1998 Third Quarter, Issue No. 43
Presented to you by
Frank C. Weyer C.M.A. at
http://www.reach.net/~fweyer/
290 Dundas Street West, Suite 1, Trenton, Ontario, K8V
351
Telephone (613) 392-2953, Fax (613) 392-2375
In This Issue...
- Mutual Funds
- U.S. Travelling tips
- Charitable Donations
- Standby Charge - Bad News
- Registered Retirement Savings Plan (RRSP)
- Dividend Splitting - Neuman
- Employment Income
- Capital Gains
- GST
- Did you know…
Past Issues - more tips
Mutual funds
43(1)
Switch Funds
Switch Funds permit investors to reallocate asset classes without triggering tax consequences thereby providing flexibility in changing asset mix.
A "Switch Fund" is a mutual fund corporation with several classes of redeemable, inter-convertible shares for separate investment categories - such as Canadian and U.S. Equity Funds. The investor could convert one Fund into the other Fund without triggering a tax disposition. There is no gain/loss until the shares of the "Switch Fund" are redeemed or sold.
However, if the Adjusted Cost Base (ACB) of the shares in the Switch Fund is higher than fair market value, it may be better to have the shares sold, thereby triggering a capital loss to be allocated to the investor.
Switch Funds may also be held inside deferred income plans such as Registered Retirement Savings Plans. If one foreign fund is switched for another foreign fund, there is no disposition and the foreign content remains the same without offending the 20%foreign content rules.
U.S. Travelling tips
43(2)
Recently Revenue Canada gave tips to Canadians travelling in the United States including:
- Consider listing valuables taken out of Canada on Form Y38 to avoid having to pay duties on these when returning to Canada.
- Jewellery taken out of Canada should carry an appraisal report, certified photographs and a bill of sale to make it easy to re-enter Canada without duties.
- Travellers should have proper identification such as passports or birth certificates and, proper identification and written permission from a parent or guardian when they travel with children who are not their own.
- Travellers that have car trouble must declare the value of all repairs and replacement parts although, they may not have to pay duties and taxes on these repairs.
Charitable Donations
43(3)
Reimbursement of Expenses
In a Tax Court case, Mr. B was an unpaid volunteer for a charitable organization. Each year, Mr. B made a claim to the charity for his expenses (gas, parking and meals) which was paid to him and immediately endorsed back to the charity as a charitable donation - a donation receipt was issued.
Good News!
The Court permitted this donation as a free and voluntary donation of amounts owed to him.
Caution - Art Flips
Some promoters are offering taxpayers the opportunity to acquire a work of art for, say, $400 but providing a certificate valuing the art at, say, $2,000 with the idea that if it is then donated to a charity substantial tax savings could result.
Revenue Canada is not pleased and has a number of ways of attacking including:
- Determining that the value is really only $400,
- Determining that the transaction is really an inventory sale and taxing the gain of $1,600 as a business gain.
- Applying the General Anti-Avoidance Rule.
However, in one Court case, Mr. Friedberg was successful in acquiring Persian rugs for an amount significantly less than their value and was permitted a donation equal to the higher value. However, this was a unique set of circumstances.
Gift By Will
The Income Tax Act permits a charitable donation deduction on the terminal return of a deceased taxpayer where the individual's Will makes a gift to a prescribed donee.
In a Technical Interpretation, Revenue Canada states that it is not good enough to simply have the Will specify that the residue of the Estate is to be divided among such registered charities as the Trustees consider appropriate. The gift must be made for a qualified charitable organization in the Will itself without any discretion by Trustees.
In another Technical Interpretation, Revenue Canada notes that where the taxpayer’s Will clearly outlines which registered charity is to receive the charitable donations after the death of the surviving spouse, the deceased taxpayer is deemed to have made a gift of an equitable interest in a Trust to the registered charity in the taxation year in which the taxpayer died. The deceased taxpayer is considered to be the donor and deducts the donation on the terminal return.
