2002 2nd Quarter, Issue No. 58
PERSONAL TAX
58(1)
SAME-SEX COUPLES
A Canada Customs and Revenue Agency (CCRA) website (www.ccra-adrc.gc.ca/ tax/individuals/faq/same_sex-e.html) has a nine-page Release on same-sex couples including fourteen questions and answers on the general tax implications and four questions and answers on the Canada Child Tax Benefit and the GST/HST credit.
These new same-sex couple tax rules are effective in 2001 and, may be used on an elective basis in 2000, 1999 or 1998.
MEDICAL EXPENSE - CELIAC DISEASE
In a March 22, 2002 Federal Court of Appeal case, the Federal Court found that Mr. H was entitled to the disability tax credit on the basis that his "celiac disease" markedly restricted his activities of daily living by requiring an inordinate amount of time to feed himself because of the requirements to prepare gluten-free diets. However, the Court also noted that persons with celiac disease, or other medical conditions that impose dietary restrictions, are eligible for the disability tax credit only if they establish that they require an inordinate amount of time to find, procure and prepare foods that can be safely eaten. Differences in the severity of the disease could result in different conclusions.
CANADA CHILD TAX BENEFIT (CCTB)
The Income Tax Act provides for a non-taxable monthly CCTB payment to the custodial parent (who is usually the mother) of children under the age of 18. The CCTB is reduced by 5% of the parents' net family income over $32,000.
In a March 8, 2002 Tax Court case, the Court found that the male parent was the one entitled to the CCTB because the children resided with him and, he was the primary caregiver. This became an issue when his former spouse claimed that she was the primary caregiver.
EMPLOYMENT INCOME
58(2)
PHANTOM STOCK PLAN
In a 2001 Advance Income Tax Ruling, a public corporation introduced a performance incentive plan for certain employees. For example, if the bonus is $210 and the employer's shares are valued at $21 per share, the employee would be allocated ten "Deferred Stock Units" which may be redeemed and included in income at a later date (say retirement).
If the shares are worth $30 per share at retirement, the employer would pay $300 - which would only be taxable at that time. This provides incentive to the employee to grow the share value.
GIFTS AND AWARDS
In a new CCRA website (www.ccra-adrc.gc.ca/tax/business/payroll/gifts/examples-e.html), CCRA includes a five-page explanation of the new policy effective January 1, 2001 on non-taxable/tax deductible gifts or awards of up to $500. For example, a wedding gift (crystal vase of $230) and an award for twenty-five years of service (a watch of $350) would both be non-taxable because the gift and the award are each under $500. They would be deductible to the employer. This implies that an employee may receive up to $500 of bona fide gifts and, up to $500 of bona fide awards on a non-taxable basis each year.
However, a gift certificate would be taxable because it is considered to be near-cash and not subject to this policy.
Also, ten other questions and answers on gifts and awards are included on CCRA website www.ccra-adrc.gc.ca/tax/business/payroll/gifts/faq-e.html.
Caution
In a January 10, 2002 Technical Interpretation, CCRA notes that this new policy may not apply to gifts and awards given by closely held corporations to their shareholders or their relatives, since these gifts and awards are normally considered to be received in their capacity as shareholders - not employees.
EMPLOYEE VS. INDEPENDENT CONTRACTOR
An article in the Beausejour newspaper highlights the problem that a local trucking corporation (Lakeland Inc.) had with CCRA. In a CCRA reassessment against Lakeland, CCRA took the position that any truck operator who leased equipment from Lakeland was an employee of Lakeland and, therefore, reassessed Lakeland for payroll deductions, plus interest and penalties for all leases entered into by Lakeland back to 1997. Even though Lakeland plans to appeal the case to the Tax Court, CCRA seized their bank accounts and receivables of $380,000 which, "rendered Lakeland incapable of meeting their financial obligations".
