DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Archive for 2017|Yearly archive page

The Morneau Massacre of 2017

In Canadian Income Tax on August 8, 2017 at 9:00 am

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If you’ve just returned from vacation and wondering what’s new in the tax world, you’d better sit down and take a pill. On July 18, finance minister Bill Morneau rolled out the federal government’s proposals designed to “close loopholes and deal with tax planning strategies that involve the use of private corporations”. In short, Finance is proposing to tax an axe to many of the tax strategies that have been available to small business owners and professionals up until now.

The proposals are complex, comprehensive and wide-ranging, covering the following main areas of tax planning:

  • Income sprinkling
  • Multiplication of the capital gains exemption
  • Converting a private corporation’s regular income into capital gains
  • Holding investments inside a private corporation

Income Sprinkling

This strategy involves the splitting of income to take advantage of lower marginal tax rates available to family members. Many rules have been put in place over the years to curtail this practice. Most notably, the tax on split income (TOSI), or “kiddie tax” applies the highest marginal tax rates to certain dividends paid to minor children.

With the new proposals, the TOSI will no longer be limited to minor children. Complex new rules will apply the TOSI to dividends paid to adult individuals unless such dividends are reasonable in light of that individual’s labour contributions and/or capital contributions to the corporation.

The TOSI will also be expanded to apply to capital gains on property, the income from which was subject to the TOSI. Further, it will also apply (for individuals under age 25) to “compound income” that was previously subject to attribution rules or the TOSI.

These proposals are scheduled to apply to for the 2018 and later years.

Multiplication of the capital gains exemption

A capital gains exemption (CGE) of up to $800,000 (indexed) is currently available to any individual on the sale of qualifying shares of a private company. Issuing shares to family members, either directly or through a trust, is a common way to multiply this tax benefit.

The finance minister has proposed a three-pronged approach that will eliminate the multiplication of the CGE:

Age limit: The CGE will no longer be available to individuals where the gain occurs in any year before the individual reaches the age of 18 years.

Reasonableness test: In essence, this rule will deny the CGE on any gain on the sale of shares if the gain from those shares is subject to the TOSI measures described above.

Trusts: With exceptions for spouse or alter ego trusts the GCE will no longer be available on any gain on a share that is held by a family trust.

These proposals will apply to dispositions after 2017. However, there will be transitional rules that will allow an elected deemed disposition at any time in 2018. The fair market value of the shares would have to be determined, and the qualification criteria for the CGE will be treated as being satisfied if they are met at any time in the preceding 12 months.

Converting a private corporation’s regular income into capital gains

Normally, a distribution of a corporation’s retained earnings is considered a dividend and taxed as such. The top rate on dividends is approximately 44%. Strategies have been used with varying degrees of success to arrange for dividends to be transmogrified into capital gains, which are taxed at 25%. This involves the utilization of the high cost base on shares that have been acquired through a non-arm’s length transaction that had previously triggered a capital gain. Current rules are in place to curtail such “surplus stripping” in limited circumstances. Section 84.1 effectively forces a return to dividend treatment where the capital gains exemption was claimed on the previous capital gain.

The government proposes to extend these rules to any situation where a non-arm’s length transaction involved even a fully taxable capital gain. This proposal is meant to address what has become known as the “pipeline” transaction.

The pipeline has been used extensively in recent years as a post-mortem planning tool to avoid double-taxation where the capital is deemed to occur on the death of a corporate shareholder. Unless the current proposals are altered, the pipeline strategy will no longer be available to an estate.

These proposals will take effect for all dispositions that occur after July 18, 2017. There will be no room for transitional planning.

Holding investments inside a private corporation

One of the long-standing advantages of incorporation is the tax deferral that comes with lower rates on business income. Once the retained income has accumulated over time, the company will have a larger amount available for investment. This has been a great contributor to the retirement of many small business owners. However, it is an advantage that salaried persons or those who don’t incorporate cannot access. Accordingly, the government proposes to eliminate it.

Of all the proposals announced, this is the only one that is not fully developed with draft legislation. The Minister has included some suggested strategies to deal with the issue, each one complex in its own right, and generally altering the system of integration currently in place by eliminating the effect of the corporate tax deferral for future passive investment.

The Minister acknowledges that there currently exists a significant amount of capital invested within private corporations, and it is not his intent to affect these holdings. Any new rules will have effect on a going-forward basis.

These proposals are subject to a consultation period which will end on October 2, 2017. Interested parties should write to the Minister of Finance with any concerns before that date. I suspect that it will be an interesting and eventful autumn for the tax community.

The End of the Tax Mulligan

In Canadian Income Tax on June 5, 2017 at 9:00 am

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What happens when a transaction is undertaken that is planned to be tax-free, but due to an unforeseen error in the execution of the plan, it is subsequently discovered that tax is payable? Until recently, if all else failed, one option was to apply to the courts to allow for “rectification”. That is, since the parties to the transaction originally based their actions on the assumption that the plan was tax-effective, ask the courts to allow them to “redo” the deal correctly to restore its original tax-free intent.

