DAVID WILKENFELD, CA, canadian tax CONSULTANT

Posts Tagged ‘Canadian Tax Consultant’

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What’s Your Tax Issue? Residence in a Trust

In Canadian Income Tax, Personal Tax, Principal Residence on January 7, 2012 at 8:19 pm

Our House is a very very very fine house

                  –Crosby, Stills, Nash & Young

The Tax Issue

I am a member (beneficiary) of a family trust that was set up years ago by my Dad. The trust currently owns two houses. I live in one, and my sister, who is also a member of the trust, is married and lives in the other. We were told that we will have taxes to pay we sell our homes. Can this be true? Please help, as no one seems to know the answer.

The Answer

The principal residence rules that apply to personal trusts are surprisingly restrictive and can be a trap for the unwary.

A trust is treated as a person for tax purposes. As such, it does have access to the principal residence exemption on the sale of a home. But here’s the kicker: if a trust designates a home as a principal residence for a given year, then every beneficiary of that trust who lived in a home owned by the trust is deemed to have made the designation. And remember, a person can only designate one property as her principal residence. This applies to a trust as well. This means that if you sell the home you are living in and the trust claims it as a principal residence, then when the trust sells your sister’s home, the trust is precluded from making the designation on the second home. Her home becomes ineligible for the exemption for those years even though it may be the only home she’s lived. This might come as a shock, and it seems unfair, but that is the way the law works.

So, let’s look at an example. Say the trust owned your home since 2000 and it is sold in 2012 at a gain of $500,000. Furthermore, let’s assume the trust owned your sister’s home since 1996, and sells in 2012 at a gain of $400,000. If the trust claims the full principal residence exemption on your home, then it will be precluded from claiming the exemption for the years 2000 – 2012 on your sister’s home. In fact, for the 16 years the trust owned your sister’s home, only 4 will qualify, so only 4/16 of the gain will be exempt. (Actually, the formula generously adds 1 year to numerator, so technically 5/16, or $125,000 of the total gain will be exempt).

Taxpayers thinking about placing personal homes in a family trust should always seek professional tax advise.

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Tax Court Rules On Ponzi Scheme Victims

In Canadian Income Tax, Losses on January 3, 2012 at 2:00 am

The Tax Court of Canada has recently confirmed the tax treatment of Ponzi scheme victims as I feared they would in the very first issue of The Tax Issue.

In a Ponzi scheme, taxpayers unwittingly entrust funds to a promoter, who, rather than investing them, uses them to make payments to other investors. The flow of funds continues this way until enough people finally ask for their money back, at which point, the fraud is exposed.

The taxpayer in the case of Johnson (2011 TCC 540) was a winner because the court ruled that in a Ponzi scheme, there is no investment and thus no source of income. The good news for this taxpayer, a victim of Andrew Lech, was that she was one of the few who cashed in her capital after a few years of receiving what she thought was a great return on her investment. The “income” she dutifully reported over the years was held not to be “income from a source” and thus not subject to income tax.The court stated that “the net receipts were nothing more than the shuffle of money among innocent participants.”

The bad news for those who have lost their investment, however, is that there is no tax relief available for the loss of their capital.  In a normal investment, the loss would be considered a capital loss, 50% of which can be used to offset capital gains. For these victims of fraud, since no income source existed, no tax deduction is available on the loss of the investment.

The only consolation is for taxpayers who reported income in past years to amend their returns and request refunds on the tax they paid on the payments received from fraudulent schemes.

Update: The CRA has decided to appeal this decision….To be continued…..

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CRA Weighs In On J.V.’s

In Canadian Income Tax on December 16, 2011 at 2:15 am

 

Last week I attended the Canadian Tax Foundation’s annual conference in Montreal. It’s a 3-day event where accountants, lawyers and government officials get together, sing Irish drinking songs, try on each others’ bow ties, and get into all sorts of wild shenanigans.

