Tax Tips Traps – 1st Quarter 2018Brian Jang ON April 5, 2018
- TAX TICKLERS
- INCOME SPRINKLING: Where Are We Now?
- INPUT TAX CREDITS: Checking Up On Suppliers
- MARIJUANA: A Growing Industry
- LOANS TO A RELATIVE’S BUSINESS: What Happens When It Goes Bad?
- BUSINESS FAILURE: Personal Liability for Corporate Tax Debt
- COMMISSION PAID TO A CORPORATION: Any Issues?
TAX TICKLERS…some quick points to consider…
- Of the approximately 28 million personal tax returns filed for the 2016 year, 58% got refunds. 68% received them by direct deposit. The average refund was $1,735.
- Only the last year of CPP survivor benefits can generally be accessed for late applications. Don’t delay submission.
- Effective December 3, 2017, parents will be able to choose to receive parental benefits under the employment insurance program, if eligible, over the standard period (12 months) or the extended period (reduced amount taken over 18 months). The total benefits would be the same regardless of the option selected.
BUSINESS LOSS OR PERSONAL VENTURE: Can I Deduct Losses Against Other Income?
On December 13, 2017, the Department of Finance released a number of updates relating to the income sprinkling proposals (originally announced on July 18, 2017). Below is a summary of the proposals as they are currently drafted.
Individuals that receive certain types of income derived from a “related business” will be subject to Tax on Split Income (TOSI) unless an exclusion applies. TOSI is subject to the highest personal tax rate with no benefit of personal credits.
Commencing on January 1, 2018 TOSI will potentially apply in respect of amounts that are received by adults, not just those under 18 years. The application of TOSI to individuals under age 18 (commonly known as the “kiddie tax”) would not generally change.
Income Streams at Risk
Private corporation dividends, partnership allocations, trust allocations, capital gains, and income from debt may all be subject to TOSI.
A related business includes any business, where another individual related to the recipient of income does any of the following:
- personally carries on the business (this means income from a sole proprietorship to a related person can be subject to TOSI);
- is actively engaged in the business carried on by a partnership, corporation or trust;
- owns shares of the corporation carrying on the business;
- owns property the value of which is derived from shares of the corporation having a fair market value not less than 10% of the fair market value of all of the shares of the corporation; or
- is a member of a partnership which carries on the business.
The definition is broadly drafted to capture income derived directly or indirectly from the business.
Exceptions and Exclusions
Several exclusions from the TOSI rules for adult individuals have been introduced.
Some exclusions depend on the age of the taxpayer at the start of the taxation year. Different rules apply to taxpayers at least 17 years of age at the start of the year (i.e. these exceptions are first available in the year the taxpayer turns 18) and to those at least 24 years of age at the start of the year (i.e. these exceptions are first available in the year the taxpayer turns 25). For the purposes of this analysis, the first age group will be referred to as those “over age 17” while the second group will be referred to as those “over age 24”.
The exclusions are as follows:
- Excluded Business: A taxpayer over age 17 will not be subject to TOSI on amounts received from an excluded business. An excluded business is one where the taxpayer is actively engaged on a regular, continuous and substantial basis in either the year in which the income is received, or in any five previous years. The five taxation years need not be consecutive.
An individual will be deemed to be actively engaged in any year where the individual works in the business at least an average of 20 hours/week during the portion of the taxation year that the business operates. A person not meeting this bright line test may also be “actively engaged” depending on the facts, but this will carry greater risk of challenge by CRA.
- Excluded Shares: A taxpayer over age 24 will be exempt from TOSI in respect of income received from excluded shares, including capital gains realized on such shares.
Many restrictions apply to qualify for this exclusion, which makes it quite complex and uncertain. The taxpayer must directly own shares accounting for at least 10% of the votes and value of the corporation’s total share capital. For 2018, this test can be met by December 31. In later years, it must be met when the income is received. Also, the corporation can not be a professional corporation (i.e. a corporation carrying on the business of an accountant, chiropractor, lawyer, dentist, medical doctor or veterinarian). Further, it must earn less than 90% of its business income from provision of services. Finally, substantially all of its income (generally interpreted as 90% or more) must be derived from sources other than related businesses, which will be problematic for holding companies.
- Reasonable Return: TOSI will not apply to amounts which reflect a reasonable return.
- For taxpayers over age 24, an amount which is reasonable is based on work performed, property contributed, risks assumed, amounts paid or payable from the business, and any other factors in respect of the business which may be applicable.
- For taxpayers over age 17, but not over age 24, the rules are more restrictive. Only a reasonable return in respect of contributions of capital will be considered.
- Certain Capital Gains: Although TOSI will be expanded to apply to capital gains of interests in entities through which a related business is carried on, some gains will be excluded. For example, capital gains arising due to a deemed disposition on death. Also, capital gains on qualified farm or fishing property, or qualified small business corporation shares will generally be excluded from TOSI.
- Retirement Income Splitting: The TOSI rules will not apply to income received by an individual from a related business if the recipient’s spouse was age 65 in or before the year in which the amounts are received and the amount would have been excluded from TOSI had it been received by the recipient’s spouse.
