I’m a happy guy, mostly. Except for right now. You see, I’ve kept the secret of tax law from you and I feel shame; perhaps not the same kind of shame felt by Tiger, or Dave, or Bill or the whole NBA (except for Steve Nash). After all, their shame comes from a deeper, more spiritual desire to atone for getting caught. I reckon that I have not had intimate relations with too many of the readers of this column. So my shame comes from a different place. My team of counsellors say that my shame is borne from the fact that I have not spoken plainly. I’ve acted unlawerly by shading the truth with jokes and big city words. Well no longer.
Here’s the secret of tax law: Every transfer of property is taxable. That’s it. The Income Tax Act (“ITA”), 1700 pages and nearly 300 sections of impenetrable code, distilled to a 6 word secret golden rule. Blair wanted me to also explain that finding ways around the secret golden rule is the essence of tax planning - I told him to get his own column.
A made up story will illustrate. Audits are never, ever, ever like what I am about to describe.
A client of mine (known as “the Beav”) owns all the shares of a private corporation that builds and sells condos. During the recent economic slowdown the Beav decided to let his dad (we’ll call him “Ward”), a retired fellow, stay in one of the unsold condos for a period of time. Kind of an informal arrangement, but his dad only has CPP to live on so this seemed like a good idea. Dad didn’t pay any rent and just kind of hung out while the work on the other condos was completed. As is often the case, my client’s company got audited. The auditor asked if Ward was paying rent to The Beav’s company. My client, said “no, that’s my dad...I can’t charge him rent.” That was not a good answer.
Private corporations typically only exist to make money. When a corporation supplies something to someone without compensation very harsh tax results occur. Let’s start with subsection 15(1) of the ITA. As a shareholder of the corporation, the Beav is taxable on the value of any goods or services transferred by the corporation to himself or a non-arms length person (usually family). So my client was deemed to have received income equal to the market value of the rent payable on the condo. The company does not get to deduct that deemed income as an expense...because it did not have an expense.
Ward also gets to pay tax. Subsection 246(1) of the ITA provides that when a person confers a benefit on a taxpayer, the amount of that benefit is included in the taxpayer's income. Dad gets to pay tax on the value of the use of the rental property. Interestingly, if my client had used the condo himself, he would be taxed under subsection 15(1) or 246(1), but not under both. However, since his dad used the property, they could both be assessed for taxes on the value of the rent.
The Beav got cute and told the auditor, “no, no no. My dad was supplying janitorial and nightwatchman services for the company. He got to use the condo. It was a barter transaction.”
“Okay”, said the auditor, “then the company failed to withhold income taxes, CPP and EI.”
There is a 10% penalty for failure to withhold taxes for employees. Your dad owes taxes on his income.”
My client muttered, “but he wasn’t an employee, he was a contractor, so I didn’t have to withhold. It was just a straight barter transaction.”
“Aha!” the auditor exclaimed. “No one paid tax on their income. The CRA lost tax on income from janitorial services and income from rent. The company pays tax on the deemed rental value and Ward pays tax on the deemed value of janitorial services. Since no one actually paid anyone, neither party has any deductible expenses. Also, you appear to know the income tax rules pretty well. I think you have conspired with your father to avoid paying taxes. You are both going to be assessed a penalty equal to 50% of the tax you avoided because you were wilfully blind to the application of the ITA.”
The Auditor then expressed doubt about the services that Ward would have been able to provide. The Beav told the auditor that he had let his Dad have one of the old company trucks to drive around in, to show that Ward really was a big help around the job site.
I then “legally” intervened by hitting the Beav on the ankle bone with a ball peen hammer. Giving his Dad a truck out of the company was a transfer of property. The company was deemed to have received the fair market value of the truck as proceeds. The Beav would be taxed on the value of the truck for directing the company to give it to his Dad.
The Beav lay writhing on the ground, but at least he wasn’t talking. “This interview is over,” I explained to the auditor. “My client needs to...um...review some documents and obtain medical attention.” The auditor looked at me with a cheshire cat smile. “Not quite”, she said. “Did your client give you that hammer?”
