Monday, June 3, 2019

Proposed Disability Tax Credit Fee Limits

The federal government proposes to limit the fee that a service provider (other than a doctor or other medical practitioner) can charge for helping a taxpayer apply for a disability tax credit (DTC) or in claiming disability tax credit deductions on an individual income tax return.

Under proposed regulations, the fee limit will be as follows.

(a) A limit of $100 for assistance in submitting Form T2201 (the application form for the disability tax credit).

(b) An annual limit of $100 for claiming the disability tax credit on an income tax return.

The Canada Revenue Agency is concerned that some service providers approach families with a disabled individual and offer to assist in filing Form T2201 and claiming the disability tax credit. These service providers often claim that the application process is very difficult and charge a contingency fee of between 15% and 40% of the resulting income tax refund. This reduces the refund amount that can be used for the benefit of the disabled family member.

Claiming the disability tax credit is not overly complex. Simply download Form T2201 from the CRA website (http://www.cra-arc.gc.ca/E/pbg/tf/t2201/t2201-16e.pdf). Complete Part A of the form. Part A consists of a single page that requests basic identification information. When filling in Part A, check the Yes box in Section 3 of Part A (toward the bottom of the page, just above the signature line). If you check this box and the claim is successful, the CRA will automatically adjust up to nine prior income tax returns in order to allow the claim in those prior years. This can result in a significant tax refund.

After filling in Part A of the form, have a medical practitioner complete Part B. This is the more detailed portion of the form and includes all the medical information. As noted, the medical practitioner is not subject to any fee limit for filling in Part B.

Then submit the completed and signed form to the CRA.

The CRA will review the submitted form in order to determine if the person meets the eligibility requirements. This will be based on the information provided by the medical practitioner. If the claim is successful and you checked the Yes box in Section 3 of Part A, the CRA will automatically adjust up to nine prior income tax returns in order to allow the claim for those prior years.

Once the Form T2201 has been approved, that means that the DTC can be claimed unless and until the CRA requests that you complete a new Form T2201. You do not have to submit a new Form T2201 every year.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

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.

Monday, May 13, 2019

Charitable Giving: Ebenezer Scrooge in a Taxable Canadian Context.

CHARITABLE GIVING: EBENEZER SCROOGE IN A TAXABLE CANADIAN CONTEXT

May 10, 2019
Paper presented at Tax Fundamentals for the Estate Practitioner (Vancouver, BC).
A Conference presented by the Continuing Legal Education Society of British Columbia

This paper discusses options for charitable giving as part of an estate plan, both during life and at death.

The paper deals with the basic requirements for a charitable gift and examines the following aspects of charitable giving.

1.               When to donate (whether during lifetime or at death).

2.               Cash gifts.

3.               Gifts of publicly-traded shares.

4.               Gifts of private corporation shares.

5.               Matching Gift Campaigns.

6.               Whether to use a private foundation or a donor-advised fund.

7.               Gifts made through a will or through a life interest trust.

To read the full article, click here.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Thursday, December 28, 2017

Family Members as Part-Time Workers

This continues consideration of the revised proposals on income splitting through a family corporation. The government released these revisions on December 13, 2017. If passed into law in their current form, the proposals will apply as of the start of 2018.

The revised proposals contain an exemption for an over-age-17 family member who is actively engaged on a “regular, continuous and substantial basis” in the activities of the family business corporation.

This will be a difficult question of fact in many cases. However, a de minimis rule allows a family member to qualify for this exemption if the family member works an average of 20 hours per week in the business during a taxation year. If the business operates on a seasonal bases, the average is for only the portion of the year in which the business operates.

If the family member has met the 20-hour per week minimum for any five previous taxation years (including years before 2018), the family member will be exempt from the proposals even during years in which the family member does not work an average of 20 hours per week.

A qualification has to be made in respect of capital gains. In order for a capital gain on the sale of shares to be exempt from the income-splitting proposals under this exemption, the family member must have met the 20-hour per week standard during five previous taxation years (not just the year of the sale). The five years need not be consecutive.

The 20-hour per week exemption applies in respect of any family corporation, including service corporations and professional corporations.

If a family member wants to rely on the 20-hour per week exemption, the family member will have to keep careful track of hours worked in the business. As the 20-hour minimum is an average, the family member may have to work more than 20 hours per week if the family member takes vacation time. The family member may (but does not have to) receive a reasonable salary for the work. The primary advantage of meeting the 20-hour per week average is that the family member can receive dividends without having to justify the dividend.

A signed employment agreement is advisable, but careful tracking of time worked is more important. In the case of an audit, the onus of proof is on the taxpayer.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Revised Income-Splitting Rules Released

On December 13, the federal government released its revised proposals on income-splitting.
If passed into law, the rules will be effective as of the start of 2018. While it will take time to fully analyze the rules, the following general points can be made at this point.

