Canadian Income Taxation
Canadian Income Taxation
Primary types of
income
Entities subject to
taxation on income
Business
Property
Employment
Capital gains
Individuals
Corporations
Trusts
Alternative forms of
business and
investing structures
used by taxable
entities
Proprietorship
Corporation
Partnership
Limited partnership
Joint venture
Income trusts
Tax jurisdictions
Provincial
Federal
Foreign
Most important is the interaction among these major variables: taxpayer, type of income, and form
of organization
o When the variables are changed in each of the major categories, alternative tax structures
are created that can then be applied to the decision process
For a tax plan to be rejected, it must fail the business purpose test and must be extreme
to the extent that it is not within the spirit of the tax system as a whole (tax planning is
not tax avoidance)
Chapter 3: Liability for Tax, Income Determination, and Administration of the Income Tax System
In addition to the income tax, Canada has a national goods and services tax (GST)
o The GST is imposed at the rate of 5% on the value of all goods or services sold by registered
businesses
o The tax is charged to businesses as well as to individual consumers
Most business entities are entitled to a full rebate of the tax on all goods and services
purchased, provided that those goods and services were acquired for business
purposes
o Businesses are generally responsible for collecting and remitting the GST to the government
Businesses that are required to have a GST registration are called registrants
The registrant remits the difference between the customers GST and the registrants
GST (because the registrants GST is a credit)
If costs happen to exceed sales, no tax is remitted, and a business is entitled to a
GST refund
GST does not apply to items that are classified as either zero-rated or exempt
o When a vendor business sells goods or services that are zero-rated, the GST is not collected;
however, that business can claim credits for any GST paid on costs associated with those
items
Zero-rated goods and services include:
Prescription drugs
Basic groceries
Agricultural products
Medical devices
Fishery products
Exported items
o Vendors that sell goods or services that are classified as exempt also do not collect GST on
those items; however, these vendors cannot claim a credit for any GST paid in relation to
those exempt items
Exempt goods and services include:
Used housing
Education services
Financial services (domestic)
Health care services
Legal aid services
As a general rule, the GST does not create any revenues or expenses for a business entity and has
no effect on its income
o The GST does not have a major impact on income tax
o Exception: businesses that have annual revenues under $30,000 are not required to be GST
registrants
Businesses that are not registrants do not collect the GST on their revenues, but
neither are they entitled to claim a credit (or refund) for the GST paid on goods and
services acquired
In such circumstances, GST for non-registrants becomes a real cost (GST paid on
inventory purchases is added to inventory cost for income tax purposes, etc.)
Any gap between the time that employment income is earned and the time that it is received can
influence both the rate of tax payable and the pre-tax value of the remuneration
o Both the time value of money and the rate of tax must be considered if one is to properly
assess the benefit (if any) of deferring employee remuneration
o The deferral of remuneration has advantages to the employer as well:
Employers income is calculated on an accrual basis employer can deduct
employment expenses when they are incurred rather than when they are paid
A bonus payment applicable to 20X1, though deferred to 20X2 would be deductible
as an expense against the employers 20X1 income reduces income taxes in 20X1
but enhances cash flows
If an employer wishes to deduct deferred compensation on an accrual basis, that
compensation must be paid within 180 days of the fiscal year end in which the
expense was incurred
If the payment is delayed beyond 180 days from the year end, the employer must
delay the deduction of the remuneration until the year in which it is paid
Indirect forms of compensation are referred to as fringe benefits
o Some fringe benefits are taxable in the year in which they are received or enjoyed; others
are taxable at some future time or are not taxable at all
o Most forms of compensation are deductible for the employer
The following typical benefits are taxable:
o Board and lodging provided to employees free or at a reduced price
o Rent-free and low-rent housing
o Personal use of the employers motor vehicle
o Gifts from the employer to the employee that are in cash or near cash
Non-cash gifts and awards with value < $500 are not taxable
Items that are of an immaterial or nominal value are not taxable
o Group term life insurance policies
o Holiday trips and other prizes and incentive rewards
o Travelling expenses of an employees spouse if no business reason for spouses presence
o Premiums under provincial hospitalization and medical care insurance plans
o Reimbursement from the employer for the cost of tools required to perform duties of
employment
o Interest-free and low-interest loans
o Financial counseling and income tax return preparation
o Reimbursement for day care costs for children, except when the employer provides on-site
facilities
o Fitness, gym, or health club memberships
o Public transit passes provided to employees
The amount of benefit that must be included in the income of the employee is usually determined
as either the cost to the employer of supplying the benefit or the fair market value of the benefit,
whichever is lower
o Special benefit calculations apply to the use of employer automobiles, loans from
employees, the reimbursement of specific relocation expenses, and stock-option benefits:
1. Automobile benefits:
Capital portion of the benefit: the employer has paid for the vehicle and has relieved the
employee of the need to acquire a personal car
o Based on availability for use based on the time period that the automobile was
available to the employee for personal use
o If the employer owns automobile, standby charge = original cost of the
automobile x 2% x # of months available
o If the employer leases the automobile, standby charge = monthly lease cost x 2/3
x # of months available
Operating portion of the benefit: the employer pays for costs associated with operating
the vehicle
o Based on actual personal use as opposed to business use
o Operating benefit = Prescribe rate [27 cents in 2015] x # of personal km driven,
OR 50% of the standby charge (if business use > 50% of total use)(whichever is
lowest)
o If automobile is driven primarily (more than 50%) for employment:
Reduced standby charge = (personal kms driven/1,667 kms per month (or 20,000 kms
per year)) x standby charge
2. Employee loans
The benefit an employee receives from the reduced rate of interest on a loan provided by
an employer, is taxable
Every three months, the CRA determines a prescribed interest rate that reflects existing
