DAVID WILKENFELD, CA, canadian tax CONSULTANT

Archive for the ‘Personal Tax’ Category

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What’s Your Tax Issue?

In Canadian Income Tax, Non-residents, Personal Tax, Principal Residence on March 15, 2011 at 4:10 pm

Tax season is upon us, and here at The Tax Issue, the questions are streaming in at a furious pace. I had a few free minutes this afternoon, so I thought I’d tackle some of the backlog.

The Tax Issue:

My partner and I each have holding companies that have joint ownership of our operating company.  If we wanted to sell a 1/3rd share in the operating company is there a mechanism to utilize our personal capital gains exemption?

The Answer:

The capital gains exemption is a $750,000 lifetime limit available to all Canadian resident individuals. It can be used to shelter capital gains on the sale of either qualified farm property or qualified shares of a small business corporation.

Since the shares of your operating company are held through a holding company, the exemption would not be available in the situation you describe. Your holding company would be the vendor of the shares and the exemption is available to individuals only.

Having said that, there may be some “reorganization” of shares you could perform to get you into a better position. Such planning would go beyond what I could explain here, so I would explore these options with a tax professional.

The Tax Issue:

I am a Canadian living/working in the US and considered non-resident of Canada for tax purposes. I do have a rental property in Canada and looking for an easy way to file my income tax on the rental property. What I have read so far makes me believe that I must file my taxes through an agent in Canada. I am wondering if I can file my taxes without using an agent and what is the process to do that.

The Answer:

The short answer is that you do not need to file a tax return through an agent.

Since you are a non-resident of Canada, the Canadian person who pays you rent must withhold taxes and remit them to the CRA on a regular basis. This person could be your tenant directly, or a Canadian agent who manages the property and collects rent on your behalf. Either way, there has to be a Canadian responsible for withholding and remitting these taxes.

You then have the option of filing a tax return under section 216 of the Income Tax Act. The taxes previously withheld would be treated as a credit against your taxes payable. There are two options for withholding and filing under section 216. I have discussed this mechanism in a previous post. Check it out. Also, the CRA has an extensive section on their web site dealing with the issue.

The Tax Issue:

My mother passed away in 1995 and my father gifted her 50% portion of a house to me, however kept himself on title for the other 50%.   He had another house that he resided in.   He kept his name on solely to protect my interest in case of divorce.    He passed away in May 2010 and now I’m told that I may have to pay capital gains.   I don’t understand why I have to pay capital gains if I’m not selling the property and the property has been my principal residence.   He had nothing to do with the house.   Is there anything I can do to avoid paying this capital gains tax?

The Answer:

Unfortunately, it sounds like your father was the owner of more than one principal residence. Upon the death of an individual, he is deemed to have disposed of all his capital property at fair market value. That includes any real estate he owned. There is an exemption for a principal residence. The definition of “principal residence” includes, not only the house he lived in, but can also include a house occupied by his child. The downside is that his estate can only claim one property as a principal residence.

Your father’s executor will have to determine which of the properties he should claim as his principal residence in order to minimize the taxes on his death. I would call in the help of a good tax accountant to crunch those numbers.

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What’s Your Tax Issue? Province of Residence

In Canadian Income Tax, Personal Tax, Residency on February 11, 2011 at 10:25 am

The Tax Issue:

I recently accepted a job position with my current employer which will transfer  me from Toronto to Montreal. Now I love Montreal however I hate Quebec income tax and I was looking for a way to physically work in Montreal (Quebec) however keep paying taxes as a resident of Ontario.  Any advice would help.

The Answer:

Welcome to the club! We Montreal-lovers and Quebec tax-haters have been struggling with this question for years. Some of have moved away never to return. Unfortunately, loving Montreal comes with a price (and I don’t mean Carey :-) ).

Individuals are subject to Canadian income taxes in the province where they reside on December 31 of any given year. Residency for income tax purposes is not a choice one makes by ticking a box on a tax return. It is a question of fact, based on your residential ties.

The most important residential ties are where your home (owned or rented) is, and where your spouse or common-law partner or dependants reside. Other ties that may be relevant include social ties, bank accounts, driver’s licence and medicare.