My favourite time is CRA round table day. That’s when representatives from the government let us tax practitioners know that they’re on our side, they’re here to help and taxpayers have rights. Then they answer a series of pre-determined questions on tax policy confirming that they are not on our side, help is a four-letter word, and whatever rights we have are readily accessible – in a court of law. Anyway, we forgive them because they’re usually the ones who spike the punch every year at the Arthur Anderson reception.

This year, the CRA was asked about the new partnership year-end rules and joint ventures. As we reported in an earlier post, new rules were introduced in the 2011 budget that will essentially eliminate any tax deferral to a corporation whose year-end does not coincide with that of any partnership in which it holds a significant interest.

A joint venture is not a partnership; however, they are often accounted for on a similar basis, with a year-end being established and each participant picking up its share of income annually. This has always been tolerated by the CRA.

With the new rules in place, the CRA stated that joint ventures will now be treated similar to partnerships. Administratively, they will also allow companies with joint venture interests to take advantage of the same transitional relief afforded to partnerships under the new rules. That is, they will be allowed to include 15% of additional stub-period income in 2012, 20% in 2013, 2014 and 2015, and 25% in 2016.

In a technical bulletin released on the same day, the CRA also stated that, going forward, for taxation years ending after March 22, 2011, income from a joint venture will have to be reported for each participant based on that participant’s fiscal period. For participants with different year-ends that don’t coincide with the joint venture, this will likely create some onerous compliance issues.

Those guys at the CRA always keep us on our toes!

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Mr. CA Goes To Tax Court

In Canadian Income Tax on October 26, 2011 at 11:36 am

Years ago, the Tax Court of Canada introduced its informal procedure, a type of “small claims” court for tax cases. I was intrigued at the time, because it allowed for non-lawyers such as myself to represent taxpayers, under certain conditions. So, I did some research and wrote an article on the topic which was published by CA Magazine. At the time, I hadn’t ever been to Tax Court (I’m confessing this now, years later, having successfully represented 3 clients since). My article was based strictly on research, and some anecdotes from a colleague. Anyhow, I thought I’d reprint an abridged version of that article for old times sake, so here it is:

Entering the courtroom I was less than impressed. It was smaller than I had imagined. And although there was a generous amount of oak trim surrounding me, it somehow felt cold and clinical. Perhaps my expectations were too high. I’ll admit to being a bit zealous. After all, here I was, about to plead a case in the Tax Court of Canada, and I was not even a lawyer.

As a chartered accountant, I was within my rights to represent my client in a tax case. The Informal Procedure Rules were established in 1991 to provide a “small claims court” environment where an individual taxpayer could represent himself without the need to adhere to strict rules of procedure and evidence. A lawyer or an agent, such as an accountant, may also represent an individual in an Informal Procedure case.

Under the rules of the Tax Court, the Informal Procedure may be invoked in an appeal where, for each assessment, the amount of federal tax involved, plus applicable penalties, is equal to or less than $12,000. In the case of a loss determination, the amount in dispute must not be more than $24,000, and where the dispute is in respect of an amount of interest only, the threshold is $12,000.

I explained to my client that the objective of these rules was expediency. Her case would be heard relatively quickly, within a few months of her application. The hearing would be short and a decision would be rendered quickly, usually in the same day, but generally not later that 90 days after the hearing. She would not be subjected to examination by the opposing counsel prior to the hearing. Her risk in the case of an unfavourable judgement would be reduced by the fact that costs could not be claimed against her by the Crown.

After our objection was denied, I had filed a timely Notice of Appeal on behalf of my client with the Registrar of the Tax Court. Since I was a layman, the strict rules of format regarding such a document were relaxed. The court had accepted my Notice, which was prepared in a letter style. However, I had still made certain that the letter contained all the necessary elements. Similar to what you might find in a Notice of Objection, the letter indicated the name of the taxpayer, the details of the assessment and the issues surrounding the appeal.