financial conditions
o The taxable benefit to an employee on a loan made from an employer is the
difference between the prescribed rate at the time and the actual interest paid
When a loan is used to acquire a house or to repay an existing loan, the benefit can be
determined using the prescribed interest rate that was in force at the time the loan was
made
o If the prescribed rate declines, the lower rate can be used
o If the prescribed rate increases, the rate in force at the time the loan was made
will remain, for a maximum of 5 years
3. Relocation expenses
The reimbursement of moving costs is not a taxable benefit
However, the reimbursement of two specific types of relocation expenses is taxable to
the employee:
o The reimbursement of costs to finance the use of a residence
The full amount of the reimbursement is taxable
o The reimbursement of a loss suffered by the employee from the decrease in value
or impairment of proceeds of disposition of the employees residence
The first $15,000 of this type of benefit is not taxable to the employee, but
one-half of any amount above $15,000 is taxable
The employee must have moved at least 40 kms closer to the new work
location
4. Stock options
Benefits arise when an employee is given the opportunity to acquire shares in the
employer corporation at a price lower than the fair market value of the shares at the
time of the purchase
Three categories of stock-option plans:
o Stock options of public companies with a designated option price below fair
market value at the date the option is granted by the employer
o Stock options of public companies with a designated option price equal or greater
than the fair market value at the date the option is granted by the employer
o Stock options of Canadian-controlled private companies
Category 1:
o A taxable benefit from these stocks are included as employment income at the
time the option is exercised and the employee purchases the shares
o The taxable employment benefit is the difference between the fair market value
of shares at the purchase date and the agreed upon price
o To the extent that the shares change in value after the purchase date, the value
change is considered to be a capital gain or loss (when the shares are sold) of
which only one-half is included in income
Category 2:
o If the shares do not have special dividend or redemption rights, one-half of the
employment income calculated when the shares are purchased is deducted as a
stock option deduction in determining taxable income
Category 3:
o The employment benefit is not taxable until the shares are sold
o Provided that the employee holds such shares for two years after acquisition, onehalf of the employment income benefit is deducted as a stock option deduction in
determining taxable income
o If the shares are not held for two years, then the stock option deduction is
available based on the same requirements as those in category 2 (that is, when
the option price is the same as or greater than the fair market value of the shares
at the date the option is offered)
Tax-deferred benefits:
4. The cost of supplies consumed directly in the performance of employment duties, provided that
the employee is required by the employment contract to be responsible for payment of such
items
o The costs of supplies are normally deductible only to the extent that they are fully
consumed when used (in a short period of time)
o Employed tradespersons can deduct the cost of eligible tools in excess of $1,000 to a
maximum of $500
5. Annual dues paid to a trade union
6. Contributions to an employers registered pension plan
o The contribution made by an employee is deductible in arriving at net income from
employment
o The maximum amount that can be contributed by the employer and the employee
combined is 18% of the employees compensation
7. Office rent or workspace-in-the-home expenses in certain circumstances
o A home-office deduction is permitted if that office is the place where the individual
principally performs the duties of employment (more than 50% of the time)
o If the above criterion is not met, a deduction may still be permitted if the space is used
exclusively to earn employment income and is used on a regular and continuous basis
for meeting customers or clients of the employer
o When these tests are met, the costs for salespeople are normally the prorated portion of
the homes property taxes, insurance, maintenance, and utilities (or the rent cost when
the home is not owned)
Employees who are not salespeople can deduct only the maintenance and utility
costs (not the insurance and property taxes)
Such costs cannot be greater than the employment income earned in the year
o When they are greater, the excess can be carried forward to the next year
An employee cannot deduct interest on a house mortgage as part of office costs
o A self-employed person can do so
8. Legal expenses paid in the year to collect or establish a right to salary or wages owed to the
employee by the employer or former employer
Chapter 5: Income from Business
In order to earn business income or incur a business loss, the taxpayer must be involved in an
undertaking that constitutes a business
o In most circumstances, the conduct of a business is readily identifiable by the nature of the
activity
o The definition does not consider size to be a factor, not does it require that the activity be
ongoing, or that it provide evidence of its existence
o An activity may constitute what is referred to as an adventure or concern in the nature of
trade a taxpayer acquires property for the purpose of reselling it at a profit, even though
it is not the normal business of that person to conduct such activity
This constitutes a business, and the resulting profit or loss on sale is considered
income or loss from business and is treated accordingly for tax purposes
Capital transactions and business transactions are treated differently
o The intended use of a property on acquisition is the principal factor in deciding its tax
treatment on a subsequent sale
1. Property acquired for the purpose of providing the owner with a long-term or enduring benefit is
capital property, and its disposition results in a capital gain or loss
2. Property acquired for the purpose of reselling it at a profit is inventory, and its disposition results
in business income or business loss
A taxpayers income for a taxation year from a business is the profit therefrom for the year
o The main principles used in determining profit for income tax purposes:
1. The determination of profit is a question of law
2. The profit of a business for a taxation year is determined by setting against the revenues
from the business year the expenses incurred to earn that income
3. The goal in computing profit is to obtain an accurate picture of the taxpayers profit for the
year
4. In ascertaining profit, the taxpayer is free to adopt any method provided that it is consistent
with the provisions of the Income Tax Act, established case law principles or rules of law,
and well-accepted business principles
1.