So, unless you’re move is temporary or you plan to commute from Toronto each day, you’re pretty much going to have to set up residential ties in Montreal and pay Quebec taxes.

If you really feel very strongly about staying out of the Quebec tax system (as a resident of Ontario you’d be saving less than 2 per cent in income tax if you’re at the top marginal bracket), you could make your home in nearby Cornwall, Ontario, which is only about a 45 minute commute from Montreal (on a Sunday Morning :-) ).

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What’s Your Tax Issue? More Personal Property Issues

In Canadian Income Tax, Personal Tax on February 2, 2011 at 3:30 pm

The Tax Issue:

In 2002, my parents put their principal residence in joint tenancy with my husband and myself. We lived on the property for a period of time. We have, since 2002, contributed to repairs and upkeep. In 2005, my father died. In 2010, my mother died. We currently use the home as a seasonal property but we plan to rent it out a few weeks of the year in order to have it pay for its upkeep. What I am wondering about is Capital Gains Tax. I am sure our portion (or maybe all of it minus the costs incurred and that step-up thing?)is subject to it, however, is it only payable if the property is sold? Also, is the step-up determined from when we received our interests in the property in 2002 or when it was no longer my mom’s principal residence (because she died) in 2010?

 
Hey, as an aside…do you recommend claiming rental income from a seasonal vacation rental as “rental income” on a personal tax return or as “business income” on a personal tax return (I did register my husband and myself as a general partnership – if that matters)…you probably recommend that the time has come to hire an accountant, right? ;-)

The Answer:

OK, let’s tackle the easy question first. You will only pay capital gains tax on the property when it’s sold.

Now, when your parents transferred the property to you in 2002, they had a deemed disposition at fair market value, so that your cost is equal to the value of the property at that time. If you have made any capital improvements since that time, you may add those to your cost.

When you sell the property, a portion of the gain may be exempt if you claim the property as your principal residence. That’s not such an easy decision to make. You can designate only one property as a principal residence in any given year, so if you owned any other residence, you may want to save those years for the property with the higher accrued gain.

Next, rental income must be reported as “rental income” not “business income”. There is no choice in the matter. Registering as a partnership doesn’t really change a thing, other than you’ve protected your partnership’s name, if any.

And finally, nothing beats a good accountant. They’re cute, warm and cuddly and yes, I do recommend you use one.

Good luck!!

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What’s Your Tax Issue? Using RRSP Funds for Private Company Investment

In Canadian Income Tax, Personal Tax, RRSP's and RRIF's on January 25, 2011 at 1:10 pm

The Tax Issue:

Can I use the funds in my RRSP to invest in shares of a private company?

The Answer:

Let’s get one thing out of the way from the top: you cannot use your RRSP funds to invest in a corporation which you control. Now, for those of you that are still with us, the following explains the rules involved.

Small Business Corporation (“SBC”) Test

Generally, an SBC is a corporation that meets the following conditions:

(a)    the corporation must use all or substantially all (i.e. 90%) of its assets principally in an active business carried on primarily in Canada. Shares or debt of connected qualifying corporations are also eligible assets.

(b)    The corporation must be a Canadian corporation that is not controlled any manner by non-residents. This control test includes control in fact, as well as legal voting control.

Any investment in an SBC will qualify as long as investor is not connected with the corporation

A shareholder is considered connected if he or any related person owns, directly or indirectly, at least 10% of the shares of any class of the corporation or a related corporation.

A connected shareholder could still invest in a SBC as long as the total investment (including investments by related persons) is less than $25,000, and the investor deals at arm’s length with the corporation.

Eligible Corporation (“EC”) Test

Most RRSP investments in private companies will fall within the rules described in the SBC test above. The EC test is an older rule that still applies. It is similar to the SBC test, but more restrictive, so let’s not bore you with the details.

Suffice to say that anyone contemplating an investment in a private company with RRSP funds should not do so without first consulting a tax professional.

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What’s Your Tax Issue? Inter-Provincial Employment

In Canadian Income Tax, Personal Tax on January 10, 2011 at 4:11 pm

“We’re workin’ our jobs, collect our pay, believe we’re gliding down the highway, when in fact…..”

