Introductory Canadian Tax

KPU Open Education

Introductory Canadian Tax Copyright © by KPU Open Education. All Rights Reserved.

Contents

- Part I. Main Body

- 1. Introduction

- Part II. ITA research and Tax Payable

- 2. How and why does tax legislation exist?

- 3. Who is liable to pay tax in Canada and on what sources of income?

- 4. Describe the differences between a regressive and progressive tax. Provide some examples of each in Canada.

- 5. What are the differences and similarities between a sole-proprietorship, partnership, corporation, and trust?

- 6. Explain the tax concept of “integration”

- 7. Describe the ITA Section 3 ordering rules formula. How does this tie into Net Income for Tax Purposes (also known as 'Division B' income)?

- 8. How do you get from Net Income for Tax Purposes to Taxable Income to Tax Payable?

- 9. What is the difference between tax evasion, tax avoidance, tax planning and tax deferral? Provide some examples.

- 10. What is GAAR? What is the Purpose of GAAR? What are the GAAR tests?

- 11. What is the Alternative Minimum Tax? How is the AMT applied? Why does it exist?

- Part III. Residency, filing deadlines, interest and penalties

- 12. What are the filing and payment deadlines for an individual, a trust and a corporation?

- Part IV. Employment income

- 13. How are the following common employment deductions calculated and treated for tax purposes: legal expenses, sales expenses, automobile expenses, meals and entertainment and dues?

- Part V. Business Income & capital gains/losses

- 14. How do you determine if something creates business income, property income or capital gain (loss)? Why is this distinction important? (6.3.2)

- 15. Why do we need to reconcile accounting/business income to taxable income? What are some common reconciling items?

- 16. What are the relevant sections of the ITA that deal with business income? Where does business income go in the S3 ordering rules?

- 17. What are taxable capital gains and allowable capital losses?

- 18. How are eligible, non-eligible and capital dividends taxed in the hands of an individual? Are there any other tax implications? Why do they have different tax treatments?

- Part VI. CCA, terminal loss & recapture

- 19. What is the purpose of CCA? How is it calculated? Why are items typically ‘pooled’ into the same CCA class?

- 20. What is a Terminal Loss? What is Recapture? How are they recorded in net income for tax purposes?

- 21. What is the purpose of the half-year rule?

- 22. What is the purpose of the short-fiscal period rule?

- 23. Can you have a capital loss on depreciable property? If not, why not?

- 24. What is the Accelerated Investment Incentive and what are the basics of how it works?

- Part VII. Other income and deductions and basic Division ‘C’ deductions

- 25. Describe indirect payments and how they are treated for tax purposes.

- 26. Child Care expenses and how they are treated for tax purposes?

- 27. What is a non-arm’s length transaction and what are the tax implications?

- 28. How are charitable donations and political donations treated on a tax return? Why are they treated this way?

- 29. What is the OAS tax credit? What is the Claw back? How is it calculated? Why does it exist?

- Part VIII. GST

- 30. What are some GST considerations when transacting with non-residents? (6.7.6)

I

Main Body

1

Welcome to our Introduction to Canadian Tax textbook!

This is the result of a class project started in the spring of 2019 to create a free tax textbook harnessing the brainpower of undergraduate tax students at Kwantlen Polytechnic University (“KPU”) in British Columbia.  We decided to do this for the following reasons:

1. Textbooks are expensive.  This one is free!

2. Most information on Canadian tax issues is readily available online and we felt students could access, summarize and synthesize that information

3. We wanted to have our students create something of ‘value’ rather than a ‘disposable’ assignment that would be discarded after it was assessed.

This is an ongoing experiment and we will continue working on, adding to and editing this book each semester.  We want this book to be amazing and, to that end, we need your help.  Please use the comments section at the end of each page to identify any concerns you have with the information, any flawed weblinks or citations, better sources you think we should use or other ways you think the information could be presented.

In addition to all the great KPU student tax authors I’d  like to briefly recognize a few individuals for their significant contributions to this text:

Rajiv Jhangiani – A tireless advocate for Open Education at KPU.  He was the spark that ignited this project.

Wahaj Awan – An Open Education grant at KPU allowed us to hire a student assistant to help compile and edit the student content into Pressbooks.  Without his help, this would just be a bunch of scattered student files on my computer.  He made this book possible.

Junsong Zhang – He translated and refined my initial ideas for the project into something that we could actually DO within our KPU Moodle site.

Thanks in advance for your help with our project and we hope you enjoy the book!

Sam Newton – Instructor, KPU

II

ITA research and Tax Payable

2

How and why does tax legislation exist?

Income tax was introduced in Canada in 1917 as a temporary measure to fund the 1st World War.  This temporary measure has proven to be remarkably resilient and has stuck around for more than a century.    During this time tax rules have grown from 11 pages in 1917 to thousands of pages today.

In the 2016-2017 fiscal year, the Canadian government raised $293 billion dollars in revenue. Of this amount approximately 50% came from individual income tax, 15% from corporate taxation, 12% from GST/HST and 7% from the employment insurance premiums.  Personal and corporate taxation play a huge role in funding schools, the Canadian military our national healthcare systems etc.

It is important to understand that there is nothing immutable about taxation and that it is often driven by the political will of the day. For example, left-leaning governments may implement wealth taxes on high net worth individuals or increase taxes paid by higher income earners arguing that this is a way to address wealth imbalance and create a more egalitarian and fairer society. Right-leaning governments, on the other hand, tend to reduce taxes for high income earners and corporations believing that this will increase job creation and help the overall economy.

Again, there is nothing set in stone for taxation. You should consider taxation policies of the various parties whenever you vote.  You can make a difference.

Sam Newton, 2019

3

Who is liable to pay tax in Canada and on what sources of income?

Basically, every person resident in Canada is required to pay income tax on their worldwide taxable income.  A “Person” is defined in the Income Tax Act (“ITA”) as a corporation,  individual or a trust.  Here are some relevant sections from the ITA.

ITA 2(1) states that “Anincometaxshall bepaid,as requiredbythisAct, onthetaxableincomeforeach taxationyear of everyperson resident inCanada atany time inthe year.”

ITA 248(1) defines a “Person” as a corporation, individual or trust and ITA 3(a) states that a taxpayer’s income includes sources “inside or outside Canada”. Therefore, Canadian resident corporations, individuals and trusts are taxed on their worldwide income

“Persons” non-resident in Canada are required to pay tax on their Canadian source income, which is basically income earned/generated in Canada (See ITA 2(3) for further details).

Why are residents taxed on worldwide income and non-residents taxed only on Canadian sourced income?

Residents are taxed on worldwide income to discourage individuals and corporations from storing their assets and sourcing revenue in tax havens with low tax rates (like Switzerland or the Cayman Islands) to avoid tax. Since Canadian residents are taxed on worldwide income there may be no point in sourcing your income in a low tax country if you – as a resident of Canada – are still required to pay tax on the amount in Canada.