2.
3.
4.
1.
2.
3.
4.
5.
6.
Business income for tax purposes is the profit determined in accordance with well-established
business principles using GAAP as an interpretive aid; it comprises the revenues earned in a
taxation year less the expenses incurred for the purpose of earning such revenues
o While there are some limitations as to what expenses can be deducted for tax purposes, it is
generally understood that all expenses incurred in an attempt to generate revenues are
deductible for tax purposes
GAAP conceptual framework concepts:
Revenue recognition
Revenues are recognized at the point in time when the earning process is substantially complete
(when title to the property passes to the purchaser or the service contracted for has been provided)
Concept of accrual
Expenses are recognized and recorded for accounting purposes when they are incurred, rather
than when they are paid
Concept of matching
Expenses are deducted in the same time period in which they contribute to the earning of
revenue
Concept of conservation
All losses are recognized when they are likely and measurable, rather than when they occur
When there is uncertainty as to measurement, a measure should be chosen that does not
overstate assets nor income
The determination of income from business for tax purposes is constrained by six general
limitations that apply to the deduction of expenses
o In order for any expense to be deductible in arriving at business income, the following
conditions must be satisfied:
Income-Earning-Purpose Test
o In order for an expense to be deductible for tax purposes, it must be incurred for the
purpose of gaining, producing, or maintaining income from business
It is not necessary that an expense have a direct relationship to the generating of
income; it must, however, have been inspired by and incurred as part of the process
of carrying on a business activity with an expectation to profit
Capital Test
o No item is deductible in arriving at business income if it was incurred on account of capital
or is an allowance in respect of depreciation obsolescence or depletion
An expenditure on account of capital is one that results in a long-term or enduring
benefit to the entity
Exempt-Income Test
o An expense is not deductible if the income that is expected to be generated is itself not
taxable revenue
Reserve Test
o An expense is not deductible if it is an amount transferred or credited to a reserve,
contingent account, or sinking fund
As a general test, no reserves are deductible for tax purposes
Personal-Expense Test
o No deductions are permitted for a taxpayers personal or living expenses except for those
travel expenses incurred away from home in the course of carrying on business (travel
expenses include meals and lodging)
Personal or living expenses encompass the expenses of properties that are
maintained by individuals for personal or family use and that are not maintained in
connection with a business carried on for profit or with a reasonable expectation of
profit
The cost of travel from home to work by a person carrying on a business is not
deductible
Reasonableness Test
o An expense may only be deducted to the extent that the expense is reasonable in the
circumstances
Even when the expense meets the other criteria for deductibility, the amount that
can be deducted is limited to a reasonable amount
An amount would be unreasonable if it were significantly in excess of what other
taxpayers in similar situations would incur
Specific income exceptions include:
Inducement payments
An inducement payment may be a grant, a subsidy, or a forgivable loan and may
come from another business or from a government
An inducement payment is treated as taxable business income and is included in the
year of receipt
As an alternative, the taxpayer can elect to apply the inducement payment as a
reduction of the cost of the property acquired
Future deductions for CCA will be lower as a result of the reduced cost base
o Insurance proceeds
When depreciable property is damaged or destroyed, insurance proceeds are likely to
be received
When the property is destroyed the insurance proceeds are treated for tax
purposes as proceeds from the disposition of the property
When the property is damaged the insurance proceeds are treated as taxable
income, but only to the extent of the cost of the repairs made to the property
o Payments based on production or use
A payment received that is based on the production or use of property, even when it
is an installment payment from the sale of a property, is considered to be business or
property income
Exceptions that deal with expenses can be divided into two basic categories:
1. Expenses Denied
o Use of recreational facilities and club dues
No business entity is permitted to deduct the expenses incurred for the use or
maintenance of a yacht, a camp, a lodge, or a golf course unless such property is
part of the entitys normal business
This restriction also denies the deduction of all expenses incurred as membership
fees or dues in any club, the main purpose of which is to provide dining, recreational,
or sporting facilities to its members
o Political contributions
No political contributions are deductible for tax purposes, even though they may
have an income-earning purpose
o Advertising expenses
The cost of advertising in a non-Canadian newspaper or broadcasting undertaking
cannot be deducted if the advertisement is directed primarily at a Canadian market
o Allowance for an automobile
The maximum allowance that can be deducted by an employer is 55 cents for each of
the first 5,000 km in a year, and 49 cents for each additional km
This limitation applies only if the allowance is tax-free to the employee
If the allowance is taxable to the employee, the employer can deduct the full amount,
provided that it is reasonable
o Interest and property taxes on vacant land
The related interest costs and property taxes of vacant land are deductible, but only
to the extent that income is generated from that land
o Certain costs during construction period
Legal and accounting fees, interest costs, mortgage costs, property taxes, and
promotional expenses incurred while a building is being constructed or altered are
not deductible
These costs are instead considered part of the cost of the building and as such are
eligible for a CCA deduction over a period of years
o Work space in a home
The expenses applicable to that space are not permitted as a deduction for tax
purposes unless one of the following conditions is met:
The space in the home is the individuals principal place of business
The space is used exclusively for the purpose of earning income from
business and used on a regular or continuous basis for meeting clients,
customers, or patients of the individual
If either of these conditions is met, the permitted expenses include a proportionate
amount of the homes common expenses, in addition to any expenses that relate
specifically to the work space
o
The total expenses cannot exceed the business income for the year if they do, the
excess is considered to be an expense of the following year
o Meals and entertainment
The amount permitted as a deduction is limited to 50% of actual costs incurred
o Costs of an automobile
Whatever the actual cost of an automobile, its cost for the purposes of claiming a
deduction for CCA cannot exceed $30,000 (plus tax)