The Tax Issue:

I have recently been hired as an employee by a firm from Ontario. I live in Quebec and I will be working exclusively from my home. My employer’s accountant tells me I am subject to Ontario payroll deductions. Is this correct?

The Answer:

The short answer is, yes.

Generally, it is not the province where the employee is resident that determines the jurisdiction for payroll deductions at source, but rather, the place of employment.

The place of employment is the employer’s place of business where the employee is required to report to work. This is true, regardless of where the employee lives or where the employer’s head office is.

If, as in your case, an employee does not report to work at the employer’s place of business, the CRA says that the province of employment is determined to be the place where the employer’s business is located and from where he pays the salary.

Based on the above, you will be subject to Ontario deductions at source. When you file your tax returns, however, you will still file as a Quebec resident taxpayer. As a result, you will probably have a large refund for federal purposes and taxes due on your Quebec return.

In this case, when you file your tax returns, you may apply a portion of your total tax withheld against your Quebec tax liability. The rules allow for you to transfer to Quebec any amount up to a maximum of 45% of the total tax withheld in another province. Simply slip the amount you wish to transfer on to the appropriate lines on both your federal and Quebec tax returns.

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Mortgage Interest – It’s On The House!

In Canadian Income Tax, Principal Residence on October 13, 2010 at 3:16 pm

It’s not often that a tax planner gets a freebee, so I’m just  giddy about this one! A recent tax court case and a related CRA opinion both give a detailed description of a tax plan and both say it’s OK!

Let’s say you have a home that is mortgage-free. You’ve decided to buy a new home, and convert your old home to rental property. If you simply move out and purchase a new residence and take a mortgage to finance it, the interest on that mortgage will not be tax-deductible, since the proceeds of the loan are used to purchase a residence. Meanwhile, your rental property (your former residence) is still mortgage-free – not the best result.

So, here’s the plan: First, sell your existing home at fair market value to someone you trust – let’s say it’s your brother. Your brother pays you with a promissory note. There is no income tax on the sale, because the property was your principal residence.

Next, Buy back the old home from your brother. To finance this purchase, you take out a mortgage on this home. Now that the home is to be used as a rental property, the future interest payments will be tax-deductible.

The mortgage proceeds go to your brother as consideration for the sale of the property back to you. He then uses these funds to pay off the promissory note he issued to you when he bought the old home.

You now have the funds from the promissory note in your hands. You can use this money to buy yourself a new home.

The Tax Court of Canada, in the case of Sherle v. The Queen, actually volunteered this plan as a way to make mortgage interest deductible in the above scenario, and the CRA approved it in a recent technical interpretation.

There you go — it’s on the house!

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Private School = Tax Break?

In Canadian Income Tax, Personal Tax, Students and Tuition Fees on September 7, 2010 at 10:55 am

It’s back-to-school season and that means time for that question we hear quite a bit over at The Tax Issue desk. Some folks are often surprised and a bit miffed when they discover that tuition fees only provide a tax credit when they are paid in respect of post-secondary education.

So where does that leave the parents of children who attend those oh-so-expensive private elementary and high schools? Generally, these fees provide no tax credit or deduction; however, there may be another way….

Could it be a Donation?

The most common alternative is that part of what we call tuition may sometimes be considered a charitable donation. It is therefore common for private schools to issue official donation receipts to parents paying private school tuition.

This practice is fraught with danger for both the payer and the school. In order for a payment to qualify as a donation, the gift must be made voluntarily and without expectation of return. No benefit of any kind may be provided to the donor or to anyone designated by the donor. Where any “donation” is mandatory as part of tuition, it is really not a gift for income tax purposes. The CRA and Revenue Quebec have both had their battles with taxpayers and private schools regarding this issue.

If a school is also a registered charity, the issuance of donation receipts for what really amounts to a portion of tuition is not, contrary to popular myth, a qualifying charitable donation.

The only exception to the above is where all or a portion of the tuition fees are in respect of religious studies. For federal tax purposes only (Quebec does not grant this concession) that would be considered as a qualifying donation, and a separate donation receipt may be issued for the religious studies portion of the annual tuition.

How About a Medical Expense?

The next alternative is not quite as popular as the charitable donation, and that is to claim the private school tuition fees as medical expenses.

