2001 4th Quarter, Issue No. 56
YEAR-END TAX PLANNING
56(1)
Some 2001 year-end tax planning tips include:
- If the following expenditures are made by individuals by December 31, 2001 they will be eligible for 2001 tax deductions: moving expenses, child care expenses, safety deposit box fees, charitable donations, political contributions and medical expenses.
- 2001 eligible Registered Retirement Savings Plan (RRSP) contribution amounts are noted on the 2000 personal income tax return assessment notices. You have until March 1, 2002 to make tax deductible RRSP contributions for the 2001 year.
Consider contributing to a spousal RRSP to achieve income splitting in the future.
The maximum 2001 addition to deductible RRSP contribution room is $13,500. $75,000 of 2001 earned income is needed to reach this maximum.
- Persons turning age 69 in 2001 must mature their RRSP into cash, an annuity or a Registered Retirement Income Fund by December 31, 2001. Certain 2001 excess contributions may be deducted in the year 2002 if contribution room is available.
- If you own a business, consider paying a reasonable salary to family members for their services rendered to the business.
- Ensure that all deductible alimony or maintenance payments are made by December 31, 2001.
- An individual whose 2001 net income exceeds $55,309 will lose all, or part, of their old age security.
Senior citizens will begin to lose their income tax age credit if net income exceeds $26,941.
Individuals facing these problems should contact their professional advisors for assistance in managing their 2001 personal income.
- Consider purchasing assets eligible for capital cost allowance before the yearend. For example, employees may claim capital cost allowance on automobiles, aircraft and musical instruments required to be used in their employment.
- If you had taxable capital gains in the year, or any of the preceding three years, consider selling capital properties with an underlying capital loss prior to the yearend. This capital loss may be offset against capital gains in the year, or in the three preceding years.
- If income in an inter vivos trust is to be taxed on a beneficiary's return, the income must be paid or payable to the beneficiary by December 31, 2001.
- Individuals may claim a tax credit related to the interest portion of student loan payments made in 2001.
- Registered Education Savings Plan (RESP)
A Canada Education Savings Grant (CESG) for RESP contributions will be permitted equal to 20% of annual contributions for beneficiaries up to and including age 17 (maximum $400 per child per year).
However, contributions for 16 and 17 year olds will only qualify for certain previous plans.
- Health and dental premiums for the self-employed
Individuals will be allowed to deduct amounts payable in respect of the year for Private Health Service Plan coverage in computing business income provided they are actively engaged alone, or as a partner, in their business, and either self-employment is their primary source of income or their income from other sources does not exceed $10,000.
- Tax on Split Income
The Income Tax Act applies the maximum marginal tax rate to certain passive income of individuals under the age of 18.
This includes:
- Taxable dividends, and other shareholder benefits, on unlisted shares of Canadian and foreign companies (received directly or through a trust or partnership); and
- Income from a partnership or trust where the income is derived from providing goods or services to a business carried on by a relative of the child or, of which the relative participates.
Therefore, consider minimizing this type of income in 2001.
- Same-Sex Common-Law Couples
The Income Tax Act extends benefits and obligations to same-sex couples effective 2001. If the couple elects, it will also be effective for the years 1998, 1999 and 2000.
- The tax rate for higher income individuals is now significantly lower on capital gains than on dividends thereby presenting an incentive to receive capital gains.
- Canadian resident shareholders receiving shares in foreign tax-free reorganizations will be able to treat the shares as a reduction in adjusted cost base, as opposed to a taxable dividend.
2001 REMUNERATION
56(2)
Some general guidelines to follow in remunerating the owner of a Canadian-controlled private corporation earning "active business income" include:
- In general, bonus down active business earnings in excess of $200,000. However, leaving corporate active business income at over $200,000 but less than $300,000, may present a tax deferral but there will likely be an overall higher tax to pay when dividends are finally paid out. Some companies may find it advantageous to bonus down to $300,000.
- Elect to pay out tax-free "capital dividend account" dividends.
- Consider paying dividends to obtain a refund of "refundable dividend tax on hand".
- Corporate earnings in excess of personal requirements could be left in the company to obtain a tax deferral. The effect on the "Qualified Small Business Corporation" status should be reviewed before selling the shares.