The interest cost on money borrowed to acquire a vehicle cannot exceed $300 per
month
The deduction for a leased automobile cannot exceed $800 (plus tax) per month
o Stock-based compensation
For tax purposes stock-based compensation is not deductible
o Unpaid remuneration
Employee remuneration, other than vacation pay, is not deductible in the year
accrued unless it is paid by 180 days after the business year end
o Unpaid amount owing to related persons
An expense accrued that is owed to a person who is not at arms length with the
business must be paid by the end of the second year of the business after the year in
which the expense was accrued
Otherwise, the accrued amount is added to the business income in the third year
after the expense was accrued, unless a special election is made
2. Expenses Permitted
o Capital cost allowance and amortization
The general rules prohibit the deduction of all depreciation and amortization of
capital assets
The exception rules do permit the gradual expensing, in a controlled and uniform
manner, of certain fixed assets and intangible property over a period of time (CCA)
o Interest
Interest incurred on loans used to acquire long-term assets is considered to be on the
account of capital and is therefore denied by the general rules
However, interest can be deducted if the long-term asset to which it relates is used in
the income process
Interest can be deducted on a cash basis when paid, rather than by the accrual
method require by GAAP
o Interest can be deducted as it is incurred, or it can be added to the cost of the
depreciable property acquired, in which case it becomes eligible for a
deduction over time in the form of CCA
o Expenses of borrowing money or issuing shares
Expenses of this nature, even though they have a long-term benefit, are permitted as
a deduction in equal proportions over five years (one-fifth per year)
Examples: cost of registering a mortgage, appraisal fees for financing, selling
commissions, and finders fees
o Landscaping of grounds
Expenses incurred for the landscaping of property around a building or other
structure that is used for the purpose of gaining or producing income are deductible
when paid (not when incurred), even though such expenditure provides a long-term
benefit through land enhancement
o Reserves for doubtful debts and bad debt expense
Amounts received by a business entity, if it is anticipated that they will not be
collected, are deductible as a reserve, provided that this reserve is reasonable and
that the debt, when established, created income for the taxpayer
Reserves that are based on an arbitrary percentage of total receivables are not
considered reasonable and are, therefore, not deductible
The CRA accepts a reserve calculated, as a percentage of the total
doubtful debts or a series of percentages relating to an age-analysis of
those debts, based on the taxpayers past collection history
If a deduction is made as a reserve in a particular year, that reserve must be added
back to income in the following taxation year and then re-evaluated
If it is still in doubt, a new reserve can be deducted
o
o
If payment is delayed beyond that period, the employer can deduct the remuneration only in
the subsequent year in which it is paid
Farming income is calculated on an accrual basis
o Taxpayers carrying on a farming business can, if they so elect, determine farming income
using a cash basis for accounting
They can recognize income when it is received and deduct expenses when they are
paid
When the cash basis is used, inventory costs are deducted at the time of payment
and not when the inventory is sold
A partnership is not a taxable entity and bears no responsibility for tax on income generated within
its sphere of operation
o Rather, income earned or losses incurred by the partnership are allocated to the partners,
for inclusion in each partners income for tax purposes
When a business is sold, the related transaction is not part of the normal operation of that business
o The sale can be considered a capital transaction, with the exception of inventory and
accounts receivable, which when sold as part of the sale of business, are considered to be
business income
o Inventory that is sold as part of the disposition of a business is deemed to have been sold in
the course of carrying on business
Any gain or loss from the sale is included as part of the business income (loss)
calculations and cannot be considered a capital gain
o When a taxpayer ceases to carry on business and the accounts receivable are sold, an
unusual tax result occurs (read over in textbook)
o
The rate signifies the maximum that can be applied in any year (there is no requirement that
the taxpayer claim this maximum)
If the maximum is not claimed in a given year, the unclaimed portion is simply
carried forward and is available in future years
Often, taxpayers who have incurred a loss will not claim CCA unless they are certain
that other sources of income will be available for offset
Look at page 186 for classes and CCA rates
The capital cost allowance system uses the declining balance method of allocating capital cost over
future years
o This method annually applied a constant percentage to the remaining undepreciated portion
of the original capital cost
o The percentage applied is the designated CCA rate for the class to which the asset is
attached
o For most cases, the amount of CCA can be claimed in the first year of an assets acquisition
is restricted to one-half of the normal rate
The one-half rule does not apply to items in class 14 or to certain specific items in
class 12
In such cases, the CCA that would otherwise apply is prorated by the number of days
in the taxation year divided by 365
The CCA system places all assets of the same class in a common pool, provided that those assets
are all used in the same business
o Each asset loses its individual identity as it gets added to the pool of its class
o In the same way that the purchase of a new assets will add that asset to the pool, the sale of
a particular asset will remove that assets from the pool
o When additions and disposals occur in the same year, the one-half rule for CCA applies only
to the extent that the additions exceed the disposals
o When assets are sold, the CCA pool is reduced only up to a maximum of the original capital
cost of the asset disposed
Any proceeds received in excess of the original cost are constituted as a capital gain
on disposition
When multiple assets are pooled in a single class under the CCA system, no gain or loss is
recognized on the sale of individual assets unless the sale price is greater than the assets original
cost
o The pool concept recognizes that some assets in a given pool will be sold at less than their
depreciated value and others at more
o The result is that gains and losses are averaged over the life of the pool
For tax purposes, gains and losses on depreciable property can occur at three particular points:
1. A loss has occurred if, at the end of a fiscal year, all assets in a class have been disposed of but
a balance remains in the pool
This balance is written off in full against business or property income as a terminal
loss. This loss reflects the net losses and gains accumulated over several years
2. A gain has occurred if, at the end of any particular fiscal year, the balance of a class pool is
negative, even if some assets still remain in the pool.