The proposals will not apply to any dividends paid during 2017. If passed into law, the proposals apply only as of January 1, 2018.
Revisions to corporate structures do not need to be finalized prior to the end of 2017. Corporate structures can be revised in early 2018 in order to take the proposals into account.
The new rules specifically target professional corporations and corporations that derives 90% or more of their income from the provision of services. A professional corporation is one that carries on the professional practice of an accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor.
The new rules will not apply to an individual over the age of 24 who earns income from a non-professional corporation that earns less than 90% of its income from the provision of services, provided that the individual has at least a 10% interest in the corporation. The 10% interest has to include at least 10% of the voting shares and at least 10% of the value of all issued shares.
If a person is 65 years of age and over and has been active in the corporate business in the past, that person can split income with his or her spouse (even if the person has retired from the business). This will be important for retirement plans.
If an adult works in the business for an average of at least 20 hours per week, the income splitting rules will not apply to amounts paid to that adult.
The rules will no longer be extended to nephews, nieces, uncles and aunts.

Further analysis of specific aspects of these new proposals will follow.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Thursday, October 19, 2017

Holding Corporation Investment Income

On October 18, the federal government released some tidbits of information about changes to its proposals in respect of investment income earned by corporations that invest active business earnings that have been taxed at the small business rate. In July, the government had proposed to impose special rules on such earnings.

While we will have to wait until the 2018 federal budget for details, the October 18 announcement indicates the following.

Any new rules will apply only on a go-forward basis. Presumably, this means (at the earliest) the date of the 2018 federal budget. Federal budgets are usually in the spring of the year.

Any new rules will apply to neither past investments nor income earned from those past investments. Presumably, past investments refers to investments in place at the time that the new rules come into effect.

Any new rules will apply only in respect of passive investment income of a corporation that exceeds $50,000 per year. Presumably, this is in addition to any income earned from past investments.

This is welcome news, although much will depend on the details that will be released as part of the 2018 budget. Presumably, the proposals will have to set up notional tax accounts, one for tracking income from pre-budget investments and one for tracking income from post-budget investments. Presumably, a corporation will be able to sell pre-budget investments and re-invest the sale proceeds without losing the grandfathering status. But we will have to wait and see.

It seems that the government is releasing snippets of information about changes as trial balloons to gauge reaction. Or perhaps the government is merely following the time-honored advice given by Machiavelli in The Prince: always release good news slowly over a long period of time.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Pipeline Still Possible?

On October 19, the federal government continued in the almost-daily announcement of reforms to its original July 18 tax reform proposals.

This latest reform announcement indicates that the government will not be moving forward with measures relating to the conversion of income into capital gains.

As has been the case all week, the actual announcement is vague. Even worse, one has to be a tax professional in order to understand the announcement. The announcement is also misleading, because the change merely allows taxpayers to avoid double taxation.

To illustrate the point, take a simple example. Assume that an individual (a parent) dies and leaves shares of a private family corporation to the parent's children.  As a result of the parent's death, the shares undergo a deemed disposition for tax purposes at fair market value. This usually results in payment of capital gains tax. To keep the numbers simple, assume that the deceased had no cost in the shares and that the shares had a date-of-death value of $100. This results in a $100 capital gain and requires payment of about $24 in tax.

This is a deemed capital gain. No actual sale has occurred, which means that the estate has no cash to pay the tax. In order to pay this tax on the deemed capital gain, the estate usually has to extract cash from the corporation.  If the corporation pays a $100 dividend to the estate, however, the estate will have to pay about $41 in tax on that dividend.  That results in total tax of $65 on a taxable value of $100.

In order to avoid this double taxation, the estate can implement a post-death corporate reorganization. This form of reorganization is called a "pipeline" by tax practitioners (but has nothing to do with oil flowing from Alberta).  The reorganization allows the estate to extract $100 from the corporation without payment of the extra $41 in tax. This always seemed fair, given that the Income Tax Act had imposed the original $24 capital gains tax on the death of the parent. The post-death reorganization merely allowed that already-taxed value to be extracted as an amount that had already been taxed (which was indeed the case).

Today's announcement is welcome. It would have been preferable, however, for the government to have called a spade a spade and to have announced that it was withdrawing a proposal that would have resulted in double taxation of value on death. The government continues to tar entrepreneurs with an implied "tax cheat" brush by referring to the withdrawal of a measure that would have prevented the conversion of income into capital gains.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Monday, October 16, 2017

Government not proceeding with Restrictions on Capital Gains Exemption

On October 16, the federal government announced its first concrete modification to the sweeping income tax changes that it had proposed on July 18.

The media has focussed on the phased reduction to the low income tax rate that applies to the first $500,000 of active business income earned by a Canadian-controlled private corporation. The federal rate on such income will decline to 10% at the start of 2018 and to 9% at the start of 2019. Tax rate cuts are always welcome, although they sometimes have the taint of bribing taxpayers with their own money.

