Taxing Topics - Dwyer Tax Law Canadian Tax Law Articles: 2007

Saturday, October 6, 2007

Current Trends in Audit Procedures

There are different sources for determining current and expected trends in the Canada Revenue Agency’s (the “CRA’s”) audit procedures in respect of taxpayers. One of these sources is the annual report published by the Auditor General of Canada. In this case, the CRA is the one being audited: the Auditor General examines CRA’s practices and points out the CRA’s foibles, failures and successes.

While many taxpayers will relish the poetic justice of the CRA being audited, the Auditor General usually ends up recommending that the CRA tighten specific procedures when auditing taxpayers. So any mud that gets in the eye of the CRA inevitably finds its way into the eyes of taxpayers. For example, the CRA Voluntary Disclosure (tax amnesty) Program has changed as a result of remarks made the by Auditor General. The program is now much narrower in its focus.

Each year, the Auditor General turns her attention on a different part of the CRA. In 2005, it was the CRA’s Audit Division. In 2006, it was the collection of unpaid taxes. Most recently, the Auditor General examined the way in which the CRA reviews international transactions. While the CRA always receives good marks in certain areas, the attention inevitably focuses on the shortcomings identified by the Auditor General.

Based on the comments in the most recent Auditor General reports, we can expect to see the following trends in audits over the next few years.

Increased use of third party information to verify personal income levels.
More audits of Canadian trusts.
Increased scrutiny of transactions involving non-residents.
Greater focus on international transactions.
A revamping of the collections program to ensure a higher level of collection.

In any dispute with the CRA, the onus of proof is always on the taxpayer. Accordingly, it is best to anticipate audits when setting up structures and implementing transactions. In order to be able to show an auditor that all was done property and in accordance with the law, it is important to ensure that transactions are properly thought out, properly implemented and properly documented. For example, trust distributions should be supported by a written trustee resolution. Dividend declarations should be supported by a director resolution.

It will be interesting to see how the CRA adopts the Auditor General’s comments in the coming years and what impact this will have on taxpayers. No doubt, the impact will mean more scrutiny and not less.

-- Devinder K. Sidhu

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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.

Thursday, September 6, 2007

More Confusion About Joint Accounts With Adult Children

In popular mythology, joint accounts are supposed to be simple. In actual fact, they are fraught with difficulty. This year, the Supreme Court of Canada had to pass judgement on two occasions about the ownership of funds in joint accounts. That such a supposedly simple matter ended up in the country’s top court twice in the same year speaks to the uncertainty that surrounds joint accounts.

Why the uncertainty? Joint accounts serve different functions for different people. Sometimes, the property in the account is meant to be held equally by all the owners of the account – the “true” joint account. But at other times, a parent will put assets into joint names with a child so as to allow the child to help the parent manage the assets – a “power of attorney” joint account. In this latter situation, the parent is giving the child an ability to deal with the assets in the account but solely for the benefit of the parent, with no thought of making the child an owner of those assets.

The problem is distinguishing between the two types of cases.

The distinction turns entirely on the intention of the parent who established the account. In most cases, nobody thinks to record that intention in clear written form. After the parent dies, the surviving joint account holder maintains that the funds in the account belong solely to that child. Siblings often take the opposite view – that the funds in the account belong to the parent’s estate. And so the family heads off to court to dissipate the estate on legal fees and to destroy whatever relationships might have existed among family members.

This year’s Supreme Court of Canada cases dealt at great length with legal rules of thumb (legal presumptions) that apply when the evidence of intention is not clear. Based on these court cases, the governing rule of thumb is to assume a gift only if a parent opens a joint account with a minor child. This means that the courts will assume that a joint account with an adult child is a “power of attorney” type of account rather than a “true” joint account – in other words, that the assets in the account form part of the parent’s estate on the death of the parent. But this rule of thumb can be rebutted by evidence, so court battles will continue to be fought on this issue.

Invariably, the evidence is circumstantial and can be interpreted to point in both directions. In this year’s two Supreme Court decisions, virtually identical facts were interpreted as favoring one conclusion in one case but as favoring the opposite conclusion in the other case.

So what to do?

The short answer is to retain clear written evidence of the parent’s intention if setting up a joint account with an adult child. It is best not to rely on documents prepared by the financial institution, as those documents primarily deal with the relationship between the account holders and the institution. The financial institution merely needs to know who can withdraw the funds – it does not usually care who owns the funds.

