DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Posts Tagged ‘CRA’

Allocating Input Tax Credits

In Canadian Income Tax on July 23, 2014 at 7:30 pm

 

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

Where

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.

What’s Your Tax Issue? Mortgage Refinancing

In Business Expenses, Canadian Income Tax on March 20, 2014 at 3:44 pm

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?

The Answer:

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.

Internet Business Beware

In Canadian Income Tax on February 17, 2014 at 9:32 am

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.

2014 Federal Budget Summary

In Canadian Income Tax on February 12, 2014 at 7:34 pm

Under the Auspices of the Order of Chartered Professional Accountants of Canada, I am pleased to provide a summary of  Federal Budget 2014. 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.

 

 

What’s Your Tax Issue? Credit Card Rewards

In Business Expenses, Canadian Income Tax, Employment benefits, Employment Income, Personal Tax on February 5, 2014 at 4:17 pm

Questions3The Tax Issue

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?

The Answer

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.

2013 Tax Issue Tax Organizer is Here!

In Canadian Income Tax, Personal Tax on January 27, 2014 at 9:00 am

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!

CRA – The Anti-Santa

In Canadian Income Tax, Employment Income on December 16, 2013 at 9:00 am

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.

Merry Christmas!

Your Honour…The Dog Ate It!!

In Canadian Income Tax on December 2, 2013 at 9:00 am

In the last edition of Fiscalitems, we dealt with the deadlines and procedures involved in making an application for an extension of time to file a Notice of Objection. Although it seems harsh, the Minister of Revenue and the courts show little leeway in allowing late objections without justification, regardless of the amount of time involved. In this issue, we discuss reasons that may be set forth and whether they would result in acceptance of a late objection

Essentially, the law requires the taxpayer to establish that he was unable to act or to instruct another to act in his name, or that he had a bona fide intention to object to the assessment. A successful request for extension must either show that the taxpayer missed the deadline through no fault of his own, or that he never agreed with the assessment and has always intended to object. Both criteria do not have to be met. However, he must show that he filed an objection as soon as circumstances permitted.

What situations will find sympathy from the courts? Here are some examples:

Physical or Mental Disability: Where a taxpayer has had an accident before the assessment was made, and remained incapacitated for some period of time thereafter, or where the taxpayer suffered an illness during the relevant time, there is clear case law and Revenue Canada commentary that would suggest an extension would likely be granted. The application should highlight the unusual nature of the disability and be precise as to the timing involved.

The above situation would fall under the category of “exceptional” or “unusual” circumstance rendering the taxpayer unable to act in accordance with the law. Other such circumstances which have been accepted by the courts include natural disasters, absence from the jurisdiction and inability to communicate in either of the official languages.

Address Problems: Often, the taxpayer argues that he moved and that he never received the assessment due to an address change. Revenue Canada’s only duty is to send an assessment at the last address made available to the department by the taxpayer. If this address is used, the taxpayer has no recourse. It is his responsibility to notify Revenue Canada of an address change immediately.

Ignorance of Time Limit: Often, a taxpayer may argue that he was simply not aware of the statutory time limit involved, and that he acted as soon as he was informed. The case law here is clear: ignorance of the law is not grounds for allowing an extension. All taxpayers are informed on the actual assessment of the time limit for objection. The courts, therefore afford little sympathy to this excuse.

Reliance on a Professional: In many cases taxpayers plead that they relied on their professional advisor. Here the case law is less clear. In one case, a taxpayer returned from a vacation to find a pile of documents, including a tax assessment, on his desk. Without reading them, he simply delivered the pile to his accountant. The court dismissed the application for extension, citing a lack of special circumstances that rendered the taxpayer unable to act. Furthermore, the simple admission of fault by a professional does not automatically absolve the taxpayer of responsibility.

In order to be successful in placing reliance on a professional, the taxpayer must show that he at all times had the intention to object, was aware of his circumstances, and exercised a reasonable degree of diligence in following up his objection with his advisor. This is particularly true where the taxpayer is a businessman or someone who should be “sophisticated” in his income tax affairs.

 

Save The Date….Please!

In Canadian Income Tax on November 18, 2013 at 8:42 pm

Imagine this: One fine day, your favourite client enters your office and hands you a tax assessment he found in pile on his desk after returning from vacation. Upon close examination of the date, you realize that the time for issuing a Notice of Objection has expired. Suddenly, you are faced with the problem of filing a late appeal. Besides demoting your client to your less-than-favourite list, what do you do?

