DAVID WILKENFELD, CA, canadian tax CONSULTANT

Posts Tagged ‘Law’

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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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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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The Twelve Points of the CRA

In Canadian Income Tax, Non-residents on December 15, 2010 at 4:32 pm

The twelve days of Christmas are soon upon us, so, I thought it would be nice if  The Tax Issue contributed to the holiday cheer by reproducing for you, the CRA’s twelve indicators to determine where a business is carried on for Canadian tax purposes. I’ll spare you any musical accompaniment. :-)

One of the basic tenets of Canadian tax law is that any non-resident carrying on business in Canada is subject to tax in Canada. This criterion is similarly relevant in determining whether you are required to collect GST/HST.

So, what does it mean to be “carrying on business in Canada”? There is no clear definition in the legislation, so we must look to the jurisprudence and the CRA’s guidelines.

In 2002, the CRA issued a comprehensive policy statement with regard to whether a business is being carried on in Canada. This policy takes into account the jurisprudence, as well as other factors such as the global economy. The CRA has established a list of twelve factors that determine where a business is carried on for Canadian tax purposes. You can read one per day during the holidays, set them to music, or read them all at once. Just remember, once they’re gone, they won’t be back till next year! :-)

1.      The place where agents and employees of the non-resident are located;

2.      The place of delivery;

3.      The place of payment;

4.      The place where purchases are made or assets acquired;

5.      The place from which transactions are solicited;

6.      The location of assets or an inventory of goods;

7.      The place where business contracts are made;

8.      The location of a bank account;

9.      The place where a non-resident’s name and business are listed in a directory;

10.  The location of a branch or office;

11.  The place where the service is performed; and

12.  The place of manufacture or production

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Get a GRIP

In Canadian Income Tax on December 4, 2010 at 11:01 am

 

It’s been almost four years since the two-tier tax on dividends was put in place in Canada, so it’s about time The Tax Issue did a little blurb on it, don’t you think? (plus, it’s been a slow week :-) )
If you have received a dividend from a Canadian company in recent years, surely you have noticed extra boxes on your T5 slip indicating whether it is “eligible” or “non-eligible” (and I promise never to call you Shirley again :-) ).

A non-eligible dividend is taxed at higher rates, because it comes from a private company who’s earnings were taxed at the lower small business rates. Eligible dividends will benefit from a higher dividend tax credit resulting in a lower tax rate to the recipient, as it comes from higher-taxed corporate earnings.

From the recipient’s viewpoint, a dividend is eligible if the paying corporation has provided written notice to that effect. There is no other requirement by the recipient to verify the status of the payment. It is the payer’s responsibility to make the determination.
From the payer’s perspective, there is a separate set of rules to follow, depending on whether the payer is a CCPC or not. Dividends from Canadian public companies will likely be eligible, as they normally pay tax at the high rates. The following commentary, therefore, will focus on Canadian Controlled Private Companies (CCPC’s).
Annual GRIP Calculation
The rules for CCPC’s involve an annual calculation of the “General Rate Income Pool”, or “GRIP”. The GRIP is determined by a formula and, as you may have guessed, consists of essentially the company’s after-tax active business income that did not benefit from the small business deduction. Also added to the GRIP are eligible dividends it has received from other companies. Losses carried back to previous years, will reduce the GRIP. Thus, a GRIP could become negative.
Investment income such as interest, capital gains, rental income and foreign income does not fall into the GRIP. However, dividends from Canadian public companies will likely be eligible, and will therefore increase the GRIP.
Paying Dividends
A CCPC that pays any dividend can designate it as an eligible dividend. The designation is made by notifying the recipient at the time the dividend is paid. There is no provision for late designations.  The CRA will accept a letter to the recipient, or a note on the cheque stub. If all the shareholders are also directors, a notation in the minutes will suffice.
If an eligible dividend exceeds the GRIP as at year end, a special 20% tax is assessed on the excess. Note that you don’t need to have a GRIP at the time of the dividend. The dividend can be paid any time in the year, and is compared to the GRIP balance at year end.
If an excessive eligible dividend is paid, an election is available in lieu of paying the 20% penalty tax. Similar to excessive CDA elections, you can designate the excess to be a separate taxable dividend. This will require the consent of the recipient, who will have to amend the treatment on his tax return.

