Chapter 3 Liability for Tax, Income Determination, and Administration of the Income Tax System

1. Chapter 3 Liability for Tax, Income Determination, and Administration of the Income Tax System • Primary source: Income Tax Act • Other sources: • Income tax regulations • Tax treaties • Tax cases • Bulletins, circulars, ruling, etc. published by CRA

2. The administrative process • Filing income tax return by taxpayers • Quick check by CRA and Notice of Assessment is issued • Filing Notice of Objection if taxpayers disagree • Taxpayers appeal to the Tax Court • Further appeal to the Federal Court • The Supreme Court is the ultimate arbiter

3. Structure of the Income Tax Act Part I – Income Tax • Division A – liability • Division B – computation of income • Division C – taxable income • Division D – non-residents • Division E – tax credits • Division E.1 – minimum tax

4. Division B - NIFTP • Employment income • Business income • Property income • Capital gains/losses • Other income/deductions

5. Income determination • Aggregate income from employment, business, property and other sources • Determine net taxable capital gains, i.e., taxable capital gains net of allowable capital losses • Sum up of (a) and (b), and net of other deductions • Aggregate losses from employment, business, and property, and allowable business investment losses (ABIL), and subtracted from (c)

6. Example - income determination A firm provides the following financial data: Business income $90,000 Gain on sale of land and building 24,000 Loss on sale of shares (40,000) Net income per financial statement $74,000

7. Additional information - Business income included accounting amortization of $37,000 - Capital cost allowance available as a tax deduction: Machinery $20,000 Equipments 12,000 Required: Compute the net income for tax purpose (NIFTP).

8. Tax planning - all parties • Planner considers the implication of taxes to all related parties, employees, employers, creditors, suppliers, etc.

9. Tax planning - all costs • Taxes represent only one among many business costs. • Non-tax costs: - financial reporting - capital and other regulations - risk sharing - incentive systems

10. Restriction to tax planningGeneral Anti-avoidance Rule (GAAR) • Intends to prevent abusive tax avoidance transactions arrangements but not interfere with legitimate commercial and family transactions • Tax benefits (tax reduction, avoidance, and deferral) from an avoidance transaction will be denied • Avoidance transaction: a transaction with no bona fide purposes other than getting tax benefits • Transactions that comply with the Act read as a whole will not be affected

11. Whether GAAR should be applied • 1. Does any other provisions of the Act apply? (no GAAR if yes) • 2 and 3. Does the transaction result in tax benefits or is the transaction part of a series of transactions which result in tax benefits? (no GAAR if no) • 4. Can the transaction be considered to have been undertaken for bona fide purposes other than to obtain tax benefits? (no GAAR if yes) • 5. Does the transaction result in a misuse of the provision of the Act or an abuse of the Act read as a whole? (no GAAR if no)

12. Examples • An individual transfers his unincorporated business to a corporation primarily to obtain the benefit of the small business deduction.

13. Examples • The owner of land agrees to sell the property to a purchaser. The purchaser wants to buy the property for cash, but the owner does not want to have the profits recognized in the year of sale. The owner sells the land to an intermediary deferring receipt of the proceeds for several years after the date of sale (so reserve can be claimed). The intermediary sells the land to the purchaser for cash.

14. Tax liability • An income tax is paid on the taxable incomefor each taxation yearof every personresidentin Canadaat any time in the year. • taxable income = income for the year – special deductions

15. Full-time individual resident • Criterion: (common law) a continuing state of relationship/ties with Canada. • the relationship/ties: - amount of time spent in Canada on a regular basis - motives for being present or absent - a dwelling - a family - personal property and social ties.

16. Deemed full-time • Sojourned in Canada in the year for an aggregate of 183 days or more. • Full-time resident will be taxed on his worldwide income for the whole year.

17. Part-time • A clean break or a fresh start • Transitional status • Part-time resident will be taxed on his worldwide income for the part of year while resident, and on his Canadian-source income for the part of year while non-resident.

18. Residence of corporation Deemed resident • Incorporated in Canada after April 26, 1965, or • Central management and control in Canada Non-resident

19. Non-resident Taxed on his income from • being employed in Canada, • carrying on business in Canada, • disposing of a taxable Canadian property, at any time in the year or a previous year

20. Chapter 4 Employment Income Employee vs. self-employed/independent contractor The courts consider the following tests: • Economic reality or entrepreneur test - control - ownership of tools - chance of profit/risk of loss • Integration or organization test • Specific result test

21. Structure Basic inclusion + benefits and allowance + ESO benefit - deductions allowed Basic inclusion: salary, wages, and other remuneration, including gratuities received

22. Example - payroll Salary gross $78,000 Payroll deductions: RPP 2,000 CPP 2,163 EI 747 Income tax withheld 17,000 Union dues 590 (22,500) ---------- Net salary $55,500 ======

23. Employee benefits All benefits are taxable except • Employer’s contributions to retirement plans including RPP and DPSP • Employer’s contribution to group sickness or accident insurance plan, private health services plan, supplementary unemployment benefits plan • Employer pays counselling services of mental or physical health and the re-employment or retirement

24. Fringe benefits & administrative practice [IT-470R] • Employer-paid social club membership is not taxable if for employer advantage • Employer-paid financial counselling and tax return preparation are included • Non-cash holiday gifts (up to 2 gifts) not over $500 are not taxable • Benefits from frequent-flyer accumulated through employer-paid trips are included

25. Taxable benefits • Special Benefit calculations apply to: • Use of employer automobiles • Loans from employers • Relocation expenses • Stock option benefits

26. Automobiles • To the extent that an automobile is for personal use, a taxable benefit results. • There are two components: • Standby charge, and • Operating cost benefit.