The more significant change was the decision not to proceed with restrictions on capital gains exemption claims. The capital gains exemption provides each Canadian resident with the opportunity to earn up to $1 million in tax-free capital gains on the sale of qualifying farm and fishing assets and just over $835,000 in tax-free capital gains on the shares of qualifying active business corporations. On July 18, the government proposed numerous restrictions, including the following.

No capital gains exemption would be available for capital gains that accrue while eligible assets are held inside a trust.
No capital gain exemption would be claimable by an individual under the age of 18.
A capital gains exemption would be claimable only to the extent that an individual could be considered to have “earned” the exemption through actively working in the business in question.

The government now indicates that it will not be proceeding with these restrictions. That is good news.

The government seems to be recognizing the difference between wages and investments. Capital gains are, after all, an investment return. If I purchase shares of Microsoft and the shares increase in value, I have made a good investment. It does not matter that I have not personally contributed anything to that increase in value. I may be completely computer-illiterate – it does not matter. I benefit from that increase in value because I was astute enough to invest in a good business.

It is to be hoped that this recognition of the difference between wages and investments will continue to guide the government’s modifications to its July 18 income tax proposals. We will have to wait and watch.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Sunday, July 23, 2017

The Old are Young Again

It’s not exactly the fountain of youth, but many Canadians might soon be treated for tax purposes as if they were once again under 18 years of age. Enabling legislation has to be passed into law, but this might come into effect as soon as 2018.

Currently, Canadian income tax law applies a special tax – colloquially referred to as the “kiddie tax” -- if a minor child receives dividends or other income that has been generated by activities of a parent. For example, this special tax might apply if a parent carries on business through a private corporation and the child receives dividends from the corporation. If the special tax applies, the dividend is taxed at the top marginal tax rate applicable to that form of dividend – as if the child were a top-rate taxpayer. This removes any income-splitting benefit.

Under current law, the kiddie tax ceases to apply in the year that the child reaches age 18. This means that income splitting can start in the year that a child has his or her 18^th birthday. As well, income can be split with one’s spouse and with other adults.

Starting in 2018, the government intends to significantly extend the “kiddie tax” rules. The special tax will apply to all individuals – including spouses and adult children – who are related to the principal of the business. For these extended rules, relatives will also include uncles, aunts, nieces and nephews (who are not normally related for income tax purposes).

The rules will apply to income that is received directly on shares owned by the related individual or indirectly on shares held through a family trust.

A limited exception will apply to the extent that income paid to the related individual is reasonable in light of services that the individual actually provides to the business. In general, the related individual will be able to receive salary or dividends provided that the aggregate amount of the salary and dividends does not exceed what would have been paid to an unrelated individual performing the same services. A more restricted exception applies if the individual is between the ages of 18 and 24.

The new rules will not totally prevent income-splitting with other family members. However, income splitting after the end of 2017 will require that the family member actually work for the business and will be limited to a level that is reasonable in light of those services.

The proposed rules will not affect other forms of income-splitting techniques, such as loans made to a spouse at the prescribed rate of interest.

The new proposals are included in draft legislation that was released on July 18, 2017. This draft legislation includes significant other changes that will be described in future blogs.

The federal government has invited comments on the draft legislation. Comments can be made prior to October 2, 2017 by sending the comments to fin.consultation.fin@canada.ca.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Wednesday, July 19, 2017

Major Tax Changes to Private Corporation Taxation

On July 18, the federal Finance Minister released his promised consultation paper on the taxation of private corporations. The paper includes draft legislation, most of which will be effective at the start of 2018 but some of which is effective as of announcement date -- July 18, 2017.

The immediate measures seem to prevent the use of pipeline planning to prevent double taxation of the value inherent in private corporation shares held on death. Double taxation of this value can arise if the estate withdraws funds from the corporation to pay the capital gains tax triggered by the death of the shareholder. While it will still be possible to avoid double taxation, the new rules seem to require use of the technique of triggering a capital loss by redeeming the shares held by the deceased in order to trigger a capital loss that can be applied to offset the capital gain triggered by the death. While this avoids the double taxation, it results in taxation of the date-of-death value as a deemed dividend (at a higher tax rate) rather than as a capital gain. The carry-back technique is also subject to strict time limits (so that the ability to avoid the double taxation can be lost if one does not act promptly).

It will take some time to work through the implications of the various immediate and proposed changes. These provisions fundamentally alter long-standing estate planning techniques.

The release is characterized as a consultation paper, but is a consultation paper that includes changes that are effective immediately (assuming that the enabling legislation is passed into law by the current federal parliament). One can expect that the government will receive lots of comments on the package before the comment deadline expires on October 2, 2017. Comments can be sent to fin.consultation.fin@canada.ca.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Monday, October 24, 2016

January 15 Fix is Still in Play.

