TAX Flashcards

Question

What is the capital dividend account (CDA) | and how does it work?

Answer 1

• Only private corporations have a CDA • CDA is to ensure that tax-free items earned in a corporation remain tax free when paid out of the corporation • A dividend paid out of the CDA is tax-free to the shareholder (an election must be filed to pay a capital dividend) • Examples of tax free items (would be added to the CDA): ‒ Non-taxable portion of capital gains in excess of capital losses ‒ Capital dividends received ‒ Non-taxable portion of gains on disposition of Eligible Capital Property ‒ Tax-free life insurance proceeds received

Answer 2

An Asset Disposal can be triggered by the following: • Selling the asset • Change in use of the asset (ex. you stop living in your home and start renting it out, the asset has changed to a property income generating property) • Change in ownership of Asset – (ex. Mother gifting an asset to her child. Mother deemed to dispose of at FMV triggering gain/loss.)

Answer 3

• Treatment depends on the taxpayer’s primary and secondary intentions in regards to the disposed asset • If the taxpayer intended to resell it at a profit like inventory it would be treated as income • If the taxpayer intended to earn income from using/owing the asset as a capital asset it would be treated as a capital gain • Factors to consider in determining the taxpayer’s intention: ‒ The nature of the asset (is it typically a capital asset or inventory)? ‒ Whether it is a type of asset that the taxpayer normally sells as part of their business activities ‒ The taxpayer’s behavior • It is possible for the taxpayer to have the intention to use the asset as a capital asset but also have the secondary intention to sell the asset at a gain if the original intention can’t e fulfilled. This would result in the transaction being considered on account of income

Answer 4

• Replacement property rules allow taxpayers to defer recapture and capital gains on disposition if: ‒ The disposition is involuntary (e.g. fire, expropriation of land) and the property is replaced within two years after the year- end of disposition ‒ A business is voluntarily relocating land and building and property is replaced within 1 year after the year-end of disposition • In order to defer the entire gain the new property must cost at least as much as the proceeds from the old property– every dollar not spent = $1 capital gain • The amount of the deferred recapture/capital gain on the old property is deducted from UCC/ACB of new property respectively

Answer 5

• The property was acquired by the taxpayer to replace the former property • The property acquired will be used in the same or similar business as the former property by the taxpayer or a related person • If the former property was taxable Canadian property, the new property must also be taxable Canadian property

Answer 6

• If some or all of the proceeds are not received in the year of sale, then the taxpayer can claim a reserve equal to the lesser of: ‒ [Proceeds yet to be received / Total proceeds] x Capital gain; and ‒ 4/5 of the capital gain in year 1; 3/5 of the capital gain in year 2; 2/5 of the capital gain in year 3 and 1/5 of the capital gain in year 4 (at least 1/5 of the capital gain must be included in income in each year over a 5 year period)

Answer 7

• Normally proceeds would be allocated based on fair values • A special rule applies to the disposition of real property (land and building) • The proceeds of the building are deemed to be the lesser of (1) and (2): (1) Fair market value of the land reduced by the lesser of (a) and (b): (a) ACB of the land (b) FMV of the land (2) The greater of (c) and (d): (c) The FMV of the building (d) The lesser of the cost and UCC of the building

Answer 8

• The calculation of a capital gain or loss is normally done on a property-by- property basis • There are special rules for calculating the ACB of properties where a group of “identical properties” is owned (for example a block of a particular class of shares of a corporation) • The ACB of each identical property is to be calculated on a weighted- average cost basis

Answer 9

• Each rental property costing more that $50K must be put in a separate CCA class (a terminal loss or capture will therefore result after each property is sold) • CCA cannot be claimed if it creates or increases a loss from all rental properties i.e. CCA is restricted to the total amount of rental income (before CCA) from all rental properties owned by the taxpayer

Answer 10

• There is a deemed disposition at fair market value at the time of the change in use (prorated for the affected portion of the asset such as when only one room in a house is to be rented) • The new ACB of the asset that has changed uses is the lesser of: ‒ The FMV at the time of the change in use ‒ The original ACB plus the taxable portion of the gain on the deemed disposition

Answer 11

• Any reasonable expenses incurred in operating the property including: ‒ Insurance ‒ property taxes ‒ mortgage interest ‒ Utilities ‒ Repairs (may need to consider whether they are capital in nature) ‒ Advertising for tenants ‒ Interest on funds borrowed to make a down payment on the property • If only a portion of the building is being rented the above expenses would be prorated in proportion to square footage • Note that CRA can deny a loss on a rental property if they determine that there is no reasonable expectation of making a profit from the investment e.g. after several consecutive years of losses

Answer 12

1. Economic Reality/Entrepreneur Test – the nature of the relationship between the person doing the work and the person that work is being done for. This test separately considers three sub tests: • Control – who is determining how the work is getting done and what is to be done? • Ownership of Tools – who is incurring cost for supplies to complete work? Does taxpayer doing the work provide and use their own tools to complete the work or does the person paying for the work provide the tools/supplies? • Chance of Profit/Risk of Loss - is the taxpayer doing the work responsible for covering own operating costs/cost overruns? Will person doing work receive a fixed amount despite what happens during work, or is there a risk of a higher or lower amount being earned if certain things happen as work progresses? 2. Integration/Organization Test – is this person doing the work economically dependent on the organization they are doing the work for? ‒ How much of the person’s income is dependent on work from this organization? ‒ Does the person doing the work have available to them the benefits that employees or the organization have available to them? 3. Specific Result Test – is there a specific end deliverable that the person doing the work has agreed to provide or are they provide more ongoing type services?