Also, a Tax Court case was heard in Calgary in September, 2001 where CCRA had assessed for unremitted CPP and EI on the basis that over one hundred sales and cable T.V. and internet installers for Shaw Communications Inc. were employees rather than independent contractors. The decision is pending.
RETIRING ALLOWANCE
In a February 15, 2002 Technical Interpretation, CCRA note that a payment on employment termination for unused sick leave credits may qualify as a retiring allowance. A retiring allowance is eligible for a rollover to an RRSP, within prescribed limits, for years of service before 1996.
Alternatively, an accumulated vacation leave payment is considered to be ordinary employment income, and not a retiring allowance.
BUSINESS/PROPERTY INCOME
58(3)
REASONABLE EXPECTATION OF PROFIT (REOP)
In a January 9, 2002 Tax Court case, the Court noted that the rental losses on a condominium at Whistler, British Columbia should be allowed because:
- There was no personal element. Neither the taxpayer, their friends or family used the property.
- CCRA is simply second-guessing the appellant's business judgment.
- CCRA did not allow a reasonable period of time to earn income.
In a September 5, 2001 Tax Court case, Mr. W commenced to carry on a lawn maintenance business in 1989 but suffered losses each year, including losses of $39,000, $40,000 and $41,000 in the years 1994, 1995 and 1996. CCRA disallowed the 1994 to 1996 losses on the basis that there was no REOP.
Good News!
The Court noted that there were no expenditures that were even "blurry" as between business and personal - there were no entertainment expenses, no personal car usages, no convention and promotion expenses. Every expense was directly applied to a "business" activity. The fact that losses may not be recovered in the foreseeable future is not a bar to the claiming of such losses. When there is a genuine business, losses can be sustained, depending on the circumstances, as long as the losses cannot be disallowed for other reasons such as personal or capital.
STRIP BONDS
In a February 27, 2002 Technical Interpretation, CCRA note that interest must be included in income over the period of ownership of the strip bond.
Generally, the interest income will be included in each taxation year on the strip bond's anniversary day.
UNIVERSAL LIFE INSURANCE
A tax exempt universal life insurance policy (UL) provides a tax sheltered investment. The portion of the premium which is used for investments accumulates tax free. Upon death, the face value of the policy, plus the accumulated investments, may be paid out tax free to the beneficiaries.
ULs are often advertised on the basis that withdrawals of the accumulated investments may be made during lifetime or, loans could be made against the policy. Upon death, the insurance proceeds would be used to pay off the debt.
This was discussed in the April 20, 2002 issue of the Financial Post. Some points noted include:
- ULs have attracted $40 billion, or 30% of the $134 billion face amount of new insurance coverage purchased in 2001.
- Even though UL is a form of permanent insurance which provides a tax free death benefit and a tax deferred investment component, one potential problem is the high commissions and management expense ratios (MERs) on the underlying investments in the UL.
- ULs are sometimes sold with overly aggressive return assumptions.
- There usually are surrender charges when a policy is cancelled within the first ten years. Cancellation may even trigger a tax liability.
FOREIGN SPIN-OFFS
A "foreign spin-off" is a reorganization where a Canadian resident shareholder of a foreign corporation receives from that corporation shares in another foreign corporation.
In an April 16, 2002 CCRA Release, CCRA note that the election to allow a tax deferral of foreign spin-off shares must have been filed by September 11, 2001 for taxation years 1998, 1999 and 2000.
Good News!
CCRA also announced that they may accept a late election, subject to late-filed penalties, under the "fairness provisions" of the Income Tax Act.
CCRA website www.ccra-adrc.gc.ca/tax/business/taxtopics/foreign-e.html includes ten pages of information.