Non-residents are only taxed on their Canadian source income as it wouldn’t seem fair to tax someone on their worldwide income if they aren’t resident in Canada. For example, let’s say a software developer resident in Mexico temporarily moves to Canada for 2 months and takes a contract with Hootsuite. Although she would be taxed in Canada on her income earned in Canada for the 2 months, it wouldn’t make sense (or be fair) to tax her in Canada on her income earned in Mexico during the rest of the year.

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References and Resources:

- ITA – 2(1), 2(3), 3(a), 248(1) “Persons”

- Image – “Earth” Originally by NASA, Digitally enhanced by rawpixel is licensed under CC BY 4.0

- Competency map: 6.1.1

Author: Sam Newton, January 2019

4

Describe the differences between a regressive and progressive tax. Provide some examples of each in Canada.

Regressive taxes are applied uniformly, and they do not change based on an individual’s level of income. A regressive tax system affects low-income taxpayers more than high-income taxpayers because it takes a higher percentage of their earnings.

A great example of a regressive tax is the 5% Goods and Services Tax (GST).   For example, say a doctor earns $175,000 annually and a retail worker earns $30,000 annually. They both purchase a laptop for $1,000, and are charged $50 GST ($1,000 X 5%).   Although the $50 GST amount is the same for both the doctor and the retail worker it is a higher percentage of the retail workers overall income.  This is known as a regressive tax because it has a larger percentage impact on lower income individuals.

Progressive taxes are the opposite of regressive taxes. Progressive taxes increase based on your taxable income. Canada has a progressive income tax system; therefore, high-income taxpayers pay a progressively higher percentage of tax than low-income taxpayers. Using our previous example, because of the doctor’s higher annual income, the doctor will have to pay more taxes than the retail worker based on Canada’s federal tax rates of 2018.

The doctor will have to pay $38,461 in taxes (an average tax rate of 21.98%) while the retail worker will only have to pay $4,500 of taxes (an average tax rate of 15%).  Progressive taxes get progressively higher as your taxable income increases.

Doctor                                                                         Teacher

Interactive Content (author: Cynara Almendarez, January 2019).

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Interactive content (Author: Matthew Amisano, January 2020)

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References and Resources:

- Article – “Canadian Income Tax Rates for Individuals – Current and Previous Years” (author: Government of Canada)

- Image – “Medicine doctor – man with stethoscope” by Juhele is licensed under CC0 1.0

- Image – “Sales Clerk (#2)” by oksmith is licensed under CC0 1.0

- Competency map: 6.1.1

Author (Text): Cynara Almendarez, January 2019

5

What are the differences and similarities between a sole-proprietorship, partnership, corporation, and trust?

A sole-proprietorship has one owner who has unlimited liability for the business.

A partnership involves two or more people who combine resources for the business and share profits and losses.

A corporation is considered to be a separate legal entity from its shareholders. For tax purposes a corporation is a “Person”.

A trust or estate usually has beneficiaries that benefit from it. A trust can include an inter vivos trust (gifted during one’s lifetime) and a testamentary trust (given because of someone’s death) as explained in ITA 108(1).

The following table outlines some of the similarities and differences of the different tax entities:

Sole proprietorship

Partnership

Corporation

Trust

Ownership

A single owner

Two or more owners

Usually owned by many shareholders

Owner passes the ownership to a trustee

Profit or losses

All profits go to the sole owner

Profits split equally, or by pre-determined terms amongst the owners

Dividends declared and given to shareholders

Beneficiaries of the trust benefit from the profit

Liability

The owner has unlimited liability

Usually split amongst the owners based on the terms

Limited liability – individuals are not usually directly liable for activities within the corporation

The trustee responsible for operating the trust

Decision-making

All decisions for the firm are made by one owner

Owners in the partnership are responsible for the decisions

Board of director and shareholders

The trustee

Tax

Owner is taxed on his personal income/profit from the company

Owners are taxed on their respective incomes

A corporation is taxed as a “person”

A trust is taxed as a “person”

See ITA – 82(1), 96(1), 104 for an in-depth explanation of how types of entities are taxed.

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References and Resources :

- ITA – 98(5), 248(1), 108(1)

- Article – “Sole proprietorship, partnership, corporation…?” (author: Government of Canada)

- Article – “An Overview of Taxation of Trusts and Estates in Canada” (author: David W. Steele)

- Competency map: 6.1.1

Author (Text): Wahaj Awan, January 2019

6

Explain the tax concept of “integration”

The concept of integration is intended to eliminate any advantages and disadvantages in the application of tax between individuals, corporations and trusts. Thus, the after-tax cash received by an individual should be the same regardless if it was generated directly (as salary) or paid out as dividends from a corporation.

To achieve integration and to avoid double taxation on dividends received from a corporation, an individual must:

• gross-up dividends received to reflect the corporate pre-tax income

• receive a dividend tax credit (DTC) for the tax deducted at the corporate level

The DTC is the sum of federal and provincial dividend tax credits, and the calculation varies depending on whether the corporation is issuing eligible or non-eligible dividends. Typically, public corporations issue eligible dividends while Canadian-Controlled Private Corporations (CCPCs) issue non-eligible dividends.

Eligible dividends are paid from income that is taxed at a higher corporate rate, while non-eligible dividends are paid from income that is taxed at a lower corporate rate. To offset this inequity (and to create integration) eligible dividends receive more favourable tax treatment than non-eligible dividends.

Here is an illustration showing how integration works for both types of dividends. Notice that the tax paid by the corporation is equal to the DTC that can be claimed by the individual shareholder. The computed tax payable amount and the total after tax cash is the same irrespective of whether it is paid through eligible dividends, non-eligible dividends or received directly as salary.

Image used with permission from Sam Newton.

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References and Resources:

Video – “Integration” (authors: Abjeet Khatra and Gursimran Kohli) – uses 2017 rates

Competency map: 6.1.1

Author (Text): Eva Viernes, March 2019

7

Describe the ITA Section 3 ordering rules formula. How does this tie into Net Income for Tax Purposes (also known as 'Division B' income)?

Division B income (Net Income for Tax Purposes) is determined by using the ordering rules found in Section 3 of ITA. Under the ordering rules formula, a person’s net income for tax purposes would be calculated as follows:

Step 1, ITA 3(a) – Determining income (revenues net of expenses) from employment, business, property and other sources for the year.

Example:   Net employment income       $40,000

Net property income                $5,000           $45,000

$45,000

Step 2, ITA 3(b) – Net taxable capital gains arise when taxable capital gains for the year exceed allowable capital losses for the same year. If allowable capital losses are greater than the current year’s taxable capital gains, the net taxable capital gains for the year will be $0, and the difference will become a Net Capital Loss that can be applied against net taxable capital gains in other taxation years.

Example:       Taxable Capital Gains           $15,000

Allowable Capital Losses      ($20,000)              Nil

$45,000

Note: Taxable Capital Gains = 50% of a Capital Gain.  Allowable Capital Losses = 50% of a Capital Loss.

Step 3, ITA 3(c) – At this point, other deductions found in ITA Subdivision e (such as spousal support payments made or moving expenses incurred) are deducted from the subtotal of the amounts in Step 1 and Step 2. If the other deductions exceed the amounts determined in Step1 and Step 2, then the subtotal is $0. It is important to note that many Subdivision e deductions are only deductible in the current year so, if you don’t use them in the current year, they disappear.