Answer 13

• If employed income will be employment income • If self-employed income will be considered business income which is usually preferable because: ‒ More deductions are available (see Q&A on deductions from business income) ‒ No source deductions (quarterly installments must be made instead) ‒ Employer is not responsible for payroll taxes (CPP, EI, EHT, Workers Compensation) • If considered self employed, the contractor may have to collect and remit HST • If CRA reassesses and concludes the individual is an employee, penalties and interest will apply on payroll tax remittances that should gave been made

Answer 14

• Registration is mandatory for businesses that have worldwide taxable supplies of goods and services (i.e. revenue) in excess of $30,000 for a single calendar quarter or over four consecutive calendar quarters • Businesses not required to register may still choose to register • If you are a GST/HST registrant, you generally have to charge and collect the GST/HST on taxable supplies (other than zero-rated supplies) you make in Canada and file regular GST/HST returns to report and remit that tax • Generally, GST/HST incurred on expenditures made by the business can be recovered by claiming and Input Tax Credit (ITC) on the GST/HST return (the amount remitted would then be the net of the GST/HST collected less the ITC amounts

Answer 15

• Generally business and property income (profit) is calculated on an accrual basis and as a general rule (where no other specific rule applies) expenditures are deductible if they are incurred in order to earn income • In an exam situation if you can’t remember the specific rule think about: 1. Whether the expenditure was incurred in order to earn income 2. Whether it is a current expenditure or a capital expenditure (will provide benefit for more than one year) 3. It is reasonable in the circumstances • Current expenditures incurred to earn income are usually deductible in the current year and capital expenditures are usually deductible over time (see Q&As on CCA) • Expenses that are not reasonable under the circumstances are not deductible e.g. unreasonable salary

Answer 16

``` Calculation Steps: Net income per F/S ______ Add/subtract Accounting/Tax differences Income for Tax Purposes ______ Subtract Division C deductions Taxable income ______ Multiple by Tax rate Taxes Payable ______ ```

Answer 17

* Taxable Canadian Dividends * Charitable Donations * Loss Carryforwards

Answer 18

1. Amortization 2. Reserves and contingencies (warranties, lawsuits, severance etc.) 3. Gains and losses on sale of assets 4. Meals and Entertainment 5. Write-down of assets 6. Employee vehicle costs 7. Interest and penalties on tax assessments 8. Related party transactions 9. Stock Options 10. Club membership dues 11. Donations (political and charitable) 12. Unreasonable expenses and personal expenses including travel 13. Accrued bonus still unpaid 180 days after year-end 14. Financing costs 15. Leasehold inducements 16. Financing costs 17. SR&ED

Answer 19

• All costs incurred to acquire the asset including taxes, transportation, legal fees etc. (similar to accounting rules) are included in the cost of the asset • “Soft” costs incurred during construction of a building including interest, property taxes and insurance are included in the cost of the asset (not deducted in the year incurred) • Subsequent expenditures that extend the life or enhance the usefulness of the asset (betterments) are added to the cost/UCC balance • Repairs and maintenance, landscaping, and disability modifications are not included in the cost of the asset but are expensed as incurred for tax purposes

Answer 20

• Taxpayers can claim Capital Cost Allowance (CCA) on capital and intangible assets used to earn business or property income (and employment income in the specific case of employee autos) • CCA can be claimed up to a maximum based on the asset class CCA rate which is in Schedule II of regulations (taxpayer can claim less than the maximum although usually beneficial to claim maximum oven when in a loss position because it increases the loss that can be carried back/forward) • CCA = rate*ending UCC balance • Most classes are subject to the half-net rule i.e. only 1⁄2 of the normal CCA can be claimed in the year of purchase • Only 1⁄2 of the net additions (additions – disposals) is added to the UCC balance to calculate that year’s CCA (if disposals > additions the half net rule doesn’t apply to that class) • Half net rule does not apply to non-arms length transactions if the seller held the asset for more than 364 days • CCA begins when the asset is ready for use

Answer 21

• If an asset is disposed of it is removed from the UCC of the CCA asset class (the lesser of original cost and proceeds of disposition is subtracted from the UCC) • If the UCC balance is negative the negative amount is brought into income as recapture • If the UCC balance is positive but no assets remain in the CCA asset class then the positive balance can be claimed as a terminal loss (if assets still remain in the class there cannot be a terminal loss) • Terminal loss can be deducted against business or property income • If the proceeds of disposition are greater than the original cost, the excess of proceeds over original cost will be a capital gain • There cannot be a capital loss on depreciable property

Answer 22

Class # Description Class #1 Buildings acquired after 1987 Class #3 Buildings acquired before 1988 Class #8 Most furniture, equipment and tools costing $500 or more Class #10 Automobiles and computer equipment Class #10.1 Each employee vehicle costing more than $30K + tax is put in a separate class 10.1 (Only 30K + tax can be added for each vehicle and there is no recapture or terminal loss on class 10.1) Class #12 Software and tools costing less than $500 Class #13 Leasehold improvements Class #14 Certain intangible assets such as patents, franchises and licenses with a limited life Class 14.1 Other intangible assets Class #29/43 Manufacturing and processing equipment (class 29 is a special class for equipment purchased on or after March 19, 2007 and before 2014 that taxpayers can elect to have assets put into – class 29 is straight line over 2 years – half net rule applies) Class #44 Patents acquired after April 26, 1993 98

Answer 23

• Leases are always treated as operating for tax purposes (they are never capitalized) i.e. only the lease payments actually made during the year are deductible for tax purposes

Answer 24

• Deductible on a straight line basis over 5 years

Answer 25

Stock option expense is never deductible for tax purposes because it does not result in a cash outflow therefore any expense recognized for accounting purposes must be added back for tax purposes

Answer 26

• Generally assets must continue to be amortized at the appropriate CCA rate for tax purposes even if they have been written down or written off for accounting purposes • Any additional write-downs recorded for accounting purposes should be added back in calculating income for tax purposes

Answer 27

• Deductions for reserves generally are not permitted except for those that are specifically allowed. Therefore expenses related to warranties or lawsuits are only deductible in the year that they are actually paid

Answer 28

``` • Allowance for bad debts • Allowance for estimated returns • Unearned revenue • Allowance for inventory obsolescence • The accounting and tax treatments for the above items will typically be the same ```