CAPITAL GAINS
58(4)
CAPITAL GAINS DEFERRAL
In a December 13, 2001 Technical Interpretation, CCRA comment on the up to $2 million capital gain deferral on the sale of "eligible small business corporation" (ESBC) shares when replacement ESBC shares are acquired. Points mentioned include:
- An ESBC share is a common share issued by a Canadian-controlled private corporation to an individual if all, or substantially all, of the fair market value of the assets are used primarily in an active business carried on primarily in Canada by the corporation or by a related ESBC; shares or debt owing by other ESBCs or a combination of the above.
- A gain on the sale of a share acquired from a third party will not qualify for a deferral because it must be a share acquired from Treasury to be an ESBC.
Also, in a March 25, 2002 Technical Interpretation, CCRA note that this does not apply where more than 50% of the fair market value of the property of the corporation (net of debts incurred to acquire the property) is attributable to real property. Therefore, shares of a farm corporation likely would not qualify for the deferral unless the farmland was highly leveraged with debt.
Other tests that must be met, include:
- the shares must have been owned by the individual throughout the 185-day period that ended immediately before the disposition, and
- the replacement share must be acquired by the individual in the year, or within 60 days after the end of the year, but not later than 120 days after the qualifying disposition.
INCOME SPLITTING
58(5)
2% LOANS
If a person makes a loan to a non-arm's length person and charges the prescribed rate of interest on the loan, income earned on the money by the borrower is not attributable to the lender as long as the interest is paid within thirty days after the end of each year.
The prescribed interest rate for loans made in the second quarter of 2002 is 2%. The prescribed interest rate has not been this low since introduced in 1984.
IN-TRUST ACCOUNTS
In-trust accounts are usually funded by the parents for a child or grandchild. Most financial institutions require that the account be opened in the name of a parent with the account designated "in-trust". Even though the attribution rules apply on investment income, they do not apply on capital gains.
In many cases, the "in-trust account" is not a legal trust and, therefore, avoids trust tax filings and statutory requirements. However, the child is now the owner of the asset.
The parent loses control of the amounts unless there is a full fledged "trust" established. A trust could provide the parent with control as to beneficiaries, distributions and so on. Therefore, for large amounts, it may be advisable to use a legally structured trust.
If a full fledged trust is not used, it is important to have proper documentation - which is usually provided by the financial institution.
Also, the child's social insurance number (S.I.N.) should be used for the account as problems with CCRA may arise if the parent's S.I.N. is used because of CCRA's computer matching program.
DIRECTOR LIABILITY
58(6)
In a January 18, 2002 Tax Court case, a furniture retail company was in financial difficulty from September 1, 1994 to June 30, 1995 when it did not remit its monthly GST returns. On July 18, 1995 it made a proposal to its creditors under the Bankruptcy Act.
Mr. V, the director, was held personally liable by CCRA and the Tax Court for the unremitted GST of $73,869 on the basis that he was aware of the financial difficulties and the unreported GST. He appeared to have made a deliberate attempt to keep the company alive by using the remittances to satisfy creditors. Even though he attempted to put the blame on the accountant, the Court noted it was clear that he was an inside director, experienced, knowledgeable and active in the company's business, and should have been, and in the Court's view was aware, that the company was not, for an extended period, making its GST remittances.
In another January, 2002 Tax Court case, CCRA assessed Mr. E as a director for unremitted payroll source deductions of $735,736 even though he did not own any stock and served only as an outside director.
Good News!
Mr. E was not liable on the basis that he acted as a reasonably prudent person. Nothing in the financial statements gave Mr. E any idea that the remittances of source deductions were not being made. There was nothing he could have done to prevent the failure.
An outside director is only required to use reasonable care to prevent defalcation.
MARRIAGE BREAKDOWN
58(7)
LIVING SEPARATE AND APART
In a November 28, 2001 Tax Court case, Mr. R claimed certain tax credits on the basis that he was "living separate and apart" from his spouse by a reason of the breakdown of their marriage, even though they continued to live in the same house. The Court noted that it is possible to "live separate and apart" and still be living in the same house however, the onus of proof is on the taxpayer and the facts must be strong.
