Taxation – LAW 345 – O’Brien

Final Outline Spring 2011 – Asif Abdulla

Table of Contents

Basic Concepts and Canada’s Tax System

Compared to Other Govt Collected Payments

Attributes of Taxes

Generally Accepted Accounting Principles (GAAP)

Section 152 – Net Worth Assessments

Equity and Policy in the Tax Law

Equity:

Neutrality:

Simplicity:

Tax Expenditures:

Constitution and Taxation

Pacer Dome Canada Ltd. v. Ontario (Minister of Finance) (2006 SCC) – Tax Act Interpretation

The Source Concept of Income

Section 3 – Income for Taxation Year – (pg3/4)

Section 4(1)(a) – (pg4)

Section 56(1)(a)(ii) – Retiring Allowance – (pg35)

“Retiring Allowance” - Section 248(1)

“Employment” – Section 248(1)

Section 6(3) – Payments by Employer to Employee – (pg7)

Surrogatum Principle: see Tsiaprailis

Interpretation Bulletin 365R2 – Damages, Settlements and Similar Receipts

Case Law on Income from a Source:

Bellingham v. The Queen (FCA 1996) – income not from a source – win-fall gains

Schwartz v. The Queen (SCC 1996) – Retiring Allowances (s.56)

Curran v. MNR (SCC 1959) – Payment in consideration for future services and lost benefits - income

Tsiaprailis v. The Queen (2005) – Surrogatum Principle

Siftar v. The Queen (2003 FCA) – Apportionment Principles

Nexus Between Taxpayer and a Source of Income

General Rule:

Calculation Rules attempt to resolve Three Basic Questions:

Case Law on Source-Taxpayer Nexus:

Field v. The Queen (2001 TCC) – Nexus for RRSP withdrawals

Buckman v. MNR (1991 TCC) – Factors to Consider Instead of Just Strict Ownership

Residence as the Primary Basis of Canadian Tax Liability

Approach:

Residence as a Tax Base

Section 2 – Taxation of Residents and Non-Residents - (pg3)

Section 250(1) – Person Deemed Resident

Section 250(3) – Ordinary Resident

Interpretation Bulletin IT-221R3 – Determination of Residence (CRA)

Case Law on Residence as a Base:

Thomson v. MNR (1946 SCC) – Determining Residence/Ordinary Residence – LEADING

Lee v. MNR (1990 TCC) – Determining Ordinary Residence; Cit/Imm status not determinative

R&L Food Distributors Ltd v. MNR (1977 TRB) – Application of Sojourning

Part-Year Residence

Section 114 – Individual Resident in Canada for Only Part of Year

Section 249(1)(b) – “Taxation Year”

Case Law on Part-Year Residence:

Schujahn v. MNR (1962 Exch Ct) – Establishing Part-Year Residence

The Queen v. Reeder (1975 FCTD) – Where Residency is long established, difficult to show Severance

Avoidance of Dual Tax Residence

Section 250(5) – Deemed Non-Resident

Tax Treaties

Section 128.1(4) – Departure Tax

Case Law on Avoidance of Dual Tax Residence:

Salt (2007 TCC) – indicia of non-residence (severance of ties with Canada) – Can/Aus Treaty

Provincial Residence

Regulation 2601 – Residents of Canada

Regulation 2607 – Dual Residency

BC ITA Section 2 – Liability for Tax

Case Law on Provincial Residence:

Mandrusiak v. The Queen (2007 BCSC) – Thompson used to determine ordinary residence

Residence of Corporations and Trusts

Section 250(4) – Corporation Deemed Resident

Case Law on Residence of Corporations and Trusts:

De Bears Consolidated Mines Ltd v. Howe (1906 HL) – Residency for corporations is a question of fact

Sources as a Basis of Tax Liability

Income from Office or Employment

Basic Definitions and Provisions

Section 248(1) – Definitions Section for Office or Employment

Section 5 – Income / Loss from an Office or Employment

Section 6(1)(a) – Basic Inclusion in Income from Employment (see Savage)

Section 8(2) – Limitation on Deductions

Section 153(1)(a) – Withholding of Tax by Employer

Section 118(10) – Canada Employment Credit

Employee vs. Independent Contractor/Consultant/Sole Proprietor

Differences Between Employee and Independent Contractor

TEST for Employee vs. Independent Contractor:

Case Law on Employee vs. Independent Contractor:

Wiebe Door Services v. MNR (1986 FCA) – Leading – single question test to employee/contractor

Ontario v. Sagaz Industries Canada (2001 SCC)

Wolf v. The Queen (2002 FCA) – Intention is a valid factor to be considered

Royal Winnipeg Ballet v. MNR (2008 FCA) – Intention in the K should be considered

Lang v. MNR (2007 TCC) – Intent should not be ignored, but weight is in question

Personal Services Businesses and Incorporated Employees

Section 18(1)(p) – General Limitations on Deductions from Business or Property Income

Section 125(7) – Definitions

Section 248(1) – Specified Shareholder

Benefits, Reimbursements and Allowances

Savage (SCC) – Benefit need only be a material acquisition which confers a benefit upon the employee

Lowe (FCA) – Is there a measurable economic benefit? Who possesses the primary benefit?