Answer 29

• There is a maximum amount per employee vehicle that is deductible by the corporation for tax purposes (in regulation 7306) ‒ $800+HST/month for lease ‒ $30,000+HST for purchased vehicle (this in the limit on the capital cost on which CCA can be taken) • Excess amount is not deductible for tax purposes unless it is included in the employee’s income

Answer 30

• Meals and entertainment are generally 50% deductible except for a special event where all employees can attend (e.g. a staff party) which is 100% deductible (maximum of 6 such events in a year) • Membership fees, club dues and maintenance fees related to the use of a yacht, golf course, camp, lodge, or a recreational or sporting facility are not deductible for tax purposes

Answer 31

• Charitable donations are deductible in the computation of taxable income (division C deduction) • Limited to 75% of corporation’s net income for tax purposes (any excess can be carried forward 5 years) • If property other than cash is donated the deduction is equal to the fair market value of the property (the donation would also result in a disposition that may result in capital gains or recapture) • Corporations can no longer make federal political contributions • Other political contributions can receive a tax credit (provincial contributions are only eligible for a provincial credit but not a federal credit)

Answer 32

• Deduction for convention expenses is limited to 2 per year and must be must be held at a location consistent with the territorial scope of the organization (could be some room for judgement here to argue both sides) • Meals and entertainment component is only 50% deductible

Answer 33

• Interest, penalties and interest on penalties are not deductible for tax purposes and therefore must be added back in calculating income for tax purposes • Legal fees related to an objection or appeal of a CRA assessment are deductible

Answer 34

• Investments in qualified SR&ED (Scientific Research and Development) are eligible for an investment tax credit • An ITC is also available for business that develop licensed child care spaces • Generally a 35% credit for CCPC (up to $3M* limit) and 15% credit for non CCPC • Any ITC received will reduce the amount of the expenditure that can be deducted from income *limit must be shared with associated corporations and is reduced when income is over certain thresholds

Answer 35

• Accrued salary or bonus must be paid within 180 days after the year-end in order for it to be deductible in the year it was accrued • If it is not paid with 180 days it will not be deductible until the year it is actually paid

Answer 36

• One of the companies directly or indirectly controls the other ‒ Example of indirect control is owning a company that controls another company (all three companies would be associated) e.g. A controls B and B controls C means that A indirectly controls C • Both companies are controlled directly or indirectly by the same person or group of persons (note that the group of persons does not have to be related) • Each company is controlled directly or indirectly by a person, the persons are related, and one of the persons owns more than 25% of both corporations (cross ownership test)

Answer 37

• Two companies are connected if one company controls the other or if one company owns more than 10% of the other company based on either voting rights or fair market value

Answer 38

• Results in a federal tax rate of 10.5% • Applies to Canadian Active Business Income earned by a CCPC • Annual limit of $500K • Must be shared amongst associated corporations • If taxable capital employed in Canada (together with associated corporations) is over $10M there is a reduction of the SBD up to taxable capital of $15M after which point there is no SBD (from $10M to $15M the SBD reduces to zero on a straight-line basis)

Answer 39

• Active business assets are assets that are used to earn active business income • Active business income is any business income except for income from a Specified Investment Business or Personal Services Business

Answer 40

• A SIB is a business that does not have more than 5 full time employees and whose principal purpose is to earn income from property • A PSB is a business that does not have more than 5 full-time employees and provides services that meet the following tests: ‒ The services are provided by a person that is a specified shareholder (together with related persons owns 10% or more of the corporation) ‒ That person, if the corporation did not exist would be considered an employee (see question on employee vs. contractor factors) • Note that having 5 full-time employees plus some part-time employees counts as having more than 5 full-time employees

Answer 41

• Taxable dividends received from Canadian corporations are allowed as a division C deduction when computing taxable income • Taxable dividends are generally all dividends except capital dividends (addressed in another Q&A)

Answer 42

• A corporation is resident in Canada if: ‒ It was incorporated in Canada ‒ It was not incorporated in Canada but the central management and control of the corporation takes place in Canada

Answer 43

• No longer eligible for small business deduction • No longer eligible for capital gains exemption • Loss of the CDA (capital dividend account) - any balances remaining at the date of acquisition would be lost and therefore should be paid out prior to the acquisition (this is a good planning point) • Loss of RDTOH account – any balances remaining at acquisition will be lost therefore a dividend should be declared prior to the acquisition large enough to use up the remaining balance (good planning point)

Answer 44

• Additional taxes on investment/property income that apply to private corporations only • Meant to increase the tax cost of earning investment income in a corporation and are partially refunded when the corporation pays a taxable dividend (dividend other than a capital dividend) to its shareholders • Additional Refundable tax (ART) (CCPC’s only) • Refundable Part I tax (CCPC’s only) • Refundable part IV tax (All private corporations)

Answer 45

• 262/3% of the aggregate investment income of a CCPC is refundable • All refundable taxes are added to the RDTOH account to keep track of the refundable taxes paid • RDTOH account can be carried forward indefinitely • When the corporation pays a taxable dividend it will get a dividend refund, which reduces the RDTOH balance, equal to the lesser of 1/3 of the taxable dividend and the balance in the RDTOH account

Answer 46

• Dividends received from public corporations or from the income of a CCPC that was not subject to the small business deduction and is not investment income are called “eligible dividends” • Eligible dividends are “grossed up” by 1.38 (the dividend is multiplied by 1.38 and that amount is included in income) and a federal tax credit of 6/11 of the gross up is allowed (provincial credit is expected to be approximately 5/11 of gross up so that the total of both provincial and federal credits is equal to the gross up) ‒ Note that a tax credit is a dollar for dollar reduction of the tax liability e.g a tax credit of $1 reduced taxes payable by $1 (as opposed to a reduction of taxable income where the actual tax savings is dependent on the tax rate) • Dividends received from CCPCs from income subject to the small business deduction or form investment income are grossed up by 1.17 and a federal tax credit of 21/29 of the gross up is allowed (provincial credit would be approximately 8/29 of gross up) • Note that the tax gross up and credit procedure applies only when an individual (not a corporation) receives the dividend AND the dividend is received from a Canadian resident corporation (dividends received by individuals from non-resident corporations are fully taxed)