Rectification is essentially not a tax concept. It generally applies where parties to a transaction discover that the legal documents that apply do not accurately represent the agreement or intent of the parties at the time. When both parties agree, the courts are inclined to grant relief and allow for a retroactive correction of the legal documents.

Back in 2000, in the case of Juliar, rectification was granted in a tax context to correct what was essentially an error on the part of the tax planners. Simply put, Mr. and Mrs. Juliar transferred shares to a holding company on the assumption that the shares had a high adjusted cost base (ACB) and no rollover provision was made. When it was subsequently discovered that the ACB was indeed low, they applied to the court for rectification, asking to convert a taxable sale to a rollover under section 85 of the Income Tax Act. The court agreed.

Since then, the case of Juliar has been cited often in cases where mistakes in legalities have created undesired tax results. However, in the recent decisions of Jean Coutu and Fairmont, the Supreme Court has overturned Juliar and has put an end to the idea that rectification can be used as a tool to correct errors in tax planning and its execution.

The court in Fairmont stated:

“…rectification is not equity’s version of a mulligan. Courts rectify instruments which do not correctly record agreements. Courts do not “rectify” agreements where their faithful recording in an instrument has led to an undesirable or otherwise unexpected outcome.”

Juliar was expressly overturned on the basis that the decision resulted in “impermissible retroactive tax planning”.

There is a famous decision (Shell Canada) that stands for the idea that a taxpayer is taxed on the way it arranges its affairs, rather than how it could have arranged its affairs. This concept is often referred to when a legal transaction is executed poorly, resulting in unintended tax consequences. These new decisions are in line with this concept, and they take away a weapon of last resort for taxpayers and their advisors.

2017-2018 Quebec Budget Summary

In Budgets on March 29, 2017 at 2:31 pm

Under the Auspices of the Quebec Order of Chartered Professional Accountants, I am pleased to provide a copy of the2017-2018 Québec Budget Summary2017-2018-Résumé du budget du Québec.  I will also place a link on the Tax Links Page, and they will remain there, along with future federal and Quebec budget summaries for future reference.

2017 Federal Budget Summary

In Budgets on March 23, 2017 at 2:07 pm

Under the Auspices of the Order of Chartered Professional Accountants of Canada, I am pleased to provide a summary of 2017 Federal budget summary/ 2017 Résumé du budget fédéral. I will also place a link on the Tax Links Page, and it will remain there, along with past federal and Quebec budget summaries for future reference.

Can Employees Deduct Cost of Cell Phone Plan?

In Canadian Income Tax, Employment Income on February 10, 2017 at 5:01 pm

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This should be an area of interest to pretty much anyone that owns a cell phone, so I thought I’d reproduce it here. It’s a recent CRA technical interpretation on the question of whether the cost of a cell phone plan is deductible from employment income.

Deductions from employment income must be specifically provided for under the Income Tax Act. Section 8(1)(i)(iii) deals with supplies used up in the course of performing employment duties. There must be a requirement under the employment contract for the employee to pay for his own supplies, and the employer must sign form T2200 to attest to this requirement.

The CRA was asked whether the cost of a basic cellular service plan is deductible from an employee’s employment income where an employer requires the employee to use a cellular phone to perform employment duties.

CRA Response: It is a question of fact. Section 8(1)(i)(iii) of the Income Tax Act (the “Act”) provides a deduction to an employee for “the cost of supplies that were consumed directly in the performance of the duties of . . . employment and that the . . . employee was required by the contract of employment to supply and pay for.” For supplies to be considered consumed directly in the performance of employment duties, the supplies must be used up and play an integral and essential part in the performance of the employment duties. The cost of the supplies should also be reasonable.

Based on the above, cellular minutes and data would be considered “supplies that were consumed directly” where it is determined that the cellular minutes and data were used up and played an integral and essential part in the performance of the employment duties. It is our understanding that service providers typically provide a detailed breakdown of each cellular minute used, but do not similarly provide a detailed breakdown of cellular data used. It is our view that without a detailed breakdown an employee would not be able to substantiate the amount of cellular  data that was used for employment purposes. Where the cellular minutes or data and costs cannot be substantiated, a deduction from employment income is not permitted under s. 8(1)(i)(iii) of the Act. If an employee can substantiate that they used their cellular phone exclusively for employment purposes (i.e., no personal use), it is our view that the basic service plan may reasonably reflect the cost of those cellular minutes and data. Where there is both employment and personal use and the employment use can be substantiated, an employee may apportion the basic service plan on a reasonable basis. However, if only the employment use of cellular minutes can be substantiated, only the portion of the basic service plan for minutes may be apportioned (i.e., the portion of the basic service plan for data cannot be deducted).