Tax: the Basics

TAX: THE BASICS

4 Elements of Tax:

Tax unit – person, residents 2(1)
Tax base – taxable income 2(1)
Accounting period – tax yr 2(1)
Tax rates – individual 117(2)

Federal Rate of Tax
15% / On the first $40,726 or less / 117(2)(a)
22% / On the amnt greater than $40,726 but less than $81,452 / 117(2)(b)
26% / On the next $81,452 but less than $126,264 / 117(2)(c)
29% / On income over $126,264 / 117(2)(d)

Good Tax System:

-Equitable tax policy (horizontal + vertical)

-Characteristics: neutrality, administrability, efficiency, fairness

Deductions – lower taxable income [better for high income earners]

Credits – reduce tax payable [benefit everyone equally]

Net income = To determine income: Net Income = s 3(a) + 3(b) - 3(c) - 3(d)

LOL GOOD LUCK

EMPLOYMENT INCOME:

Division B, subdivision A, rules 5-8

5: Salaries and remuneration (inclusions)

6: benefits from employment (inclusions)

7: stock options (inclusions)

8: deductions (deductions)

Rules 5 + 6 + 7 – 8 = NET EMPLOYMENT INCOME

It is net employment income that goes into 3a

INCLUSIONS: What is included in income? 6(3)

1. Remuneration:

-Pre-employment amounts: inducement payments (Curran)

-Post-employment amounts: compensation for breach or contractual obligations (Moss)

-Payments on or after termination (ex: retiring allowance 248(1))

-NO tort damages for injury/death (Cirella)

2. Benefits: 6(1)(a)

-General rule – all benefits received or enjoyed in respect to office or employment

-No single test, have to consider elements (characterize, relationship, value)

3. Other Benefits:

-Automobile (if “available” Hewitt)

Reasonable standby charge6(1)(e) [rule] and 6(2) [calculation]

Operating expenses 6(1)(k) [rule & calculation] and 6(1)(l) [exception]

-Insurance benefits

Contributions by the employer to medical, disability, health insurance etc. are not taxable (6(1)(a)); the benefits paid out under are (6(1)(f))
Once payments brought in to income = taxable
Surrogatum principle:
“Where pursuant to a legal right, a trader receives from another person compensation for the trader’s failure to receive a sum of money which, if it had been received, would have been credited to the amount of profits...the compensation is to be treated for income tax purposes in the same way as that sum of money would have been received instead of the compensation.”
What was the payment intended to replace?
Would the replaced amount have been taxable in the recipient’s hands?

 If it was meant to replace income under employment or office it is taxable.

-Interest-free & Low-interest loans

Interest on EE debt 6(9)

-Relocation assistance

4. Allowances:(are not reimbursed)

-Personal or living expenses 6(1)(b) with exceptions

-Employment at remote location worksite 6(6)(a)

DEDUCTIONS:Can only deduct as allowed by s. 8(1) and (2)

1. Travel Expenses

-Can deduct unless received allowance; or falls under 8(1)(e)(f)&(g)

-Requirements to qualify:

Have to pay travel expenses per EE duties (Cival)
Required to work away from bns (Nelson; IB-IT522R)
No travel allowance (Yurkovich)

-Luks - own choice to travel = not deductible

2. Meals–8(4)Healy

3. Legal Expenses– 8(1)(b) Werle

4. Professional Membership Fees – 8(1)(i)(i),(iv)-(vii)Montgomery

5. Office Rent – 8(1)(i)(ii)

6. Expenses of a salesperson – 8(1)(f)

-Must meet 5 requirements for expenses

TIMING:

Cash method: items received and expenses incurred in that period = claim in that period (even if earned or incurred in a different period)

BUSINESSS INCOME

CHARACTERIZATION OF INCOME

Distinction between income from bns and income from ppty:

Have to be able to distinguish the activity from a hobby or personal pleasure
ex: gambling cases (Morden;LeBlanc;Walker)
Have to distinguish from capital gain

AINT characterizationTaylor

-Negative propositions – no outright indications not AINT

Isolated/one-shot transactions
Organization not set up to carry it in to effect
Selling exactly what you bought without enhancement
Transaction is totally different in nature from any of the other activities of the TP and have never entered upon transaction of that kind before
No intention to sell subject matter at profit (behaviour matters, not intention)

-Positive guides– indications of an AINT

If what you are doing is the same as what an organized trader would do, indication that this is an AINT
Nature and quantity of the subject matter of the transaction

