Why Don’t You Write Me?

Why don’t you write me I’m out in the jungle, I’m hungry to hear you
Send me a card I am waiting so hard to be near you….Paul Simon

If a person transfers capital property to his or her spouse, Income Tax Act (ITA) subsection 73(1) deems it be transferred at cost, unless the taxpayer elects in his return not to have the rollover apply.

A bad debt on a loan may be considered to be a disposition of that debt for tax purposes under ITA section 50, but only if the taxpayer elects in his tax return to have that provision apply.

On a change of control of a corporation, there is an automatic deemed year end. If that date is within 7 days after the normal year end, then that normal year end can be extended to the date of the change of control, but only if the taxpayer so elects in his return of income under ITA paragraph 249(4)(c).

I could go on and on, but point is, there are many provisions in Canadian tax law that require elections or designations in a taxpayer’s tax return. Some elections require specific prescribed forms to be filed. Others, however, have no form assigned to them. These are usually handled with a letter attached to the return stating that the taxpayer wishes to elect to have a certain provision apply.

So, how does a taxpayer wishing to make an election “in his tax return” do so if he is electronically filing? Currently, the CRA has no way of processing these “letter” elections electronically. However, they do make the statement in various guides and publications that a separate letter should be sent to the Taxation Centre, and even though it is not actually “in the return of income” as is required by law, if the letter arrives before the due date of the return, it will be valid. Furthermore, for corporate filers, the CRA states that an election may be included as part of the notes to the financial statements in the GIFI.

But what if no actual “letter” is produced? What if the taxpayer, in his return of income, simply takes advantage of the election? For example, isn’t it obvious that a taxpayer who makes a claim for a capital loss on the disposition of a bad debt under section 50 in his tax return has made the election in his return? Similarly, if a taxpayer shows a disposition at fair market value on a property transferred to his spouse, isn’t it clear that he has elected out of subsection 73(1)?

Clearly, the CRA’s polcies would suggest that a letter expressly making the election under the specific section of the law should always be prepared. However, for those who have not done so, the recent case of Dhaliwal may offer some support.

In Dhaliwal, the taxpayer failed to send a letter to the CRA and and claimed a loss under section 50 in his tax return. The loss was denied by the CRA, but the Tax Court of Canada had this to say:

The question thus becomes: Must a subsection 50(1) election be made with an express reference to electing to have subsection 50(1) apply, or is it sufficient that the taxpayer elects to report a loss in his or her tax return on a deemed disposition that results because he or she has chosen to avail himself or herself of subsection 50(1)? In an electronic-filing age, this takes on considerable importance as, if an election making a specific reference to subsection 50(1) is required, but no such choice is available in the CRA’s electronic tax returns, this would mean that subsection 50(1) is only available to paper-filers or that the CRA is derelict in its duties in administering the Income Tax Act .

 …upon a proper interpretation of section 50, it is sufficient to communicate the taxpayer’s election by clearly communicating in his or her tax return that he or she wants to be allowed an ABIL in respect of particular debt or shares disposed of in that year. This same analysis applies equally to electronic and paper format tax return. In this case, Mr. Dhaliwal’s 2007 electronic tax return clearly claims an ABIL, using the CRA’s ABIL schedule, in respect of a $156,000 loan made in 2005 and disposed of in 2007. The matter could hardly be clearer.

Perhaps at some point in the future, the CRA will come up with a clearer procedure to make elections and submit written information within an electronically filed income tax return. For now, those who are vigilant should follow their guidelines, but those who are not should follow Dhaliwal.

Tax Organizer 2012 Is Here

Hey everyone, The Tax Issue Tax Organizer 2012 is up and running. I received many emails last year from accountants and individuals expressing their appreciation for this useful tool so I encourage you to try it and let me know how you like it.

Happy tax season!!

Foreign Reporting Redux

In this issue of The Tax Issue, we go around the horn of foreign reporting requirements of the CRA. These forms were first introduced back in 1995 and have been filed on a rather inconsistent basis by taxpayers in the past. That is, until the CRA in 2006 decided to enforce the onerous penalty provisions in place for late filers.