On January 15, 2016, the federal government released legislative proposals designed to fix some of the problems created by 2015 legislation on the taxation of trusts. See earlier posts from January 18 and 19, 2016 .

On October 21, 2016, the January 15 proposals were finally released as part of a budget implementation bill. This means that the fix to the 2015 legislation is that much closer to becoming law. Once the correcting legislation is passed, it will be retroactive to the start of 2016.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Thursday, April 14, 2016

News Headlines Unfair to Red Cross

Several newspapers have reported allegations that the International Committee of the Red Cross (the “ICRC”) was listed as the beneficiary of two Panamanian foundations used by clients of the infamous Panamanian law firm Mossack Fonseca.

These reports are unfair to the ICRC.

The ICRC has no control over whether it is named as beneficiary of a trust or foundation. Any person setting up a trust or foundation can name any person in the world as a beneficiary. If the ICRC was named as a beneficiary, the ICRC was likely named as an “ultimate” beneficiary who would receive something only if something was left over after distribution of the assets to the “real” beneficiaries. While offshore trusts and beneficiaries frequently name the ICRC and other charities as “ultimate” beneficiaries, I suspect that the ICRC and those other charities never actually see any funds from those trusts and beneficiaries. The charities are being used as an unwilling tool to satisfy requirements of trust and foundation law.

And really, if some of the funds actually went to the ICRC and other charities, would that be such a bad thing?

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Thursday, April 7, 2016

An Apple for the Teachers

Budget 2016 introduces a new tax credit in recognition of personal expenses incurred by teachers and early childhood educators who often end up buying supplies for their students.

Effective for 2016, eligible employed educators will be able to claim a 15% tax credit for up to $1,000 in eligible expenditures made in a taxation year.

The tax credit will be refundable. If an eligible educator has no tax to pay after claiming the basic personal exemption and any other available tax credits, the educator will receive a cheque from the government for any portion of this new credit that was not actually applied to reduce tax owing.

The new credit does not apply to an individual who is self-employed because self-employed individuals can deduct business expenses as a matter of course.

As with any tax credit (and classroom setting), rules apply.

To qualify as an eligible educator, a teacher must hold a valid teacher’s certificate and an early childhood educator must hold a valid certificate or diploma in early childhood education. In each case, the certificate or diploma must be recognized by the province or territory in which the individual is employed.
Expenditures must be for the purchase of eligible supplies for use in a school or a regulated child care facility for the purpose of teaching.
Eligible supplies will include the following durable goods.

Games and puzzles.
Supplementary books for classrooms.
Educational support software.
Containers (such as plastic boxes or banker boxes for themes and kits).

Eligible supplies will also include consumable goods, such as the following.

Construction paper for activities, flashcards or activity centres.
Items for science experiments, such as seeds, potting soil, vinegar, baking soda and stir sticks.
Art supplies, such as paper, glue and paint.
Various stationery items, such as pens, pencils, posters and charts.

The employer must certify that the supplies were purchased for the purpose of teaching. Eligible educators will have to retain all receipts for verification purposes.

While teachers and early childhood educators will welcome this credit, it provides only partial relief for the out-of-pocket expenses incurred by teachers and early childhood educators. I hope that cash-strapped school boards and other employers will not use the tax credit as an excuse for requiring teachers and early childhood educators to personally bear more of the costs of classroom supplies.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Monday, April 4, 2016

Budget 2016 and Kids' Stuff

The 2016 federal budget consolidates the Canada Child Tax Benefit (the CCTB) and the Universal Child Care Benefit (the UCCB) into a single acronym with one less letter: the CCB (which stands for Canada Child Benefit).

The CCB will be non-taxable and will provide a maximum benefit of up to $6,400 per year ($533.33 per month) per child under the age of 6 and $5,400 per year ($450 per month) per child aged 6 through 17. An additional amount of $2,730 per year ($227.50 per month) is paid for a child who qualifies for the disability tax credit. The CCB amounts depend on the family net income, however, and are gradually reduced if family income for the previous taxation year exceeds $30,000.

The new benefit system will start in July 2016. To see how your family will fare under the new system, use the CCB calculator at http://www.budget.gc.ca/2016/tool-outil/ccb-ace-en.html.

When using the calculator, you will have to manually take into account the following forms of tax relief eliminated by the 2016 Budget.

The budget eliminates the income-splitting tax credit for couples with a child under the age of 18. This is effective for 2016. The credit allowed a higher-income spouse or common-law partner to notionally transfer up to $50,000 of taxable income to the lower-income spouse or common-law partner for the purpose of reducing the couple’s total income tax liability by up to $2,000.
The budget will phase out the children’s fitness and arts tax credit. For 2016, the maximum eligible amount will be halved. For the fitness tax credit, the eligible amount will be reduced to $500. For the arts tax credit, the eligible amount will be reduced to $250. The supplemental amount for a child who qualifies for the disability tax credit will remain at $500 for 2016. However, the credits will be eliminated for the 2017 and subsequent taxation years.
The budget will eliminate education and textbook tax credits for the 2017 and subsequent taxation years. As a result, unused portions of those credits will no longer be transferable to a supporting individual. The tuition tax credit will remain in place.

