Under the Auspices of the Order of Chartered Professional Accountants of Canada, I am pleased to provide a summary of 2015 Federal budget summary / 2015 Résumé du budget fédéral. I will also place a link on the Tax Links Page, and it will remain there, along with future federal and Quebec budget summaries for future reference.
These days, with all the complexities of the GST/HST rules regarding what is taxable and what isn’t, many businesses and professionals may find themselves providing a mix of supplies; that is, sales are taxable or exempt, depending on the rules (for example, a pharmacist who sells taxable items as well as exempt prescription drugs). This begs the question: to what extent can a business or professional claim input tax credits (“ITC’s”) with respect to the GST/HST paid on its expenses?
With the notable exception of financial institutions, which have their own set of specific rules, in general, a business may claim ITC’s based on the amount of its expenditures consumed in pursuit of its commercial activities.
General Rule for Claiming ITC’s:
The starting point is the general rule which requires ITC’s to be calculated based on the following formula:
A x B
A is the GST/HST paid or payable on the purchase of a property or service, and
B is a percentage, which represents the extent to which the person acquired the property or service in the course of the commercial activities of the person.
Based on the above, it is therefore necessary to determine what is meant by the term “commercial activity”. The law defines a commercial activity as a business carried on by a person, except to the extent to which the business involves the making of exempt supplies by the person.
Therefore, to the extent that the business activities do not involve the making of exempt supplies, they constitute commercial activities.
Allocation of Expenditures for ITC Purposes:
There is no requirement to apportion expenditures based on revenues or any other measurement. The only criterion set out in the law is that the apportionment must be reasonable and consistent.
The CRA provides guidance as to how to allocate ITC’s between commercial and non-commercial activities. In its GST Memorandum 8.3, it states that the methods used should link the property or service on which the input tax was paid to commercial and other activities. It suggests that directly allocating expenses to a commercial activity is most desirable. For example, where an expenditure relates exclusively to a taxable (or zero-rated) sale, then a full ITC should be claimed on this amount. The CRA suggests that expenditures be categorized between two groups, as follows:
1. single-use property and services used wholly in a particular activity; and
2. multiple-use property and services used in more than one kind of activity;
In the case of single-use property and services, it is clear that either a full ITC will be claimed (commercial activity) or no ITC will be claimed (exempt activity).
Note that a property or service consumed substantially all (i.e.90%) for a single purpose (either commercial or non-commercial) it will be deemed to be used 100% for that purpose and so will be considered a single-use property.
For multiple-use property or services, the recommended method is an “input” based method. This means that the allocation should be made based on usage. For example, if a self-employed contractor is providing services to both the taxable and exempt activities, then an allocation based on time spent may be reasonable. Rent may be allocated base on square footage used in either activity.
The CRA goes on to state that allocation based on “output”, i.e. revenues, should be made with caution to ensure such a method fairly represents the ratio of inputs used in each activity.
The issue of “reasonable allocation” was addressed by the Federal Court of Appeal in the case of Ville de Magog v. the Queen. The point made in this case was that the law requires only that the allocation method be reasonable and consistent. If the government performs an audit, and, as they did in this case, disagrees with the method for allocating expenses, they cannot change the allocation used by the taxpayer, as long as the taxpayer’s method was reasonable. In other words, the government was not allowed to change the method used on the basis that their method was “more reasonable” than the taxpayer’s method.
The Tax Issue:
Our rental property is coming up for mortgage renewal. Can we take equity out of the rental to pay down on our principal residence? Obviously then, the mortgage on the rental has increased and the interest is being written off. Can we do this?
Well, since this is the second time this week I’ve been asked the same question, here’s the answer: NO!
Perhaps I should elaborate.
Under Canadian tax law, interest on borrowed money is deductible only under certain specific conditions. For the sake of bandwidth, I will only mention the most important:
The borrowed money must be used for the purpose of earning income from a business or property.
The emphasis on the word used is intentional. The Supreme Court of Canada, many years ago, laid down the rule that it is the use of the borrowed funds that we look to to determine whether this condition is met. To be more specific, it the direct use made of the borrowed funds. This is a technicality that has both helped and hindered the CRA over the years.
In your case, for example, even though you have dutifully paid down the mortgage on the rental property and now own equity in it, refinancing it is simply borrowing money, using your equity in the rental property as collateral. It is not the collateral that is important, but the direct use of the borrowed funds. Therefore, if you use the borrowed money, as you intend, to pay down you personal mortgage, this will be viewed as money borrowed for personal use, and the interest would not be deductible.