This gain is fully taxable as business or property income and is referred to as a
recapture or recovery of CCA
3. If, at any time, the selling price of a depreciable property exceeds the original cost of the
specific property sold, the excess is recognized in the year as a capital gain
o
2. The return of interest income on investments in bank deposits, loans, mortgages, bonds, and
debentures
3. The return of rental income on the ownership of real estate or other tangible property
4. The royalty income on the ownership of properties, such as patents and mineral rights
In each case, property income is the annual or regular return received for allowing another party to
use ones property
o It does not include the gain or loss that may result from the sale of that property (this is a
capital gain or loss)
When PP&E is sold, the gain in excess of the original cost is a capital gain, but any recapture of the
CCA is property income, and any terminal loss is a property loss
To qualify as property income, interest must be earned in a relatively passive way, without the
commitment of significant time, labour, and attention by the owner
A taxpayers income from property for the year is the profit therefrom
o It takes into account not only the revenues from such sources, but also the related expenses
incurred to earn those revenues
In general, expenses incurred to earn property income can be deducted for tax purposes provided
that:
a) they are incurred for the purpose of earning income that is taxable
b) they are not an expenditure of a capital nature, an expenditure on the account of capital, or
depreciation and amortization
c) they are not a reserve
d) they are not a personal or living expense, and
e) they are reasonable under the circumstances
Although interest expense incurred on a loan used to acquire an investment is on the account of
capital, an exception to this general rule permits the deduction of interest expense if the loan was
incurred to acquire property that is used to generate property income
o Interest on loans used to purchase investments is deductible against the interest, dividends,
and rental income earned
o It is important that the taxpayer establish, through documentation, that a specific loan was
used for the purpose of making an investment, since this ensures that interest can be
deducted from income
Establishing the purpose for which funds are used is best done by maintaining a
separate bank account for investment activities
o Individual taxpayers can borrow money for investment by increasing the mortgage on their
personal residence
The portion of the mortgage interest that was used to make the investment is
deductible for tax purposes
o When individuals are in a position to acquire both personal assets and investment assets,
they should apply the following principles with respect to loan financing in order to maximize
their after-tax cash flow:
1. Personal assets should be acquired with excess cash. Such assets can be used as collateral
to obtain loans for investment purposes.
2. When individuals have both personal and investment loans, excess cash should first be used
to repay the personal loans that are incurring non-deductible interest
A reduced personal debt makes for an expanded borrowing capacity, which, in turn,
makes loans for investment purposes easier to obtain
Interest income the compensation received for the use of borrowed funds
o In most circumstances, the amount of interest income earned on a debt obligation is readily
identifiable from the stated interest rate attached to the obligation
Sometimes a loan is made without interest/low interest rate but the debtor must
repay an amount greater than the original principal loan
To the extent that the additional payment of principal reflects the normal interest
rate, that extra amount is interest income
If the extra principal is more than the normal interest rate, the amount is a capital
gain
All corporations must recognize income according to the normal rules for profit determination and
do so on an accrual basis
o A corporation must include interest as income as it is earned on a daily basis, even though
the interest may not have been received and may not be receivable until some future time
Individuals, unlike corporations, have the following three methods for recognizing interest income:
o The receivable method
Interest is included in income only when the amount is legally due and payable
o The cash method
Interest income is taken into income for tax purposes only if it has been received by
the individual in the year
o The anniversary day accrual method
Interest income is recognized for every 12-month period from the date the
investment was made
Interest income recognition can be deferred for only a limited period
Interest earned on investments in a foreign country is recognized in terms of Canadian dollars
under the same rules described above
o When foreign taxes are withheld from the payment, the full amount of interest, before the
amount is withheld, must be included in property income
However, Canadian tax on this foreign income can be reduced through a foreign tax
credit reduces Canadian tax only to the extent that Canadian taxes are paid in the
same year
When a life insurance policy includes a savings element that accumulates interest returns, income
must be reported annually
Some typical expenses incurred to earn interest income are:
o Interest expense on loans used to acquire interest-bearing investments
o Investment counseling fees
o Costs incurred to obtain a loan, such as legal fees, mortgage appraisal fees, and registration
fees (amortized over five years at the rate of one-fifth per year)
o Fees paid to managers of investment portfolios
o Fees paid to a financial institution for holding securities. The cost of a safety deposit box is
not deductible
o Accounting fees for record-keeping and determination of income from property
o Reserves or complete deductions for interest income that has been accrued but is not
collectible because of the debtors inability to pay (A4DA)
If the expenses incurred exceed the interest income, a loss from property occurs that can be offset
against the taxpayers other sources of income
Dividend income can be received by both individuals and corporations
o Corporate earnings are taxed in the hands of the shareholder, either as dividends (property
income) or as capital gains, depending on whether or not the corporate profits are
distributed
o When a single corporation is owned by a single shareholder
The profits of the corporation are subject to tax, and those after-tax profits are
subject to a second level of tax when received as a dividend by the individual
shareholder
o When Corporation Xs shareholder is Corporation Y whose shareholder is the individual:
The after-tax profits earned by Corporation X are distributed and received as dividend
income (property income) by Corporation Y
This increases the earning of Corporation Y, which can either retain those
earnings or distribute them as dividends to its shareholder (the individual)
