright v. The Queen (2001 DTC 437) originally argued  (and won) by yours truly.

The Wright case dealt with interest on unpaid non-resident withholding taxes. Under Part XIII of the Act, anyone paying rent to a non-resident must withhold tax based on the gross amount paid. The rate is 25% unless reduced by treaty. The basis for withholding may be reduced to the net amount after expenses if an undertaking is filed with the CRA and form NR6 is filed. (For more, see my post on Non-resident Real Estate Investors)

If the non-resident recipient files an income tax return under section 216 of the Act by the required deadline, tax under Part I of the Act is applied “in lieu of” the Part XIII tax withheld. In essence, any tax withheld in excess of the Part I liability is refunded.

Where the Part XIII tax is not withheld, but the section 216 is filed, the CRA’s position is to charge interest based on the withholding tax that should have been remitted. The original argument in Wright was that if the filing of the 216 return replaces the Part XIII liability with the Part I liability, then there is no longer any tax upon which an interest calculation may be made. The Tax Court agreed, and a loophole seemed to be exposed.

The Pechet case heard in Tax Court overturned Wright, but there was still a glimmer of hope as it was appealed to the Federal Court of Appeal.

Now, sadly, it appears my own personally victory remains just that. Since decisions in  the informal procedure cannot be appealed, my client’s victory is final and my Tax Court record is still 3-0. However, my legacy as a precedent-setting barrister is over for good.

The Court of Appeal in Pechet upheld the decision of the lower court and concluded that the filing of a return under section 216 of the Act does not retroactively eliminate the requirement to withhold under Part XIII. Rather, the withholding requirements continue to apply, up until the point in time when the tax liability of the non-resident has shifted from Part XIII to Part I. The phrase “in lieu of” does not mean that the Part XIII liability never existed, but that it is replaced, at the time of the filing of the return, with the Part I tax liability. Any interest accruing on unpaid withholding tax up to that point must be paid.

This interpretation, in all fairness, seems to be the correct application of the provisions, given the scheme and intent of the Income Tax Act as it applies to non-resident taxpayers.