Answer 47

• The principal amount of the loan will be included in the shareholders income in the year the loan is made unless: ‒ Loan is repaid within one year from the end of the company’s fiscal year in which the debt arose as long as it is not part of a series of loans and repayments • For example if a Corporation has December 31 year end a loan made on Jan 1 2018 would have to be repaid by December 31, 2019. ‒ It is one of the exceptions (see next question) • There will be an imputed interest benefit on loans not included in income

Answer 48

The loan principal does NOT have to be included in income if all three of the following are met: 1. Loan was made to shareholder by virtue of employment and not shareholding (consider whether other employees of a similar rank would be eligible for similar loans) 2. The loan was made to an employee that is not a specified shareholder OR if loan is made to a specified shareholder (together with related persons owns at least 10% of shares or is not at arms length with employer) it must be to acquire: • A house to live in • Unissued stock of the company or a related company • Motor vehicle for employment use 3. Bona fide repayment arrangements made for payment within a reasonable timeframe *Note that if the loan principal is NOT included in income, imputed interest will apply

Answer 49

• Taxable benefit that can be provided by an employer to an employee • Benefit is the interest savings calculated based on the CRA quarterly prescribed rate prorated for the number of days the loan was outstanding (imputed interest) • Prescribed rates can be found in the Tax Information at the back of the exam paper • Any interest benefit included in income is deemed to be interest paid and so may be deductible if it was incurred to earn income e.g. to purchase investments (same rules as for interest actually paid)

Answer 50

• Special rules apply when the loan is to purchase a dwelling (house to live in) • Interest benefit is the lessor of the rate calculated based on the prescribed quarterly rate and the rate calculated using the prescribed rate in effect when the loan was granted (that rate is re-set every 5 years) • If the loan was to purchase a new dwelling at least 40KM closer to the employees workplace (home relocation loan) the employee can claim a division C deduction for the amount of the interest benefit on an amount of loan up to $25,000 (basically there is no interest benefit on the first $25,000)

Answer 51

• Interest benefit is calculated using the difference between the quarterly prescribed rates (provided to you in the exam) and the rate actually paid, prorated for the number of days the loan was outstanding in each quarter • Total days in each quarter are: ‒ 90 days in Q1 (91 if a leap year) ‒ 91 days in Q2 ‒ 92 days in Q3 and Q4 • Special rules if the purpose of the low interest loan is to allow the employee to purchase a dwelling ‒ Lower of the calculation above and the calculation using the prescribed rate in effect when the loan was received (this is reset every five years) ‒ A division C deduction is also available if the new dwelling is at least 40KM closer to work place

Answer 52

• PUP is property used for personal reasons (as opposed to earning income) • Capital losses on PUP are denied • Capital gains (which are rare on PUP) are taxable • On dispositions of personal property both proceeds of disposition and the ACB are deemed to be the greater of actual proceeds/ACB and $1,000

Answer 53

• LPP is specific types (a subset) of PUP • Use the acronym Coin JARS to remember the qualifying assets: ‒ Coins ‒ Jewelry ‒ works of Art ‒ Rare books or manuscripts/folios ‒ Stamps • Often a question will use the term “antique” to trick you into thinking that it is LPP, but only the items listed above qualify as LPP • Since LPP is a subset of PUP the $1,000 minimum ACB and Proceeds rules also apply • The only difference from other PUP, is that you can have a capital loss on LPP, but the capital loss can only be used to offset LPP capital gains

Answer 54

• Tax payer giving the gift is deemed to have received proceeds equal to fair market value and the taxpayer receiving the gift is deemed to have acquired the property at fair market value • Since most gifting occurs between related parties, also see the Q&A on related party rules and the implication of not reporting the transaction at FMV (double taxation)

Answer 55

• The taxpayer can shelter the entire capital gain arising from the sale of a personal residence if you designate it as your principal residence for the years in question using the principal residence gain exemption • The tax payer can only designate one principal residence per taxation year • If two residences are owned within the same taxation years the taxpayer will want to designate as many years as possible to the residence with the higher per year gain (you will need to calculate the gain per year on each residence) • The calculation gives 1 “free” year (see below) so the maximum number of years that needs to be allocated to any one property to shelter the entire gain is the number of years it was owned minus 1 • The amount of the gain that is exempted from tax is calculated as: 1+number of years designated * Capital gain Number of years property was owned

Answer 56

• Purpose of the election is to avoid having to determine whether the securities were bought for the purpose of earning income (dividends) or resale • Taxpayers (including corporations and trusts) can elect to have all Canadian securities that they own deemed to be capital property which means that disposition will result in capital gains (50% taxable) as opposed to business income • Once this election is made, it cannot be revoked and it applies to all future dispositions of Canadian securities by the taxpayer. • The downside is that if a taxpayer experiences a loss on the disposition of securities, it must be treated as a capital loss (50% deductible)

Answer 57

• Two taxable benefits are calculated in relation to employer provided vehicles: standby charge and operating cost benefit (if the employer also pays for the operating costs of the car) • Standby charge is equal to: ‒ 2% x the cost of the automobile x the number of months in the year that the automobile is available to the employee (if the employer owns the automobile) OR ‒ 2/3 x lease payments (if the employer leases the automobile) ‒ Note: for the standby charge you use the actual cost of the automobile (even if it costs more than $30,000) but for CCA purposes the maximum amount that can be added to UCC is $30,000 plus applicable sales tax on $30,000 • If the automobile is used more than 50% for business use you can reduce the standby charge to: (Personal use km’s / 20,004) x Standby charge • If the employer also pays for the operating costs of the car (e.g. gas and maintenance) then there will also be an operating cost benefit equal to 26 cents x personal use kilometres driven in the year. ‒ If the employee used the car for more than 50% business use then the employee can elect to use 1⁄2 of the standby charge as their operating benefit • Note: driving to and from work is considered personal use of an automobile (and not business use)