- Dividends, as opposed to salaries, will reduce an individual's cumulative net investment loss balance thereby providing greater access to the capital gain exemption.
- Retaining income in the corporation may adversely effect provincial and federal capital tax and certain provincial clawbacks.
- Excessive personal income affects receipts subject to clawbacks, such as old age security.
- Salary payments require source deductions to be remitted to Revenue Canada on a timely basis.
- Individuals that wish to contribute to the Canada Pension Plan or a Registered Retirement Savings Plan may require a salary to create "earned income".
- Salaries paid to family members must be reasonable.
- Some provinces have "payroll taxes" thereby increasing the costs of paying salaries versus dividends.
PERSONAL TAX
56(3)
MEDICAL EXPENSES
In a Tax Court case, the Court found that $703 paid to a pharmacist for vitamin supplements by an HIV patient, as prescribed by a physician, were eligible medical expenses.
Also, travel costs and expenditures to receive therapeutic touch treatment in Washington State by medical doctors were considered as medical expenses even though the same type of treatment was available in her town in Victoria, but not nearly the same quality.
Also, in another Tax Court case, the taxpayer suffered severe chronic pain and was prescribed by a doctor to take various herbs, enzymes and vitamins. The Court permitted a medical expense for the herbs and vitamins purchased at two pharmacies for a total of $533. The Judge noted that this was not an "open invitation" for vitamin and herb medical expenses. The decision is limited to those taxpayers in rare situations who suffer severe medical problems and acquire vitamins and related matters through a pharmacist as prescribed by a medical practitioner or dentist.
In another Tax Court case, the Court permitted as a medical expense the costs to replace carpeting with hardwood floor and install an air cleaner to resolve the serious asthmatic condition of their son as prescribed by a medical doctor.
Also, in a Technical Interpretation, Canada Customs and Revenue Agency (CCRA) noted that a custom-built shower with appropriate grab bars and seat would qualify as a medical expense for a person with a severe and prolonged mobility impairment.
MOVING EXPENSES
In a Technical Interpretation, CCRA confirmed that where an individual moves and is reimbursed by his employer for the mortgage interest on the former house pending its sale, this reimbursement is normally a taxable benefit.
However, they permit a deduction for interest, property taxes, insurance premiums and heating and utility costs, to a maximum of $5,000, for the old residence during the period that reasonable efforts are being made to sell it, and it is neither rented out nor occupied by the taxpayer or a member of the taxpayer's household.
EMPLOYMENT
56(4)
LONG-TERM DISABILITY INSURANCE SETTLEMENT
In a Tax Court case, the taxpayer was injured in a motor vehicle accident and had to sue the insurer for the long-term disability benefit payouts. He received a Court-ordered settlement of $82,500.
The settlement was based on $1,389 per month, minus $516 for CPP disability, leaving $873 per month for 6.5 years plus $15,000 as a contribution to legal expenses.
Good News!
The Court found that the lump-sum settlement was not taxable because the Income Tax Act only taxes amounts received on a periodic basis under a disability insurance plan. This was a lump-sum payment.
REDUCED STANDBY CHARGE
In a Tax Court case, the taxpayer claimed a reduced automobile standby charge on the basis that his business use of the vehicle was more than 90% even though he did not maintain a log for the period in question. The Court allowed the reduced standby charge and noted that even though the appellant does not have any records pertaining to the use of his company car for the years under audit (1996, 1997 and 1998), this does not necessarily bar him from claiming a reduced standby charge. Corroborating oral and other evidence, if credible, can discharge the Appellant's evidentiary task of proving on a balance of probability that he used the car more than 90% for employment purposes.
The taxpayer prepared a travel log for 1999 and stated that his work duties and travel schedules in 1999 were the same as in the years under audit.
Editor's Comment
Keeping a log for the year under audit may prevent the cost, time, inconvenience and uncertainty of a Court case.
INVESTMENT INCOME
56(5)
INTEREST
Individuals are required to report accrued interest annually on the anniversary date of the investment. For example, if an August, 2001 Treasury Bill is acquired for $89,000 to mature in November, 2001 for $90,000, the $1,000 of interest must be reported in 2001. However, if the Treasury Bill matured in January, 2002, the reporting of the interest could be delayed until 2002.