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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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Don’t Take CDA For Granted

In Canadian Income Tax, Shareholder Agreements on August 16, 2010 at 9:30 am

Employees Beware! I recently saw the film by Michael Moore entitled “Capitalism: A Love Story”. In it was a pretty gruesome segment about how some large corporations like Walmart take out life insurance on their employees, essentially placing “bets” on their lives, and cashing in on their deaths, with all of the insurance proceeds going to their bottom lines, and nothing to the families of their employees. Pretty cold.

I can’t really comment on whether that story was embellished or slanted in any way, but I can comment on a Canadian case that recently caught my eye, and it’s a cautionary tale about proper planning and not taking anything for granted.

Mr. A entered into an employment agreement, whereby life insurance was taken out on him by his employer. Mr. A was also a shareholder of the company, and in the case of his death, the insurance proceeds would be used to purchase his shares. The agreement did not go any further.

Life insurance proceeds are tax-free to the beneficiary. In this case, the beneficiary was the company. In many cases, the tax-free nature of the life insurance is passed on to benefit the deceased’s estate through the use of a capital dividend (CDA) election. If not, the repurchase of shares by a company are taxable.

A CDA election is a choice that is made by the company, who is not legally required to make it, unless obliged to do so by contract.

In the case of Mr. A, the CDA benefit was not passed on to him, costing his estate to be liable for $250,000 in taxes. It may be that in this case, the intent was never to use the CDA for the share repurchase. In my experience, though, the omission is usually an oversight. The question of using the CDA to repurchase shares must always be addressed and resolved at the time the agreement is drafted.

The CDA was used by the remaining shareholders of the company which I’m guessing turned out to be a windfall for them. Mr. A’s estate attempted to sue for damages, but again, without a clearly defined obligation in the shareholders’ agreement, the company was not held responsible for the deceased’s tax liability.

What’s the moral of this story? Well, I can’t really comment on the character of the parties involved in this case (I’m sure they all have some good in them), but I can say this: Never sign a shareholder’s agreement without the help of a tax professional!

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CA Responsible For Client’s Tax Bill

In Canadian Income Tax on August 2, 2010 at 12:09 pm

Here’s an item that should come as no surprise to anyone:  accountants who earn undisclosed commissions from tax shelter promoters could be held liable to their clients if they are reassessed.

In a recent Ontario Superior Court decision, Michael Perris, an Oakville chartered accountant was found liable for recommending an “art flip” tax scheme to his clients and was ordered to pay over $45,000 in damages.

First of all, CA’s are members of a profession that adheres to a code of ethics. A CA is an advisor and has a fiduciary duty to his client. In Ontario, earning a commission – and not disclosing it to the client – is a clear ethical breach. It is not yet known if the Ontario Institute of Chartered Accountants plans to take disciplinary action.

The clients in this case, Eric and Valerie Lemberg, sued their CA for damages. They had invested $78,500 in a deal where they purchased a block of paintings at a discount, donated them to a charity and claimed a donation tax credit for an amount equal to their appraised market value of about four times their cost. This type of transaction was very popular in the 1990’s, but many participants have since been reassessed by the CRA, and have had little success in the courts. After the CRA assessed them, the Lembergs discovered that their accountant had earned a $7,500 commission on the deal, and sued for the $38,500 of taxes they owed, plus more than $75,000 in interest payable to the CRA.

Mr. Perris had recommended the deal, but had not informed his clients that he was making a fee on the other end. The court held that “…they relied on his advice and his integrity.  As it happened, their trust was misplaced.  His advice was not independent”. The clients were awarded an amount equal to the taxes owing, plus the accountant’s commission. Mr. Perris was not required to pay his client’s interest charges, since they had use of the funds during the period in question and could have invested it at rates as high as what the CRA was charging.

This case could become a precedent for future lawsuits, and should serve as a warning to accountants or other advisors with a responsibility to their clients to ensure that they do not violate the ethical boundaries of their professional relationships.

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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.