Secondary intention Regal Heights

-Transaction may be characterized in the nature of trade only where “the possibility of re-sale at a profit was one of the motivatingconsiderations that entered into the decision to acquire the property in question”

REOP Stewart– determine source of income

Determine whether the taxpayer’s undertaking is for profit or for personal purposes.
For profit/purely commercial = source of income
To determine if TP’s dominant intention is to make a profit, look at: (Objective factors from Moldowan)
The taxpayer’s profit and loss experience in past years;
The TP’s training and expertise in the field of her activities
The TP’s intended course of action;
The financial viability of the venture to show a profit
If it is not a personal endeavor, is the source of the income a business or property?

INCLUSIONS:9(1)

1. Gains for illegal activities

-Included in income and property (No 275 v MNR)

2. Damages & other compensations

-Surrogatum principle [again! See above] applies when damages awarded in lieu of income

Test:

(1) Damages are received pursuant to legal right, and
(2) amount received would have been included as income

-See IB-IT365R –characterization of payments received n cancellation or non-performance of a business contract

3. Interest – 12(1)(c)

-If received something in lieu of interest, need to include it in income

-Interest characterized as so in 3 situations:

Characterize the amount “as, on account of, in lieu of payment of or in satisfaction of interest” within the meaning of 12(1)(c)Perini Estate
Disposition of capital ppty for an amnt which is payable in one or more TYs, will characterize a portion of deferred payment as interest (and not capital)
16(1)(a) – anti-avoidance provision; if it should be interest can call it interestGroulx
Gain realized on a debt obligation that was acquired at a discount or dispose at premium, or on which a bonus is payable at maturity
Sherway Centre Ltd;O’Neil

4. Royalties – 12(1)(g)

Manner in which amounts received by the TP must “depend” on the use or production of property (see MNR v Morrison)
Relationship between “amounts received in the year” and the use or production of the property (see Huffmanv MNR)

5. Rent

-distinguish leasing v renting (Pitman)

DEDUCTIONS:

1. Damage payments

-payment must be necessary, an not merely incidental (Imperial OiI)

2. Fines and penalties – CANNOT deduct

3. Theft

-Deductibility of stolen funds (ThayerLumber; Cassidy’s)

4. Legal defence costs

-Legal expenses incurred in defending practices used in the pursuit of business and earning income are deductible. (LD Caulk; Rolland Papervs. Neeb Canada)

5. Promotional Expenses

-must be some how connected, if too remote won’t be allowed (Ace Salvage)

See Ace Salvage vs. Ross;OlympiaFloor

6. Recreational, Meal, and Entertainment

-Expenditures can be incurred for the purpose of business promotion, but also can confer personal benefits both on the objects of the promotional activities and on the persons who conduct these activities on behalf of the business.

Royal Trust Company – note: wouldn’t be valid today
Grunbaum – expenses had personal characters, but were clearly business purposes

7. Home Office Expenses Lock v MNR

-s 18(12)(a) has the requirement:

must be (i) principal place of business ; or (ii) used exclusively

-s 18(12)(b) has the exceptions/limitations

8. Interest Expenses

-Can be excluded by 18(1), but then allowed through 20(1)(c)

-Shell Canada 4 elements of the provision [ note – not our case]

Taxation year – amount must be paid in the year or be payable in the year in which it is sought to be deducted
Characterization of the legal interest – the amount must be paid pursuant to a legal obligation to pay interest on borrowed money
Purpose – the borrowed money must be used for the purpose of earning non-exempt income from a business or property
Reasonableness – the amount must be reasonable, as assessed by reference to the first three requirements

-Brofman Trust – application of 20(3)

Characterize the use and purpose of the money
Must be current use o fthe money
Direct use of the money (not indirect)

TIMING ISSUES

s. 9(1) – profits

s. 9(2) – losses

s. 12 – additional amnts that should be included

20(1)(c) – permits deductions for interest paid/payable in the yr

18(1) – disallows deductions for everything else

Bns income typically included/deductedon accrual/cash basis –claim in tax year earned/incurred, rather than received/paid (West Kootenay Powery)

How to determine whether something is profit? (Canderel)

Look at the Act, see if it specifies treatment
Any established rules from case law/judicial interpretation