- Additional exclusions apply for some income from inherited property and property acquired as a result of a relationship breakdown.
This new draft legislation is a substantial change from the current rules. The provisions are lengthy, complex and nuanced, and it is likely that additional concerns and challenges will be identified. It is uncertain whether there will be further changes, given the concerns which have already been identified, as well as the recommendations of the Senate Finance Committee released on the same date as these proposals.
Action Item: Review whether your earnings may be impacted. Consider whether additional documentation should be kept to prove meaningful contributions and time worked. Also, restructuring of ownership or working relationships may be beneficial in some cases.
INPUT TAX CREDITS: Checking Up On Suppliers
In a January 29, 2016 Tax Court of Canada case it was noted that CRA had denied over $500,000 of input tax credits (ITCs), and assessed penalties and interest, in respect of GST and QST paid to twelve suppliers. Unknown to the taxpayer, the suppliers did not remit the tax.
The taxpayer, a scrap metal dealer, obtained evidence of prospective suppliers’ GST and QST registration prior to accepting them as suppliers.
Taxpayer wins – mostly
A taxpayer must use reasonable procedures to verify that suppliers are valid registrants, their registration numbers actually exist, and that they are in the name of that person or business.
The Court held that the taxpayer’s procedures (reviewing the suppliers’ registrations, stamped by Revenue Quebec) were generally sufficient. It was not relevant that some suppliers did not have scrapyards and/or vehicles to carry on scrap businesses, nor that payment was often made in cash, making it difficult to verify the suppliers’ revenues. The taxpayer could not be expected to query government officials to ensure that GST registrations were properly issued.
However, in respect of one supplier, the facts showed that the taxpayer had been sloppy to the point of gross negligence in accepting evidence of registration where it was clear that the registered supplier was not acting on their own account. Those ITCs were denied, and the related gross negligence penalty upheld.
As well, one purchase was made on the date the supplier’s registration was canceled, so the supplier was not a registrant on that date, and the ITC was properly denied. However, the related gross negligence penalty was reversed, based on the due diligence undertaken in respect of the supplier previously.
Action Item: Implement a system for checking GST/HST numbers, especially for major purchases, in CRA’s GST/HST registry. You may want to select a purchase dollar level for which extra revision of supplier GST/HST numbers is performed. The registry is located at https://www.businessregistration-inscriptionentreprise.gc.ca/ebci/brom/registry/
MARIJUANA: A Growing Industry
As the legislation to legalize marijuana for non-medical purposes works its way through parliament (Bill C-45 entered the Senate phase on November 27, 2017), producers, vendors, regulators, enforcement, and potential customers are seriously considering the implications. Although it has been expected legalization would occur by July, 2018, the timeline is not certain (as the Senate has recently been scrutinizing draft legislation and other stakeholders have noted concerns).
Where are we at from a tax perspective?
On December 11, 2017, the federal and provincial/territorial Finance Ministers reached an Agreement in principal regarding the taxation of cannabis for the initial two years after legalization. This agreement followed a consultation with stakeholders.
The Agreement noted that in addition to general sales taxes, the combined rate of all federal and provincial/territorial cannabis-specific taxes will not exceed the higher of $1 per gram, or 10% of a producer’s selling price. Of the tax generated, 75% will go to provincial/territorial Governments, while 25% will go to the federal Government. The federal portion of cannabis excise tax revenue will be capped at $100 million annually with the excess going to the provinces and territories.
The exact allocation, rates, and method for taxation are dependent on the final legislation.
Where will it be retailed?
While retailing cannabis will vary across the country, many provinces are currently looking to either sell, or at least regulate sales through provincial liquor boards or commissions.
For example, in Ontario, the Liquor Control Board of Ontario (LCBO) itself will oversee the sale and distribution of recreational cannabis through a subsidiary corporation. Standalone stores, which would not also sell liquor, will be set up and online distribution will be made available. Approximately 150 standalone locations are expected to be open by 2020.
In Alberta, in-person sales are planned to occur through private corporations but regulated provincially, while on-line sales will be conducted directly by the province.
Most provinces/territories are still working out the details.
CRA has significant, and rapidly improving tools for detecting the underground economy. In addition, they have methods for estimating yields and unreported income having to do with grow operations.
If one wanted to get compliant and onside with CRA, a voluntary disclosure may be made. However, it is important to note that the Voluntary Disclosure Program is changing March 1, 2018 such that reduced relief will apply in some cases, and no relief will be available in others.
LOANS TO A RELATIVE’S BUSINESS: What Happens When It Goes Bad?
You’ve loaned money to a family member’s corporation. Perhaps it was an investment, maybe it was a favor, or both. Or, perhaps, it was made for a completely separate reason. Regardless, sometimes the loan may go bad and you are not able to collect on the debt. What happens from a tax perspective when this occurs?
If the loan was made to earn income and other conditions are met, you may be able to write-off half against your regular income as an allowable business investment loss (ABIL). A recent tax court case shed some light on defining whether the loan was made to earn income.