Most of us are familiar with the deadlines involved for objecting to an assessment, but let’s go over them again for good measure: An individual taxpayer must file an objection on or before the later of 90 days from the date of the assessment and one year after the balance due date of the taxpayer for the year. For a corporation or a trust, only the 90-day limit applies.

If the deadline is missed, the first step is to request an extension of time from the Minister of Revenue. This would consist of a letter addressed to the Chief of Appeals in a District Office or Taxation Centre, outlining the facts and reasons why the extension should be granted. You must also enclose the actual proposed Notice of Objection that the taxpayer wishes to file. The request for extension must be made within one year from the time the objection was otherwise due.

To be successful, the taxpayer must show that he was unable to act or to instruct another to act on his behalf within the relevant time period, or he must prove that he had a bona fide intention to object to the assessment within the normal time period. He must also show that the application was made as soon as the circumstances permitted, and that it would be just and equitable for the Minister to grant the extension.

The time periods involved can be a bit confusing. For example, in one case, the taxpayer’s lawyer failed to file a Notice of Objection on time. When he realized his mistake, rather than sending in his request for extension as soon as the circumstances permitted, he waited almost one year, because he thought that he had this amount of time to make the request under the rules described above. His request was denied, due to his misinterpretation of the law.

Should 90 days expire after making a request to the Minster without a response, or if the request for extension is denied, the next step is to request the extension from the Tax Court of Canada. This application must be filed within 90 days following a refusal of the application (if any) by the Minister. The taxpayer must send three copies of: (a) the request made to the Minister, (b) the proposed Notice of Objection, and (c) the Minister’s Notice of Refusal (if any) to the Registry of the Tax Court of Canada. It is also advisable to include a covering letter briefly explaining the facts and reasons for the request.

The Tax Court has the power to grant the application only where the first application was made with the Minister of Revenue within the one-year time period discussed earlier. The criteria used to determine whether the request will be granted are basically the same as those set out above. The only difference here is that the review will be made by the Tax Court, which is a body independent of Revenue Canada.

The Tax Court will, after receiving the application, fix a date for a hearing under the Informal Procedure Rules. This means that a taxpayer may be represented by an agent (such as an accountant) other than a lawyer.

Finally, we come to the question everyone is asking (I can hear you all now): What are the circumstances under which an extension of time will be granted? The case books are filled with some very interesting tales. For the answers, you are invited to wait by your laptops for the next edition of The Tax Issue.


Taxpayers Behaving Badly – Part 2

In Business Expenses, Canadian Income Tax on October 29, 2013 at 3:42 pm

In the case of CIBC v R., the CRA disallowed a deduction for expenses solely on the basis that the taxpayer’s conduct was morally reprehensible. The tax court agreed, and The Federal Court of Appeal was asked to rule on this question.

 The issue in this case was the deductibility of $3 billion in payments made by the CIBC to settle litigation in the U.S. relating to the bankruptcy of Enron Corporation. The CIBC was named as a co-defendant in the case, and the settlement was paid to avoid being jointly and severally liable with Enron for its part in the dissemination of misleading financial information.

 In disallowing the settlement amount as a tax deduction, the CRA argued:

 The misconduct of [CIBC and its affiliates] was so egregious and repulsive that any consequential settlement payments […] cannot be justified as being incurred for the purpose of gaining or producing income from a business or property …. The [CIBC affiliates] knowingly aided and abetted Enron to violate the United States’ federal securities laws and falsify its financial statements. The misconduct of [the CIBC affiliates] in enabling Enron to perpetrate its frauds, known to [CIBC], or the misconduct of [CIBC] itself, was so extreme, and the consequences so dire, that it could not be part of the business of a bank.

 If you know your tax history, you will recognize the CRA’s words as stemming from the comments made by the Supreme Court of Canada in the case of 65302 British Columbia Ltd. v. R. In that case, the taxpayer deducted quota penalties it was charged for the over-production of eggs. The quotas were intentionally exceeded in order to maintain a major customer. The court in that case allowed the deduction, but also stated, with regard to penalties in general that:

 It is conceivable that a breach could be so egregious or repulsive that the fine subsequently imposed could not be justified as being incurred for the purpose of producing income.

 In the end, Finance enacted a provision which generally disallows the deduction of any government penalties. But, the CIBC case did not involve penalties, and there is no specific provision of the Income Tax Act that would disallow a settlement payment based solely on the moral conduct of the taxpayer. Indeed, it is a well known fact that income from all sources, including criminal activities is taxable in Canada.

 So, in the end, the Court of Appeal overturned the decision of the Tax Court and did not disallow the deduction solely on the basis of the taxpayer’s conduct. The case will, however, resurface when the time comes to judge whether the deduction should be allowed on its merits as a business expense.