Anything else (ex: GAAP) is just an interpretive aid

Have to know what the amnt is in order to qualify as profit/loss

-claim in the year the amount is ascertained (Benaby Realties; CommonwealthConstruction)

-Amounts must be certain/mandatory, not contingent (against 18(1)(e)) (JL Guay vs. Wawang)

-Obligation to pay in the future is not a deductible expense (Burnco); have to actually incur an expense (Buck)

s 18(9) prohibits the deduction in the TY in which it was made or incurred, allows amounts to be deducted in the subsequent year – give truer picture of income (Urbandale Realty)

Can claim a ‘reasonable amount’ as per a doubtful debt (s 20(1)(l)(i))

-amount claimed as reserve in prior yr must now be included in income for this yr (s 12(1)(d))

-Copely – reasonable can be determined using GAAP

Bad debts –can claim under s.20(1)(p)(i) See Anjalie

Capital Cost Allowances

Can claim a deduction for capital cost allowances (depreciations) 20(1)(a)

-CCA is only deductible against income earned in the business or property in which asset was used

-Depreciable assets are divided into separate classes, defined in Regulations

Class 1 – 4%
Class 8 – 20%
Class 10.1 – 30%

-Cannot claim on undepreciable ppty (ex: land)

-Can’t claim on ppty that not acquired for gaining or producing income (Reg 1102(1)(c)) – Ben’s Limited

Undepreciated capital cost of all classes starts at 0:

-All assets are acquired at the adjusted cost base and added to the class, and all assets sold are then subtracted from the class

-End of each fiscal, undepreciated capital cost of each class is determined, and CCA may be claimed on that amount at the applicable rate

Don’t include those that were sold halfway through
But have to include those that are gained – but at a reduced amount (½)
Reduced amount of CCA

-Balance remaining after CCA of each class subtracted is the starting point for the NEXT fiscal

Process repeats; called the declining balance method of CCA

-CCA is permissive, can deduct less than full amount

NOTE: CCA from rental cannot be used to create a loss, only reduce income to 0 (Regulation 1100(11))

Have to be able to characterize something as a capital expense Canada v Johns-Manville

-Consider factors:

The purpose of the expenditures: was the expenditure operational, and not the acquisition of a capital asset?
Were these expenditures incurred regularly (yearly) and as an integral part of day-to-day operations of the TP?
The expenditures form an easily discernible, more or less constant, element and part of the daily and annual cost of production?
The lands were not acquired for any intrinsic value but merely by reason of location? That is, was it merely for consumption, rather than capital gain?
Would not incurring this expense cause the business to halt? Do expenditures produce a transitional benefit, which had no enduring value, bc similar expenditures were required in the future to continue the operation?
Do these expenditures add to the capacity of the business or are they simple expenditures to maintain the current capacity?
The relative cost of the expenditures in relationship to the cost of the running the business.

-Determination is a policy analysis – use assessment of evidence and conclusions, then common sense to apply the related provisions – with ambiguity in favour of TP

How to calculate the undepreciated capital cost at the end of the year for each class?s. 13(21)

When is property acquired?  must be available for use; normal incidents of title (WaldeanDrilling)

When is property disposed? no incidents of title, change of use (Browning Harvey; Hewlett Packard)

Recaptured depreciation– Sell price > UCC/undepreciated value

-value of “B”: amount resulting when sell asset for more than remaining value of asset after depreciation, therefore deducted too much for depreciation-difference b/t sale price and remaining value which must be added back

-Sell price > UCC

-Have deducted too much CCA over the yrs – the over-deprecation amount is recaptured into income (up to original price) and the remaining is a CAPITAL GAIN

Terminal loss:Sale price < UCC/undepreciated value

-therefore deducted too little for depreciation-difference b/t remaining value and sale price. Amount added to E to get actual total depreciation

Calculating UCC for Year 1

(1) Start with CAPITAL COST of an asset

Capital Cost = actual cost + laid down costs (legal, accounting, engineering, other fees incurred to acquire property)

(2) Apply half-year rule (rule prevents tax avoidance by discouraging taxpayers from acquiring property at the end of a year in order to claim the full year’s allowance)