The law allows as a medical expense an amount paid for care and training at a special school. A clear example would be a school dedicated to children with hearing deficits, such as the Montreal Oral School for the deaf.

A not-so-clear-example, is where a child has a learning disability, such as attention deficit disorder, and is placed in a private school offering tighter structure and smaller classes, where, perhaps the staff has had some training in dealing with such students.

This was the subject of the case of The Queen v. Scott . The taxpayer’s son was diagnosed with several learning disabilities. The court of appeal laid out the requirements for deductibility as follows:

  1. The taxpayer must pay an amount for the care or care and training at a school, institution or other place.
  2. The patient must suffer from a handicap.
  3. The school, institution or other place must specially provide to the patient suffering from the handicap, equipment, facilities or personnel for the care or the care and training of other persons suffering from the same handicap.
  4. An appropriately qualified person must certify the mental or physical handicap is the reason the patient requires that the school specially provide the equipment, facilities or personnel for the care or the care and training of individuals suffering from the same handicap.

The requirements in 3 and 4 above were at issue in the Scott case. Firstly, the private school was not a school specializing in children with learning disabilities. Rather it was a private school which offered smaller classes and other services to a wide range of students. The fact that some of the services offered to the general student body were beneficial to the taxpayer’s son and other students with special needs was not sufficient to bring the private school within the ambit of the provision.

Next, the fact that a doctor had recommended this particular school to the taxpayer was also not sufficient. The rule requires a “certification” by a qualified person. A mere recommendation did not meet the criteria, which, according to the court, would have required a formal expert opinion specifying the condition and reasons why this particular school had the equipment or personnel to treat the patient.

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What’s Your Tax Issue? Related Party Sale of Home

In Canadian Income Tax, Principal Residence, Residency on August 30, 2010 at 10:34 am

The Tax Issue:

Hi David,

My girlfriend (soon to be fiance) and I are seriously considering purchasing her parents home since they will be moving in six months time.  Her father has offered to sell the house to us at a price that is $40,000 below the fair market value.  It is my understanding that as long as I purchase the house from him before we are married (therefore not related for tax purposes), then there will be no tax consequences for him or myself on the transaction.  However, I’m also of the understanding that if I purchased the house from him after we were married than there would also be no tax consequences for him or myself since he would have use of his principal residence exemption which would eliminate any tax on the deemed capital gain resulting from selling the house to me at less than FMV.  Is this correct?  Also, does the fact that my girlfriend will be contributing up to half of the down payment for the house impact the transaction in any way?
I really enjoy your website, keep up the great work! Cheers!

The Answer:

You are correct when you say that the consequences to your future father-in-law are the same no matter when you make the deal. No matter what his proceeds or “deemed” proceeds are, any gain on the sale of his house will be exempt from tax (see my previous post on the principal residence exemption).

So what was your friend alluding to? Section 69 of the Income Tax Act. Let’s say the property you were purchasing was not an exempt principal residence. Section 69 contains special provisions dealing with transactions between persons who are not dealing at arm’s length. The rules are somewhat punitive in nature because they make one-sided adjustments to the price.

If the price is less than fair market value, as in your case, then the deemed proceeds to the vendor are adjusted upwards to equal that value. However, the cost to the purchaser is not adjusted and remains whatever was paid. If the price is more than fair value, the proceeds are not adjusted downward, but the purchaser’s cost is reduced for tax purposes.

So, would these rules apply to you if the sale was made before you were married? Probably, yes. The rules apply to non-arm’s length transactions. People who are related are, by definition, not at arm’s length, so if you made the purchase after getting hitched, there would be an automatic non-arm’s length situation. However, there is also a rule that states that any two people may be deemed to be not dealing at arm’s length if the facts warrant it. In your case, the facts would seem to warrant it.

Finally, the fact that your future bride is putting in part of the money won’t make any difference, because there is only one principal residence allowed between spouses, so it really doesn’t matter who makes the claim in the end, when you finally pass the property on to your kids at a generous discount, right?

Congratulations!