Valuation of Employment Benefits

Giffen v. The Queen (1995 TCC) – Method of valuing benefits – no longer used for loyalty points – IT470R

Dunlap

Allowances

The Queen v. Huffman (1990 FCA) – distinction between allowance and reimbursement

The Queen v. MacDonald (1994 FCA) – Leading case on s.6(1)(b) – what constitutes an allowance

Special and Remote Worksites

Automobile and Traveling Allowances

Deductions and Computing Income from Office or Employment

General Limitations on Deductions:

Traveling Expenses

Martyn v. MNR (1962) – Travel to and from work is not deductable

Hogg v. The Queen (2002 FCA) – Travel to/from work not deductable even w/ work-related security issues

Legal Expenses

Professional and Union Dues

The Queen v. Swingle (1977) – s. 8(1)(i)(i) – interpreted strictly – professional required by statute

Cost of Supplies

Home Office Expenses

Income from Business or Property

Business Source of Income: Organized Activity and Pursuit of Profit

Framework for Income from Business or Property

Definition of a Business

Luprypa v. The Queen (1997 TCC) – Specific expertise or a system to make money gambling = business

LeBlanc v. The Queen (2007) – Lottery is pure chance = not an expected earning source = no source/no tax

The Pursuit of Profit – Reasonable Expectation of Profit (REOP)

Stewart v. The Queen (2002 SCC) – New test to find out if activity is a Business or Property

Adventure or Concern in the Nature of Trade (ACNT)

IT-459 – Adventure or Concern in the Nature of Trade:

MNR v. James A Taylor (1956 Exch Ct) – Transaction is ACNT – factors to consider – trade was business-like

Regal Heights Ltd v. MNR (1960 SCC) – Secondary objective of earning profit on land results in an ACNT

Irrigation Industries Ltd v. MNR (1962 SCC) – Investment in shares of a company are capital investments

Arcorp Investments (2000 FCTD) – Securities trading business = business income (not ACNT)

Income from a Property

Business vs. Property

Hollinger v. MNR (1972) – Approach for Business vs. Property Income

Walsh and Micay v. MNR (1965) – Rental properties generally seen as income from property, not business

Interest

Groulx v. MNR (1967 SCC) – Court found blended payments from an increased purchase price

Rent and Royalties

Wain-Town Gas and Oil (1952) – After-sale share in profits are royalties and subject to income tax

Dividends

Deductions in Computing Income from Business and Property

Structure of the Act – Business/Property

Income Earning Purpose Test

Imperial Oil (1947) – If Expense in ordinary course of business, then generally deductible

Royal Trust Co v. MNR (1957 Exch Ct) – Ordinary course of business expenses are generally deductible

Personal and Living Expenses

Section 18(1)(h) – Personal and Living Expense

Benton (Thomas Harry) v. MNR (1952) – House-keeper is a personal expense – not deductable

Section 63 – Child Care Expense Deduction

Symes v. The Queen (1994 SCC) – s.63, found not discriminatory towards women – note LHD dissent

Commuting Expenses

Dr. E Ross Henry – Travel from/to Home is not deductable aginst income from business/property

Moving Expenses

Home Office Expenses

McCreath (2008 TCC) – Travel between home-workspace and place of employment MAY not be deductable

Example Problem – Home Office Deductions and Carry-forward

Deduction of Interest Expense – see handout

Section 20(1) – Deductions Permitted in Computing Income from Business/Property

The Queen v. Bronfman Trust (1987 SCC) – Requirement that Borrowed funds be used for an income earning purpose; Money must be borrowed to use directly on the income earning purpose

Policy Reasons for Denying Decuctions

Eldridge

Bribery of Certain Officials – s. 67.5

Fines and Penalties – s. 67.6

Policy:

Computation and Timing

Capital vs. Current Expenditures

Section 18(1)(b) – Capital Outlay or Loss

British Insulated and Helsby Cables Ltd v. IRC (1926 HL) – One time payment to create asset - capital

Repair of Tangible Assets

Canada Steamship Lines Ltd v. MNR (1966 Exch) – Boiler of the ship is a capital asset itself

The Queen v. Shabro Investments Ltd (1979 FCA) – New tech improved the building – capital outlay

Gold Bar Developments Ltd v. The Queen (1987 FCTD) – New test outlined for finding repairs over capital