The judge gave me a curt nod and asked me to begin. I rose from my seat, thanked him respectfully, and gave my opening statement. I tried to avoid showing my anger at the injustices heaped on my poor, suffering client by the cold-hearted tax department. I would be better off, I figured, with a brief and logical summary of my case.

I guided my client logically through the sequence of events, ensuring that she stayed to the point at all times. As we went along, I introduced documents to support the testimony. In the Informal Procedure, the rules governing the introduction of evidence are markedly relaxed.

After cross-examination, I was asked to give my closing argument. I reviewed the evidence and referred to a court case as an authority to support our position. I came to a conclusion based on the facts and the law surrounding the issues, and I once again concluded with a request to have the Minister’s assessment altered. I thanked the court and sat down, hoping no one had seen me sweat.

I was done. I had presented a concise and forceful case. Although I was feeling exhilarated, I wasn’t sure whether I would give up my accounting practice just yet to pursue a law degree. The judge had been lenient with me, knowing I was a layman. The Informal Procedure was designed with non-lawyers in mind…

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What’s Your Tax Issue? Home Built By Company

In Canadian Income Tax, Shareholder Benefits on October 3, 2011 at 10:12 am

The Tax Issue

I recently built our “dream” home for 2.50M$. However, not having sufficient funds personally, my professional corporation financed the construction of the house for me, writes off the maintenance, utilities and taxes, and I rent the house from my company at a market value rent, having researched comparable rents in the neighbourhood. Apart from forgoing the principal residence exemption – are there any other detriments to this strategy?

The Answer

Could be. I’m assuming, since you are paying rent, that you’re aware of the shareholder benefit rules. That is, by virtue of the fact that the company has financed your house and pays expenses on your behalf, you are exposed to tax on the value of the benefit you are receiving from the company.

What you may not be aware of is how the CRA might establish the value of the benefit. It could be the market value rent as you have researched, and if so, the rent you’re paying would be enough to offset the taxable amount completely.

In your case, however, it may not be so simple. There is a line of jurisprudence, starting with the case of Youngman v. The Queen, that suggests that the benefit or advantage conferred on you is not merely the right to use or occupy a house; it is the right to use or occupy a house that the company, at your request, had built specially for you in accordance with your specifications. How much would you have had to pay for the same advantage if you had not been a shareholder of the company?

So what is this “alternative” calculation? Generally, the value of the benefit could be calculated by reference to the income the corporation would have earned if its capital had been productively employed and not based on the fair market rental value (which might be considerably lower).

As an example, on a $2.5M capital outlay, the company could have been expected to earn interest in a relatively risk-free investment of, say anywhere from 2% to 5%. This would mean an annual rent of $50,000 to $125,000, plus expenses. If you are paying any less than this in rent, despite what the market rents are in the area, then you could be exposed to a greater taxable benefit than you thought.

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Harassment, Conflict and Litigation – Part Three

In Business Expenses, Canadian Income Tax on September 21, 2011 at 9:50 am

In the final instalment of this series on what creates the most HCL with the CRA in our SAS (“harassment, conflict and litigation” with the “Canada Revenue Agency” in our “self-assessment system”), we cover the granddaddy of disputable expenses – automobile costs. Any tax auditor worth his salt will zero right in on auto expenses like my tee shots to water. Why? Because everybody loves to drive and everybody loves to deduct car expenses. The problem is that the rules in this area are so onerous and complex, few taxpayers under investigation ever come out of it with no HC or L. It’s the record-keeping burden that gets most people into the HCL zone. So heed the following, and minimize your grief.

First, let’s summarize the basic rules for deductibility. As with any expense, the costs deducted must be in connection with your business. So how do we identify the business portion of the cost of something we regularly and continuously use for both personal and business purposes?

Kilometres.

Anyone who uses a car for business should keep track of the total amount of kilometres driven during the year, and a detailed account of which of those kilometres were driven in the performance of their business or employment functions.

Keep receipts and a detailed account of all your auto expenses, such as gas, repairs and maintenance, insurance, licence, registration, car loan interest and leasing costs. If you own your car, you may be able to claim depreciation (CCA).