The big-picture answer, however, is to think clearly about whether establishing a joint account with an adult child makes sense in the context of your overall estate plan. Specifically, get good advice on the tax implications. Placing investment assets into a true joint account with anyone other than your spouse can lead to capital gains tax. As well, assets held in a true joint account pass automatically to the surviving joint owner – there is then no possibility of placing the assets into a testamentary trust for the benefit of the survivor (such a trust can have tax and other advantages). Also think about creditor implications: what if the child runs into financial difficulty and the child’s creditors attempt to seize half the funds in the account?

Confusion will continue to reign in respect of joint accounts even in spite of this year’s Supreme Court of Canada decisions. Indeed, certain passages in the Supreme Court judgement – if taken out of context -- will lead to confusion about the tax implications of setting up a joint account. But as the court itself pointed out, it was just deciding who owned the assets in the account – not the tax implications. Clarification of those comments will require another Supreme Court of Canada decision, most likely.

-- Blair P. Dwyer

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Wednesday, June 6, 2007

Dual Wills May Mean More Dollars in the Pocket

People may have dual or multiple Wills to cover assets in multiple jurisdictions. For example, someone could have assets in both Canada and Tahiti. Instead of one Will to deal with all the assets, there could be two Wills: one to deal with the Canadian assets and one to deal with the Tahitian assets. This facilitates the smooth and timely administration of an individual’s overall estate.

Probate fee reduction is another reason to have dual Wills. A grant of probate essentially provides legal authority to the executor of a Will to deal with the estate and distribute it to the beneficiaries. While it is not mandatory to obtain a grant of probate, some organizations will not recognize an executor’s authority under a Will unless the executor has a grant of probate to back it up.

The concern that organizations have is that the Will appointing the executor may not be the last Will and testament of the deceased. The deceased could have written a new Will that revoked the earlier Will, and the organization could be held liable to the new beneficiaries if the later Will surfaced. It is up to the organization whether it wants to take that risk. The Land Title Office will not transfer property to an executor unless the executor has a grant of probate for the Will. Banks often have a policy that a grant of probate is required for assets greater than a threshold level (say $25,000; it varies from bank to bank) but not for assets below that threshold. For assets below the threshold, banks will accept an indemnity from the executor and beneficiaries; this way the bank has protection in the event a later Will surfaces.

Because probate is not mandatory, the surviving directors of a private family corporation can choose to transfer shares owned by the deceased without requiring probate of the deceased’s will.

Not having to obtain a grant of probate results in saving probate fees of 1.4% of the gross value of the estate. However, the executor cannot pick and choose which assets to declare when making a probate application. If the estate included both a residence and shares in a private corporation, the Land Title Office would require a grant of probate. The executor would then have to apply for probate and include the value of both the residence and the shares. In order to avoid having to include the value of the shares in the probate application, the shares could be dealt with under a separate will with qualifying attributes.

To illustrate the situation with some numbers, assume that Jim-Bob died leaving a house worth $500,000 and shares in a private corporation worth $10,000,000. Assume that Jim-Bob had separate Wills dealing with each of these assets. A probate fee of 1.4% would be payable only on the value of the house (probate fee payable of $7,000) but not on the value of the shares (probate fee avoided of $140,000). This is a significant saving.

While the dual Wills technique has been successfully argued in Ontario courts, no court in British Columbia has ruled on whether this technique avoids probate fees. The British Columbia legislation uses different wording from the Ontario legislation, so the Ontario case might or might not apply in British Columbia. As always, professional advice should be sought before using the dual-will technique. For example, it is important to use appropriate wording so that one will does not revoke the other. As well, any consideration of the dual-will technique should take into account your overall estate and tax planning objectives.

-- Devinder Sidhu

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Sunday, May 6, 2007

Small Business Profits on the Rise

Look for profits of small business corporations to rise over the next few years. The increases have started already. It’s all due to government tax policy – but not in the way that you would expect.

Traditionally, small business corporations have paid year-end bonuses in order to get profits down to $200,000. Any corporate profit above the $200,000 limit was taxed at a higher corporate tax rate, which resulted in double taxation if that after-tax profit was later paid out as a dividend. It was better for the owner-manager to take any surplus profits as a bonus. This effectively capped small business corporation profit at $200,000.