The after-tax profits of Corporation X are received as dividend income for tax
purposes by both Corporation Y and the individual
Dividends paid by one corporation to another are included in the recipients net income for tax
purposes when they are received
o The taxable income of a corporation is determined by reducing net income for tax purposes
by certain specific items, one of which is dividends received from other taxable Canadian
corporations
The dividends received by one Canadian corporation from another Canadian
corporation are excluded from taxable income and are therefore not subject to
normal tax
Dividends received by a Canadian corporation from a foreign corporation are
excluded from taxable income only if the foreign corporation qualifies as a foreign
affiliate (if the owners equity percentage in the foreign corporation is not less than
10%)
Royalties are normally treated as property income from an investment when they are received for
the use of owned property when the taxpayer has acquired these properties by a purchase, gift, or
inheritance
o The royalties earned require little, if any, effort by the owner to achieve the revenue
o Royalty income may also be classified as business income if considerable effort is made to
earn that income
Any loss suffered from the sale of personal-use property is deemed to be nil, even
though gains on such property are taxable
o The loss on sale is equivalent to the enjoyment received from the use of the
property
The loss on one item of personal-use property cannot be offset against a capital gain
realized on the sale of another personal-use property
Personal-use property has a deemed minimum cost of $1,000 for tax purposes and
deemed minimum proceeds of $1,000
o Small items of personal-use property will be subject to capital gains treatment
only to the extent that the proceeds of disposition exceed the minimum
amount of $1,000
2. Listed personal property
o Items that are for personal use but also have some element of investment value
A print, etching, drawing, painting, or sculpture, or other similar works of art
Jewelry
A rare folio, rare manuscript, or rare book
A stamp
A coin
o A loss from the sale of listed personal property is recognized for tax purposes
However, capital losses from listed personal property can be offset only against
capital gains from listed personal property (not against other capital gains or other
forms of income)
To the extent that capital losses from listed personal property cannot be used in the
current year, the unused loss can be carried back three years or forward seven years
and deducted against listed personal property gains, if any, in those years
Similar to personal-use property, listed personal property has a deemed minimum
cost of $1,000 for tax purposes and deemed minimum proceeds of $1,000
3. Financial property
o All capital property that was acquired primarily to generate a benefit through a financial
reward
Shares, bonds, loans, land, buildings, equipment, patents, licenses, franchises, and
vehicles
Capital gain/loss on the disposition of a given capital property = Proceeds of Disposition ACB
Expenses of Disposition
o Only one half of the capital gain/loss is included in the calculation of net income for tax
purposes (taxable capital gain/allowable capital loss)
o At the end of the year, the taxable capital gains and the allowable capital losses on all
properties are totaled separately and included in the aggregate formula
Capital gains and losses are recognized for tax purposes only when a disposition of the property
occurs, which is when:
o Property is sold
When property is sold, proceeds of disposition = the selling price
When property is sold in exchange for other property, proceeds of disposition = fair
market value of the property received in exchange
o Property is involuntarily eliminated by theft, destruction, or expropriation
Proceeds of disposition = compensation received for stolen, destroyed, or
expropriated property
o A share, bond, debenture, note, or similar property is cancelled, redeemed, or settled; or
o A share owned by a taxpayer is converted by amalgamation or merger
In some circumstances, property is deemed to be disposed at fair market value, even though no
proceeds of disposition are received. This can occur when:
1. Property is transferred by way of a gift to another party
2. The use of the property changes from personal use to business or investment use, or when it is
change from business or investment use to personal use
3. A taxpayer ceases to be a resident of Canada for tax purposes
4. An individual dies
Normally, the adjusted cost base (ACB) of a property is the original purchase price plus other costs
incurred to make the acquisition
When a taxpayer receives a government grant or subsidy to acquire an asset, the purchase
price of the asset is reduced by the amount of the grant to arrive at the adjusted cost base
for tax purposes
o The taxable benefits received when shares are purchased under an employee stock option
are added to the cost of the shares to ensure that the same income is not counted twice
o When a person receives a gift of property, the adjusted cost base (although the recipient
didnt actually pay anything) is deemed to be the fair market value at the time of acquisition
o A taxpayer immigrating to Canada is deemed to acquire all assets immediately before
immigrating
The acquisition amount is the assets fair value (and the ACB)
Immigrants are taxable in Canada only on gains above the market value of property
at the date of arrival
All costs incurred to complete the disposition are deductible when arriving at the capital gain or loss
o Such costs include legal fees to complete the sale agreement, brokerage fees or
commissions to agents, advertising, and mortgage discharge fees
In order to facilitate a sale, a vendor may accept payment in the form of an immediate down
payment in cash, with the balance, with interest, to be paid over some future time period (deferred
proceeds)
o The vendor can recognize the taxable capital gain over a period of years in proportion to the
receipt of the proceeds of disposition
The deferred recognition of capital gains is restricted to a maximum of five years, and
a minimum of 20% for the capital gain must be recognized, on a cumulative basis, for
each of the five years
The time limit of 5 years is extended to 10 when the sale is made to a child of
the taxpayer and the property sold is shares of a small business corporation,
farm property, or an interest in a family farm partnership
o Deferring the recognition of the capital gain to future years in proportion to the receipt of the
proceeds is referred to as a reserve
The reserve is deducted from the capital gain in the year to arrive at the taxable
amount
Claiming the reserve is discretionary a taxpayer may not defer the recognition of
the gain if the taxpayer has a capital loss in the year to offset the gain or if it is
anticipated that the tax rates will be higher in the future years
o The maximum reserve in any year is equal to the lesser of:
Deferred proceeds/total proceeds x gain
