Canadian Tax Primer 1: Where do you Reside?

Canada imposes income tax on the basis of residence.  A Canadian resident pays Canadian income tax on all income arising anywhere in the world (including interest earned on a bank account in the Cayman Islands).  In contrast, a non-resident of Canada pays Canadian income tax only on specific types of Canadian-source income.

Unlike the United States, Canada does not impose income tax on the basis of citizenship.  So to escape Canadian income tax, you need not turn in your passport.  You merely have to leave Canada, cut off all your ties to Canada and start to reside elsewhere.  However, the termination of Canadian residence may trigger significant Canadian tax liability on deemed capital gains that have accrued up to the date of departure.

In determining your place of residence, you have to look at all the connections that you have in your daily life, from the big ones to the small ones.  Do you have your home in Canada?  Do you use a Canadian driver’s licence?  Do you subscribe to Canadian magazines and periodicals?  Do you rely on Canadian health care funding?

There is considerable confusion about a 183-day test that applies when determining residence status.  This test applies only to individuals who are clearly non-residents.  A non-resident becomes a deemed resident of Canada by being physically present in Canada for more than 182 days in any one calendar year.  The test does not work in reverse, however.  If you are in fact a resident of Canada, you do not escape Canadian tax by spending more than half the year at a vacation resort outside of Canada.  If only life were that simple (and if only one were wealthy enough to spend over half the year on vacation)!

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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.

Purchase or Sale of a Business: having your cake and eating too

Canadian-resident individuals can receive up to $800,000 in tax-free capital gains on the sale of qualifying shares of an active business corporation.  Alas! Most buyers prefer to buy amortizable assets rather than non-amortizable shares.  But why be locked into an "either/or" approach?  With good planning, you can combine both approaches and enjoy the best of both worlds.

The trick is for the seller to sell enough shares to use the capital gains exemption without giving the buyer control of the corporation.  The buyer then buys the business assets from the corporation.  The corporation then buys back the shares owned by the buyer.  This leaves the seller with tax-free cash from the sale of the shares and gives the buyer amortizable asset costs that can generate future tax deductions.  The seller also never gives up full control of the corporation, which now has proceeds from the sale of the assets.

Proper proportions have to be maintained when deciding how much value to allocate to the share sale.  Additionally, the corporation will likely have to create special-purpose shares.  By thinking flexibly and with proper planning, both buyer and seller can have the best of both worlds.  At the closing, buyer and seller can have their cake and eat it too!

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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.

Active Business Income Consultation

It’s nice to be asked for your opinion.

The federal government is asking for comments about the criteria used to distinguish between active business income and investment income earned by corporations.

The distinction is important.  The first $500,000 of annual income from an active business qualifies for a special low corporate tax rate.  Income in excess of that threshold is taxed at a higher rate (but one that is still below the rate that applies to investment income).  The lower rate provides the corporation with more after-tax income that can be invested back into the business operations or passed up to a special purpose holding entity for other investment uses.  In contrast, investment income is taxed at full rates with a partial refund of some of that tax when the corporation pays a taxable dividend (the refund is approximately equal to the tax that the dividend recipient will pay).

If the principal purpose of a business is to derive income from property (such as rental income from the use of real estate), the income generated by the business is considered investment income unless the business employs more than five full-time employees throughout the year.

Concern has been expressed about how this distinction applies in the case of self-storage facilities and campgrounds.  While not specifically mentioned in the budget materials, this issue also applies in the case of many roadside motels and mobile home parks.  Usually, smaller-scale operations of these types do not employ more than five full-time employees throughout the year.  For example, campgrounds and roadside motels are often seasonal operations.  However, the business is more akin to a business that requires active management than a passive form of investment.

The government has invited interested persons to submit comments no later than August 31, 2015.  Comments should be sent to by email to business-entreprise@fin.gc.ca.