If you are required to file any of these forms and haven’t been, I would suggest you get cracking. There is a chance the CRA will waive the penalties if you come forward through the voluntary disclosures program before they make a request.

Form T106 should be filed by anyone who carries on a business and has transactions with related non-resident persons. An example would be a corporation who regularly charges management fees to its foreign parent, or has borrowed money from a related foreign entity.

Luckily for most of us, there is an exemption from filing if the total amount of the transactions does not exceed $1,000,000. If you are required to file this form, it is due with your income tax return.

File form T1134-A for a taxpayer with a non-controlled foreign affiliate (a non-resident corporation in which the taxpayer’s equity is not less than 1% and the total equity percentage of the taxpayer and related persons is not less than 10%)

File form T1134-B for a taxpayer with a controlled foreign affiliate (a foreign affiliate that is controlled by not more than 4 Canadian residents with or without the taxpayer, or persons not at arm’s length with the taxpayer)

Because of the onerous amount of information requested on these forms, they are due within 15 months after the end of the fiscal year. Where applicable, they must be filed by corporations, individuals and trusts.

If you have ever transferred funds or made a loan to a foreign trust, you may have to file form T1141. If you have received a distribution or a loan from a foreign trust, you may be required to file form T1142. A foreign trust is a trust not resident in Canada and has at least one Canadian resident beneficiary or a beneficiary that is a controlled foreign affiliate of a Canadian resident. These forms are due on the filing due date for the Canadian filer.

Form T1135 is what many individuals see on their personal returns each year. It is required from any Canadian resident taxpayer (including corporations and trusts) who owns foreign investments with a cost of more than $100,000 at any time in the year.  The form applies to “specified foreign property” which includes money deposited outside Canada, shares of foreign corporations, foreign rental property, loans to non-residents, interests in non-resident corporations, trusts, and partnerships. Exclusions include property held in the course of carrying on an active business, and personal use property (such as a vacation property).

Returns are due on the filing due date of your income tax return.

Penalties for non-filers can be heavy. For simple non-compliance the fine is $25 per day (maximum $2,500), or $500 per month (maximum $12,000) for non-compliance due to gross negligence. If Revenue Canada requests the information and does not receive it, they will charge $1,000 per month (maximum $24,000). If forms remain unfiled for more than 24 months, an additional 5% fine will be added to the above.

If you do not have a drawer full of the above forms, you can download them (and any others, for that matter) from the CRA site on the world-wide web.

An Unexpected Penalty for Unsuspecting Taxpayers

My son Victor who is hard at word assisting me with tax returns this year, today learned of a little known penalty that hits many average Canadians who file their returns honestly and in a timely fashion every year. If you’d like to know what it is, just visit his blog.

Thanks for reminding everyone about this Vic. Now get back to work!!

What’s Your Tax Issue? Quebec Business Income

The Tax Issue

I live in Ontario. I have $130K  of self employment income earned in Ontario and $12K  of  self employment income earned in Quebec. Do I have to file a Quebec return? Will I have any balance of taxes owing given the amount I earned in Quebec?

The Answer

Every self-employed person resident in Canada may have to perform an allocation of income if their income is earned through a permanent establishment (“PE”) in a different province. If you don’t have a PE in another province through which you earn your business income, then no allocation is necessary.

A PE is defined as a “fixed place of business”, and includes an office, a branch, a mine, an oil well, a farm, a timberland, a factory, a workshop or a warehouse. You will also have a PE if:

(a) You have an employee or agent established in the province if he has the general authority to contract on your behalf or if he has a stock of merchandise from which he regularly fills orders; or

(b) You have made use of substantial machinery or equipment in the province at any time during the year.

If you have a PE in another province, you must make an allocation of your income among the provinces in which you do business. There is a specific formula you must use to make the allocation, which is done on form T2203. The allocation you make will affect your provincial tax payable.