Now you’re almost there, but you should be aware of certain limits that apply. If you lease your vehicle, deductible payments are restricted to $800 per month (or less, based on a formula, if the value of the car exceeds $30,000).

If you’ve borrowed to purchased your car, loan interest is limited to a maximum of $300 per month. For CCA purposes, there is a maximum on the capital cost of $30,000.

Finally, if you receive a non-taxable per-kilometre allowance from your employer, then you are not entitled to claim any auto expenses personally.

These rules are fairly detailed and objective, so where does the HCL come in? Problems normally arise in two areas – record-keeping, and what constitutes business mileage.

Most people by nature do not keep records as meticulously as the CRA would love to see. If you are audited, and need to justify the amount of kilometres you drove in a year for business purposes, the best evidence you could have would be a logbook where you keep track of where you drove, the number of kilometers, and the business purpose. Compare that to the total kilometres driven for the year, and you have pretty well justified your calculation. In most cases, however, a logbook does not exist, and the taxpayer is left to plead, cajole, regale and negotiate with mostly unsympathetic auditors to have them accept his ad-hoc percentage of business use.

In Quebec, the law requires that you keep a logbook if you drive a company car. Employees must provide their employer with a logbook within ten days after the end of the year, or face a fine of $200.

The second issue of concern is that sometimes it is not clear whether a trip qualifies as business use. Some taxpayers are unaware that travel from home to the place of work does not constitute business travel. However, here’s a tip: if you start out at home, make a stop for business purposes, say at a client’s premises, then proceed from there to your office, then the entire trip would qualify.

What about the case where home is the regular head office and work is carried out at remote sites, such as in the case of a self-employed contractor? If you can establish that your home is your center of operations, then all travel to a work site should be considered for business.

In this series of posts, we touched on some of the most common areas where taxpayers find themselves in hot water with the CRA. Our SAS requires good record-keeping and knowledge of the law. Hopefully, these articles have helped you with the SAS and your HCL level should go down from here.

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Harassment, Conflict and Litigation – Part Two

In Business Expenses, Canadian Income Tax on September 13, 2011 at 9:06 am

This series of articles deals with a topic that often gets taxpayers into conflict with the taxman, what a client of mine described as “harassment, conflict and litigation”, which I have shortened to the easy-to-spell HCL. In our self-assessment system (SAS) of tax reporting, we are required to be aware of the rules, and honestly provide the CRA with correct information about our taxes. Most often, tax auditors like to zero in on those deductions that are most easily “miscalculated” by us SAS-ers. That’s because of the strict rules surrounding them, and their potential personal component. I am speaking, of course of meals and entertainment, and automobile expenses (MENTA). This article will discuss the rules surrounding meals and entertainment expenses.

Taking a client out for a meal is a long-standing and acceptable business practice. Traditionally, business-related meals have been deductible in our system. However, there is a 50% restriction on the deduction, in recognition of the fact that there is at least one person (you) enjoying a personal benefit from the arrangement. (In Quebec, there is a further restriction based on a percentage of gross sales.)

What constitutes a business meal to a taxpayer may not always pass muster with the CRA, and here’s where the HCL comes in. For example, there are some tax auditors who simply make the assumption that any meal consumed on the weekend is non-business related and automatically disallowed. Evidence that a meal is business related should include a copy of the restaurant bill, the name of the guest and the business reason for the meal. The burden is on the taxpayer to prove his case on a balance of probabilities.

There are similar rules for entertainment expenses. Sports and theatre tickets are good examples. If you purchase season tickets to a sporting event, for example, you must show the business purpose for the purchase by keeping track of who uses them and their business relationship to you.

Golf is pretty popular in the business world, and the CRA has always known this. That’s why there is a special rule for golf and other such club dues and fees. It’s a simple one: they are not deductible.