Answer 58

• As long as the allowance is “reasonable” it is not taxable to the employee and the employee would not deduct the expenses that are covered by the allowance (an allowance that is more or less than the actual amount expended by the employee may not be reasonable) • An automobile allowance is considered reasonable if it is $0.55 for the first 5,000 KM and $0.49 for each additional KM driven for employment duties (these are 2018 rates) • If the allowance is not considered reasonable it is included in the employee’s income and the employee may deduct eligible expenses e.g. motor vehicle expenses under certain conditions

Answer 59

- Grant Date + CCPC = No Taxable Benefit - Grant Date + Non-CCPC = No Taxable Benefit - Exercise Date + CCPC = No Taxable Benefit - Exercise Date + Non-CCPC = • Employment income inclusion = FMV of shares at exercise date – Exercise price • Division C deduction = 50% of employment inclusion (if options are granted not in the money i.e. if strike price is more than or equal to market price at time options granted) - Sale of Shares + CCPC = • Employment income inclusion = FMV of shares at exercise date – Exercise price • Division C deduction = 50% of employment inclusion (if options are granted not in the money i.e. if strike price is more than or equal to market price at time options granted) OR if the shares were held for at least 2 years after exercise of the option • Capital gain or loss = Proceeds – ACB ACB = Exercise price + income inclusion - Sale of Shares + Non-CCPC = • Capital gain or loss = Proceeds – ACB • ACB = Exercise price + income inclusion

Answer 60

• In order to deduct the moving expenses, they must be incurred in respect of an eligible relocation which is generally defined as: -moving 40 km closer to new work location or post- secondary learning institution • Moving expenses can only be deducted against income from the new work location in the year of the move and can be carried forward to the next year • If the taxpayer is being reimbursed by their new/old employer for moving expenses, they cannot then deduct moving costs, unless the reimbursement is included in their income on their tax return

Answer 61

- Travel costs of family to new residence - Costs to move and store household items (i.e. furniture, clothes) - Meals and accommodations near old or new residence for up to 15 days - Lease cancellation costs of old residence - Selling costs of old residence - Legal costs in respect of new residence (excluding GST) - Cost of revising legal documents for address change - Can use a simplified method that allows a flat rate deduction based on the number of meals and KM travelled (benefit is no receipts required) - $17/meal up to max of $51/day - 54 cents per KM

Answer 62

• An employee can deduct home office expenses only if the home office is: ‒ the place where the individual principally performs their work duties OR ‒ used exclusively for work purposes and the employee must regularly meet customers or others there • The home office expense cannot create or increase a loss from employment income • Any un-deducted home office expense can be carried forward 1 year (subject to the same restrictions)

Answer 63

• Non-capital expenses only (mortgage interest and CCA cannot be deducted) • Non-commissioned sales people can deduct: ‒ Rent ‒ Utilities ‒ Maintenance ‒ Minor repairs • Commissioned sales people can deduct all of the above plus: ‒ Property taxes ‒ Insurance

Answer 64

• Professional or union dues • Contributions to a Registered Pension Plan • Cost of tools in excess of $1,161 for a tradesperson (limited to $500/year) • Salary paid to an assistant • Supplies used directly in employment • Rent paid for an office • Reasonable selling expenses for commissioned sales people (limited to commission income) • Attendant care and other disability support expenses incurred to allow a disabled person to work or attend school (disability support deduction)

Answer 65

• Child care expenses are deductible if they are incurred to earn income or to allow the parent to attend secondary or post-secondary education • Includes babysitting, daycare, boarding school and camp • Lower income parent must claim the childcare expenses (unless the lower income spouse is in school, jail or infirm) • Limitations on deductibility of childcare expenses: • Maximum for camp or boarding school of $200/week (per child 6 and under) or $125/week per child 7 to 16 • Total child care expense cannot exceed the lesser of: ‒ The actual amount spent ‒ $5,000*# of children aged 7 to 16 + $8,000*# of children 6 and under ‒ 2/3 of earned income (employment income including taxable benefits and business income)

Answer 66

• Spousal support payments are included in the income of the recipient and deductible to the payer • Child support payment are not deductible to the payer and are not taxable to the recipient

Answer 67

• Capital dividend (see Q&A on capital dividends) • Social assistance e.g. welfare payments • Life insurance proceeds received as a result of someone’s death • Strike pay • Lottery winnings • Disability payments if the employer did not pay any of the premiums • Payouts from a private health insurance plan • Withdrawals from a TFSA

Answer 68

• Overtime meals up to $17/meal • Frequent flyer miles earned while travelling for business purposes • Non-cash gifts up to $500/year

Answer 69

1. Employing spouse and children • Must be reasonable in light of services • Consider whether spouse and children have skills that would allow them to provide services 2. Increase lower income spouse’s investments • Higher income spouse should pay household expenses to allow lower income spouse to purchase investments 3. Transferring of capital property to children (no attribution on capital gains) 4. Issuing shares to lower income spouse and paying dividends to take advantage of lower marginal tax rate (Note that the Tax on Split Income (TOSI) rules must be considered (see subsequent Q&A) to ensure that one of the exceptions applies)

Answer 70

Non-service business • Business is not a professional corporation (owned by a doctor, lawyer, engineer, accountant) and derives at least 90% of its income by selling anything other than services • Family member receiving the dividends is at least 25 years of age and owns at least 10% of the shares of the corporation. Family member works in the business • The family member worked in the business for at least 20 hours per week continuously in the current tax year or for at least 20 hours per week for 5 prior years (does not have to be consecutive years) • The amount of the dividend paid is reasonable based on the work performed. Family member invests in the business • Family member receiving dividends is at least 25 years of age and has invested in the corporation • Dividend is reasonable based on the financial investment that they make. The reasonability of dividends paid is determined by looking at factors such as the amount of the financial investment made and the risk assumed