Example:       RRSP deduction                     ($7,000)             ($7,000)

$38,000

Step 4, ITA 3 (d) – We then deduct losses incurred in the year (typically from business or property income). Losses are created when expenses exceed revenues for any given source of income. These losses are then deducted from the Step 3 subtotal. If the total amount is negative, then Net income for Tax Purposes (Division B income) is $0, and the difference becomes a non-capital loss that can be deducted from net income for tax purposes in other taxation years.

Example:       Business loss                           ($12,000)            ($12,000)

Net income for tax purposes (Division B income):                   $26,000

Note losses are recorded in 3(D) rather than offsetting income in 3(A) so you are able to maximize your 3(C) deductions in the year. Remember that many of the 3(C) deductions expire if they are not used in the year.   Therefore by maximizing the income in 3(A) (by leaving losses in 3(D)) you may be able to increase the amount of 3(C) deductions you can use in the year.

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References and Resources :

- ITA- Section 3

- Competency map: 6.3.2

Author – Amra Bayasgalan, January 2019

8

How do you get from Net Income for Tax Purposes to Taxable Income to Tax Payable?

After determining Net Income for Tax Purposes using the Section 3 ordering rules, Division C deductions are subtracted to get to the Taxable income (note, don’t confuse Division ‘C’ deductions with section 3(c) deductions). Then Marginal rates are applied to the Taxable Income to calculate the Tax Payable before credits. Lastly, credits are deducted to get to the Tax Payable.  This is best illustrated with an example using 2019 marginal rates and tax credits.

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This is a video walkthrough of a tax payable worksheet originally prepared at BCIT (author unknown).  Note, some tax rates and credits used in the video may be slightly outdated but the concepts remain the same.

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References and Resources:

- ITA – 3(a)-(f), 109-114, 117, 118

- Competency map: 6.3.2

Author (text) – Gurveer Brar, January 2019

9

What is the difference between tax evasion, tax avoidance, tax planning and tax deferral? Provide some examples.

Tax evasion occurs when an individual intentionally understates their revenue or overstates their expenses to reduce their tax payable. Tax evasion is considered a crime. Unlike tax avoidance, tax evasion has criminal consequences and the individual may face prosecution in criminal court.

For example, Alex works at an accounting firm and wants to minimize his tax bill, he claims $700 in deductions for fictitious meals and entertainment, moreover he neglects to report $7,000 he earned in cash from renting out a room from his house. Alex is committing tax evasion.

Tax avoidance is associated with tax evasion, but it’s not considered a crime. Tax avoidance occurs when a person reduces or eliminates tax within the letter of law but not within the spirit and intent of the law.  KPMG’s Isle of Mann scheme is a good example of a tax avoidance scenario.

If CRA believes there is an avoidance transaction they may challenge your application of tax law under the General Anti-Avoidance Rules (GAAR).

Tax planning is an attempt to reduce one’s tax liability, within the framework and spirit of existing tax rules and laws. An individual could reduce their income, increase their deductions and take the advantages of the tax credits through proper tax planning.

Tax deferral is an attempt to use existing tax rules and law to push tax payments/liability into the future. Tax deferral is not considered a crime.

A good example of both tax planning and tax deferral can be found in a Registered Retirement Savings Plan (RRSP). RRSP deductions reduce tax in the current year and defer it to the future when amounts in the RRSP are withdrawn. If, for example, you withdraw amounts from your RRSP when you are retired you will have achieved deferral (you’ve pushed taxation of the amount into the future when it was withdrawn) and you may have achieved tax planning/tax reduction if you are in a lower tax bracket during retirement than you were when you were working.

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References and Resources:

- ITA 245, IC73-10R3 (tax evasion)

- Article – “ IC88-2 General Anti-Avoidance Rule – Section 245 of the Income Tax Act” (author: Government of Canada)

- Competency map: 6.3.2

Author (Text): Deepali, March 2019

10

What is GAAR? What is the Purpose of GAAR? What are the GAAR tests?

What is GAAR?

The full name of GAAR is “The General Anti-Avoidance Rule” and it can be found in section 245(2) of the Income Tax Act. If a transaction or series of transactions is tax deducted, avoided or deferred, and such transactions or series of transactions are not performed for any primary purpose in order to obtain tax benefits, such tax consequences may be invalid.

What is the purpose of GAAR?

Canada Revenue Agency (CRA) uses GAAR to enhance their ability to target and challenge possible tax avoidance and / or abuse.  They use GAAR when tax planning strategies may be within the ITA rules but not within the ‘spirit’ of those rules.

What are the GAAR tests?

The Canadian Supreme Court made a three-point test in determining whether GAAR applies.

1st test – Does the transaction or series of transactions generate tax benefits?

- This test will almost always be met as CRA would likely only challenge transactions that created a tax benefit.

2nd test – Has the transaction been identified as an avoidance transaction?

- This test addresses whether the main purpose of the transaction was to obtain tax benefits.  If there was another purpose (business or other) of the transaction, then this test may not be met.

3rd test – Is the transaction abusive?

- “Abusive” is challenging to define and to prove.   It depends on whether the transaction is inconsistent with the object, purpose, or spirit of the tax laws being used by the taxpayer to obtain the tax benefit.

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Author (text): Mingyao Geng (January 2020)

References and Resources:

- Article – Canada: Tax Avoidance & Tax Planning – General Anti-Avoidance Rule – Canadian Tax Lawyer Analysis

- Article – Cameco and Oxford cases front and centre in 2018

- (https://www.mondaq.com/canada/Tax/631674/Tax-Avoidance-Tax-Planning-General-Anti-Avoidance-Rule-Canadian-Tax-Lawyer-Analysis)

- (https://www.lawtimesnews.com/practice-areas/tax/cameco-and-oxford-cases-front-and-centre-in-2018/262892)

11

What is the Alternative Minimum Tax? How is the AMT applied? Why does it exist?

For this topic you’ll need to know the following:

1. What is the AMT?

2. What is the purpose of the AMT?

3. What are the basics of the AMT calculation?

Interactive content by Sharon Basi

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References and Resources:

- ITA 127.51, 127.531

III

Residency, filing deadlines, interest and penalties

12

What are the filing and payment deadlines for an individual, a trust and a corporation?

According to ITA 248(1) the “Balance-due day” is a deadline for payment of tax which varies for individuals, trusts and a corporations.

Under ITA 249(1) “Taxation Year” is defined as the calendar year for an individual, and the fiscal year for a trust and corporation.

Tax Filing and Payment Deadlines – per ITA 248(1) “Balance-Due day”

Taxpayer

Filing deadlines

Balance-due Day

Individual

April 30th

April 30th

Individual (Self-Employed)

June 15th

April 30th

Trust

Within 90 days of the year-end

90 days after the end of calendar year

Corporation

Within 6 months of the year-end

2 months after the corporation’s fiscal year end

Corporation (Private)

Within 6 months of the year-end

3 months after the corporation’s fiscal year end*

*Note: Refer to section 125 deductions and business limits for further details on corporate tax payment deadlines.