I feel better. I’ve disclosed the secret golden rule and provided a colourful illustration of its application. My shame is washed away. And don’t fear me because of what happened to the Beav, he was only a character in a story. If we meet, I promise not to hit you on the ankle bone with a ball peen hammer, unless it is necessary in the course of the provision of paid legal advice.
- J. Andre Rachert
Here’s the secret of tax law: Every transfer of property is taxable. That’s it. The Income Tax Act (“ITA”), 1700 pages and nearly 300 sections of impenetrable code, distilled to a 6 word secret golden rule. Blair wanted me to also explain that finding ways around the secret golden rule is the essence of tax planning - I told him to get his own column.
A made up story will illustrate. Audits are never, ever, ever like what I am about to describe.
A client of mine (known as “the Beav”) owns all the shares of a private corporation that builds and sells condos. During the recent economic slowdown the Beav decided to let his dad (we’ll call him “Ward”), a retired fellow, stay in one of the unsold condos for a period of time. Kind of an informal arrangement, but his dad only has CPP to live on so this seemed like a good idea. Dad didn’t pay any rent and just kind of hung out while the work on the other condos was completed. As is often the case, my client’s company got audited. The auditor asked if Ward was paying rent to The Beav’s company. My client, said “no, that’s my dad...I can’t charge him rent.” That was not a good answer.
Private corporations typically only exist to make money. When a corporation supplies something to someone without compensation very harsh tax results occur. Let’s start with subsection 15(1) of the ITA. As a shareholder of the corporation, the Beav is taxable on the value of any goods or services transferred by the corporation to himself or a non-arms length person (usually family). So my client was deemed to have received income equal to the market value of the rent payable on the condo. The company does not get to deduct that deemed income as an expense...because it did not have an expense.
Ward also gets to pay tax. Subsection 246(1) of the ITA provides that when a person confers a benefit on a taxpayer, the amount of that benefit is included in the taxpayer's income. Dad gets to pay tax on the value of the use of the rental property. Interestingly, if my client had used the condo himself, he would be taxed under subsection 15(1) or 246(1), but not under both. However, since his dad used the property, they could both be assessed for taxes on the value of the rent.
The Beav got cute and told the auditor, “no, no no. My dad was supplying janitorial and nightwatchman services for the company. He got to use the condo. It was a barter transaction.”
“Okay”, said the auditor, “then the company failed to withhold income taxes, CPP and EI.”
There is a 10% penalty for failure to withhold taxes for employees. Your dad owes taxes on his income.”
My client muttered, “but he wasn’t an employee, he was a contractor, so I didn’t have to withhold. It was just a straight barter transaction.”
“Aha!” the auditor exclaimed. “No one paid tax on their income. The CRA lost tax on income from janitorial services and income from rent. The company pays tax on the deemed rental value and Ward pays tax on the deemed value of janitorial services. Since no one actually paid anyone, neither party has any deductible expenses. Also, you appear to know the income tax rules pretty well. I think you have conspired with your father to avoid paying taxes. You are both going to be assessed a penalty equal to 50% of the tax you avoided because you were wilfully blind to the application of the ITA.”
The Auditor then expressed doubt about the services that Ward would have been able to provide. The Beav told the auditor that he had let his Dad have one of the old company trucks to drive around in, to show that Ward really was a big help around the job site.
I then “legally” intervened by hitting the Beav on the ankle bone with a ball peen hammer. Giving his Dad a truck out of the company was a transfer of property. The company was deemed to have received the fair market value of the truck as proceeds. The Beav would be taxed on the value of the truck for directing the company to give it to his Dad.
The Beav lay writhing on the ground, but at least he wasn’t talking. “This interview is over,” I explained to the auditor. “My client needs to...um...review some documents and obtain medical attention.” The auditor looked at me with a cheshire cat smile. “Not quite”, she said. “Did your client give you that hammer?”
I feel better. I’ve disclosed the secret golden rule and provided a colourful illustration of its application. My shame is washed away. And don’t fear me because of what happened to the Beav, he was only a character in a story. If we meet, I promise not to hit you on the ankle bone with a ball peen hammer, unless it is necessary in the course of the provision of paid legal advice.
- J. Andre Rachert
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.