One often recommended strategy, taking advantage of the “direct use” rule, would be to use funds that you currently have invested in savings, such as stocks and bonds to pay down your personal mortgage. Then, refinance the rental property, and use the borrowed funds to repurchase your income-earning investments.
Alternatively, if you remortgaged your rental property and purchased a second rental property, or invested in some other income-earning vehicle, then the interest would be deductible.
Under the Auspices of the Quebec Order of Chartered Professional Accountants, I am pleased to provide a copy of the Québec Budget Summary 2014-2015 / Résumé du budget du Québec 2014-2015. 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.
If you make use of the internet to earn income, the CRA would like to know about it.
Changes to the Form T2125 (statement of self-employment earnings for individuals), and a new Schedule 88 for corporations will now require any business with an internet connection (double meaning intended) to provide information to the CRA. Schedule 88 is not yet provided in most corporate tax preparation software, but it can be found on the CRA’s website.
The CRA is asking for the URL of up to five web sites through which you carry on any business. In this regard carrying on business through a web site includes pretty much any connection your business has to the internet. It includes:
- the sale of goods or services directly from your web page (with payments made online through a shopping cart)
- the sale of goods or services through orders taken by email or forms on the web page, even if payment and delivery are made offline
- the sale of goods or services through an auction, marketplace or similar website, including Ebay, Kijiji or Craigslist
- earning advertising revenues online, for example, through static ads placed on the company’s website, or through advertising traffic programs such as Google AdSense or Microsoft AdCentre
Even if you do not have your own website you must file the form if you have a profile or other page describing your business on blogs, auction, marketplace or any other portal or directory website from which it earns income. For example, if your business can be found through a listing in the online Yellow Pages, this must be reported as a web site through which you carrying on business.
The CRA official I spoke with regarding this new requirement stated that this is essentially a research project designed to gather information on internet business. The non-reporting of revenue from online sales is an ongoing concern to the CRA and these new requirements are the start of a project designed to “level the playing field” between traditional business and internet sales.
The reporting requirements are for 2013 and future years. For corporations who have early 2013 year-ends and may have already filed their tax returns, the CRA official stated the form will not be requested.
Interestingly, there is no specific legislation sanctioning the requirement to file these forms as there is, for example, for the reporting of income from foreign sources. However, the CRA does have the legal authority to demand any information from taxpayers that would have any bearing on their tax liability. Furthermore, non-compliance could result in penalties for failure to file information returns, which could add up to as much as $2,500.
These requirements are so new, and have been introduced with so little publicity (Schedule 88 is not even available in French as of this date), it will be interesting to see, at least in the short run, what the level of compliance will be. But be warned. If you are generating any type of business revenue through the internet, the CRA will be trying to track you down.
What is the policy for using a personal rewards credit card to pay business expenses? Do I get taxed if I use the points I earned for business only. Will this raise red flags with CRA if I start spending 50k/month on this personal card?
Believe it or not, the CRA has put so much thought to this question and changed their policy so often, I don’t blame anyone, including me for needing a quick refresher, so I’m glad you brought this up.
Basically, the CRA’s position is rooted in section 6 of the Income Tax Act, which essentially taxes an employee on the value of any employment-related benefit received in any manner whatever.
Regarding your question, the CRA’s general position has historically been as follows:
Where an employee accumulates points while incurring employment-related expenses which are reimbursed or paid for by the employer, the employee will be in receipt of a taxable benefit if the points are redeemed by the employee for personal travel or to obtain other personal benefits.
It is the employer’s responsibility to quantify the value of the benefits received by the employee, and include that amount on the employee’s T4 slip each year.
However, in 2009, the CRA modified its position, recognizing that it would be difficult for employers to quantify the benefit where the credit card was a personal one controlled by the employee. So, unless it’s a company credit card, the employer is off the hook. But the employee is not.
Well, not entirely. The CRA does acknowledge that it would be difficult for an employee to track personal expenses vs. business expenses on his personal credit card, so their position is that no taxable benefit will arise on points earned on a personal credit card. However, there are conditions.
No taxable benefit will arise on points redeemed from the use of a personal credit card, as long as:
- the points are not converted to cash
- the plan or arrangement is not indicative of an alternate form of remuneration, or
- the plan or arrangement is not for tax avoidance purposes
The CRA provides an example of an employee who is allowed by her employer to pay for business expenses whenever possible through her personal credit card, for which she is reimbursed. In order to maximize her points, she uses her personal credit card to pay for various employer business expenses, including travel expenses of other employees.