80% of the gain in year 1, 60% in year 2, 40% in year 3, 20% in year 4, and zero in
year 5
Capital losses are recognized only when a disposition occurs and they can be deducted for tax
purposes only to the extent that capital gains were realized in the same year
o Because of this, a taxpayer who has incurred a capital loss should consider disposing of
other capital property that has appreciated in value (to recognize a capital gain so the loss
can be recognized)
o Conversely, a taxpayer who is facing a capital gain should consider disposing property that
has declined in value in order to create an offsetting loss
o If a capital loss cannot be used in the current year, it can be carried forward indefinitely and
used in the future when a capital gain occurs; or it can be carried back to the previous three
years provided that capital gains were incurred in those years
An allowable business investment loss (ABIL) is the allowable capital loss (50% of the actual loss)
incurred on the disposition of a loan to a small business corporation, or on a sale of that
corporations shares
o Small business corporation = private corporation that is Canadian controlled and that uses
all or substantively all (>90%) of its assets to conduct an active business
o Such a loss can be offset against all other sources of income derived by the taxpayer
The tax savings on this loss is readily available
When an investment in shares of a corporation has declined in value because the corporation has
suffered extreme financial problems or when an outstanding loan is uncollectible due to the
debtors inability to pay, the owner may be unable to sell the property and trigger the disposition
o Property that is a loan or a share of capital stock of a corporation is subject to deemeddisposition rules that permit the loss to be recognized before an actual disposition occurs:
o
Commodities must be treated as business income for taxpayers who are associated with the
commodity business or who are taking commodity positions as part of their normal business
or trade
Although eligible capital property (i.e. goodwill, franchises, licenses) are capital in nature, they are
not subject to capital gains treatment for tax purposes
o Gains or losses on the sale of eligible capital property are treated as business income or
business losses
A principal residence is a housing unit owned by the taxpayer and ordinarily inhabited for personal
use (it is personal use property)
o The capital gain realized on the sale of a principal residence is reduced by the following
formula:
(1 + Number of years designated as principal residence)
/(Number of years owned)
x Gain
Special treatment is provided for the recognition of capital gains on the disposition of real estate
that is used to conduct a business
o The recognition of the capital gain can be deferred, provided that the replacement property
is acquired in the same year the property is sold or before the end of the first taxation year
that begins after the property was sold
o The replacement property must be used for a similar purpose as the original property
o The capital gain that would normally be recognized is used to reduce the adjusted cost base
of the replacement property acquired
o This gain deferral does not apply to real estate used to earn property income from rentals or
personal-use real estate
o The same treatment applies to property that has been lost, stolen, destroyed, or
expropriated and for which compensation has been received
The capital gain can be deferred if replacement property is acquired before the end of
the second taxation year that begins after the property was disposed
Individuals who dispose of a small business investment can defer the recognition of a limited
amount of the related capital gain if the proceeds from the sale are used to make other small
business investments (eligible small business investments)
o Investment must be in newly issued treasury common shares of a replacement entity (the
replacement entity is strengthened by the receipt of additional capital resources that can be
used to support its growth)
o The eligible capital gain is deferred until the new investment is eventually sold or the
proceeds of its sale are again reinvested in another qualified replacement investment
If a taxpayer disposes of Canadian public securities by gifting them to a public charity, the
unrealized gain on the security is deemed to be nil and no income tax cost results
Capital gains incurred on the donation of shares of private corporations and real estate are also
exempt from tax
o However, these investments are not easily transferable to a qualified charity
o So, a capital gain for these two properties will be exempt when a person donates all or some
of the cash proceeds received from the sale within 30 days after the disposition
o The disposition must be to an arms length purchaser for the exemption to apply
o If the donor gifts less than 100% of the cash proceeds, the exempt portion is determined as
the proportion that the cash proceeds donated is of the total proceeds from the sale of the
shares or real estate
o
If the EAP originated from contributions made by the contributors, the EAP is
not taxable
While the annual permitted contributions to a Tax-Free Savings Account (TFSA) are limited and not
tax deductible, all qualified investment income generated in the account are tax-free when earned
and when withdrawn from the account
o Canadian residents who are at least 18 years of age can contribute up to $10,000 annually
to a TFSA
Any unused portion of the annual limit can be carried forward indefinitely and
contributed in any future year
Interest on money borrowed to invest in a TFSA is not deductible
o If the TFSA has an over-contribution, a 1% per month penalty tax will apply on the amount of
the excess
o When an amount is withdrawn from the plan, the amount withdrawn is added to the
accumulated contribution limit in the following year and can be re-contributed at any time
o Individuals can contribute to their own and spouses TFSA without attribution consequences
Spouses and common law partners have a combined annual contribution limit of
$20,000 regardless of the source of the contributions
o A TFSA can be wound up at any time or maintained until death
On wind-up the assets are deemed to be disposed of at fair market value and
accrued gains are not taxable
All items that are deductible from any source of income are deductible only to the extent that the
expenditure is considered reasonable in the particular circumstances
o The reasonable test applies to deductions for all types of income
o Specific reasonable tests apply to meals and entertainment (50%) and there are limits for
the deduction of interest, lease costs, and the capital cost of a passenger vehicle
The following rules apply to taxpayers not dealing at arms-length (they are related)
1. Property sold at a legal price less than its fair market value is deemed to have been sold by the
vendor at fair market value. No adjustment is made to the purchaser, for whom the cost of the
property for tax purposes remains the actual price paid.