½ Capital Cost

(3) Calculate the CCA of the asset

CCA = ½ capital cost x class rate

(4) UNDEPRECIATED CAPITAL COST (UCC) of an asset

UCC = ½ capital cost – CCA

(5) UCC at the end of year 1

UCC at the end of year 1 = UCC + remaining ½ capital cost

Calculating UCC for Year 2

(6) Take into account any additions or dispositions to the class

Net additions = Capital cost of additions – POD

(7) Apply half-year rule

½ Net additions

(8) Add net additions to Year 1 UCC

Balance before CCA = ½ Net additions + UCC at the end of year 1

(8) Calculate the CCA of the asset

CCA = Balance before CCA x class rate

(9) UNDEPRECIATED CAPITAL COST (UCC) of an asset

UCC = balance before CCA – CCA

(10) UCC at the end of year 2

UCC at the end of year 2 = UCC + remaining ½ net additions

Cumulative Capital Expenditures = “a nothing that you have paid for”defined/calculated at s 14(5)

-if amnt becomes negative,s 14(1)requires ⅔ of that to be brought in to income (therefore taxing half of any recaptured eligible expenditure and half of any gain exceeding the original cost of the eligible capital ppty

CAPITAL GAINS AND LOSSES

General rule: a gain or loss from the disposition of property will be characterized as income or loss from a business where the property is disposed of in the course of a business according to its ordinary meaning or pursuant to an AINT

Types of Property:

1. Real property

-Gain or loss from disposition of property will be characterized as income or loss from a business where the disposition takes place in the course of business in its ordinary meaning, or pursuant to an AINT (Regal Heights)

-IBIT-218(R) – factors to consider distinguishing capital vs. inventory

2. Tangible property

-Personal property that can be seen, weighed, measured, felt, or touched, or that is in any way perceptible to the senses

-Characterisation depends on purpose (Kodak)

-IB IT-102R2:

Basically: Need to separate sale from leasing activities, be able to prove which were sold and which were released, and if you sell the lease units you sell them for less than their cost … we will allow you to call those depreciable property used to carry on a business, and their sale will fall under the normal disposition of capital property rule as opposed to the sale of inventory

3. Corporate Shares

-fractional interests in the ownership of the issuing corporation; confer a proprietary interest in the corporation itself (rather than the assets of the corporation)

-Characterization of gains from the disposition of shares Irrigation Industries

IBIT-479R– course of conduct in carrying out transactions, business, etc.

4. Debt Obligations

-Gains may be characterized as interest income as per 12(1)(c) or as part interest and part capital under 16(1)(a)Wood v MNR

-If not characterized as above, have to decide whether it is a capital gain or income from a business

Freud – AINT; Milford Developments – characterized as income

5. Canadian Securities

-s 39(4) allows election whereby every Canadian security owned by the TP in that year or a subsequent yr is deemed to be a capital property in those years, and every disposition of such is a disposition of capital property

does not apply to traders or dealers of securities, financial institutions, corporations in bns of lending money or purchasing debt obligations, or non-residents (s 39(5))
Refers to anyone who fits this description (Vancouver Art Metal Works)

6. Foreign Exchange

-Foreign currency must be converted to CAD based on exchange rates prevailing at the relevant time Profit when converting = taxable (Tip Top Tailor;Shell)

Dispositions

-Most commonly sale of property

Applies as soon as TP is entitled to the sale price of the ppty sold
If leased with option to purchase is as soon as all incidents of ownership sold

-Robert v MNR- assumed mortgage was part of proceeds

-Anti-avoidance rulesin s 68 and 69

Can get around by doing two transactions:
ex: I will sell you a half interest for 50k (so face value on the half share; you now have proceeds of 50k and she has ACB of 50k), then the next day in separate transaction you give her the half interest for 50k (bc it’s an outright gift, under c she will be treated as receiving it for fair market value – acquiring an ACB of 50k.)

“adjusted cost base”

a)where the property is depreciable property of the taxpayer, the capital cost to the taxpayer of the property as of that time, and

b)in any other case, the cost to the taxpayer of the property adjusted, as of that time, in accordance with section 53

s. 47 – when you have identical ppty, you avg the costs

Can only deduct the costs associated with buying (Stering)

40(1)(a) (b) allow deduction for “any outlays and expenses to the extent that they were made or incurred by the taxpayer for the purpose of making the disposition”

-“for the purpose of” means immediate or initial purpose of, not eventual or final goal (Avis)

SPECIAL RULES

Personal use property

-includes most kinds of ppty being used for personal use/enjoyment (not gaining or producing income)

-40(2)(g)(ii) cannot have deduction of losses on personal use dispositions (Burnet; Boudreau)

Listed property

-Personal interest or right to certain other types of property