Answer 71

• Attribution rules are intended to discourage income splitting through the transfer of property to a spouse or related minor (including nieces and nephews). • To avoid the attribution rules, the assets must be transferred to the spouse or minor at fair market value i.e. equivalent consideration must be received. • If the consideration is in the form of a loan, interest must be charged (and paid) at the prescribed rate in effect at the time the loan is granted (there is no requirement for principal payments to be made). If interest is not charged, attribution will apply. ‒ Unlike with spouses, there is no attribution on capital gains generated from assets transferred to minors

Answer 72

• Contributions are limited to an annual maximum the lesser of: ‒ 18% of the prior year’s earned income (generally employment income, business income, spousal support payments received and rental income from renting real property); and ‒ $26,230 (2018 limit) • If the taxpayer has a work pension plan (i.e., a RPP) then the pension adjustment will reduce the amount that they can contribute to an RRSP. • Any unused RRSP contribution room carries forward • Taxpayers must withdraw all funds from their RRSP in the year that they turn 71. Instead of taking the RRSP funds (and including the amount in income) taxpayers can convert their RRSP to an RRIF. ‒ An RRIF can also grow tax-free but no additional funds can be contributed to it and each year the taxpayer must withdraw a portion of the funds (and include the amount withdrawn in their income) • Any withdrawals from RRSPs (other than the Home Buyers Plan and the Lifelong Learning Plan) are taxable

Answer 73

• The individual contributes based on their own contribution room and receives the tax deduction on the year of contribution, but income will be taxed in spouses hands on withdrawal • Beneficial when the spouse is expected to have lower income in the year of withdrawal (usually in retirement)

Answer 74

• Withdrawals are included in the taxpayer’s income as ordinary (RRSP) income (even if the RRSP has earned capital gains or dividends they are taxed as ordinary income when withdrawn) • Not subject to any special tax treatment such as for capital gains or dividends

Answer 75

• Retiring allowances and termination payments are included in the taxpayer’s income in the year they are received • Part of the allowance may be transferable to an RRSP (and therefore be eligible for an RRSP deduction) with the maximum allowable amount calculated as: ‒ $2,000*(# of years employed prior to 1996) + $1,500*(# of years employed prior to 1989 where the employee did not have pension or deferred profit sharing plan) • The transfer to an RRSP does not impact RRSP contribution room

Answer 76

• Beginning in 2009 individuals 18 and over can contribute up to $5,500 ($5,000 for 2009-2012) per year to a registered TFSA account (unused room carries forward) • Any income or gains earned in the TFSA will be tax free • Unlike RRSPs contributions to a TFSA do not get a tax deduction • Funds can be withdrawn at any time on a tax-free basis and any withdrawals will be added to the following year’s contribution room

Answer 77

• Helps taxpayers to save for children’s or grandchildren’s post-secondary education • No tax deduction for contribution (unlike RRSP) • Funds can grow tax-free while in the plan • Contributions can be withdrawn tax-free but any income earned in the plan and the government grant (see below) are taxed in the hands of the beneficiary when withdrawn • Aggregate maximum contribution is $50,000 per child • Eligible for a government grant in the amount of 20% of the annual contribution to a maximum annual grant of $500 and a total maximum grant of $7,200 per child (unused grant room can be carried forward but the maximum grant that can be paid in any one year is $1,000) • If the child does not go to school the grants must be repaid and the accumulated income will be taxed in the hands of the person that contributed the funds

Answer 78

• Charitable donation credit (see specific Q&A) • Medical expense credit (only on expenses exceeding threshold but can be claimed by either spouse regardless of who paid) • Tuition credit, Examination fees (for professional/trade exams) and education credit (unused credits can be transferred to a spouse, parent or grandparent or carried forward indefinitely) • Credit for interest on student loans • EI and CPP contributions credit • First-time home buyer’s credit ($5,000 credit if neither the taxpayer or spouse has owned a home in the past 4 years) • Note that the credits above (with the exception of charitable donations above $200) are multiplied by the lowest federal rate i.e. 15% when calculating the tax savings e.g. a $1,000 credit would result in an actual federal tax savings of $150 • All of the above credits are non-refundable (cannot reduce taxes payable below zero)

Answer 79

• Receive a charitable donation tax credit • Can be claimed by either spouse • Credit is multiplied 15% up to $200 and by the highest marginal rate (29% if income is less than $200K or 33% if income is over $200K) for donations over $200 • Maximum of 75% of taxpayer’s net income • Can be carried forward five years • If assets are donated rather than cash the amount of the donation is considered to be the FMV of the asset

Answer 80

• Part I.2 applies a tax on Old Age Security (OAS) benefits received by individuals with net income over a certain threshold • In 2018 the threshold is $75,910 (for every dollar of income in excess of this amount 15% is clawed back from any OAS received

Answer 81

• Full time residents – includes those deemed to be full time residents ‒ Sojourners are people deemed to be full time residents because they were in Canada for 183 or more days throughout the taxation year in question. • Part-time residents – those that stopped or started becoming a resident part way through the taxation year in question • Non-Residents

Answer 82

Canadian Resident: • Pay tax on worldwide income Non-resident: • Only pay tax on Canadian source income: • Canadian employment income • Canadian business income • Capital gains on dispositions of taxable Canadian property (TCP) which includes: • real property (land and buildings) in Canada • business assets relating to a business carried on in Canada • Canadian resource properties • Shares that derive more than 50% of their value from real property in Canada or Canadian natural resources ``` • Pay a 25% withholding tax i.e. no tax return filed but tax is withheld and remitted (can be reduced by a tax treaty) on certain passive Canadian income including: • Rental income • Interest income • dividend income • pension income • RRSP withdrawals. ```

Answer 83

Primary Indicators (Significant factors/ties to Canada – have the most weight) - dwelling place in Canada (owned or rented that is available to live in) - Spouse lives in Canada - dependent children live in Canada Secondary factors/ties to Canada (much less important than primary indicators) - personal property in Canada - social ties with Canada - economic ties with Canada - medical insurance and hospital coverage in Canada - registered vehicle in Canada - Canadian passport - seasonal home in Canada (ex. Cottage) Nature of Absence from Canada - Intention to return or permanently leave Canada - Regular visits back to Canada • Note that a taxpayer must have at least one country of residence for tax purposes