The CRA would view this arrangement as being indicative of an alternate form of remuneration and would therefore not allow their administrative concession. The employee would have to calculate the value of the benefit and add that amount to her taxable employment income.
So, to finally answer your question, if you use your personal credit card mostly for normal personal use, and for your own normal business expenses for which you are reimbursed, the CRA would likely not charge you with a taxable benefit; however, if you suddenly start putting $50K/month of your employer’s business expenses on your personal credit card, I would say that it appears this might be a plan to increase your remuneration as outlined in the above example. And yes, the CRA might come knocking on your door.
Hey everyone, The Tax Issue Tax Organizer 2013 is up and running. This useful tax preparation tool is offered free of charge. Hope you enjoy it, and happy tax season!
The Tax Issue
I am a Canadian citizen living in Quebec. I had sold stock options shares acquired through my employer which was a US based public company at the time, and I had paid taxes on capital gains taxes.
I want to know If could have had benefited from Capital Gains Exemption then, and if so, could it be done retroactively?
The Capital Gains Exemption provides every Canadian resident individual with a lifetime cumulative amount that may be used as a deduction against certain capital gains. For 2013, the lifetime amount was $750,000. In his 2013 federal budget, the Minister of Finance has proposed to increase the amount to $800,000 for 2014 and the amount will be indexed to inflation for taxation years after 2014.
But there are restrictions.
The exemption is available only on gains generated from the sale of Qualified Farm Property, or Qualified shares of a Small Business Corporation.
In the case of shares, they must meet certain restrictions. Essentially, the shares must have been owned for at least two years, and the company must meet certain asset tests for a period of two years.
In addition, the company must meet the definition of a Small Business Corporation, or SBC. An SBC refers to a Canadian controlled private corporation, all or substantially all of whose assets are used principally in the course of carrying on a business in Canada.
Since the shares you sold are shares of a US public company, the company would not qualify under the definition of an SBC and so unfortunately, your gain would not have qualified for the Capital Gains Exemption.
It’s Christmas time, and that’s got the CRA thinking about gifts – taxing them, that is. The recent case of Shaw v. R. is a cautionary tale for anyone who believes that a gift of cash is never taxable to the recipient.
When a taxpayer tries to take advantage of technicalities in the Income Tax Act (“ITA”) to his advantage, it’s called an abuse of the provisions of the ITA. If the taxpayer is successful, the law is usually changed.
When the CRA taxes an amount of income twice, using the provisions of the law to its benefit, well, that’s just the way it is, end of story. In a previous article, we described a case where the CRA unsuccessfully attempted to tax the same amount of income twice. In the case of Shaw, they succeeded.
Mr. Shaw was a long time employee of a private company called Robert Ltd. Mr. Robert, the owner, apparently did very well and sold the assets of the company to CEDA International. At the time of the sale Mr. Robert had substantial amounts owing to him by his company which had been taxed as bonuses in previous years and credited to his shareholder loan account.
After the sale, Mr. Robert wanted to reward his long-time managers. He sent them each an amount of cash from Robert Ltd., representing $10,000 for each year of service, along with a letter thanking them for their loyal service, and assuring them that these amounts were tax-paid gifts that would be charged to his shareholder loan account and therefore not taxed in their hands. Only one condition was attached to the gift, and that was that they remain employees of CEDA International. Mr. Shaw received $140,000.
Section 6(1)(a) of the ITA provides that all “benefits of any kind whatever” are to be included as employment income if they were received “in respect of, in the course of, or by virtue of an office or employment.”
In this case, the court explained that subsection 6(1)(a) is a broadly worded provision and that the amounts received by Mr. Shaw fell into the category of a taxable employee benefit. The amount was calculated based on his number of years of service, and also came with the condition that he remain employed by the purchaser. Accordingly, the payment, regardless of who made it and what form it took, was made by virtue of Mr. Shaw’s employment.
What is unfair in this scenario is, of course, the fact that the amounts paid had been taxed previously; so in assessing Mr. Shaw, the CRA was essentially successful in taxing the same amount of income twice. It didn’t matter that the person who paid the amount was not the employer, nor did it matter that Mr. Shaw was no longer an employee of Robert Ltd. at the time the amount was paid.
This case should be seen as a warning to those who believe they can avoid tax by directing funds to another person on the premise that it is a gift. The CRA will always look to the underlying reason for any payment and apply the provisions of the ITA accordingly, regardless of whether or not it seems fair to the parties involved.
And no, don’t expect the law to be changed to prevent such an unfair result in the future.