If, say, a five-year term deposit is acquired for $80,000 in October, 2001 and accrues interest of $4,000 a year, the $4,000 must be reported in income each year beginning with the 2002 year.
Planning
A maturity or anniversary date in January, rather than, say, December, will defer the reporting for one year.
MARRIAGE BREAKDOWN
56(6)
EQUIVALENT-TO-SPOUSE CREDIT
In a Tax Court case, Mr. and Mrs. B divorced and had joint custody of their daughter. In 1998 Mr. and Mrs. B agreed that the daughter would live with Mr. B for all of the year, except for weekends, and Mrs. B would give up the $500 child support on the basis that Mr. B will be responsible for clothing, school and extracurricular activity expenses. Both parents claimed the equivalent-to-spouse tax credit because they could not agree as to whom may claim the credit.
The Court permitted the credit to Mr. B on the basis that the daughter was wholly dependent for support on Mr. B and living in his residence.
SAME-SEX PARTNERS - RRSP ROLLOVER
In a Technical Interpretation, CCRA note that beginning with the 2001 taxation year the term "common-law partner" extends spousal provisions to unmarried same-sex couples. For example, a transfer of RRSPs on a breakdown of a common-law partnership is allowed if the transfer is made under a decree, order or judgment of a competent tribunal, or under a written separation agreement relating to a division of property.
Editor's Comment
This may also apply to the years 1998, 1999 or 2000 if jointly elected by the common-law partners.
ARREARS
In a District Office Memo, CCRA notes that where arrears are settled for an amount which is less than the total periodic amounts due, the amounts paid and received, whether as a lump sum or by way of installments, would not generally be deductible to the payor or taxable to the recipient.
STOCK OPTIONS
56(7)
Stock options were discussed in a May 7, 2001 Paper by CCRA which notes that:
History
Stock options are used by corporations to attract and retain key employees, most notably in the fast-growing high technology industries. Also, cash strapped startup companies may use stock options as the primary source of future revenue for employees.
Other than in the case of stock options granted by certain Canadian-controlled private corporations (CCPCs) and certain publicly listed shares, stock option benefits are generally taxed in the year that an employee acquires a share equal to the difference between the fair market value of the share at the time the option is exercised and the amount paid to acquire the share. Consequently, employees with insufficient cash to pay the income taxes resulting from the stock option benefit inclusion may be forced to sell some of their shares. In the case of CCPCs and publicly listed shares, the taxable employment benefit is generally deferred until the year of disposition of the share.
Publicly Listed Shares
The February 28, 2000 Budget, subject to an annual $100,000 limit, defers the employee income inclusion from exercising stock options after February 27, 2000 until the earlier of the employee's death, the employee ceasing to be a resident of Canada or, the employee's disposition of the shares.
A number of conditions must be met to qualify including the employee must be a Canadian resident, the share is listed on a Canadian or foreign prescribed stock exchange, the amount paid by the employee to acquire the security was not less than the fair market value of the security when the option was granted, the employee was dealing at arm's length immediately after the option was granted with the employer, the share is an ordinary common share, and immediately after the option was granted, the employee was not a specified shareholder of the employer. (A 10% test)
Subsequent Decrease in Fair Market Value
Many employees had to report significant taxable benefits in 2000 even though the shares had dropped significantly in value as a result of the recent decline in the markets. For example, if shares valued at $100 are acquired under a stock option for $20 and then subsequently drop in value to $20 when they are sold, the employee will have a $80 taxable employment benefit and a $40 allowable capital loss ($80 capital loss @ 50% allowed). Any allowable capital loss can only be offset against taxable capital gains and cannot be applied against previous employment benefits.
However, this issue is under review and when a final determination is made by Finance taxpayers will be informed.
Possible Changes
The Canadian Advanced Technology Alliance (CATA) are lobbying CCRA and the Department of Finance for changes which would prevent this problem.
CATA wants employees who exercise stock options to only pay tax on the difference between the option price and the price at which the employee finally sells the shares.
FARMING
56(8)
SALE OF TIMBER RIGHTS
In a Tax Court case, the farmer sold timber rights in 1992 thereby triggering a capital gain of $76,000 which was incorrectly not reported on the return.