Timing – Amounts Receivable

Section 12(1) – Income Inclusions

CASE LAW RULES:

J. Colford Contracting – When an amount becomes receivable, it must be included in income

Benaby Realties – An amount is not ‘receivable’ for tax purposes until the actual amount is ascertained

West Kootenay Power and Light (1992 FCA) – Receivable means: everything has been done that is required to give rise to entitlement to be paid – even where customer is not legally obliged to pay at that moment

JL Guay Ltee – An amount is not receivable while it is still contingent on a condition precedent

Non-Capital Losses

Section 111(1)(a) – Carry Forward and Back of Non-Capital Losses

Capital Gains

Introduction to Capital Gains

Taxation of Capital Gains and Losses: 3(b) and subdivision E

Distinguish Income from Property: 9(3)

Calculation of Capital Gains and Capital Losses:

Carry Forward and Back of Capital Losses: 111(1)(b) and 111(2)(a)

Policy Evaluation of Preferential Taxation of Capital Gains

Definitions

Section 248(1) – “Property”

Section 54 – Definitions

Example – Identical Properties:

Section 248(1) – “Disposition”

The Queen v. Compagnie Immobiliere BCN Ltee (1979 SCC) – Disposition and POD – stat/normal meaning

Deemed Dispositions and Deemed Proceeds

Section 128.1(1) – Immigration

Section 128.1(4) – Emigration

Gifts and Sales Below FMV to Non-Arm’s Length Persons

Section 70(5) – Capital Property of a Deceased Taxpayer

Lottery Winnings Revisited

Rollovers: Transfer of Capital Property to Spouse/CLP

Section 248(1): “Common-Law Partner”

Section 73(1) and (1.01) – Inter Vivos Transfers

Example – Spousal Rollover

Section 74.2(1)(a) – Spousal Attribution Rule

Example – Opt-out of Spousal Rollover and Attribution Rule

Spousal Rollover on Death

Personal Use Property (PUP) and Listed Personal Property (LPP)

Section 54 – Definitions

Section 46(1) – Personal use Property

Section 40(2)(g)(iii) – Loss on PUP other than LPP is Deemed NIL

Calculation of LPP Net Capital Losses and Gains

Principle Residence Exemption

Policy for Principle Residence Exemption

Section 54 – “Principle Residence”

Section 40(2)(b) – Calculation of Principle Residence Exemption (PRE)

Example – Principle Residence Exemption

Example – Principle Residence Exemption 2

Basic Concepts and Canada’s Tax System

-Tax is a compulsory and unrequited (nothing identifiable is returned for that payment)

-Used to fund government/public services

-Wealth distribution from rich to the poor

-Reflects how society thinks Canada should function – what to encourage/discourage

Compared to Other Govt Collected Payments

-Tax is compulsory and unrequited

-Fines/penalties – compulsory as well but are used to deter/punish behaviour

-Royalties – made to Crown for extraction of natural resources | to company for software use rights

-Prices – a ‘requited’ payment to the govt in exchange for a good or service (licence, transit, etc)

-Taxes are sometimes used to encourage a certain behaviour (RRSP, RESP, etc) or discourage/account for a dangerous behaviour (alcohol/tobacco)

Attributes of Taxes

Tax Bases:

-Income, Consumption, Wealth (not usually used in Canada)

Rates of Tax:

-Statutory (set out in s. 117)

-Marginal Rate – highest rate that applies to the last dollar of income for a tax year

-Average Rate – total tax paid divided by the taxable income

-Effective Rate – total tax paid divided by the total income (including non-taxable income

-Classifications:

  • Progressive Rates: increasing proportion of income as income rises
  • Higher income persons have a greater ability to pay – they should be paying
  • Regressive Rates: declining proportion of income as income rises – usually results from flat tax
  • Low income persons pay a higher portion of their disposable income

Tax Period:

-Period over which tax is calculated; Income – annually

-Instalments may be required over the period

-Others are transactionally based

Exemptions: exempted income does not have be reported

-Lottery Winnings; Gifts; Strike Pay

Deductions: taxable income = total income – deductions

-RRSP/RESP; Moving Expenses; Childcare Expenses; Union Dues

Credits: tax payable = total taxes – credits

-Personal Tax Credit; Education Credits; etc

Generally Accepted Accounting Principles (GAAP)

-Rules set out by the Canadian Institute of Chartered Accountants for how to produce financial statements

-May be relevant for tax purposes, but may be overwritten by ITA or case law

Section 152 – Net Worth Assessments

(7) Assessments no dependent on return information – The Minister is not bound by a return or information supplied by T, and in making an assessment, may assess the tax payable

(8) Assessment deemed valid and binding – Assessment shall be deemed to be valid and binding absent errors

Equity and Policy in the Tax Law

Equity:

-Vertical Equity: Tax should consider how parties are situated against those in unequal positions