Elimination of very specific tax credits (such as the fitness and arts tax credits) in favor of more generally-based financial assistance is generally preferable from a tax policy perspective. Having said that, elimination of the fitness and arts tax credits may reduce the number of children participating in fitness and arts programs. We will have to wait and see how this plays out.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Tuesday, March 29, 2016

Preventing Too Much of a Good Thing

As indicated in the last blog (click here to read it), small business corporations enjoy a low rate of tax on the first $500,000 of profit from an active business carried on in Canada. In British Columbia, this low rate is 13%. This consists of a 10.5% federal rate and a 2.5% provincial rate.

The low rate of tax leaves a small business corporation with more after-tax cash. Because the rate applies only to the first $500,000 of profit in any one year, taxpayers have an incentive to try to multiply access to that $500,000 threshold. Income tax law already contains various anti-avoidance rules that seek to prevent this. The 2016 federal budget adds a few more.

Some taxpayers have tried to have more than one $500,000 limit apply to a single business by having other corporations provide services to a corporation that carries on the main business.

For example, assume that Storeco carries on the business and has two shareholders, Manfred and Peter.
In order to increase access to the low rate of tax, Storeco does some creative outsourcing to “friendly” corporations.
Manfred incorporates a corporation (“Manco”) and Storeco hires Manco to provide business management services to Storeco.
Meanwhile, Peter also incorporates another corporation (“Peterco”) and Storeco hires Peterco to handle inventory purchases.
Storeco pays a fee to Manco and Peterco for those services.

Under current rules, each of the three corporations is carrying on a separate business and can claim the low rate of tax on up to $500,000 of income from that active business. If there had been no outsourcing, Storeco would have had a single $500,000 limit.

Under the new rules, neither Manco nor Peterco will qualify for the low rate of tax because

each corporation is owned by a shareholder of Storeco; and
neither corporation earns substantially all its active business income from arm’s-length persons other than Storeco.

The same result applies if the shareholders are spouses or children or other persons who do not deal at arm’s length with Manfred and Peter.

In order to claim an independent low rate of tax, each corporation (Manco and Peterco) would have to earn substantially all its respective active business income from arm’s-length entities (and Storeco doesn’t qualify as arm’s length). In other words, the corporation would have to carry on an independent business that happens to also provide services to Storeco, among many other clients.

Similar new rules will apply to a partnership that outsources various parts of its business to friendly corporations. If the friendly corporation (or a shareholder of the friendly corporation) is also a member of the partnership, the new rules will require that the $500,000 limit be shared among all such friendly corporations dealing with that partnership.

A corporation will be deemed to be a partner if

the corporation provides services to the partnership; and
a member of the partnership is related to, or otherwise deals on a non-arm’s-length basis with, that corporation or a shareholder of that corporation; and
the corporation does not earn substantially all its active business income from arm’s-length persons other than the partnership.

A corporation (even if friendly) will escape the rules if the corporation carries on an independent business that happens to include the partnership as one of many clients.

These rules could affect family businesses in which various members of a family have their own independent incorporated businesses if the separate corporations also do significant business with each other. Whether substantially all business income is earned from arm’s-length customers will be a question of fact in any one case.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Thursday, March 24, 2016

Steady As She Goes For Small Businesses

The 2016 federal budget did not make the small business rate unavailable for professional businesses, despite the rumours that suggested it would. However, the budget did include changes that will affect small business corporations.

Small business corporations are Canadian-controlled private corporations that earn income from an active business carried on in Canada and that have taxable capital of less than $10 million. The first $500,000 of active business income qualifies for a low rate of tax. In British Columbia, this low rate is 13%. This consists of a 10.5% federal rate and a 2.5% provincial rate.

The former government had proposed to reduce the federal component of this tax rate in stages between 2017 and 2019. The 2016 budget cancels those planned rate reductions. As a result, the low rate of tax will remain at 13% for British Columbia small business corporations. In order to integrate the tax paid by a small business corporation and the tax paid by shareholders on dividends received from those corporations, the dividend gross-up and tax credit rates will also remain at 2016 levels.

The low rate of tax applies only to active business income – for example, income from a retail store or a service business. Except in the case of real estate rentals, it does not matter how many people are employed by the business corporation. If a corporation is in the business of renting real estate, however, rental income qualifies for the low rate of tax only if the rental business employs more than five full-time employees. This restriction applies to corporate landlords as well as corporations that rent storage units.

In 2015, the federal government announced a review of the active business classification rules. It has now completed that review and will not make any changes to the active business income concept at this time. This means that incorporated real estate rental businesses will still have to employ more than five full-time employees in order to gain access to the low rate of tax on that income.