Upon discovering the 1992 taxable capital gain, CCRA reassessed this and did not allow the capital gain exemption.
Good News!
Upon review, the Court found that the taxpayer should be allowed to claim the capital gain exemption because the omission of claiming the exemption was done innocently and not with the intent to defraud CCRA.
CANADA CUSTOMS AND REVENUE AGENCY (CCRA)
56(9)
TAX PROTESTER HIT
On August 30, 2001, CCRA announced that Mr. L and his corporation were fined more than $2.4 million after being found guilty of tax evasion. Mr. L was also sentenced to more than five years in jail. Mr. L failed to file both personal and corporate tax returns for the 1993 through 1998 tax years and failed to report more than $8 million of income.
Mr. L unsuccessfully argued that income tax was unconstitutional and that the Income Tax Act was invalid and unenforceable.
TAX SHELTERS
In an August 14, 2001 Publication, CCRA warned potential investors to be wary of any tax shelter promotion where the anticipated net return in the first few years comes mainly from projected income tax refunds, especially where:
- no real business activity will be carried on,
- the business has no reasonable expectation of profit,
- the expenses are inflated or unreasonably high,
- losses for tax purposes will exceed the amount of the investment that is actually at risk, or
- the promoter or others are making verbal assurances of income tax consequences that are different from, or are not confirmed by, professional opinions contained in the investment documents.
Even if the tax shelter has an Advance Income Tax Ruling, CCRA warn that they do not generally Rule on the above-mentioned items. Therefore, the Ruling does not necessarily guarantee proposed deductions.
CHARITABLE DONATIONS
56(10)
REGISTERED CHARITIES NEWSLETTER NO. 11
This eight-page newsletter notes that:
- An example of charities that were challenged by CCRA involved Mr. J, the executive director of three religious charities. Mr. J was found guilty of tax evasion when he unsuccessfully argued that he did not have direct knowledge of the donations tendered and that his wife filled out the particulars on the receipts.
The evidence showed that he issued tax receipts far in excess of the amounts received from the donors.
Mr. J was ordered to perform 240 hours of community work and was fined $32,000 (50% of the $64,000 in tax evasion).
- From the year April 1, 1999 to March 31, 2000 the CCRA Charities Directorate received 3,974 new applications for registration, registered 3,285 organizations, advised 885 applicants that they did not qualify, revoked 2,742 charities because they did not file their annual Registered Charity Information Return (Form T3010) in the six month period after their fiscal year-end, and audited 419 charities, most of whom had complied with the Income Tax Act.
Some charities misunderstood the requirement to keep adequate books and records and were given a letter of explanation by CCRA.
CULTURAL PROPERTY
On August 22, 2001 CCRA introduced revised IT-407R regarding donations of cultural property (example, works of art, antiques) to designated Canadian institutions (example, art galleries, museums).
The advantages include an exemption from the capital gains realized on the disposition, and a donation for the fair market value.
REGISTERED RETIREMENT SAVINGS PLAN (RRSP)
56(11)
LOCKED-IN RRSP
Up to 10,000 investors in Ontario, Quebec and Western Canada were taken in by a scheme where locked-in retirement savings were swapped for near-worthless shares in private corporations for a fee of 30% or more of a pension's value.
In another version, "loans" were given to the RRSP holder using the locked-in accounts as collateral. CCRA notes that this triggers a deregistration of the RRSP.
Securities and pension authorities are co-operating with the RCMP and commercial crime divisions to attack these schemes.
GST
56(12)
NEW RESIDENTIAL RENTAL PROPERTY REBATE
On August 7, 2001 CCRA introduced a twenty-nine page Guide RC4231 - GST/HST New Residential Rental Property Rebate.
The Guide provides information for landlords of residential rental properties on how to apply for the rebate and how to complete Forms GST524 and 525.
GST/HST TELEFILE
Businesses may now file GST/HST returns through TELEFILE offered to business clients on an invitation-only basis.
An Access Code will be printed on the business' personalized GST/HST return.
The return must also have a nil balance or a refund of $10,000 or less, and cannot be making a rebate claim.
For more information, see www.ccra.gc.ca./gsthst-telefile
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.
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