And yes, if you have PE in Quebec, which has its own tax return, then you must file a Quebec tax return. Report the full amount of your income on the Quebec return. Then the provincial allocation is made and the Quebec tax payable is apportioned based on the allocation.

So, to answer your question, if you have a PE in Quebec, you will have a Quebec tax return to prepare and you will likely have some Quebec tax to pay, based on the formula.

Support Payments Redux

So you’ve split up with your significant other, and you’re forced to make support payments. The first thing you’ll be asking me is, “are they deductible?” Well, just like your relationship, it’s complicated. That’s what The Tax Issue is here for.

There are two basic requirements before you even consider taking a deduction. First, the payments must be based on a written agreement or a court order. Second, they must be periodic payments. Lump sums or payments based on a mutual, non written understanding are not deductible.

Once you’ve passed these hurdles the rules are different depending on when your agreement or court order was signed. We’ll tackle them one at a time, but before we do, you should be aware of one more thing: any amount that is deductible to the payer is also taxable to recipient.

Written Agreement or Court Order After April 1997

If your document is dated after April, 1997, only payments made in support of your spouse (or common law partner) are deductible. Child support is not.

Your agreement must clearly specify which payments are exclusively for spousal support. If no mention is made of the purpose of the payments, they are deemed to be for child support and are not deductible.

Payments made to a third party qualify as long as they are for the benefit of your spouse and he or she has control over them. For example, if a court order specifies that payments are to be made to a landlord for your spouse’s rent, it must also be made clear that your spouse may at any time have those payments made to her instead if he or she so desires.

If you qualify for a deduction under the above rules, you must register your agreement or court order with the CRA by filing form T1158.

Written Agreement or Court Order After April 1997

If your document is dated prior to May, 1997, then payments for spousal support and child support are deductible.

However, if the agreement was amended after April, 1997 and the amount of child support payments is modified, then you fall into the new rules, and they will no longer be deductible.

You can also choose, if your spouse agrees, to have the new rules apply to make the payments non-deductible (and non-taxable to the recipient) by filing an election on Form T1157.

Those are the basic rules. If you need more information, try the CRA guide P102. That should answer most of your questions.

Introducing The Tax Issue Tax Organizer for 2011!!

Organizing tax information for your tax preparer can be a daunting task. Do you use a shoebox? a shopping bag? Despite your best intentions, you may not have the time or the knowledge necessary to provide a complete and organized dossier.

Those of use who prepare your taxes just don’t have the time or energy to instruct their clients on how to properly prepare their income tax papers.

And so, as a public service to those beleaguered tax preparers, and to those of you who want your accountant to love you at tax time, The Tax Issue introduces the Tax Issue Tax Organizer.

The Tax Issue Tax Organizer is a free PDF file that you can download and use as an accountant, to give to your client, or as a client to use yourself to help organize the information you give to your tax preparer and make his or her life a little easier.

How to use the Tax Issue Tax Organizer

Simply download and print the Organizer. Each page represents a section that will let you organize the information for that topic. It starts with a list of the relevant documents you should submit to your tax preparer. Attach each page to a separate envelope or file folder containing the documents for that section.

Each page has a list of Do’s and Don’ts to help ensure that you help your tax preparer by including all the necessary documents and receipts he needs to efficiently prepare your taxes.

Finally, each page contains a few tax tips to help guide you through the process.

Even if you prepare your own tax returns, The Tax Issue Tax Organizer is a great tool to help you prepare.

Have a great tax season and enjoy using the Tax Issue Tax Organizer!

What’s Your Tax Issue? Residence in a Trust

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 or used the 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 the trust sells the home you are living in and 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 in. 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).

Also, if a trust claims the principal residence exemption on home, then all beneficiaries of that trust who may have used the home are deemed to have used their own principal residence exemptions on that property. So, for example, if a summer cottage is owned by a trust and is used by all the family members, some of whom own their own homes, they could lose their exemptions if the trust claims the cottage as a principal residence.

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

Tax Court Rules On Ponzi Scheme Victims

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…..

CRA Weighs In On J.V.’s

 

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!