Please attempt the following question.

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Interactive content by Oscar Chan

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References and Resources:

- ITA – 156.1(4), 248(1) “Balance-due day”, 249(1) “Taxation Year”

- Image – “Confused boy” by J4p4n is licensed under CC BY 2.0

- Competency map: 6.4.1

Author (Text and Interactive): Shubhneet Kaur Grewal, January 2019

IV

Employment income

13

How are the following common employment deductions calculated and treated for tax purposes: legal expenses, sales expenses, automobile expenses, meals and entertainment and dues?

Employees don’t tend to have access to as many deductions as individuals that are self-employed.  That said, there are some expenses that may be deductible to employees.   The Income Tax act section 8 covers the common deductions that employees can have on their employment income.

Legal Expenses:

- Under section 8(1)(b) in the Income Tax Act, legal expenses are amounts paid by a taxpayer regarding legal inquires.

- The amounts paid are to be collected or established if incurred by the taxpayer and should be included in the Taxpayer’s income if received.

Sales Expenses:

- Under section 8(1)(f) in the Income Tax Act, sales expenses are limited to commission-based income.

- A taxpayer can deduct sales expenses if their income comes from commission of selling goods or negotiating a service if these expenses are for the purpose of earning their commission.

Automobile Expenses:

- Under section 8(1)(h) in the Income Tax Act, motor vehicle expenses can be deducted when a taxpayer is required to carry out their duty of their employment away from the office and the contract of their employment states that they are required to pay for motor vehicle expenses that are incurred.

Meals:

- Under section 8(4) in the Income Tax Act, meals expenses cannot be deducted by an individual unless a meal was eaten while away from the office and was the individual was required by the duties of the job to be away at that time and that time has to be for a period not less than twelve hours.

Entertainment:

- According to the CRA, entertainment expenses that are incurred in the process of generating income to a business can be deducted up to 50% in an allowable event and they are in a reasonable circumstance.

Dues:

- Under section 8(1)(I) in the Income Tax Act and according to the CRA, dues expenses that can be deducted are: professional or malpractice insurance, professional board dues and annual dues for memberships that are in a trade union.

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References and Resources:

Income Tax Act

https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/industry-campaign-approach/meals-entertainment-expenses.html

https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-212-annual-union-professional-like-dues.html

V

Business Income & capital gains/losses

14

How do you determine if something creates business income, property income or capital gain (loss)? Why is this distinction important? (6.3.2)

One of the most important reasons to differentiate business and property income from capital gains is that 100% of business and property income (and losses) are taxable whereas only 50% of capital gains are taxable.   This has a big tax impact (which often ends up in court) and therefore it is important for us to understand how to differentiate business and property income from capital gains.

Business Income vs. Capital Gain.

There is limited specific guideline in the ITA on whether economic activity represents business income.  If you look up ‘business’ in ITA 248(1) it basically says a business is “…an adventure or concern in the nature of trade but does not include an office or employment.”  This is not particularly helpful guidance as it basically says ‘well we don’t really know what a business is, but we know it is not office or employment’.

The CRA has filled this void by publishing IT-459 “Adventure or Concern in the Nature of Trade”. This Interpretation Bulletin provides guidance to determine whether amounts represent business income or capital gains. In determining whether something is an ‘Adventure or Concern in the Nature of Trade’ (i.e. business income) the CRA primarily looks at “Taxpayer Conduct”, the “Nature of the Property” and the “Taxpayer’s Intention”

Taxpayer’s Conduct: One of the major considerations is whether the taxpayer is acting in a manner that is consistent with the way other taxpayers would typically act with the same property, goods or services.   So, per IT-459, you would compare the activity to what “dealers would do with the same kind of property and what the taxpayer did when he purchased the property, when he sold it and during the time when it was in his possession.”  If the taxpayer’s activity is consistent with what a dealer in the property would typically do, then this would be an indication of business income.

Other elements of the taxpayer’s conduct that might indicate business income include the following:

- Evidence that the taxpayer attempted to find a purchaser for the property shortly after the initial purchase

- Evidence that the taxpayer improved the property to increase potential re-sale value.

- The purchaser has a commercial background dealing with similar property.

Nature of the Property: When property is of such a nature that it couldn’t create income on its own (for example a building might be able to create rental property income on its own) or be enjoyed by the taxpayer on its own, then it likely would be considered business income.  Effectively this criteria is looking at the goods or services themselves and saying ‘look, you did a wholesale purchase of 15,000 rolls of toilet paper, the only reason to have this would be for resale and therefore this will create business income.’

Taxpayer’s Intention: IT-459 states that “A taxpayer’s intention to sell at a profit is not sufficient, by itself, to establish that he was involved in an adventure or concern in the nature of trade. That intention is almost invariably present even when a true investment has been acquired, if circumstances should arise that would make it financially more beneficial to sell the investment than to continue to hold it.”  So, intention to sell at a profit does not, on its own, indicate business income.  If however intention to sell is linked to the other criteria (Taxpayer Conduct, Nature of the Property) then this would provide further support that this is business income.

The CRA will look at both the taxpayer’s primary intention and their secondary intention when considering whether activity creates business income or capital gains.

Business Income vs Property Income

The difference between business income and property income is usually based on the amount of activity needed to generate the income. If it is an active source of income it is typically considered business income whereas a passive source of income would be considered property income.

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References and Resources:

- IT-459 “Adventure or Concern in the Nature of Trade”

- Competency map: 6.3.2

Author (Text): Sam Newton and Gurmehar S. Grewal, March 2019

15

Why do we need to reconcile accounting/business income to taxable income? What are some common reconciling items?

Businesses often follow Generally Accepted Accounting Principles (GAAP) while preparing their own financial statements. The Income Tax Act, however, has a different set of rules for determining business income. The difference between these two sets of rules (GAAP vs ITA) requires us to reconcile business income for accounting to business income for tax purposes when preparing tax returns.

The reconciliation typically starts with accounting business income and then adjusts for all the differences between GAAP and the ITA.  Most of the ITA rules for businesses can be found in Sections 9 to 37 of the ITA but some key criteria for business deductions are as follows:

18(1)(a) – States that you are only allowed deductions for expenses that were incurred for the purpose of generating income

20(1) – States that regardless of Section 18, if an item is listed in Section 20 it is deductible.

The relationship between these two sections can be seen in the treatment of accounting deprecation and Capital Cost Allowance (“CCA” – tax depreciation). 18(1)(b) of the ITA states that accounting depreciation is not deductible while 20(1)(a) says that you can deduct CCA. So, to reconcile these amounts you would start with your accounting business income, add back the accounting depreciation and deduct CCA.  This revised amount would be your business income for tax purposes.