Answer 84

Becoming a Resident: • Deemed disposition and reacquisition (immediately before becoming a resident) of all property (other than taxable Canadian property) at fair market value • Cost for tax purposes of all properties will generally be equal to the fair market value on the day that they became a resident of Canada • A corporation will be deemed to have a year end immediately before becoming a resident Ceasing to be a Resident: • Deemed disposition and reacquisition of all property (with some limited exceptions) at fair market value • Pay tax on any accrued gains (earned while the taxpayer was a resident of Canada) • Exceptions to the deemed disposition include Canadian: real property, pensions and business assets. (Canadian real property and business assets are taxable Canadian property, and pensions are subject to a 25% non-resident withholding tax)

Answer 85

• Limited liability for shareholders (although they may still be required to provide some personal guarantees) • Lower tax rate on earnings subject to the small business deduction (if the CCPC criteria are met) • Deferral of personal tax on the earnings retained by the corporation • Possibility for income splitting by paying dividends on shares owned by family members or by paying reasonable salary to family members • Greater planning opportunities for owner-manager compensation • Access to lifetime capital gains exemption (if the shares are Qualified Small Business Corporation shares) • Facilitation of estate planning through corporate rollovers • Reduction in tax on earnings subject to manufacturing and processing credit

Answer 86

• Costs of initial incorporation and ongoing compliance (professional fees) • Inability to claim corporate losses against other sources of personal income ‒ Critical during start-up period if losses are expected, especially if owner has other sources of income (pension, investment, part-time employment etc.)

Answer 87

How are assets transferred from sole proprietorship into a partnership or corporation?

Answer 88

Advantages: • Owning shares of an operating company via a Holdco gives more flexibility to multiple owners re: cash management ‒ One shareholder may have an immediate need for dividends (e.g. for living expenses) whereas the others may want to leave funds in the corporation to take advantage of the tax deferral ‒ This is facilitated by each shareholder owning his/her shares of the operating company through a holding company ‒ When the operating company pays dividends (tax free) to the holding company, the individual shareholders can decide when to withdraw the funds from their respective corporations Disadvantage: • It is more expensive (incorporation plus annual compliance costs)

Answer 89

• Salaries are deductible to the corporation as long as they are: ‒ Reasonable ‒ Payment for real and identifiable service • Bonus must be paid within 180 days of year-end to be deductible by the corporation in the year • Salary is taxable to the employee in the year received • Salaries are included in “earned income” for RRSP room calculation • Subject to CPP contributions, but the employee will be able to collect CPP benefits upon retirement at age 65

Answer 90

• Dividends do not require the individual to do work for the corporation whereas salary must be • Reasonable • Payment for real and identifiable service • Subject to dividend tax credit (see Q&A on taxation of dividends received by individuals) • Certain level of dividends may be received tax free if no other income • Dividends do not reduce accounting income of the corporation (salary does) • Impact on covenants and ability to get financing • Impact in valuation if sale likely to occur • Preferable if corporation has losses that are about to expire ‒ In this case salary deduction is of no use to corporation so overall (personal plus corporate) tax will be lower if dividends are paid • Generate refunds if there is RDTOH • Reduces the CNIL balance, which preserves the capital gains exemption

Answer 91

• Purchaser has choice of which assets to acquire • Increase/bump in UCC of assets up to FMV ‒ results in higher CCA and/or less future capital gains if the assets are subsequently sold • Purchaser is not liable for any undisclosed liabilities

Answer 92

* Able to utilize non-capital loss carry forwards if the criteria are met (see Q&A in corporate tax section on ability to use losses) * May be able to negotiate lower price since vendor may be able to use Capital Gains Exemption on sale which will increase their after-tax proceeds

Answer 93

• May be able to use capital gains exemption on QSBC shares if criteria are met (see Q&A on capital gains exemption) • Do not have to incur the cost and effort to sell the individual assets and wind up the corporation (legal and selling costs) • Selling assets usually results in recapture and/or capital gains • No responsibility for liabilities of the corporation after the sale • Can claim a reserve on capital gain for any amount uncollected (see Q&A on capital gains reserve)

Answer 94

1. Calculate the tax implications (corporate taxes payable) for the corporation of selling each of the assets (capital gains and/or business income or loss). Remember the buyer is purchasing the assets from the corporation so the corporation must pay the tax on the asset sales. 2. Calculate the funds remaining for distribution to the seller/shareholder after settlement of liabilities and payment of taxes i.e. proceeds from sale of assets less: a) existing liabilities of the corporation (accounts payable, mortgages payable, etc.) b) taxes payable as calculated in step 1 3. Calculate the personal tax payable on the dividend to the shareholder (amount of the dividend is calculated in step 2). Remember after the corporation sells the assets it must pay a dividend to allow the shareholder to realize the proceeds. If the corporation redeems the shares there will be a deemed dividend equal to the proceeds of the redemption less the PUC of the shares (which the taxpayer can receive tax free). 4. Calculate the after-tax proceeds (amount from step 2 less amount from step 3).