Standby Charge - Bad News
43(4)
In a 1995 Tax Court case, an automobile general sales manager was not required to include a taxable standby charge (24% per year times the original cost of the automobile) on vehicles provided to him by the dealership where the taxpayer had only restricted use of the automobile during business hours.
Ouch!
Unfortunately, the Federal Court has now reversed this decision and notes that:
- 1. Revenue Canada's right to impose the standby charge is not dependent on whether a taxpayer has unrestricted use of an employer's automobile.
- 2. An automobile is subject to a standby charge if it is made available to an employee. This occurs if it is at his/her disposal and there is a right of usage.
- 3. However, the Income Tax Act has a "minimal personal use" exception enabling an employee to obtain a reduction in the standby charge if "all or substantially all" (usually considered to be more than 90%) of the distance travelled was in the course of employment and personal use is less than 12,000 km per year.
Registered Retirement Savings Plan (RRSP)
43(5)
Share Purchase
An RRSP may invest in the shares of an "eligible corporation" if, immediately after the purchase, the RRSP annuitant is not a "connected shareholder".
Based on the number of Technical Interpretation requests, this is a hot subject. Some points to consider include:
An "eligible corporation" requires the use of "all or substantially all" of its property in a qualifying active business. This is a question of fact determined on a case-by-case basis on either cost, fair market value, or some other basis. For example, where a franchise business acquires franchise shares under the terms of its Agreement, Revenue Canada considers these shares to be considered to be used in an active business.
A "connected shareholder" is a taxpayer who owns, directly or indirectly, 10% or more of the issued shares of any class unless that person deals at arm’s length with the company and the total cost amount invested is less than $25,000.
This requires a self-administered RRSP with an independent manager who may require confirmation as to the value and qualifying status of the shares and, also possibly annual audits.
Some examples include:
- An owner wished to retire and sell his shares tax free using the capital gain exemption. He sold 70% of the shares to the RRSPs of twenty-four employees.
- An owner financed the acquisition of a condominium in Hawaii by selling shares to employee RRSPs.
- An owner financed the expansion of the business by issuing preferred shares to eleven employees.
- An owner brought key employees into the ownership of the business by selling shares to their RRSPs.
- An owner brought employees into an ownership position to improve their decision-making abilities.
- An owner rewarded employees by offering their RRSP shares before the company was taken public.
- An owner reduced debt to make the company more viable by raising cash through a share issuance to RRSPs of employees.
- An entrepreneur financed a new business idea with funds raised from private investors through their RRSPs.
Caution:
The company must be an "eligible corporation" at the time the shares are acquired by the RRSPs.
A potential problem for an owner of a corporation that brings employees into ownership through their RRSPs is that there are now other shareholders. For example, on a subsequent sale, the minority shareholders must be considered, A shareholder agreement becomes important.
Another implication for the owner is that in previous years companies making greater than $200,000 of income simply bonused the excess to the owner. This requires more consideration when there are minority shareholders.
Two disadvantages in acquiring shares in a company through an RRSP include:
- Dividends paid to the RRSP are not eligible for a dividend tax credit and therefore receive full treatment when paid out of the RRSP.
- The $500,000 capital gain exemption on qualified small business corporation shares is not available to an RRSP. If the RRSP has a gain on sale it will not be taxable to the RRSP but, when the proceeds are distributed to the annuitant, they will be taxable.
Caution:
This is a very technical area and requires special professional assistance.
Dividend Splitting - Neuman
43(6)
In a Supreme Court of Canada (SCC) case, the Court permitted the payment of dividends on a class of shares owned by Mrs. Neuman, largely to the exclusion of Mr. Neuman, even though Mrs. Neuman's contribution to the company was nominal.
This reaffirms the position that taxpayers are entitled to arrange their affairs to minimize tax and, there is no general scheme in the Income Tax Act to prevent this type of income splitting.