If you send in a submission, please indicate whether you consent to having the submission posted on the Department of Finance website.  If you consent, indicate the name (your name or the name of your organization) that should be identified on the website as having made the submission.  Submissions should be provided electronically in PDF format or in plain text.  The Department will not post submissions that do not clearly indicate consent to posting.

I suggest that you clearly consent to having the submission posted on the Department of Finance website.  If your submission is posted, there is a better chance that others might support your ideas.  Your submissions will have the chance to go tax-world viral.

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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.

Reporting Ownership of Foreign Assets

When filing income tax returns, Canadians have to indicate whether they own foreign assets that had an aggregate cost of more than $100,000 (measured in Canadian currency) at any time during the taxation year.  If they do, details of the foreign assets must be provided on Form T1135.  This is the case even if the foreign assets are held inside a Canadian brokerage account and even if the foreign assets did not produce any income that year.  Specific exceptions apply for specific types of foreign assets, such as a foreign vacation home that is used only for personal purposes (in other words, that is not rented out to others at any point in the year).

This is a complicated filing requirement that has caught many Canadians who were unaware of the breadth of the reporting requirement.  After all, the question arises on an income tax return, not a wealth tax return.

The Canada Revenue Agency (the CRA) revised Form T1135 in 2013.  The revised form requires much more detailed information about foreign assets, increasing even further the compliance burden.  In some cases, the cost of compliance is out of all proportion to the value of the foreign assets.

The 2015 Budget proposes to simplify the foreign asset reporting system for taxation years that begin after 2014.  These new rules will not apply for 2014 returns but will apply for returns that cover the 2015 taxation year.

The simplification will retain the CAD $100,000 aggregate cost threshold.  If the total cost of reportable foreign assets is less than CAD $250,000 throughout the year, the taxpayer will be able to report these assets under a more simplified system.  Details of the simplified system have not yet been released.

It does not look as if the proposed streamlining will eliminate the need to report foreign investments that are held in a Canadian brokerage account and in respect of which the broker issues information slips reporting the income received.  That type of streamlining would require a statutory amendment rather than just changes to Form T1135.

If you have failed to report all foreign assets in the past, you may be able to avoid penalties by voluntarily disclosing the failure to the CRA.  In order to avoid penalties, you must approach the CRA before the CRA approaches you.  Generally, voluntary disclosures (also called tax amnesties by some advisers) are initiated on a no-names basis through a law firm so that you do not have to disclose your name until you have an idea of what the CRA will require in order to correct the past omission.

If you need advice about the voluntary disclosure program or believe that you may need to make a disclosure, please contact Layli Antinuk at 250-360-2110.  Any conversations will be protected by lawyer-client privilege.

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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.

2015 Budget: Source Deductions and Non-Resident Employers

If a non-resident employee performs duties of employment in Canada, the employer must deduct and remit source deductions made on account of income tax.  This is the case even if the employee’s salary is expected to be exempt from Canadian taxation by virtue of a tax treaty between Canada and the non-resident employee’s home country.  If the employment income is exempt from Canadian tax under a treaty, the employee pays tax on the income in the employee’s home jurisdiction but must file a tax return in Canada in order to claim a refund of the source deductions withheld from his or her paycheque.

This source deduction requirement applies whether the non-resident employee works in Canada for a foreign employer or a Canadian employer.

To avoid the source deduction requirement, the non-resident employee (not the employer) must apply to the Canada Revenue Agency (the CRA) for a waiver from the source deduction requirement.  If granted, the waiver applies on an employee-by-employee basis and applies for only a specific period of time.  This makes for an inefficient system.

In an attempt to address this administrative issue, the 2015 budget proposes a statutory exception to the normal source deduction requirement for salary paid by qualifying non-resident employers to qualifying non-resident employees.  The statutory exception will apply for salary paid after 2015.
 

A non-resident employee will qualify for the exemption from source deduction requirements if the employee

• is exempt from Canadian income tax under a tax treaty between Canada and the home country of the employee; and
• is not physically in Canada for more than 89 days in any 12-month period that includes the time of the salary payment.