In a November 3, 2016 Tax Court of Canada case, at issue was whether an ABIL could be claimed in respect of the loan from a taxpayer to his daughter’s start-up company. Within approximately two years, operations had ceased and the daughter had claimed personal bankruptcy.
The loan agreement stipulated that interest at 6% was to be charged from the onset, but no payments would be made for approximately the first two years, which, as it would turn out, was after the business eventually ceased. The Minister argued that no interest was charged, and therefore, there was no intent to earn income. This was partially based on accounting records of the daughter’s company which were inconsistent in their reflection of accrued interest.
Despite the conflicting records, the Court opined that the interest rate included in the agreement was legitimate and that there was an intent to earn income. The ABIL was allowed.
The Court did not opine on whether the intention to earn income requirement would have been met if the agreement only stipulated that interest would begin to be charged or accrued at the time that repayment commenced (i.e. interest-free loan for first two years, but interest generating thereafter).
Action Point: Loans to businesses of relatives are more closely scrutinized by CRA due to the inherent possibility that it was made for non-income earning reasons. If considering a loan to a relative’s business, ensure that the income earning nature is clearly documented.
BUSINESS FAILURE: Personal Liability for Corporate Tax Debt
There are special laws which hold a director personally liable for certain amounts that their corporation fails to deduct, withhold, remit, or pay. Most commonly, these amounts include federal sales tax (GST/HST) and payroll withholdings (income tax, EI and CPP). It does not generally include normal corporate income tax liabilities.
In a June 22, 2017 Tax Court of Canada case, at issue was whether the director of a corporation could be held liable for $66,865 in unremitted source deductions, related penalties, and interest six years after the corporation went bankrupt. The taxpayer presented various defenses.
In general, CRA must issue an assessment against the director within two years from the time they last ceased to be a director. The taxpayer argued he should not be liable since he was forced off the property and denied access by the Trustee in bankruptcy more than two years before the assessment. However, the Court determined that only once one is removed as director under the governing corporations act will such liability be absolved. In this case (under the Ontario Business Corporations Act), bankruptcy does not remove directors from their position. As the taxpayer never officially ceased to be a director, the two-year period had not commenced, and therefore, had not expired at the date of assessment.
Liability can be absolved if the director can show due diligence. In this case, the director argued that he was waiting for large investment tax refunds to fund the liability, and also, entered into a creditor proposal so as to enable the corporation to continue to pay off the liability. However, the Court noted that diligence was required to prevent non-remittance rather than simply diligence to pay after the fact. As there was insufficient proof to demonstrate diligence at the prevention stage, this argument was also unsuccessful.
With All Due Dispatch
Finally, the taxpayer argued that the issuance of the assessment 6 years after bankruptcy was inordinate and unreasonable, thereby contravening the requirement to assess with all due dispatch. The Court, however, found that this requirement related to the assessment of a filed tax return as opposed to the assessment of director liability. In particular, the law allowing CRA to hold the director liable states that “the Minister may at any time assess any amount payable”. This defense was also unsuccessful.
The Minister’s assessment of liability to the director was upheld.
Action Point: Ensure that the charging, collecting, and payment of GST/HST and source deductions is always done properly. Not doing so can result in personal liability for the director. Also, note that CRA has the ability to directly garnish a corporation or person’s bank account for such amounts, even if an objection has been filed.
COMMISSION PAID TO A CORPORATION: Any Issues?
Consider the successful real estate or insurance agent, the financial product vendor, the area sales representative, or any other person earning commission income. One day they are asked, if they ever considered running their activities through a corporation as opposed to providing the services personally. There are definitely some valuable possibilities, but there are dangers too.
In a July 11, 2017 Technical Interpretation, CRA opined that whether a corporation is actually carrying on a business and earning commission income is a question of fact and requires more than a mere assignment of income.
CRA noted that “if insurance agents, realtors, mutual fund salespersons, or other professionals are legally… precluded from assigning their commissions to a corporation, then the commission income must be reported by the individuals, and cannot be reported through a corporation, regardless of the documentation provided”. Care must be taken to document that it is truly the corporation providing the services and not just an individual. Commission contracts identifying the corporation as the service provider rather than simply the individual would be valuable.
While some professionals earning commission income are legally prohibited from incorporating (due to the provincial/ territorial laws), others may be practically precluded from doing so due to, for example, a refusal by customers or key suppliers to contract with a corporation.
If a corporation does earn commission income, one must ensure that the corporation would not be considered a personal services business (PSB). A PSB is essentially an individual acting as an employee for a third party, but for the presence of their own personal corporation as an intermediary. For example, consider John, an employee of a car manufacturer (CarCo). If John set up a new corporation, had CarCo pay his corporation, but kept on doing the same things under the same terms and conditions as his previous employment contract, he would likely be conducting a PSB. If classified as a PSB, the worker and their corporation could be subject to substantially higher taxes, plus the denial of several types of deductions.
Action Point: Take care when incorporating a business to earn employment-like commissions. Talk to an advisor to determine if it is right for you.