The low rate of tax is an advantage because it leaves a small business corporation with more after-tax cash. The rate applies only to the first $500,000 of profit in any one year. This creates an incentive for taxpayers to try to multiply access to that $500,000 threshold. Various anti-avoidance rules seek to prevent this. For example, associated corporations must share the $500,000 limit. Associated corporations are corporations that have an element of common ownership or that are separate purely for tax purposes.

The 2016 federal budget adds to these anti-avoidance rules. These new rules will be addressed in the next blog.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Tuesday, March 22, 2016

What Was Not In The Budget

Prior to the 2016 federal budget, rumors swirled surrounding the following possible changes.

· An increase in the capital gains tax rate.

· Restrictions on the availability of the small business tax rate for professional corporations and certain other small businesses.

Neither of the above rumors turned into reality on Budget Day.

Capital gains will continue to be taxed at half the normal tax rate. This compensates somewhat for the effect of inflation over time, as part of any capital gain is usually attributable to inflation.

The small business rate will continue to apply much as it has in the past. The government announced that it has completed its review on how the small business rate applies in the context of businesses that earn income principally from the rental of property (such as a storage business). The government has decided to make no changes to the rules at this time.

The small business rate is a low rate of tax that applies to a qualifying corporation on its first $500,000 of active business income. While the basic rules applicable to this rate continue to apply, the federal government will introduce legislation targeting business structures that attempt to get around the annual $500,000 income limit. I will describe these rules in a future blog.

Among other announcements, the government has decided to proceed with changes to the amortization of the cost of goodwill and other forms of intangible property. Such amortization will move to the capital cost allowance system that applies to most equipment and other forms of business property. This will eliminate the separate amortization system that had applied to goodwill in the past.

Charities will be disappointed that the government has chosen not to implement the 2015 proposal that would have provided an exemption from capital gains tax for certain sales of real estate or private corporation shares to the extent that the proceeds were donated to a charity within 30 days of the sale. The government did not give any reason for this decision.

As in the past, this firm will comment on specific budget proposal over the next few weeks. Stay tuned for more on our Tax Talk Blog!

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Friday, February 26, 2016

Canadian Tax Primer 16: Capital Gains Exemption on Farming and Fishing Property

As noted in Tax Primer 14 (please click here to read it), a Canadian-resident individual can realize up to $1 million in tax-free capital gains on the sale of qualified farming and fishing property.

City slickers should not necessarily skip over this tax primer discussion. In some circumstances, farming property can include property that is not currently used as a farm. For example, assume that your parent (or grandparent, or even great-grandparent) operated a farm and left the farmland to you prior to June 18, 1987. As long as that ancestor operated a farm on that property for a total of at least five years (consecutive or not), that previous use of the property can allow you to claim a capital gains exemption of up to $1 million on a sale of that real estate.

The date of acquisition is important in the case of farming property. If you acquired your interest in the farming property on or after June 18, 1987, more stringent rules govern whether you can claim the exemption. For farming property acquired on or after June 18, 1987, you must satisfy a two-year gross revenue test. In at least two years, the gross revenue (before deduction of expenses) from the farming operation must have exceeded the operator’s income (after deduction of expenses) from all other sources. The test can still be satisfied by gross revenue realized during two years while your parent (or grandparent, or great-grandparent) owned the property. However, no gross revenue test applies if you acquired your interest in the farming property prior to June 18, 1987.

In the case of fishing property, the two-year gross revenue test must be met (no matter when you acquired your interest in the fishing property).

Remember that the capital gains exemption exempts only the capital gain that arises on a sale. For example, assume that you are selling farmland that includes barns and other structures that have been depreciated for income tax purposes (read Tax Primer 7 for a discussion of tax depreciation by clicking here). The capital gains exemption will not apply to any part of the sale proceeds that constitutes a recovery of tax depreciation that has been claimed in past years on the barns and other structures.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Tuesday, January 19, 2016

A Better Sense of Timing

Recent 2016 legislative proposals (described in greater detail in our previous article) fix a timing problem that could have arisen in respect of charitable donations made by the trustees of alter-ego trusts, joint spousal trusts and testamentary spousal trusts (“Life Interest Trusts”).

As described in our previous article, the assets of those trusts are subject to a deemed disposition on the death of the initial beneficiary or beneficiaries (the person who established the trust in the case of an alter-ego trust or the surviving spouse in the case of a joint or testamentary spousal trust). I will call this individual the “Relevant Beneficiary”. If the trust document authorizes the trustee to make charitable donations, the trustees can use the donation tax credit in order to reduce the tax payable as a result of that deemed disposition.

The 2015 changes introduced a deemed taxation year-end at the end of the day on which the Relevant Beneficiary died. This deemed year-end created a problem. In order for the trust to use the donation tax credit against capital gains triggered by the deemed disposition, any charitable donation had to be made before the end of the day of death. Even if death occurred first thing in the morning, this would not give the trustee much time to make the donation.