For Example, say your accounting income was $500,000 and includes $75,000 in depreciation. Your CCA is $85,000. The reconciliation of these amounts to determine business income for tax purposes would be as follows:

Business income for Accounting Purposes

$500,000

Add: -Depreciation ITA 18 (1) (b)

$75,000

Less: – CCA ITA 20 (1) (a)

($85,000)

Business Income for Tax Purposes

$490,000

Here are some of the more common reconciling items look out for:

Particulars

Examples

Citations

Deductions Generally Non- deductible/ Restricted

General limitation

ITA 18 (1) (a)

Accounting depreciation and amortization expenses

ITA 18 (1) (b)

Recreational facilities and club dues

ITA 18 (1) (l)

Deductions Allowed Generally

Capital Cost Allowance

ITA 20 (1) (a)

Expenses re financing

ITA 20 (1) (e)

Bad debts

ITA 20 (1) (p)

Meals and Entertainment

ITA 67.1 (1)

Please attempt the following question.

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References and Resources:

- ITA 18(1), 20(1), 67.1(1)

- Competency map: 6.3.2

Author (Text and Interactive): Jatin Gupta, March 2019

16

What are the relevant sections of the ITA that deal with business income? Where does business income go in the S3 ordering rules?

ITA 9(1) – “Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.”

248(1) “business” — “For purposes of the Act, a business is defined to include a profession, calling, trade, manufacture, or undertaking of any kind whatever, as well as an adventure or concern in the nature of trade. It does not include an office or employment.”

In accordance with the ordering rules, business income is recorded under Division B S3(a) if revenues are higher than expenses. If a business has a net loss for the year (i.e. revenue is less than expenses) then the net loss will be allocated under S3(d) and recorded as a loss.

When calculating the Net Income for Tax Purposes, business income goes under S3(a) if there is a profit. For example, if you have a restaurant that has revenue of $1,000,000 and expenses of $300,000, then the total income is recorded as a profit of $700,000 under S3(a).  However, if the restaurant had expenses greater than revenues then the net loss for that restaurant would be recorded in S3(d)

Revenue

Expenses

Total Income (Loss)

Restaurant #1

$1,000,000

$300,000

$700,000 under S3(a)

Restaurant #2

$600,000

$650,000

($50,000) under S3(d)

Let’s say that in addition to your restaurant, you also have an electronics store that has revenue of $500,000 and has expenses of $1,400,000. This would cause the electronic store to have a total loss of $900,000. The income from the restaurant would still be recorded under S3(a) and the business loss of the electronic store would be recorded under S3(d). These two business incomes would not be combined and are intended to be assessed separately.

In this case, there is a total loss of $200,000, but the Net Income for Tax Purposes will be recorded as $0. The $200,000 loss is added to your non-capital loss balance and can be applied against income for other years.

Revenue

Expenses

Total Income

Restaurant

$1,000,000

$300,000

$700,000 under S3(a)

Electronic Store

$500,000

$1,400,000

($900,000) under S3(d)

Total

$1,500,000

$1,700,000

$0– NITP

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References and Resources:

- ITA 9(1), 39(1), 248(1) “business”

- Contingency map: 6.1.1, 6.3.2

Author (Text): Amanda Luies, January 2019

17

What are taxable capital gains and allowable capital losses?

Capital Gains are the profits realized from the sale of Capital Property (see ITA 54 for definition).  Although the arguments over whether transactions create business income, property income or capital gains can become pretty complex, in general, if the sale of an asset is a bi-product of its main purpose then it likely creates a capital gain (loss).

A standard example is an apple tree in an orchard business that sells apples.  Typically the ongoing sale of apples would generate business income while the sale of the actual apple tree would create a capital gain.

Only 50% of a Capital Gain is included in income, this is known as the Taxable Capital Gains (“TCG”). For example, if the Capital Gain is $30,000, then the TCG would be $15,000 ($30,000 x 50%).  Similarly, Allowable Capital Losses (“ACL”) are equal to 50% of the Capital Loss [ITA 38(b)]. ACL’s are deducted against TCG’s in the year.

Where do TCG’s and ACL’s go in the S3 ordering rules? What happens if your ACL > TCG?

In terms of the S3 ordering rules, capital gains and losses recorded in Net Income for Tax Purposes in 3(b).  ACL’s are netted against TCG’s however the amount in section 3(b) cannot be negative.  If ACL’s are greater than TCG’s  then 3(b) will be $Nil and the difference becomes a Net Capital Loss that can be applied against net TCG’s in other years.

Example: Kylee sold two of her properties last year, a building and some shares, both purchased in 2016. There was no depreciation on the building. The building was bought at a price of $100,000, and sold for $160,000. The shares were bought at $50,000 and sold for $30,000.

The first transaction realized a capital gain of $60,000 and the second transaction realized a loss of $20,000. Kylee’s TCG would be ($60,000 x 50%) $30,000 and her ACL would be ($20,000 x 50%) $10,000. The amount recorded in 3(b) would be $20,000 (TCG-ACL).

Now, let’s say Kylee bought the building for $100,000, and sold it for $110,000. The shares she bought for $50,000 and sold for $30,000.

The first transaction realized a capital gain of $10,000, and the second transaction realized a capital loss of $20,000. Kylee’s TCG would be ($10,000 x 50%) $5,000. Her ACL would be ($20,000 x 50%) $10,000. ACL>TCG, therefore the amount recorded in 3(b) would be $Nil and the $5,000 difference ($10,000-$5,000) would be added to her Net Capital Loss balance and could be applied against 3b amounts in other years.

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References and Resources:

- ITA 248(1) “capital gain”, “property”, ITA 38(b),

- Article – “Capital Gains and Losses. ” (author: TaxTips )

- Competency map: 6.3.2

Author: Jasmine Marahar, January 2019

18

How are eligible, non-eligible and capital dividends taxed in the hands of an individual? Are there any other tax implications? Why do they have different tax treatments?

Eligible dividends are typically paid out by public corporations, from income that has been taxed at a higher corporate tax rate.

Non-eligible dividends are generally paid out by private corporations from income that has been taxed at a lower corporate tax rate.  Note public corporations may sometimes declare a portion of their dividends as non-eligible (if some of their income has been taxed at lower corporate rates).

Once eligible or non-eligible dividends have been received by an individual, they are subject to gross-up rates.   The grossed-up/taxable dividend is intended to reflect the corporate pre-tax income which is then taxed at the individual’s marginal tax rate. The individual is also given a dividend tax credit which is equivalent to the tax paid by the corporation on the dividends. (Refer to the “Integration” topic for an example).

Rates as of 2019

Gross-up rate

Federal dividend tax credit

Eligible dividends

38%

6/11

Non-eligible dividends

15%

9/13

(These rates can be found in the FITAC>Tax Rates and Tools under the heading “Eligible dividends reference tool”)

ITA 83(2) describes capital dividends as dividends paid by a corporation on the shares of the corporation’s capital stock.

ITA 83(2)(b) states “no part of the dividend shall be included in calculating the income of any shareholder of the corporation”. In other words, there is no tax on capital dividends.

Capital dividends are essentially the non-taxable 50% portion of a capital gain, which ‘flow-through’ tax free to the shareholder.

Suppose a private corporation has a capital gain of $2,000 and is paying out dividends on that amount. The tax treatment for the corporation and in the hands of the individual for this gain is as follows:

In the above example you should note that the after tax cash is the same ($1,000 from the capital dividend and $600 from the non-eligible dividend) regardless of whether the capital gain was earned by the corporation (with dividends paid out to the shareholder) or earned directly by the individual.