But what about business meals at a golf club? Back in 1997, the CRA came up with a policy that meals consumed at the club in conjunction with a game of golf were not deductible. So, as long as you weren’t playing golf, you could go there for a meal. If you played, you had to go somewhere else afterwards to enjoy a nice tax deduction with your meal. The CRA has since seen the silliness of this policy and now allows business meals at a golf club to be deductible (subject to the 50% restriction). Club dues and green fees, however are still off limits.

The meals and entertainment rules have been great fodder for HCL for many years. In one case, the CRA applied the 50% restriction to an investment advisor who routinely gave donuts to his clients to thank them for referring business. The Tax Court of Canada held that donuts did not constitute a “meal”, and allowed the deduction in full. Personally, I can’t imagine the staggering number of Timbits it would take to justify the cost of going to court over this issue, but at least the judge was able to show he was familiar with the basic food groups :-) .

In another case, a food critic, whose sole job it is to eat meals at restaurants was told by the CRA that the 50% restriction applied to her. This illustrates that there are no exceptions to the 50% rule (except, of course the exceptions, which include employee parties and charitable events – but I digress).

In our next article, more HCL with automobile expenses.

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Harassment, Conflict and Litigation – Part One

In Business Expenses, Canadian Income Tax on September 5, 2011 at 2:50 pm

I took a client to lunch the other day and he made an interesting observation. He thinks the income tax system in this country is based on harassment, conflict and litigation (what I will hereafter refer to with your permission as the HCL of Canadian tax). I felt obliged to point out to him that although HCL is a dominant feature, the actual basis of our tax mechanism is quite the opposite. In fact it relies at its core on the “self assessment system” of taxes by the taxpayer himself (Let’s call it the SAS). If a taxpayer practices accurate and honest SAS, then he will completely avoid the HCL. Well, that’s what our government (the CRA) tells us anyway, and I guess that would be true, at least in a perfect world (APW). Of course we don’t live in APW, and in our constant efforts to SAS, we might inadvertently cross the line, receive a friendly visit from the CRA and get into some stressful HCL.

The next three articles will deal with what I believe to be among the most common causes of HCL in our system: meals and entertainment, and automobile expenses (MENTA). When MENTA are related to the process of earning taxable income they may be deducted from income for tax purposes. Therefore, I should have been allowed to write-off the cost of that lunch as well as the gas and other car expenses for my trip downtown, right? True, but what about the personal element to my expenses? Arguably, I had to eat anyhow, and what about my little side trip to Golf Town on the way back to the office?

Now you’ve got the picture, right? These business expenses will invariably contain some personal element and it is this problem that not only causes a great deal of HCL, they have led to constantly changing sets of rules developed and refined over the years that are so difficult to understand and comply with, that only The Tax Issue could be relied upon to explain them to you, kind reader.

Before we get into the actual details of what can be deducted, let’s talk about who can take these deductions. For the purposes of our discussion, let’s divide the world into two types of taxpayers: those who are employed and those who are in business. If you are in business, then you generally have no restrictions on what you can deduct as an expense as long as it relates to your earning of income. All you have to do is follow the specific rules relating to the MENTA as we will discuss later.

One more general note about business (and forgive the digression) – the calculation of deductible expenses is generally the same, whether the business is run by an individual (sole proprietor), partnership or corporation. So please don’t ask again.

Employees are not so lucky. In fact, they are treated in an opposite fashion. In general, they are allowed no deductions from income unless specifically provided for them under the law. In the case of MENTA, luckily, such provisions do exist, but there are certain conditions.

The most common MENTA deductions allowed to employees are automobile expenses. In order to claim auto expenses, employees must meet strict conditions. They must have a contract (verbal or written) with their employer providing that they are required, as part of their employment duties to travel, and that they must bear the cost of their auto expenses. As evidence, they must have their employer complete and sign a prescribed form stating the terms of their employment and whether auto expenses are reimbursed either directly or through an allowance.