The 2016 proposals alleviate this timing problem by providing the trustee with 90 days from the end of the year of death to make the donation. If the Relevant Beneficiary dies on the last day of a calendar year, the trustee has 90 days in which to make the donation. If the beneficiary dies earlier in a calendar year, the trustee has additional time because the trustee has the rest of the calendar year in question plus the 90 days after the end of the calendar year.

As long as the trustee makes the donation within 90 days of the end of the calendar year in which the death occurs, the trustee can decide how to use the donation tax credit from among several options. The trustee can use the credit in the taxation year in which the gift is made, in any of the following five taxation years or in the trust taxation year that is deemed to end on the death of the Relevant Beneficiary (the most likely choice). By choosing this last option, the trustee can use the donation tax credit to reduce tax triggered by Relevant Beneficiary’s death.

The legislation does not address a second timing issue that arises in respect of donations made by a Life Interest Trust: the time of the donation itself. In order for the trust to use the donation credit at all, the donation must be made by the trustee pursuant to a power to make donations. If the trust deed requires that the trustee pay money to a charity on the death of the individual, the trustee is legally obliged to transfer funds to the charity and is not making a gift. In this case, the gift would have been made at the time that the trust was first established. But if the gift depends on a future date of death and on the amount of property left in the trust at the time of that future death, it is impossible to quantify the amount of the gift at the time that the trust is established and no donation tax credit can be given at that earlier time.

So the 2016 proposal addresses one timing issue but not the other. In order for the trust to be able to use the donation tax credit against tax triggered by the deemed disposition, the trustee has to make the donation pursuant to a power to make donations and has to do so within 90 days of the end of the calendar year in which the death occurs. Usually, the trustee will honor the expressed wishes of the deceased individual when exercising this power but has no legal obligation to do so. The trustee will follow the expressed wishes purely as a matter of honor – the trustee cannot be legally obliged to make the donation.

The Department of Finance is aware of this remaining anomaly. I hope that a future amendment will fix this issue so that generous Canadians have some legal assurance that their charitable wishes will be legally enforceable if they choose to leave assets to charity through a Life Interest Trust.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Monday, January 18, 2016

The Way We Were (Almost)

On January 15, 2016, the federal government released proposals that will fix some of the problems created by its earlier 2015 legislation on the taxation of trusts.

The earlier 2015 legislation changed the taxation rules for alter-ego trusts, joint spousal trusts and testamentary spousal trusts (collectively, “Life Interest Trusts”). In these Life Interest Trusts, the trust assets are held solely for the benefit of the initial beneficiary or beneficiaries (the person who established the trust in the case of an alter-ego trust and the surviving spouse in the case of a joint spousal trust or a testamentary spousal trust). On the death of the last of those initial beneficiaries, the assets in the Life Interest Trust are subject to a deemed disposition. This results in the taxation of any previously-untaxed increase in asset value. Prior to 2015, that deemed disposition occurred inside the Life Interest Trust so that the trust assets could be used to pay any resulting tax.

The 2015 legislation would have changed this starting in 2016. Instead of the deemed disposition occurring inside the Life Interest Trust, the deemed disposition would have occurred outside of the Life Interest Trust and would have become a liability of the personal estate of the deceased individual (as if the individual had personally owned the assets in the trust). This rule would have created a host of problems, especially if the will and the Life Interest Trust had different beneficiaries – as can happen in blended family situations.

The 2016 fix reverses that aspect of the 2015 legislation and returns us back to way things used to be. As a result, any tax triggered by the deemed disposition of trust assets will be paid by the Life Interest Trust rather than by the personal estate. Big sigh of relief.

For those who may have altered their estate plans based on the 2015 legislation, there is an elective procedure under which the trustees of the Life Interest Trust and the executors of the estate can jointly choose to have the deemed disposition tax paid by the personal estate. In order to do so, however, the specified individual must die before 2017. So this elective rule merely provides time for someone who altered an estate plan in an attempt to comply with the 2015 legislation to once again alter the estate plan based on the fix to the 2015 legislation.

The death of the initial beneficiary will still trigger a deemed taxation year-end for the Life Interest Trust – so we are not fully back to the way we were – but at least the tax liability will be in the proper place.

The 2016 proposals also fix a problem that could have arisen in respect of charitable donations made by a Life Interest Trust. That fix will be the subject of a future blog.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.

Friday, December 4, 2015

Canadian Tax Primer 15: Capital Gains Exemption and Shares of Active Business Corporations

As indicated in Tax Primer 14 (click here to read it), each Canadian-resident individual can claim up to $813,600 in tax-free capital gains on a sale of shares of an active business corporation.