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References and Resources:

- ITA – 82(1), 83(2), 89(1), 89(14)

- Video – “Integration” (authors:  Abjeet   Khatra  and Gursimran Kohli)  – uses 2017 rates

- Article – “Eligible dividends” (author: Government of Canada)

- Example provided by Sam Newton

Author: Wahaj Awan, January 2020

VI

CCA, terminal loss & recapture

19

What is the purpose of CCA? How is it calculated? Why are items typically ‘pooled’ into the same CCA class?

Capital Cost Allowance (“CCA”) is the depreciation mechanism used for tax purposes.  Unlike accounting depreciation, CCA can be deducted from income for tax purposes. Capital assets require depreciation because the capital assets wear out over time. Undepreciated Capital Cost (UCC) is the capital cost of an asset minus the CCA claimed in previous years.

How is it calculated?

CCA is usually calculated based on the Declining Balance Method. Let’s consider the following example: Assume Alpine Industries has machinery with an Undepreciated Capital Cost (UCC) of $40,000 at the start of 2016.  The machinery falls under class 53 and has a 50% CCA rate.  In this situation CCA is calculated as UCC multiplied by the CCA rate.  The following examples shows CCA in 2016, 2017 and 2018.

CCA is also impacted by other tax laws such as the half-year rule, short fiscal year rule, available for use rule, recapture and terminal losses which will be addressed in subsequent sections of this text. The rates for different classes can be found in the Income Tax Regulations 1100(1).  In general, the rates are intended to reflect the anticipated depreciation of the related assets.   So, for example buildings, which tend to have a long useful life, will have a relatively low CCA rate (usually 4%) whereas computer software, which tends to depreciate quickly, has a much higher CCA rate (up to 100%).

Why are items typically ‘pooled’ into the same CCA class?

Assets are pooled into certain classes largely because the government believes they depreciate in a similar manner. For example, tools, medical and dental instruments, and kitchen utensils are grouped together in class 12. Similarly, roads, parking lots, sidewalks, airplane runways, storage areas or similar surface construction are pooled into class 17. The assets in these classes really don’t have much in common other than the belief that they depreciate the same way.

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References and Resources:

- ITR 1100(1)

- Video – “CCA Part 1 2015” (author: BCC Education)

- Article – “Income Tax Folio S3-F4-C1, General Discussion of Capital Cost Allowance” (author: Government of Canada)

- Article – “CCA classes” (author: Government of Canada)

- Competency map: 6.3.2

Author (Text): Daljinder Nijjar, January 2019

20

What is a Terminal Loss? What is Recapture? How are they recorded in net income for tax purposes?

Terminal loss

According to TaxTips the author states that, “When a depreciable fixed asset is sold, its capital cost allowance (CCA) class is reduced by deducting the lower of its original cost, or its proceeds of sale. If all the assets in a class have been sold, but at the end of the fiscal year there is still a balance of undepreciated capital cost (UCC) remaining in the class, this balance can be fully written off against business or property income as a “terminal loss”.”

So, if you have disposed of all the assets in a specific CCA class but there is still a remaining UCC balance in the class, effectively it means you didn’t claim enough CCA in previous years.  The ITA addresses this by allowing you to claim a Terminal Loss on this remaining balance in the current year.   The Terminal Loss is deducted from your business or property income and reduces the remaining UCC balance in the class to $Nil.

Recapture

According to TaxTips, the author states that, “When a depreciable fixed asset is sold, its capital cost allowance (CCA) class is reduced by deducting the lower of its original cost, or its proceeds of sale. If, at the end of a fiscal year, the balance of the class is negative, a gain has occurred. This gain is referred to as a “recapture” of CCA andmust be included in business or property income for the year.”

If we sell an asset and the balance in the class is negative at the end of the fiscal year, we have created Recapture. This means we have claimed too much CCA in the past.  The ITA addresses this by adding back the Recapture amount to the business or property income in the year.

Terminal Loss

Recapture

UCC, beginning of year

$6,000

$6,000

Sold asset for…

$4,000

$9,000

Terminal Loss

$2,000 ($6,000 – $4,000)

Not applicable

Recapture

Not applicable

$3,000($6,000-$9,000)

Note: Terminal losses are only recorded when there are no other assets in the CCA class.

Remember, Terminal Losses are subtracted from your business or property income, and Recapture is added to your business or property income.

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References and Resources:

- Article- “Terminal Loss” (Author: TaxTips)

- Article- “Recapture” (Author: TaxTips)

- Article- “Example for the calculation of recapture of CCA and terminal loss” (Author: Government of Canada)

- Competency map: 6.3.2

Author (Text): Gurtaj Pannu, March 2019

21

What is the purpose of the half-year rule?

The half-year rule reduces the amount of CCA (tax depreciation) that can be claimed in the year that you purchase an asset.

Income Tax Regulation subparagraph 1100(1)(b)(i) states “If the capital cost of the property was incurred in the taxation year and after November 12, 1981,(B) if the property is not an accelerated investment incentive property and is not described in any of subparagraphs (b)(iii) to (v) of the description of R in subsection (2), 50 per cent of the amount for the year calculated in accordance with Schedule III.”

Effectively it says ‘we are going to pretend you bought the asset halfway through the year and therefore you are only going to be able to claim CCA on half of the purchase amount this year…don’t worry you can claim the remaining CCA in future years.’

How the half-year rule works

The half-year rule temporarily cuts the cost of an asset purchased during the year in half.  This lower amount is then used to calculate CCA for the year.

For example, say I bought a $25,000 car during the year for my new car-rental business.  I checked on the CCA “classes list” and determined the new car would be recorded in CCA class 10 which has a 30% CCA rate.  I add the $25,000 car to my class 10 pool but then must reduce this amount by $12,500 for the half-year rule.  In the 1st year I can claim $3,750 in CCA ($12,500 X 30%).

I then add the $12,500 back to my UCC balance and will be able to claim $6,375 CCA on the remaining balance in the following year (($25,000 cost – $3,750 1st year CCA) X 30% CCA rate).  CCA on the full remaining amount in the next year as follows:

Original purchase

Capital Cost Allowance

Accumulated CCA

UCC

$25,000

1st year

$25,000*50%* 30%=$3,750

$3,750

$21,250

2nd year

$21,250*30%=$6,375

$10,125

$14,875

You can find the appropriate CCA class and rates for a given asset in the “Classes list” in the FITAC under “tax rates and tools”

Why do we use the half-year rule?

The half-year rule allows taxpayers to claim CCA regardless of the actual purchase date of the asset.  Without this rule, taxpayers would have an incentive to buy assets at the end of the year and claim CCA for the whole year. In addition, half-year rule creates convenience to both taxpayers and CRA, because this method makes the calculating process of CCA a lot easier, as the actual purchase date of the property does not matter.