Generally, you cannot deduct meals and entertainment costs if you are an employee. The only exception to this rule is if you earn commissions. A commissioned employee is generally treated similar to a person earning income from a business. That is, there is a general rule allowing the deduction of expenses relating to the earning of that income. The only restriction is that the deductions are limited to the amount of commission earned in the year.

Next time, we’ll be discussing the deduction of meals and entertainment expenses and the HCL that goes along with it!

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Moving Expenses – Stay In Canada

In Canadian Income Tax, Personal Tax on April 12, 2011 at 3:15 pm

One of the big misconceptions out there is that moving expenses are deductible. Yes of course that’s true, but there are restrictions and rules.

It is widely known that moving expenses are only deductible when moving from one job to another. Students may also, under certain circumstances claim moving expenses.

One major restriction that slips people’s minds is that generally the move must be within Canada. If you move to Canada from another country (or vise versa) for employment (or self-employment) your moving costs are not deductible.

However, if you are away from Canada but are still considered a resident of Canada for tax purposes throughout the year (perhaps because you haven’t cut your residential ties or you are a deemed resident), then the  “in Canada” restriction is not applied. A move to and from a foreign location will qualify and the new location need not be in Canada.

Your move must result in you being at least 40km closer to your new place of employment (or self-employment).

You must cease your business or employment and your moving expenses are only deductible to the extent of your income from the new location in the year or the following year.

Students

If you have been in full-time attendance at a post-secondary institution in Canada and move to start a job within Canada, you may claim moving expenses.

If you move to attend school full-time at an institution  you may deduct moving expenses, but only against income from scholarships, fellowships, research grants and similar awards.

Foreign students coming into Canada to study at a post-secondary institution are also entitled to deduct moving expenses against income from scholarships, fellowships, research grants and similar awards.

As with employment moves, you must be at least 40km closer to your new school.

You are considered a full-time student for the purpose of claiming moving expenses if you regularly attend a post-secondary school and you take, during a semester, 60% or more of the usual course load for the program in which you are enrolled.

For more info on moving expenses, check out Interpretation Bulletin IT-178R3.

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Establishing Disability

In Disability, Personal Tax on March 29, 2011 at 5:00 pm

The Income Tax Act contains many provisions dealing with disabled persons. Such things as the disability tax credit, certain medical expense deductions, the registered disability savings plan and other provisions are currently available. What’s more, the federal budget has proposed new rules for disabled persons (but we’ll have to wait until after the election to see if they become law)

But before taking advantage of any of these rules, the first step is to establish that you have a disability that qualifies. To be more precise, you must be a person with a “severe and prolonged mental or physical impairment”.

An impairment is considered “severe and prolonged” if it is expected to last continuously for more than 12 months and markedly restricts your ability to perform a basic activity of daily living.

Activities of daily living include:

  • Mental functions of daily life, such as memory or problem-solving
  • Blindness
  • Feeding or dressing oneself
  • Speaking
  • Hearing
  • Eliminating (bowel or bladder functions); or
  • Walking

You would also qualify if you require life-sustaining therapy administered at least 3 times a week for a total time of at least 14 hours per week. This includes time spent by parents of children to administer life-sustaining medication such as insulin.

You can read more details explaining what constitutes a marked restriction for each of the above impairments by consulting form T2201.

If you believe you have an impairment that qualifies under the above criteria, then you must obtain form T2201 (and if you live in Quebec form TP-752.0.14) and have it completed and signed by a doctor or other qualified medical practitioner. A qualified medical practitioner other than a doctor must be a medical professional that is recognized as such in the province where you reside. Optometrists, audiologists, psychologists, or physiotherapists are examples of medical practitioners that would be authorized to sign the form. Examples of practitioners who have been denied the authority to sign the form are massage therapists, acupuncturists and naturopaths (depending on their status in the province where they practice).

Once the form is completed and signed, it must be submitted to the CRA for assessment and approval. This process can take several weeks. You can either attached the form to your income tax return or send it in alone prior to filing your return, to avoid delays in processing your claims.