2. Property sold at a price higher than its fair market value is not adjusted to the vendor, and the
selling price constitutes the proceeds of disposition. However, the cost to the purchaser is
deemed to be equal to the fair market value, not the actual purchase price.
3. Property transferred by way of a gift is deemed to have been sold at fair market value by the
person making the gift. The recipient of the gift is deemed to have purchased the property at a
cost equal to fair market value. This rule applies even when the gift is made to an arms-length
party
Non-arms-length transactions can occur between:
o An individual and another individual
Individuals are related to each other if they are direct-line descendants or if they are
brothers, sisters, spouses, or in-laws
Excluded: cousins, aunts, uncles, nieces, and nephews
o An individual and a corporation
An individual is related to a corporation if he or she controls the corporation, is a
member of a related group that controls the corporation, or is related to an individual
who controls the corporation
Control (>50% ownership)
o A corporation and another corporation
Two corporations are related if one corporation controls the other corporation, if both
corporations are controlled by the same person, or if one corporation is controlled by
one person who is related to the person who controls the other corporation
Property transferred to a child, whether by gift or by sale, is deemed for tax purposes to have been
sold at fair market value (exception is farm property)
o Subsequent income received by the child on transferred property is attributed to the parent
until the child is 18 years old
o Subsequent capital gains or losses are not subject to attribution
Property transferred to a spouse, whether by gift or by sale, is deemed to have been sold and
acquired at cost
o Capital property is deemed to have been sold at its adjusted cost base and depreciable
property at its undepreciated capital cost
Any amount that is not allocated is subject to tax in the trust, at which point it becomes part
of the trusts residual capital and can subsequently be distributed tax-free
o If losses of a trust exceed income during a year, they remain within the trust as either noncapital losses or capital losses and may be carried back or forward in accordance with the
normal loss carry-over rules
The taxation year for a trust is the calendar year
o A testamentary trust that is designated a Graduated Rate Estate is permitted to retain a
non-calendar taxation year if:
The deceased died less than 36 months prior to December 31, 2015
The testamentary trust arises on death and continues for no longer than 36 months
Inter vivos trusts and testamentary trusts must apply the highest federal tax rate to all income plus
the highest applicable provincial or territory rate
o However, two types of trusts are permitted to apply the graduated tax rates to income:
A trust that is designated as a graduate rate estate
A qualified disability trust
A testamentary trust with a beneficiary who qualifies for the disability tax
credit
When calculating tax for inter vivos and testamentary trusts the federal tax can be reduced by the
dividend tax credit, donations and gifts tax credits, foreign tax credit, political contribution tax
credit, and various investment tax credits
o Neither type of trust can deduct any of the personal tax credits
In order to prevent a trust from escaping tax on property that it holds for an extended period of
time, inter vivos and testamentary trusts are deemed to have sold certain properties at market
value on its 21st anniversary date and every 21 years thereafter.
o The properties include:
Capital properties
Depreciable properties
Land that is inventory
Resources property
o The trust can avoid the deemed disposition at fair market value by transferring the
particular properties to the beneficiary prior to the 21-year anniversary date
Such transfers are deemed to be disposed at the propertys cost amount
o When a trust holds property beyond 21 years and triggers a deemed disposition, for tax
purposes it will recognize the related gains or losses on the relevant properties as if they
were sold
The trust then is deemed to reacquire the properties at fair market value, which
becomes the new cost amount of the property for the trust
A beneficiary who is entitled to receive income from the trust is considered to have an income
interest in the trust, and is an income beneficiary
o When trust property is transferred to a beneficiary who has only an income interest, the
trust is deemed to have disposed of the property at market value that may realize taxable
income
A beneficiary who is entitled to received capital from the trust is considered to have a capital
interest
o When trust property is transferred to a beneficiary who has only an income interest, the
trust is deemed to have disposed of the property at its cost amount
o Most common
A trust is a spousal trust if the spouse of the settlor is entitle to receive all of the income of the trust
and no person other than that spouse can use or receive the capital of the trust before the death of
the spouse
o There are three unique features of a spousal trust:
1. When property is transferred into the trust, the settlor is deemed to have sold the
property at its cost amount. Therefore, the tax status of property prior to its transfer
is assumed by the trust
2. The 21-year deemed disposition requirement is waived for the first 21-year
anniversary. Therefore, in most situations, the property remains without tax until the
death of the beneficiary spouse
3. Upon death of the spouse who is the beneficiary, the spousal trust property deemed
to be sold at market value. In addition, the trust is deemed to have a taxation year
o
that ends on the day that the deemed disposition occurs. Any taxable income created
from the deemed disposition is deemed payable to the deceased individual in the
year of his or her death. Therefore, the gain is taxable in the deceaseds final tax
return using the gradual tax rate scale of an individual.