The technical rules in the Income Tax Act actually refer to the sale of shares of a “small business corporation”. Like too many tax terms, however, this technical term is misleading. A corporation’s shares can qualify for the capital gains exemption even if the shares are worth $10 million. So this tax primer will use the term “active business corporation”.

To be an active business corporation, a corporation must meet the following requirements.

It must be a taxable Canadian corporation.
It must be a privately-held corporation (not listed on a stock exchange).
It must not be controlled by any combination of non-residents and corporations that are listed on a stock exchange.
At the time in question, it must use substantially all its assets in carrying on an active business primarily in Canada.
During the preceding 24 months, it must have used at least 50% of its assets in carrying on an active business primarily in Canada.

For example, the capital gains exemption will often apply in respect of a sale of shares of a family-held corporation that carries on an active business – provided that the corporation has been structured properly.

While this may seem bizarre, access to the capital gains exemption can be lost if the corporation is too successful. For example, assume that you have a very successful family business corporation and you decide to leave profit inside the corporation to bolster the retained earnings figure on the balance sheet. The corporation does not need this surplus cash for its operations, so the corporation invests the surplus income in mutual funds and GIC’s. If the value of the investments grows too large (for example, if the mutual funds do too well), the corporation will have too many investment assets and its shares will no longer qualify for the capital gains exemption. Substantially all the corporation’s assets will no longer consist of assets used in the active business because the investments will make up too large a proportion of the corporate value.

The Canada Revenue Agency treats “substantially all” as meaning 90%. While this is not necessarily the correct legal position, it is generally best to keep the value of non-business assets below 10% of the value of all corporate assets. As one invests in the hope that investments will grow significantly in value, this means that it is best to hold investments outside the active business corporation.

Many successful entrepreneurs get tripped up on this aspect of the rule. Fortunately, this problem can easily be avoided through the use of a holding corporation to receive surplus cash from the active business corporation through the payment of tax-free intercorporate dividends. The holding corporation can then invest the surplus cash. If the business corporation unexpectedly needs access to cash for a business use, the holding corporation can simply lend funds back to the business corporation and can even secure that loan (as if the holding corporation were a bank).

As noted above, each individual resident in Canada can claim the capital gains exemption. If you have an incorporated family business and hope to sell the shares some day in the future, it is important to structure the share ownership so as to make maximum use of the exemption. This is best done far in advance of any sale, as value has to accrue on shares held for the benefit of other family members.

For example, assume that you and your spouse have two children. Using the 2015 exemption level, this gives rise to four potential exemption claims. Four times $813,600 is equal to $3,254,400. However, the other family members must have an ownership interest in the shares for this level of exemption to apply.

One option is to have the shares held by a family trust. If each member of the family is a beneficiary of the trust, the trust can sell the shares and allocate the capital gain out to the beneficiaries so that the beneficiaries can claim the capital gains exemption on their respective shares of the capital gain. However, the trustee (usually, the entrepreneur) manages the shares while they are held inside the trust and so can decide when to sell the shares and can have the final say on the negotiation of any share sale terms. As well, the trust can protect the shares from matrimonial claims if a child’s marriage breaks up (or if a common-law relationship turns sour).

In order for the trust to be able to allocate the gain out to the beneficiaries, the capital gain must accrue while the shares are held inside the trust. If you are the sole shareholder of the corporation, there is no point in transferring the shares to the trust just before a sale. At that point, the value will be in the shares held by you. Transfer of that value to a trust will give rise to a capital gain that will be solely your gain. There will be no time for the shares to increase in value inside the trust if the sale is completed one month after the trust acquires the shares.

Only individuals can claim the capital gains exemption. Accordingly, the corporate structure must ensure that growth can accrue to individuals but that surplus cash can be transferred on a tax-deferred basis to a holding corporation. These may seem like conflicting objectives, but proper structuring can achieve both goals. In order to maximize use of the exemption, it is important to put this structure into place as soon as possible and in any event well in advance of a sale.

Sometimes, a buyer will insist on buying assets rather than shares. In this situation, it is possible to get the best of both worlds by engaging in a hybrid sale in which the seller sells shares for part of the value and the corporation sells assets for the rest of the value. In this regard, see our blog post from May 11, 2015 “Purchase of Sale of a Business: having your cake and eating it, too” (click here to read it).

Even if it is not possible to sell shares of the corporation or to use the hybrid transaction technique, the capital gains exemption can still be of use. If the corporation sells its assets, it will replace its business by cash and become an investment corporation. At that point, the corporation’s shares will cease to qualify for the capital gains exemption. Prior to the sale, it might be wise to lock in the exemption by triggering a sale of the corporate shares so as to increase the tax cost of those shares. This can reduce the capital gains tax that will be payable in future on the death of a shareholder (see Tax Primer 8 which discusses the subject of deemed dispositions on death by clicking here). This can make it easier for heirs to manage the tax burden that is triggered by a death.

Visit the Dwyer Tax Law web site
for information about our services and lawyers' profiles.