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CRA and the Air Miles Double-Standard

In Canadian Income Tax, Personal Tax on July 27, 2010 at 10:06 am

Whenever I use my frequent flier points, it always seems like I’m getting something for free. That’s the beauty of it, isn’t it? But of the course, like everything else, the CRA has to spoil it. The CRA believes there’s value to those points. Sure, there’s value, but does this view only hold true when it benefits the government?

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Using Points For Personal Purposes

Everyone loves a vacation. So when you use those travel points to fly for free, would you ever think that the CRA would tax you? Until recently, the CRA’s policy was indeed to tax an employee on the value of reward points used for personal purposes if the credit card charges to earn those points were made as an employee and reimbursed by the employer. So, let’s say you took a trip to Vancouver on business and charged the hotels, flight, meals etc. on your credit card. When you returned, you put in an expense report and were reimbursed for all those costs. In December, you decided to take a trip to Disney World with the kids, and used reward points to pay the airfare. Prior to 2009, the CRA would have asked you calculate the value of your points, then the portion of that value that related to the amount that was reimbursed by your employer, and then they would tax you on this amount. I kid you not!

Well, the CRA has since changed their policy. They came to the realization that they were being completely nutty (my word, not theirs :-) ) in asking employees to make such determinations. Starting in 2009, they no longer tax you in cases such as the one described above. As long as the credit card is yours, and the reimbursements are not in some way abusive to the point where you are really disguising some form of additional remuneration, then there will now be no taxable benefit on the use of your points. However, if you are spending money on a company credit card, where the employer controls the points, any use you make of them will be taxed in your hands, and your employer will be required to value the benefit as described above, and add it to your T4 as taxable employment income.

The Johnson Case – Points Used For Medical Travel

The above policies by the CRA shows how interested they are in the value of these reward programs – when there is tax to be collected. But what about when there is a deduction to be taken? Suddenly these valuable points become totally impossible to appraise.

In 2007, Mr. Johnson flew to Chicago from Thunder Bay in search of medical care. Travel costs can be eligible medical expenses, and Mr. Johnson claimed the value of his flight, even though it was paid with his Aeroplan points.

Given the CRA’s clear view that such points have value (when it suits their purpose), it is truly baffling to note that the Minister of National Revenue argued in Tax Court that “the value of the points that were used to obtain the ticket could not be determined, and therefore, that it could not be said that an amount was paid for the ticket”.

Really, CRA? Have you not read your own policies?

In the end, the judge decided that the points had a value, since they could be exchanged for something that had a price.

The taxpayer won his case and of course, the CRA policy  still exists (although far less onerous since 2009).

Free travel? Have you seen my credit card statement?

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What’s Your Tax Issue? – Renting Out Your Home

In Canadian Income Tax, Personal Tax, Principal Residence on July 20, 2010 at 2:59 pm

The Tax Issue:

I live in Ontario and own a house.  I’m thinking about renting out the house (to supplement my income).  I bought the house in 1986 with my then-husband for $85,000, both of our names were on the deed.  We separated in 2006 with me remaining in the house; then divorced in 2008 at which time I ‘bought him out’ of the house resulting in the house being solely in my name.  The house is currently valued at approx. $260,000.  If I move out, rent it out, then decide to sell it within 1-5 years, how do I calculate the tax I would owe re capital gains?

The Answer:

Your question actually has three “tax events” happening so it’s a good exercise for a 2nd year tax student like me (as I was at the turn of the century :-) ).

First, you bought out your husband at the time of your divorce. I’m not sure about the circumstances, but the general rule here is that regardless of the actual price you paid, your husband’s share of the original cost became your cost for tax purposes unless, at the time, you both elected on your tax returns to apply the actual price you paid.

Second, at the time you decide to move out and rent the property, there is “change of use”, which would normally result in a deemed disposition at fair market value. Since the house is your principal residence, your gain is tax-exempt.

Third, once the change of use has occurred, any future increase in value might be taxable when you sell the house. There is a special election you can make under section 45(2) of the Income Tax Act that will allow you to avoid the change in use rules and treat the property as your principal residence for up to 4 years. In order to benefit from this concession, you cannot claim depreciation during the time you rent the property. If you sell the house within the 4-year limit after making the election, then the full amount of the gain will be exempt as a principal residence. However, if you sell after the four years, then the full amount of the increase in value from the time you moved out will be taxable as a capital gain.