Bad News!
Based on the facts, the spouses were not living separate and apart because of the breakdown of their marriage. The finances were still intertwined, the communication was more than one would normally expect from separated persons, they shared domestic duties and their social activities were limited, but not non-existent.
THIRD PARTY PAYMENTS
In a November 10, 2000 Tax Court case, the Court noted that third party payments, such as mortgage payments and municipal and school taxes, are deductible if the Marriage Breakdown Agreement refers to Subsections 60.1(2) and 56.1(2). This confirms that both parties know there are tax consequences to such an Order. An Oral Agreement or consent by the recipient does not fulfil this criteria.
ARREARS
In a February 15, 2002 Technical Interpretation, CCRA notes that arrears settled for an amount less than the total unpaid periodic payments, whether as a lump sum or by installments, would not be deductible to the payor or taxable to the recipient.
Interest in respect of arrears (or in respect of a reduced amount) would not be deductible to the payor but would be taxable to the recipient.
CHILD SUPPORT - AMENDING AGREEMENT
In a March 6, 2002 Technical Interpretation, Individuals A and B became divorced prior to April, 1997. A was required to make deductible/taxable child support payments to B. However, after the child support income tax rules changed in April, 1997, A and B entered into an Amending Agreement which provided for an increase in the child support. Therefore, the child support payments were no longer deductible/taxable. The Court noted that even if the Agreement indicates that, for income tax purposes, the payments are deductible/taxable this is not determinative of the tax consequences.
FARMING
58(8)
RETIRING ALLOWANCE (RA)
In a 2001 Advance Income Tax Ruling, CCRA ruled that where Farmer A employed his spouse in the farming operation, even though salary was not paid in all the years, Farmer A may pay the spouse a retiring allowance to be rolled over to an RRSP within the prescribed limits for pre-1996 employment.
The employment duties of the spouse were picking rocks, harrowing/packing during seeding, cultivating, summer fallow, combining and truck driving during harvest, and numerous other farm-related duties.
INVESTMENT TAX CREDITS (ITCs)
In a February 6, 2002 CCRA News Release, CCRA notes that ITCs will be available to farmers who make financial contributions towards scientific research and experimental development (SR&ED) through agricultural organizations often referred to as check-offs, assessments, or levies.
More information may be obtained at www.ccra-adrc.gc.ca/newsroom/releases/2002/feb/agrifood-e.html.
RRSP/PENSIONS
58(9)
RRSP BENEFICIARY
If the beneficiary of an RRSP is a child or a grandchild of the deceased who is financially dependent on the deceased at the time of death as a result of a mental or physical infirmity, the RRSP may be transferred to an RRSP, RRIF or annuity for that child.
Where the child is a minor who is financially dependent, but not mentally or physically infirm, the child may use the funds to acquire an annuity up to age 18.
CCRA normally takes the position that a child is not financially dependent if his/her income for the year prior to death was greater than the "basic personal amount" - $7,634 for 2002, unless the taxpayer can prove otherwise.
INDIVIDUAL PENSION PLANS (IPP)
An IPP is a defined benefit pension plan for an owner-manager of a corporation. However, contributions to an IPP reduce RRSP contribution levels.
The IPP contribution is made on a tax-deductible basis by the corporation for the owner. It usually provides higher contributions than RRSPs, based on actuarial evaluations. It also provides creditor protection under Provincial Pension Acts.
At retirement, the owner-manager may transfer the accumulated money to a Locked In Retirement Fund (LIRF) or acquire an annuity and take income as needed within certain boundaries. To implement an IPP, an actuary will be required. The fees could be in the $1,000 per year range with initial setup and wind-down fees in the $2,000 to $3,000 range and, three year tri-annual valuation reports in the $1,000 range. Also, an asset manager or pension consultant may be involved in the investment of the funds and required paperwork.
IPPs are complicated and require ongoing consultation with advisors, such as actuaries.