A qualifying non-resident employer must be resident in a country with which Canada has a tax treaty. If the employer is a partnership, at least 90% of the partnership’s income for the fiscal period that includes the time of the salary payment must be allocated to persons that are resident in a treaty country.  In either case, the employer must not carry on business through a Canadian permanent establishment and must be certified by the CRA.
 

This new statutory exception will not cover all cases in which the employment income is likely to be exempt from Canadian income tax.  Most of Canada’s tax treaties provide an exemption for Canadian employment income earned by a non-resident if the employee is present in Canada for no more than 183 days.  As noted, the employee must be present in Canada for no more than 89 days in order to obtain the source deduction exemption.  As a result, at least some non-resident employees will still have to apply for the waiver.
 

The source deduction exception does not apply if the employer is resident in Canada.  This likely means that foreign employees on very short-term Canadian assignments (less than 90 days) will remain employed by a foreign employer.  Only foreign employees who are likely to be in Canada for 90 days or more will end up being seconded to a Canadian affiliate of the foreign employer.

Even if not required to make source deductions, a qualifying non-resident employer will continue to be responsible to file information slips with the CRA reporting all income paid to non-resident employees.

2015 Budget: Good News for Charities with Endowment Funds

Some charities (such as charitable foundations) have endowment funds that are invested to produce income that can then be used for charitable purposes.  The 2015 Budget provides a greater range of investment possibilities for those funds by making it easier to invest in limited partnerships.

Traditionally, partnerships were closely-knit groups of individuals who carried on business together.  For many years now, the partnership concept has morphed into much more complicated business structures in order to take advantage of tax rules that apply to partnerships.  Many partnership units are traded on stock exchanges in the same way that corporate shares are traded.  Even so, each partner is considered to be carrying on the partnership business.  Usually, partnerships that are traded on stock exchanges are limited partnerships so that investors are not fully liable for the debts of the partnerships and are therefore more like shareholders of a corporation.

Income tax rules restrict the types of businesses that a charity can carry on.  As even a limited partner of a partnership is considered to be a participant in the partnership business, this limits the types of limited partnership investments that a charity can make.

Effective for investments made after April 21, 2015, a charity will not be considered to be carrying on a business solely because the charity invests in a limited partnership interest as long as

• the charity – together with all non-arm’s length entities – holds no more than 20 per cent of all interests in the limited partnership; and
• the charity deals at arm’s length with each general partner of the limited partnership.

These rules will also apply to registered Canadian amateur athletic associations.

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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.

2015 Budget Refinements for Gifts to Foreign Charities

With so many Canadians anxious to help with earthquake relief in Nepal, I hesitate to deal with the following very technical 2015 budget change for fear that confusion might result.

A very technical change announced in the 2015 federal budget will adjust the rules that apply for gifts to selected foreign charities.  However, this has nothing to do with donations to help those in Nepal.  Donations for earthquake relief can be made to the Red Cross and various other Canadian charities that have international arms providing disaster relief.  There is no need to give a gift to a foreign charity.  This budget change has nothing to do with disaster relief in Nepal.

Under current rules, Canadians can deduct a gift made to a foreign charitable organization if the foreign charitable organization has received a gift from the federal government within the past two years and is registered by the Canada Revenue Agency (CRA).  For example, Canadians can deduct gifts made before November 7, 2015 to the US-based Clinton Foundation (see http://www.cra-arc.gc.ca/chrts-gvng/qlfd-dns/qd-lstngs/gftsfrmhrmjsty-lst-eng.html).  The time limit for making the donation is the second anniversary of the gift from the Canadian government.

The current rules allow for registration only if the foreign charity is a “charitable organization” – one that carries on its own charitable works.  Canadian tax law distinguishes a charitable organization from a charitable foundation.  Under Canadian tax nomenclature, a foundation exists primarily to fund charitable works carried on by charitable organizations.