Answer 95

• When a person (individual or corporation) sells accounts receivable as part of a sale of assets (i.e. a sale of substantially all of the property used in carrying on a business to a purchaser who will carry on the business) the seller and purchaser can jointly elect to have section 22 apply • Allows the seller of the accounts receivable to claim a loss on the sale of the accounts receivable (if one exists) as a business loss (which is fully deductible) rather than a capital loss and allows the purchaser to claim an allowance for doubtful accounts on the purchased receivable • Purchaser include the business loss claimed by the seller in income

Answer 96

• Additional compliance costs (tax returns, withholdings etc.) • If the new division is incorporated, losses will be “trapped” since they can’t be used to offset income from the existing business (or vise versa) • Transfer price between the entity’s must be fair market value if incorporated separately, or double taxation will occur • The two corporations (new division and existing corp) will likely be associated and will therefore have to share the small business deduction

Answer 97

• Deemed year end (day immediately following acquisition of control) • Inherent losses on depreciable and capital property are triggered by AoC i.e. where FMV UCC/ACB • Non capital losses carried forward will be deductible if the meet the criteria (see next Q&A) • Deemed year-end uses up one year of non-capital loss carry forward

Answer 98

1. Loss business is being carried on in year LCFs are used 2. Loss business being carried on at a profit or with a reasonable expectation of profit 3. Being used against income from the same or similar business

Answer 99

* Done to use up net capital losses that will otherwise expire * Maximum elected amount is the FMV of the property you are electing on * Elect an amount that will use up the net capital losses that are expiring * Want to avoid recapture so elect on non-depreciable property i.e. land or depreciable property with small amounts of recapture * Elected amount is the new ACB of the property

Answer 100

• Transfer the assets of a profitable similar business into the newly acquired corporation using a section 85 rollover • Merge the acquired business with the existing business (if similar). ‒ Can be done via an amalgamation or wind-up (see next slide) • Intercompany transactions such as management fees, transfer pricing, rental agreements to shift income into the loss company). ‒ This is cheaper than the other alternatives, but takes longer

Answer 101

Amalgamation: - Simplicity -> Cheaper and easier than a wind-up - Description: Two predecessor companies have a deemed year-end immediately before amalgamation. A brand new company starts after the amalgamation. (vertical or horizontal) - Losses: Deductible starting in the first taxation year of the amalgamated company Wind-up: - Simplicity -> More expensive and time consuming - Description: Parent swallows the subsidiary. Parent company continues to exist and owns assets directly. (vertical only) - Losses: Deductible starting in parent's taxation year following the year in which the wind-up occurred

Answer 102

• Upon death, a taxpayer is deemed to dispose of all of their assets at fair market value (FMV) triggering capital gains and other types of income that must be reported on the taxpayer’s final tax return – the terminal return. • The terminal return must be filed by the later of 6 months after the date of death and the normal due date. Normal due dates: - 4 months after year-end of year of death (April 30th) - 5 1⁄2 months after year-end of year of death (June 15th) for individuals carrying on a business or who’s spouse was carrying on a business in the year of death • A benefit in the year of death, is that a taxpayer’s allowable capital loss carry-forwards can be used to offset any type of income, not just capital gains.

Answer 103

Rights or Things Return (for amounts earned and right to collect at death) ‒ matured, uncashed bond coupons ‒ dividends declared but unpaid at time of death ‒ salary/vacation pay etc from pay period completed before death but not yet paid out ‒ WIP not yet billed for only certain professionals and they have to elect to do so (accountants, lawyers, doctors etc. but NOT ENGINEERS) – when not in year of death must treat as on accrual basis ‒ Partnership income in year of death ‒ bond interest – earned for payment date ending before death but not paid out yet Stub year return (for period of time from year-end of a trust (usually a trust, can also be a partnership) to the date of death Filing deadline These elective returns are due at the later of: i. 1 year after death ii. 90 days after mailing notice of assessment (“NOA”) for year of death Reasons for filing Elective Returns 1. You start at the lowest marginal tax rate for each return filed and work your way up through the graduated tax rates. Resulting in overall less tax. If you hit the threshold for the lowest tax rate on your terminal return, you can potentially put items on your elective returns and start at the lowest tax rate again until you use it up again. 2. You get to claim the following tax credits on each return filed (Basic personal amount, Age amount, Spousal/Equivalent to spouse amount and the infirm Dependant credit- Remember BASED). This reduces the overall tax payable.

Answer 104

Spousal Rollovers • can defer gains on property by rolling it over to your spouse as spouses automatically transact at cost (ACB/UCC) • can elect out of the automatic spousal cost rollover to trigger a capital gain to use up allowable capital losses or unused lifetime capitals gains exemption in year of death Testamentary Spousal Trust • type of trust that arises on death of the taxpayer • trust income is taxed at spouse’s rates, which allow for income splitting if spouse’s tax rate is lower • no risk of attribution rules kicking in as taxpayer is dead

Answer 105

Fair market value of RRSP included in income on terminal return unless: • RRSP transferred to spouse – subject to tax in spouse’s hands unless spouse transfers amount to an RRSP, RRIF or other annuity within 60 days of yearend of the year of receipt • RRSP transferred to child/grandchild and refund of premiums taxed in child’s hands but if under 18 and financially dependent can use refund to acquire annuity tax free • RRSP transferred to mentally or physically infirm dependent child and amount can be transferred to an RRSP etc. tax

Answer 106

* Child purchases shares directly * Share exchange using section 86 * Share exchange using section 85

Answer 107

• Results in a disposition of shares and taxable capital gain to parent • Capital gains exemption could be used to shelter all or a portion of the gain (if unused and conditions met) • Parent is not entitled to any future income steam and loses all control of the company – therefore would use only when parent does not need any future income steam and wants to retire completely • Look for case facts such as whether the child is/wants to be involved in the business, whether they have the skills to run the business etc.

Answer 108

* Common shares of the company are exchanged for preferred shares redeemable and retractable at the fair market value at the time of the exchange * The children subscribe to newly issued common shares at a nominal value and all future growth accrues to the children * Cannot use or crystallize the capital gains exemption using this method – therefore would likely use only if CGE not available or already used

Answer 109

• Child subscribes to common shares at a nominal value of a newly created holding company(must be purchased with their own money to avoid attribution) • Parent transfers common shares of the existing company into the Holdco using a section 85 rollover and takes back preferred shares having FMV = old common shares (note that in order for section 85 rollover to apply shares must be taken as consideration) • Children subscribe to common shares of the new holding company at a nominal value all future growth will accrue to them • Capital gain can be crystallized through section 85 rollover by electing amount greater than ACB to trigger gain (taxpayer can elect any amount between the tax value and FMV) • Parent can retain voting control through preferred shares if desired • Parent can receive dividends or redeem shares for cash flow

TAX Flashcards

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