The years in question were before the introduction of certain anti-avoidance rules and, therefore, the SCC left the door open for Revenue Canada to argue or apply:
- attribution rules for the purpose of income splitting to a non-small business corporation where a spouse or minor owns 10% or more of the voting shares.
- General Anti-Avoidance Rule (GAAR) - however, it may be difficult to apply GAAR since arguably income splitting is not an abuse having regard to the provisions of the Act read as a whole.
- doctrines of sham or artificiality.
It is unknown how the Department of Finance will react - will they introduce compensating legislation?
Caution:
- This Ruling assumes that the taxpayer had no preexisting entitlement to a dividend (i.e. be careful where there are preferred shares that are entitled to dividends in priority to the common shares).
- This Ruling assumes that the shareholder that receives the dividend gave proper consideration for the shares when issued.
Employment Income
43(7)
Director Liability Insurance
Revenue Canada notes that where the risks covered by a director’s liability policy are inherent in normal duties of a director or officer, neither the premiums paid by the employer, nor proceeds which may become receivable under such policy, will be considered a benefit to the director or officer.
However, when an insurance policy also covers risk and expenses other than those provided for in the relevant Business Corporation Act, that portion of the premium relating to other risks and expenses is a taxable benefit for the director. If there is no breakdown of the insurance premium between the various risks, the entire premium paid is regarded as a taxable benefit.
Reserved Parking Spot – More Bad News
In a Tax Court case, Mr. R was employed by the Municipality of Toronto and provided with a reserved parking space at no charge. Even though Mr. R only used the parking space when it was necessary to attend business meetings away from his place of work (say one day per week), the Court found that the taxable benefit is based on the yearly value - a total of $1,800 ($150 per month).
Royal Canadian Mounted Police
In a Tax Court case, the issue was whether certain expenses could be deducted by an RCMP officer including haircuts (were obliged to have their hair cut at a certain length), pagers and basic telephone service (sometimes needed to keep in touch with informers), special gloves (not provided by the RCMP), flashlights (the ones issued by the RCMP were of inferior quality) and extra set of handcuff keys (for convenience).
Ouch!
The Court found that the expenses were not deductible and noted that:
- To be deductible, the employment expenses would have to be for, "supplies consumed directly in the performance of the duties". This was not the case.
- "Supplies" are limited to materials that are used up in the employment. For example, it includes such items as gasoline for a blowtorch but in the Court's opinion, does not include the blowtorch itself. The latter, as well as tools in general, fall within the category of equipment.
- The word "Supplies" also did not include items of individual dress such as a police officer's uniform.
Capital Gains
43(8)
Capital Gain Exemption
The Income Tax Act denies the capital gain exemption on "Qualified Farm Property" and "Qualified Small Business Corporation Shares" where an individual knowingly, or under circumstances amounting to gross negligence, fails to disclose the capital gain on his/her tax return.
In a Court case, Mr. C had a capital gain of $413,250 qualified small business corporation shares, which were entitled to a capital gains exemption. However, Mr. C failed to disclose the capital gain on his return. Revenue Canada included the capital gain, disallowed the exemption and assessed 50% gross negligence penalties.
Fortunately for Mr. C, the Tax Court found that the unreported capital gain was an honest mistake and that the exemption should be allowed and, the gross negligence penalties not applied. In this case, Mr. C filed his own tax return.
Caution:
Remember to report the taxable capital gain and claim the exemption to avoid the substantial risk of not receiving the exemption plus, gross negligence penalties. Other taxpayers have not been as fortunate as Mr. C.
GST
43(9)
Audits
A Revenue Canada Memorandum states that audits will not normally go beyond the current and immediately preceding year - the "One-Plus-One" policy.
This policy recognizes the four-year (GST)/three year (income tax) audit periods but notes the significant costs to both Registrants and Revenue Canada of four-year/three year audits.