-Horizontal Equity: Those that are similarly situated should be taxed in a similar fashion

-Tax is premised on the notion of equity/fairness – most important factor

Neutrality:

-Taxes should not unduly effect personal decisions – marriage vs. common law, market factors, etc

-Difficult to obtain because our tax system is built on encouraging/discouraging certain actions

Simplicity:

-Comprehensibility – should be able to se how the system is meant to work with little effort

-Certainty – should be able to determine in advance the tax consequences of decisions

-Compliance Convenience – should not be difficult or inconvenient to comply with tax law

-Administrative Convenience – should not be too difficult for govt to administer the tax collection

-Difficult to Avoid/Evade – should be efficient to avoid dishonesty

Tax Expenditures:

-Where individuals would not be able to participate in a govt encouraged initiative, they are given tax breaks in the form of deductions, exemptions or credits

-Evaluation Expenditures

  • What govt objective is being served by the expenditure?
  • Are benefits distributed fairly? Is a program efficient? Does govt have control over the spending and politically accountable for it? Can the money be better spent elsewhere?

Constitution and Taxation

-91(3): Fed has unlimited power to tax/raise money by any mode

-92(2): Prov can impose direct taxes for the purpose of raising revenue for Provincial purposes

-Tax Collection Agreements – Feds collect on behalf of both Fed/Prov and then distribute to Prov

Pacer Dome Canada Ltd. v. Ontario (Minister of Finance) (2006 SCC) – Tax Act Interpretation
-Words of the Act are to be read in their entire context and in their grammatical and ordinary sense, harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament
-Where the words are plain in their meaning, that is the favoured interpretation
-Only where there is ambiguity, greater recourse to the context and purpose is necessary
-There is a rarely relied upon residual presumption in favour of the T, only where cannot be resolved
-T has the burden of establishing that the factual findings of the assessment are wrong (Siftar)

The Source Concept of Income

Section 3 – Income for Taxation Year – (pg3/4)

Non-Capital Income

T’s income for a taxation year is the T’s income for the year determined by the following rules:

(a)Determine the total of all positive income (other than taxable capital gains) from a source inside or outside Canada, including but not limited to, the T’s income from each office, employment, business and property

NOTE: New sources are allowed by the Act, but none found to date - Bellingham

Capital Gains and Losses

(b)Determine amount by which

  1. The total of: (A) T’s taxable capital gains from disposition of property other than LPP, AND (B) T’s taxable net gain for the year from dispositions of LPP (must be a positive figure for LPP)

Exceeds

  1. The amount of T’s allowable capital losses for the year from dispositions of property other than LPP

(c)Determine the amount of (a) plus (b) exceeds the allowable deductions permitted by 60, 62, 63

Non-Capital Losses

(d)Determine the amount (c) exceeds the total amount of T’s loss from the year from an office, employment, business or property

Section 4(1)(a) – (pg4)

-Calculate income/loss from each source separately

-Because deductions/inclusions differ from source to source

-Net income is still a consolidation of all the income/loss from each source

Section 56(1)(a)(ii) – Retiring Allowance – (pg35)

-There shall be included in computing T’s income, a retiring allowance, other than an amount received out of an employee benefit plan, retirement compensation arrangement or a salary deferral arrangement

“Retiring Allowance” - Section 248(1)

-An amount received (other than superannuation, pension, death benefit)

  • (a) On or after retirement of T from an office or employment in recognition of T’s long service OR
  • (b) In respect of loss of an office/employment whether or not received as damages or pursuant to an order or judgment of a competent tribunal

“Employment” – Section 248(1)

-Position of an individual in the service of some other person

Section 6(3) – Payments by Employer to Employee – (pg7)

-(a)Payments made during a period while the payee was an officer or in the employment of the payer, OR (b) on account, in lieu of payment or in satisfaction of an obligation, shall be deemed income from an office or employment under section 5

-UNLESS, the payment was made (c) as consideration for accepting the office/contract/employment, (d) as remuneration for services as an officer or under k for employment; OR (e) in consideration for a covenant with reference to what the officer/employee is or is not to do before/after termination

Surrogatum Principle: see Tsiaprailis

-When payment is received in substitute for another payment, where the payment being replaced is taxable, then the replacement payment should also be taxable

-Two-part Test:

  • 1. What was the payment intended to replace? (Must be clear)
  • 2. Would the replaced amount have been taxable in the recipient’s hands?

Interpretation Bulletin 365R2 – Damages, Settlements and Similar Receipts

-Damages for personal injury or death are excluded from income

-Except the amount that could reasonably be considered to be income from employment

Case Law on Income from a Source:

Bellingham v. The Queen (FCA 1996) – income not from a source – win-fall gains
-T owned an investment property but it was expropriated by the city