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References and Resources:

- Article – “Income Tax Folio S3-F4-C1, General Discussion of Capital Cost Allowance” (author: Government of Canada)

- Article – “PART XI Capital Cost Allowances – DIVISION I – Deductions Allowed” – 1100(1)(b)(i) (author: Government of Canada)

- Competency map: 6.3.2

Author (Text and Interactive): David Ren, January 2019

22

What is the purpose of the short-fiscal period rule?

ITA 249(2) (a)- A “Fiscal Period” is the time when a new taxation year is beginning and the current taxation year is ending (See ITA 249.1(1) for further explanation).

Afiscal period is the time between a start of a business and itsyear-end which is usually the calendar year. A fiscal period cannot be more than 12 months; however,it can be shorter than 12 months also known as a “short-fiscal period”.For example, if Gary opens a business on June 1stand his fiscal periods ends on December 31stthen hisfiscal period would consist of214 daysinstead of 365 days. This would be known as a “short-fiscal period for Gary’s business. A business reports its income based on the fiscal period. A business that goes bankrupt prior to its fiscal year-end would also have a  “short-fiscal period”.

How the short-fiscal period relates to capital cost allowance ?

CCA rates are based on a full year. Therefore, an adjustment is made to the CCA of a business that was in operation for less than a year.

If one has a short- fiscal period that consists of less than 365 days, they take into consideration the days the business was operating. For example, Tim shuts down his tire company on September 1 st and his CCA would have been   $4 , 000 for the full year.  Because Tim had a short-fiscal period of 243 days , his actual CCA would be calculated as $2 , 663 ($4,000 x (243/365) ). Therefore , the CCA has to be prorated, as the CCA claim is based on the days in your fiscal period.

Please attempt the following question.

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References and Resources :

- ITA- 249(2) (a) “Fiscal Period”

- Article- “Fiscal Period – Government of Canada ” (author: Government of Canada)

- Article- “Short tax year – Investopedia” (author: Julia Kagen)

- Competency map: 6.3.2

Author (Text and Interactive): Gurvir Sahota, January 2019

23

Can you have a capital loss on depreciable property? If not, why not?

No, we cannot have a capital loss on depreciable property.

A “Capital loss” occurs when a non-depreciable asset (such as land) is sold for less than its original cost.   However you cannot have a Capital Loss on “depreciable property”, i.e. items whose value declines over time such as cars, buildings, houses etc.

Why can’t you have a capital loss on depreciable property?

You can have a “Capital gain on depreciable property if you sell it for more than its adjusted cost base plus the outlays and expenses incurred to sell the property” (Canada Revenue Agency, 2018). But, “A loss from the sale of the depreciable property is not considered to be a capital loss. However, you may be able to claim a terminal loss” (Canada Revenue Agency, 2018). Depreciable assets are considered a part of the activities of your business and property; therefore, they are better integrated with your business or property through tax depreciation (CCA) and Terminal Losses than as a Capital Loss. Generally, a Terminal Loss is generated when you sell assets for less than their tax carrying value (UCC), and there are no other assets remaining in the CCA class.

When we buy a non-depreciable asset like land for example, and we sell it for less than what we paid for it, there is a Capital Loss. When we buy a depreciable asset like a car, there is no Capital Loss at the time of sale. Instead, we can claim CCA during the lifetime of that asset, and if it sells for less than the remaining UCC balance, we can claim a Terminal Loss (as a reduction to our business or property income) assuming there are no other assets remaining in the CCA class.

Let’s say we bought a table for $1,000. We claimed $200 in CCA (tax depreciation) over the last 3 years and its UCC is now $800. The table is subsequently sold for $700 and there are no other remaining assets in the CCA class. The difference between the sale price ($700) and the UCC ($800) creates a $100 Terminal Loss. The Terminal Loss represents additional tax depreciation we can claim in the year.

Original Cost

$1,000

(1,000-800) $200 CCA (Tax depreciation)

(800-700) $100 UCC (Terminal loss)

UCC

$800

Selling Price

$700

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References and Resources:

- Article – “Depreciable property – 2018, January 03” (author: Government of Canada )

- Competency map: 6.3.2

Author (Text and Interactive): Pooja Sehgal, January 2019

24

What is the Accelerated Investment Incentive and what are the basics of how it works?

The accelerated investment incentive (AII) began in Canada in 2018. It was introduced as a means to encourage corporations to invest in more capital assets as there is now added benefits to doing so, however, it is only a temporary measure and will be phased out by 2028.

The accelerated investment incentive is just a temporary change to the Capital cost allowance (CCA). CCA works as a tax deduction representing a capital asset’s depreciation .

The main benefit of the AII is that it allows for a larger CCA deduction within the first year of acquiring an eligible depreciable asset. For most assets purchased after November 20, 2018 the AIC provides two main advantages:

- No half-year rule applied in the year of acquisition

- Net additions for the year (additions less disposals) are multiplied by 1.5 X the CCA rate for the class of assets.

Both of these new rules create a big increase in the amount of CCA that can be claimed in the year of acquisition.  Prior to this incentive, in the year that equipment was acquired the taxpayer could only claim CCA on half of its value in the year of acquisition. This is known as the half year rule and is not applicable under the accelerated investment incentive.

It is important to remember that the AII does not affect the overall amount a taxpayer can deduct. The AII only increases the CCA deduction in the first year, ultimately allowing for decreased deduction throughout the following years.

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References and Resources:

- Article – “Accelerated Investment Incentive” (author: Government of Canada)

Author (text): Addan Ayaz January 2020

VII

Other income and deductions and basic Division ‘C’ deductions

25

Describe indirect payments and how they are treated for tax purposes.

Definition

A typical indirect payment would occur when person ‘A’ instructs the payee to pay person ‘B’ for work performed by person ‘A’.  For example, I might instruct my employer to pay my spouse (instead of me) because my spouse is in a lower tax bracket.  The indirect payment rules (ITA 56 (2)) bring this income back into the hands of the individual who actually provided the service rather than the one who received the payment.

In chapter 2 we learned about tax avoidance, tax evasion, tax deferral and tax planning as well as the purpose of General Anti-Avoidance Rule (GAAR). Indirect payments would lean towards tax avoidance, considering that these payments exist to reduce a family’s overall tax burden.

As per all taxable income, if an indirect payment satisfies all the conditions, that payment would be taxed accordingly as an addition to the taxpayer’s taxable income.

Four conditions required to satisfy subsection 56(2) rule:

A. If the payment or transfer of assets is made to a person other than the taxpayer

B. The payment was made in pursuant to the direction or concurrence with the taxpayer (does not need to be obvious, can be passive or implicit)

C. There is a benefit involved in the payment, whether to the taxpayer or another person that the taxpayer wishes to give the payment to

D. The payment would have been included in the taxable amount of the taxpayer if the payment was directly made to the taxpayer

Application

An example of this would be if Corporation Neasco decides to give gifts to their shareholders’ family members, such as apparel or appliances. Let’s say these gifts are worth $20,000 in total. The first condition is already satisfied, as Neasco transfers the said $20,000 assets to the family members other than the shareholders themselves. Since that the gifts were given to the shareholders’ family members, both the shareholders and Corporation Neasco concurred to make this happen. This satisfies Rule B. Moreover, the gifts worth $20,000 were to the shareholders’ family members so that they can use them, which would be considered as a benefit, satisfying rule C.