27. Standby charge Employer owns the automobile, standby charge = Original Cost Number of the x 2% x of Months Automobile Available

28. Standby charge • Employer leases the automobile, standby charge = Monthly Number Lease x 2/3 x of Months Cost Available

29. Reduced standby charge • Reduced when the distance travelled is primarily for employment duties (defined as 50% or more) • Personal use must be less than 20,000kms for the year • Multiplying the standby charge by non-employment km/1,667kms x #of months

30. Operating cost benefit Operating Costs = Prescribed rate ($0.24) x Personal kms or ½ of standby charge, if primarily for employment duties (defined as 50% or more)

31. Example A car is leased by company for $6,000 Operating costs paid by company for $4,800 Business use of car 14,000km Total use of car 24,000km Calculate taxable benefit.

32. Employee loans • Low-interest or interest-free loans provided by employers are a taxable benefit Taxable Benefit = Prescribed rate – actual interest paid

33. Employee loans—home purchase/relocation loans Rate used to determine the deemed interest benefit is the lesser of: • The prescribed rate in the quarter the loan was outstanding. • The prescribed rate in effect at the time the loan was granted. • If the prescribed rate declines, the lower rate can be used.

34. Employee loans - Example • Mr. Maple borrowed $70,000 from his employer on April 1,2010 at an annual rate of 2%, to purchase common shares of a public co. Interest was payable monthly. Note: the prescribed rates are: Q1 5%, Q2 5%, Q3 4%, Q4 7%

35. Relocation expenses Reimbursement of loss on sale of home: • First $15,000 – not taxable, but • one-half of any amount above $15,000 is taxable

36. Allowances • All allowances are taxable, subject to specific exceptions. • Allowance refers to: • a fixed, specified amount that is paid on a regular basis • over and above a normal salary • to cover certain expenses incurred

37. Deductions • Rule: no deductions allowed, unless specifically permitted • Most Common: • Travelling Expenses • Salesperson’s Expenses • Professional and Union Dues • Works Space in Home • Contributions to RPP

38. Travel expenses • Travel expenses incurred in the course of work-related duties provided that the following circumstances exist: • Ordinarily required to carry employment duties away from the employer’s place of business, • Employee is required to pay the travel costs, and • Has not received a non-taxable allowance designed to cover such costs.

39. Travel expenses • Travel expenses include: • Transportation • Meals –if away from the metropolitan area of the employer for at least 12 hours, and limited to 50% • Lodging

40. Travel expenses • Vehicle cost, subject to limitations, include: • Gas and oil, repairs, insurance, • Financing costs (interest), and • Capital cost or lease costs • Limitations to Vehicle Costs • Vehicle cost limited to $30,000 • Lease cost limited to $800 per month • Interest cost limited to $300 per month

41. Salesperson’s expenses • Deduct all amounts spent • Limited to commission earned • Items not limited to commission: • CCA on an automobile • Automobile financing costs

42. Salesperson’s expenses • The following items are specifically not deductible: • Payments for the use of a yacht, camp, lodge, or golf course • Membership fees or dues in a club • main purpose to provide dining, recreational, or sporting facilities to its members. • Capital expenditures that have a long-term benefit

43. Salesperson’s expenses Deductible items include: • Advertising and promotion • Telephone • Parking • Automobile • Supplies • Fees paid to assistants • Work space in home • Travel expenses

44. Work space in home • Permitted only when the work space is either: • The principal place duties are performed, or • If first condition not met, then: • Used exclusively for earning employment income, and • Used on a regular/continuous basis for meeting customers or clients

45. Work space in homeallowable costs • Non-salesperson: • Appropriate portion of maintenance and utility costs. • Salesperson: • The preceding items, plus an appropriate percentage of property taxes and house insurance premiums.

46. Chapter 5 Business Income • Business Income Defined • General Rules for Determining Business Income • Deductions denied and allowed

47. Business income defined • Can be earned by all three of the taxable entities – individuals, corporations, and trusts • Should be carried on with a “reasonable expectation of profit.”

48. General rules for determining business income • The Act: “A taxpayer’s income for a taxation year from a business is the profit therefrom for the year” • Business income for tax purposes is the profit determined in accordance with well-established business principles (such as IFRS/ GAAP). • IFRS/GAAP is good starting point – adjustments are made where the Act specifies other requirements.

49. IFRS/GAAP and ITA • Similarities: • Accrual • Net Concept • Major Differences: • Amortization (Depreciation) • Other Allocations • Permanent Differences • Non-Arm’s Length Transactions

50. IFRS/GAAP and the ITA Net IFRS/GAAP Income XXX Add: Expenses not allowed • Disallowed deductions XXX • Unreasonable amounts XXX XXX Deduct: Expenses specifically allowed (XXX) Net income from a business for tax purposes XXX ====