One presumes that if the one-plus-one audit does not uncover problems, the audit period should not be extended. However, if a reassessment occurs it can be expected to be subject to a four-year/three-year audit.
Coin-Operated Devices
Persons who make post-April 23, 1996 sales through coin operated devices designed to accept a single 25 cent coin, or less, may apply for a rebate.
However, in a recent Court case, the Court found this should have been made retroactive to January 1, 1991. Persons may therefore apply for a rebate by filing Form GST 189 within four years after the day GST was remitted.
Also, another recent change exempts coin-operated washing machines and clothes dryers located in a residential complex effective after April 23, 1996.
Revenue Canada Announcement
Beginning October, 1997, GST/HST registrants who owe tax, or who are behind in filing returns, will only receive one letter reminding them of their obligations. Fol1owing this, registrants can expect to receive, a call from a Call Centre agent.
Did You Know…
43(10)
Canada Pension Plan (CPP) Disability Payments
CPP disability must be included in income however, individuals may exclude benefits that relate to prior years (except for prior year benefits less than $300) and to pay tax on those benefits as if they had been received in the prior year.
Penalty Not Waived
In a Federal Court case, Revenue Canada's refusal to waive penalties on the late filing of a source deduction remittance was sent to the Federal Court for a judicial review. The taxpayer noted that the remittance that was due on March 15th,was received by Revenue Canada on March 17th, even though it was mailed on March 10th. In another instance, a remittance was received on March 16th and penalties were not applied. Therefore, the taxpayer argued that penalties should not apply in this case either.
Bad News!
The Court rejected the appeal and noted that Revenue Canada's rationale was based on relevant considerations such as the history of non-compliance. The treatment of other taxpayers is irrelevant.
Capital Gain Attribution
The advantages of transferring capital gains to children are great. Therefore, the documentation should be precise. Gifts of assets from parents to children results in attribution on income (like interest and dividends) but, not generally, on capital gains. In some situations, rather than formalizing a Trust to own he assets, the assets are simply put "in trust" in the child's name.
This may cause problems if it is not in fact a Trust. A Trust requires the three certainties of intention, property and beneficiary. A Trust should name the beneficiary, the settlor and the trustees.
Caution:
To avoid attribution, the trustee and the settlor (person contributing the asset) should not be the same person. Also, the Trust Indenture could indicate that the property will not revert to the settlor and that the settlor's permission is not required to distribute assets to the beneficiary.
Advertising and Promotion Costs – Golf Tournament
The Income Tax Act denies the deduction of expenses for the use of property that is a yacht, a camp, a lodge or a golf course or facility. Revenue Canada recently noted that promotional expenses incurred in respect of a golf tournament, such as T-shirts and golf balls with the company name and logo, would not be disallowed. However green fees would be disallowed.
The non-deductibility of green fees are now affecting golf courses because some businesses are replacing corporate golf tournaments with other forms of entertaining clients which would be 50% deductible as entertainment. The golf industry has set up a "fair Tax Committee" and hired a national Chartered Accounting firm to lobby on behalf of the 4.8 million golfers in Canada and approximately 335,000 people working at the golf courses.
Meals at The Golf Course - O.K
It was recently announced by Revenue Canada that the 50% deduction of the cost of business meals and beverages at a golf club will now be allowed. However, Revenue Canada requires that meal and beverage expenses incurred be clearly itemized. An all-inclusive charge that is not broken down will not be accepted.
Reserves for Bad Debts
Revenue Canada recently noted that general reserve is not permitted as a doubtful account deduction for income tax purposes. The loans in which a bad debt is claimed must be identified. Where a taxpayer can identify specific receivables that are doubtful as to collection, a reasonable reserve may be deducted.
The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a commentary such as this, a further review should be done. Every effort has been made to ensure the accuracy of the information contained in this commentary. However, because of the nature of the subject, no person or firm involved in the distribution or preparation of this commentary accepts any liability for its contents or use.