The 2015 budget will extend the current rules to foreign charities in general so that foreign charitable foundations can also be registered in Canada if the Canadian government makes a donation to the foreign foundation.  This is a very technical change that will affect only a small number of selected foreign charities.

This budget change will cause some to ask how Canadians can make tax-deductible gifts to the Clinton Foundation if foreign charitable foundations are not covered by the current rules.  The answer is one of tax nomenclature.  The Clinton Foundation (despite its name) carries on charitable works in partnership with other charities and would be classified in Canada as a charitable organization.  The “Foundation” moniker was presumably chosen for reasons other than Canadian tax classifications.

As noted, most Canadian charities have international operations.  As a result, there is no need to donate to a foreign charity to assist with international aid relief.  Various Canadian charities are providing much-needed relief in the earthquake-ravaged areas of Nepal.  In order to assist in that effort, simply donate to one of those many Canadian charities.  I repeat that this budget change has nothing to do with earthquake relief efforts.

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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.

Good News for Giving Back to the Community

The 2015 Budget contains an important change affecting charitable donations made in 2017 and subsequent taxation years.

For much of the past, the charitable donation system assumed cash donations and actually discouraged Canadians from donating property to charity.  If property had an accrued gain, part of the charitable donation receipt had to be used to avoid tax on the capital gain that resulted from the making of the donation.

Recent changes have made it easier for Canadians to donate property by eliminating the capital gain for specific types of donated property.  For example, assume that I donate $100 worth of shares that are listed on a stock exchange (such as shares of Bell Canada Enterprises).  Even if the shares have a nominal cost, the donation will not result in any capital gains tax.  As a result, I will be able to apply the full $100 donation receipt against my other income.  This makes sense, as I will have actually given $100 away.

The 2015 Budget will extend this enhanced treatment to cash donations that are sourced from sales of real estate and from sales of private corporation shares (shares that are not listed on a stock exchange).  However, these new rules will come into effect only in respect of sales that occur after the end of 2016.

The new rules will not apply if the real estate or the shares are donated to the charity.  Instead, the donor sells the real estate or the shares and donates cash from the sale proceeds within 30 days of the sale.  No capital gain arises on the part of the sale proceeds donated to the charity.  This means that the charitable donation deduction can be applied to reduce capital gains tax on the portion of the sale proceeds that is not donated to the charity.

To use a very simple example, assume that I sell real estate (not my principal residence) for $3 million and would have a capital gain of $3 million on that sale.  If I donate $1 million (one-third of the sale proceeds) to a charity within 30 days of the sale, I pay tax on a capital gain equal to only $2 million (2/3^rd of the sale proceeds).  As only 50% of a capital gain is included in income, I have an income inclusion of only $1 million.  Any tax arising on that $1 million income inclusion will be completely offset by the charitable donation of $1 million.  As a result, I give $1 million to the charity and retain $2 million out of the sale price of $3 million.  Without the charitable donation, I would have paid about $690,000 in tax and retained about $2.31 million of the sales proceeds.  So the charitable donation would have cost me only $310,000.

The tax relief applies only to the capital gain.  A sale of rental real estate will often give rise to taxation of depreciation taken in previous years if the building has not actually declined in value.  Tax will still apply in respect of previous depreciation claims that have to be brought back into income on the sale.

As noted, the donation to the charity must occur within 30 days of the sale.  Furthermore, the sale must be to a purchaser who deals at arm’s length with both the donor and the charity.  Anti-avoidance rules will apply to prevent abuse of the new rules.  For example, anti-avoidance rules apply if the donor or another family member re-acquires any of the sold property within five years of the sale.

While I have used the colloquial term “charity”, the new rules will apply in respect of a donation to any “qualified donee”.  Besides registered charities, that term includes registered Canadian amateur athletic associations.

As with any charitable donation, the tax system provides tax relief to assist with the donation.  However, the donor is still making a donation and has to want to give back to the community.  The new rules will make it easier to give back starting in 2017.

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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.