Lastly, if this $20,000 was given directly to the shareholders, it would be included as a part of their income because of subsection 15(1), which says that if a benefit received by a shareholder from a corporation, that benefit would be included in their taxable income. In this case, the $20,000 worth of gifts that the family members of the shareholders received would still be included in the shareholders’ taxable income as all the conditions of subsection 56(2) are satisfied.

Exemption

Any amount in a retirement plan assigned by a taxpayer under subsection 65.1 (“portion of a contributor’s retirement pension to the contributor’s spouse or common-law partner”) of the Canada pension plan or a similar provincial pension plan as stated in section 3 of the Canada pension plan/prescribed provincial pension plan is exempt from the rules mentioned in Subsection 56(2).

Some forms of split income (like split pension income) are also exempt from the indirect payment rules.

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References and Resources:

- Subsection 56(2) of the Income Tax Act

- Subsection 65.1 of the Canada Pension plan

- Article No. IT-335R2, Indirect Payments, Canadian Revenue Agency

- https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/it335r2/archived-indirect-payments.html#P41_1016

Author (text): Sean Co, January 2020

26

Child Care expenses and how they are treated for tax purposes?

Child care expenses are amounts you or your spouse or Common-law partner spend to have someone look after an eligible child so that you or the other person could work to generate income or handle business or attend school ITA 63 (3). An eligible child is

- Under the age of 16 at any time during the year (exceptions are made to the age limit if the child is mentally or physically infirm).

- You or your spouse’s or common-law partner’s child.

- Was dependent on you, your spouse or common-law partner in the taxation year.

Examples of child care expenses (“CCE”) are the amount paid to a child care provider, day care centers, day nursery school, nannies, day camps and overnight camps, not including fees paid for education, leisure or recreational activities, medical or hospital bills, clothing or transportation cost.

CCE is recorded as deductions in section 3(c) of the section 3 ordering rules, when calculating Net Income for Tax Purposes.

Who can claim the CCE?

In order to understand it in much detail there is a good example in income tax folio S-1,F-3,C-1 on paragraph 1.44.

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References and Resources:

- ITA 63; 63(2), 63(3)

- Article – “Income Tax Folio S-1, F-3, C-1, Child Care Expense Deduction”, (Author- Government of Canada)

- Image – “family” by Bhavish Toor licensed under CC BY 4.0

- Competency map: 6.3.2

Author (Text and Interactive): Bhavish Toor, January 2019

27

What is a non-arm’s length transaction and what are the tax implications?

CRA defines a non-arm’s length transaction as “a relationship or transaction between persons who are related to each other.”

ITA 251(2)(a) describes related persons as “individuals connected by blood relationship, marriage or common-law partners or adoption” with 251(6) elaborating on what is meant by “blood relationship”.

Why is the government concerned about non-arm ’ s length transactions?

ITA 248(36) states that fair market value should be applied to the transaction of the property. However, in a non-arm’s length transaction it is not always relied on that fair market value was used. In a related party transaction the related individuals may be able to work together to set the property below or above fair market value to their tax advantage.

ITA 69(1)(a) describes inadequate considerations as “where a taxpayer has acquired anything from a person with whom the taxpayer was not dealing at arm’s length at an amount in excess of the fair market value thereof at the time the taxpayer so acquired it, the taxpayer shall be deemed to have acquired it at that fair market value.”  Effectively, the ITA 69 rules state that non-arm’s length transactions that are not recorded at fair value will result in extra taxation.  For the seller they do this by recording the transaction at the greater of FMV and actual proceeds therefore maximizing the potential capital gain.  For the purchaser they do this by recording the transaction at the lesser of FMV and actual proceeds thereby minimizing potential future CCA claims or maximizing capital gains on future sales of the asset.

(table created by CPA Canada)

You could be subject to double taxation if you are dealing in a non-arm’s length transaction, and the CRA thinks you may be selling (or buying) something for not the fair market value to gain some kind of advantage for tax purposes.

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References and Resources:

- ITA – 69(1)(a), 251(2)(a), 248(36)

- Article – “ Non-arm’s length transactions” (author Government of Canada)

- Article – “ Definitions for letter N (Business)” (author: Government of Canada)

- Competency map: 6.3.2

Author: Vianna Tran, January 2019

28

How are charitable donations and political donations treated on a tax return? Why are they treated this way?

For charitable and political donations you will need to know the following:

1. The amount of the credit you can claim

2. The formula for the charitable donations credit

3. The specific rules for political donations

4. Why political and charitable donations have these special rules

5. The carry forward rules

References and Resources:

- https://turbotax.intuit.ca/tips/tax-benefits-of-charitable-donations-5414

- https://www.creditkarma.com/tax/i/reasons-tax-deductible-donations/

- http://theconversation.com/explainer-why-are-donations-to-some-charities-tax- deductible-72968

29

What is the OAS tax credit? What is the Claw back? How is it calculated? Why does it exist?

The Old Age Security (OAS) tax credit is a monthly payment available to Canadians aged 65 or older. It is funded from the general tax revenues of the Government of Canada (you do not pay directly into it) and exists to assist low-income seniors. To qualify, you must be:

- 65 or older

- A Canadian citizen or legal resident when your application is approved

- A Canadian citizen or legal resident on the day prior to leaving Canada, if you no longer live in the country

- Have lived in Canada for at least 10 years since your 18th birthday to receive OAS in Canada

- Have lived in Canada for at least 20 years since your 18th birthday to receive OAS outside of Canada

From January to March 2020, the OAS maximum monthly payment amount regardless of your marital status is $613.53. Further details regarding the payments can be found at: Article – “Old Age Security payment amounts” (Author: Government of Canada)

OAS Claw back

If your worldwide income exceeds the minimum threshold amount (see table below), you must repay either a portion of your OAS pension, or the entire amount. After the maximum threshold amount, you are no longer eligible to receive the OAS pension.

To calculate the claw back amount, you take the difference between your income and the minimum threshold and multiply this amount by 15%.

Recovery Tax Period

Income Year

Minimum Threshold

Maximum Threshold

July 2020 – June 2021

2019

$77,580

$126,058

July 2021 – June 2022

2020

$79,054

$128,137

For example:

If your income in 2019 was $90,000, the claw back amount would be:

Income – Minimum Threshold = Difference, Difference x 15% = Claw Back Amount

$90,000 – $77,580 = $12,420, $12,420 x 15% = $1,863

You are required to pay back $1,863 of your OAS pension.

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References and Resources:

- ITA 180.2

- Article – “Old Age Security and the OAS Clawback ” (Author: Million Dollar Journey)

- Article – “Old Age Security – Overview (Author: Government of Canada)

- Article – “Old Age Security payment amounts” (Author: Government of Canada)

- Article – “Old Age Security pension r ecovery tax” (Author: Government of Canada)

Author (text): Pavin Hundal, January 2020

VIII

GST

30

What are some GST considerations when transacting with non-residents? (6.7.6)

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