Actuarial calculations show that IPPs make the most sense for individuals aged fifty plus having annual personal earnings of $100,000 or more.
INTERNATIONAL
58(10)
U.S. ESTATE TAXES AND GIFT TAXES - PENALTIES
The U.S. Internal Revenue Code includes penalties for unreported taxes based on valuations which were not entered into in "good faith". The Estate and Gift Tax penalties are 20% if the value claimed on the tax return is 25% to 49% of the actual value; and 40% if the value on the return is less than 25% of the actual value.
For example, in a July 6, 2001 case the penalties were $30 million U.S. on a tax deficiency of $76 million.
CANADIAN RESIDENTS
CCRA recently introduced IT-221R3 which explains their position concerning an individual's residence status for income tax purposes. The IT looks at factual residence upon entering or leaving Canada such as residential ties, regularity and length of visits to Canada, and residential ties elsewhere.
GST
58(11)
ALLOWANCES AND REIMBURSEMENTS
Where an employer reimburses an employee for costs incurred in employment, there is usually no taxable benefit for income tax purposes. The Excise Tax Act usually deems GST to be included in the reimbursement. Therefore, an input tax credit (ITC) is allowed to the employer based on the amount of GST payable. However, as an option, the employer may simply claim an ITC for 6/106 of the reimbursement.
Also, where the employer pays a non-taxable allowance to an employee (for example, a per-kilometre payment for the employment use of a vehicle), the amounts are not included in income by the employee and are eligible for an ITC to the employer based on 7/107 of the allowance for provinces not participating in the HST system and 15/115 of the allowance in provinces participating in the HST system.
If an allowance is unreasonable and, therefore included in income by the recipient, no ITC will be available to the employer. However, if the employee deducts expenses against this amount he/she would be eligible for a GST rebate.
WHAT'S NEW
Starting in July, 2002, CCRA will recalculate the GST/HST credit as soon as they are advised about changes to your family situation, such as births, deaths, marriages, reaching the age of nineteen years, and becoming or ceasing to be resident in Canada.
For example, if a taxpayer turns nineteen before April 1, 2003, he/she may apply for the GST/HST credit on a 2001 Personal Tax Return. If you became a resident of Canada in 2002, you can apply for the GST/HST credit by completing Form RC151.
If there is a change in marital status, the taxpayer is asked to inform CCRA in writing at their respective Taxation Centre.
The GST/HST credit is available to lower income Canadians.
DID YOU KNOW...
58(12)
INSURANCE REFUNDS
In a March 7, 2002 Supreme Court case involving Co-operators General Insurance Co. (Co-operators), the Court found that motorists who have written off vehicles in the last twenty years will have a case to recover their deductibles, averaging between $500 and $1,000, from their insurance companies. More than twenty class-action suits have commenced in the six provinces that do not have government car insurance plans - Ontario, Alberta, New Brunswick, Nova Scotia, Newfoundland and Prince Edward Island. As many as two million Canadians could be eligible for refunds of their insurance deductibles, dating back more than twenty years.
In this case, Gary McNaughton of Newbury, Ontario wrote off his 1992 Chevy Van in 1998 and lost his $1,000 deductible when he was only paid $7,235 (not $8,235) by Co-operators. Co-operators then sold the van for salvage recovering $1,419. The Court noted that this is "double dipping". If the insurance company wants the wrecked vehicle, they cannot withhold the deductible.
CPP BENEFITS - SAME-SEX COUPLES
Two class-action suits were launched in Vancouver and Toronto on behalf of thousands of same-sex couples who were denied survivor benefits under the Canada Pension Plan for deaths prior to January 1, 1998. The January 1, 1998 date was arbitrarily set by CCRA when it introduced Bill C-23 which grants a variety of rights to same-sex couples. Lawyers in Halifax, Winnipeg, Saskatoon and Vancouver had news conferences to announce the class-action.
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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