The situation has changed considerably over the past few years, however. The government has increased the $200,000 limit to $400,000, so there is no longer any need to pay the same size of bonus to the owner/manager. For many small business corporations, this means that profits have doubled in just a few short years. Who says government policies are always ineffective?

While a higher tax rate still applies to small business corporation profits above the $400,000 threshold, that higher tax rate is now just 35% -- not as high as it used to be and well below the top individual tax rate of 44%. So tax deferral occurs if the small business corporation keeps that surplus profit in the corporation or pays the surplus profit to a holding corporation. In addition, the 35% corporate tax rate is being integrated with the personal tax rate on dividends. To the extent that the corporation has paid 35% tax on its business income, the dividends paid out of that profit are eligible for a special low tax rate so that the total corporate and personal tax paid is the same amount that would have been paid if the owner-manager had earned the income directly (without using a corporation).

No doubt, statisticians will be flabbergasted by this fundamental change in the Canadian economy. Usually, rising corporate profits are accompanied by an increase in management salaries. But this increase in small business corporate profits will be accompanied by a reduction in management salaries. This may lead some to conclude that management courses are futile, given that the lower-paid small business managers end up producing higher small business corporate profits. We will have to wait to see whether this has a negative impact on MBA enrolments.

As owner-manager salaries decline and small business corporation profits rise, many statisticians will notice a substantial increase in Canada’s productivity index. Will the federal government seek credit for making Canada more competitive on the world stage? Will other politicians complain that the productivity gains are being made on the backs of Canadian workers? After all, the statistics will clearly show that profits are rising while salaries are decreasing.

As owner-manager salaries plummet and dividends increase, however, owner-managers can expect some relief on the salary front. Contribution limits for RRSP’s were $18,000 in 2006 but have risen to $19,000 in 2007 (assuming that 18% of earned income is equal to at least $19,000). Whereas the owner-manager needed a salary of just $100,000 in order to max out on RRSP limits in 2006, the higher 2007 limit will require a salary of just under $106,000. So a small salary increase is in order for owner-managers in 2007. That will mean a little less in dividends, but it is always nice to have a pat on the back for a job well done.

-- Blair P. Dwyer

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Saturday, January 6, 2007

Guess Who Pays the Tax On Death

When it comes to estate planning, parents often wish to distribute their assets equally among their children. Without proper planning, the actions taken could have the opposite effect and result in unequal distributions.

For example, assume the rapper “50 Cent” is widowed and has two children, Nickel and Dime. Assume also that 50 Cent's last few albums did not do so well on the charts, so 50 Cent is left with an RRSP worth $150,000 and remaining assets worth $150,000, for a total of $300,000 in assets.

50 Cent wants to benefit his children equally but he also wants to save a bit of tax. He decides to name Nickel as the sole beneficiary of his RRSP and name Dime as the sole beneficiary under his will. 50 Cent believes that this method will allow him to save on probate tax by excluding the RRSP from the estate and split his assets equally between Nickel and Dime. Unfortunately, 50 Cent's plan will not have the desired effect. Nickel will end up receiving the whole $150,000 in the RRSP free and clear of any tax, whereas Dime’s share of the estate will end up absorbing all the tax.

When 50 Cent passes away, income tax will be payable on the $150,000 held in the RRSP because this amount is being transferred to a child (rather than a surviving spouse). However, the RRSP will be included as the income of 50 Cent on his final tax return. This means that the estate – not Dime – will be liable to pay $66,000 of tax on the value of the RRSP. After the estate pays the tax, the estate will have only $84,000 left.

While the RRSP will not be subject to probate tax, the assets passing under the will are subject to probate tax. The probate tax of $2,100 has to be paid by the estate, leaving the estate with only $81,900.

After all taxes are paid, and assuming no other debt, Nickel (as sole beneficiary of the RRSP) is left with $150,000 while Dime (as sole beneficiary under the will) is left with $81,900. The end result is an unequal distribution and Nickel receives an unintentional windfall. Due to the application of the tax rules, 50 Cent's desire for equal distribution of his assets between his two children is not met and Dime feels he’s been “nickel and dimed” out of his fair share.

One simple way around this would have been for 50 Cent to name both Nickel and Dime as equal beneficiaries of both his RRSP and his will. This way, the $231,900 remaining after taxes would have been split equally between them.

Without careful planning and advice, the application of the tax rules may result in unintended consequences. It is important to keep in mind who is paying the tax.

-- Devinder Sidhu

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