Canadian Income Tax: Introduction & Liability for Tax PDF

Chapter 1&2: Introduction & Liability for Tax Overview ​ T1 ○​ Filed by Canadian tax resident individuals ○​ Due date: April 30, June 15 if taxpayer/spouse earn business income ​ T2 ○​ Filed by Canadian resident corporations ○​ Due date: 6 months...

Chapter 1&2: Introduction & Liability for Tax Overview ​ T1 ○​ Filed by Canadian tax resident individuals ○​ Due date: April 30, June 15 if taxpayer/spouse earn business income ​ T2 ○​ Filed by Canadian resident corporations ○​ Due date: 6 months after the taxation YE ​ Income Tax Act ○​ Over 30 parts ○​ Reference: 6(1)(b)(i)(A) - [section/subsection/paragraph/subparagraph/clause] ○​ Definitions: see S248 ​ Regulations ○​ Can find specific rates & allocations ○​ Can be changed without Parliament ratification, but are tied to particular Act sections ​ Interpretation Act, Tax treaties ​ Court cases / CRA Income Tax Folios or Interpretation bulletins (“IT”) ○​ Depends on court’s hierarchy; not the law but CRA’s views Liability of Individuals for Income Taxes - Residency ​ Resident ○​ Show a continuing state of relationship with Canada (e.g. has a house, spouse and kids live in Canada, work, etc.) ○​ Taxed on worldwide income ○​ Entitled to full amount of non-refundable credits ​ Deemed resident ○​ Sojourned (temporary residence) in Canada for 183 days+ (part day stay also included per CRA), deemed to be a full-time resident ○​ Taxed on worldwide income ○​ Entitled to full amount of non-refundable credits ​ Part-time resident ○​ Evidence of “clean break” or “fresh start” needed ○​ Either became a resident or non-resident during the year: ​ Residency period: Taxed on worldwide income ​ Non-residency period: Taxed on income earned in Canada from employment, carrying on business, and from disposal of taxable Canadian property ○​ A person can live for 183 days+ but with “fresh start” evidence to be a part-time resident b/c the stay is not temporary ​ Non-resident ○​ Taxed on income earned in Canada from employment, carrying on business, and from disposal of taxable Canadian property  ○​ Not entitled to non-refundable credits unless report >90% of worldwide income to Canada ○​ File T1 tax return during the “become non-resident” taxation year when: ​ Was employed in Canada ​ Carried on a business in Canada, or ​ Disposed of a taxable Canadian property (at any time in the year or a previous year) ○​ Passive Income: withholding tax at a specified rate (generally 25%) on interest, dividends, etc. So a non-resident doesn’t need to file for passive income ○​ Tax treaties: with various countries (e.g., U.S.) to determine residency status ​ Steps to Address Resident Issue ○​ Assess the situation and identify the issues ○​ Analyze the issue ○​ Conclude and advise Liability of Corporations for Income Taxes - Residency ​ Resident ○​ If incorporated after April 26, 1965 (deemed resident per S250(4)) ○​ If incorporated before April 27, 1965, and has the central management & control in Canada (deemed resident per Common Law) ○​ Taxed on worldwide income ​ Non-resident ○​ Taxed on its Canadian source of business income if it has a permanent establishment in Canada (determined by Tax Treaties; non-treaty countries are taxed regardless, e.g., Liberia) ○​ Also pay withholding taxes on passive income like individuals Chapter 3: Employment Income Employment Income Computation ​ Inclusions ○​ Section 5: Salary, wages, other remuneration including gratuities received in the year (cash basis) ○​ Section 6: Value of benefits derived by virtue of employment as income from employment (e.g., auto benefits, imputed interest, gifts, other benefits) ○​ Section 7: Value of stock option benefits realized from participating in a company’s stock option plans ​ Deductions ○​ Section 8: deductions from employment income Employed Vs. Self-employed ​ Tax reasons: deductibility of expenses (e.g. CCA & interest)  ​ Non-tax reasons: EI eligibility, holidays, liability for services they perform, severance pay, job security and so risk ​ 3 primary tests to determine status ○​ Economic Reality or Entrepreneur Test: control; ownership of tools; chance of profit / risk of loss ○​ Integration or Organization Test ○​ Specific Result Test ​ Steps to Analyze the Issue ○​ Assess the situation and identify the issue ○​ Analyze the issue ○​ Conclude and advise Imputed Interest Benefit [S80.4] ​ Amount of interest expense saved by employee by not paying FMV interest to an employer on loans received (FMV rate = CRA’s quarterly published prescribed rate) ​ Computed on a daily basis ​ Any owing must be paid within 30 days from YE to obtain a deduction S80.5 ○​ Good if the loan is used in a income earning portfolio or car purchase, then interest paid can be deducted ○​ Thus if the loan is for investment purposes, generally the amount included per S80.4 less deducted per S80.5 =$nil ​ Home purchase loans ○​ Can choose the calculation rate based on the lessor of: ​ (a) prescribed rate at the time loan was issued (reset every 5 year) ​ (b) prescribed rate in effect for a particular quarter Employer Owned Auto - Standby Charge [6(1)(e) and 6(2)] ​ When an employee uses an employer owned or leased automobile 𝐴 2 ​ Calculation: 𝐵 × [2% × (𝐶 × 𝐷) + 3 (𝐸 − 𝐹)] ○​ A = lessor of: ​ (a) total personal-use KM during the period ​ (b) value of B 𝑡𝑜𝑡𝑎𝑙 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑑𝑎𝑦𝑠 ○​ B = 1667 𝐾𝑀 × 30 ○​ C = full original cost of the car, HST included 𝑡𝑜𝑡𝑎𝑙 𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑑𝑎𝑦𝑠 ○​ D = 30 ○​ E = lease payments by employer, HST included ○​ F = portion of lease payments for loss or damages insurance ○​ A=B except when employee uses 50%+ for employment purpose and employer required to do so ○​ If auto is used 100% for employment, then A=nil thus standby charge =nil Employer Owned Auto - Operating Cost Benefit [6(1)(k)] ​ Exists whenever a standby charge >0  ​ When employer paus the operating cost of the car and employee uses the car for personal uses, the employee has to: ○​ (a) reimburse for personal use KM within 45 days of YE ○​ (b) include the benefit in taxable income ​ Calculation 1: 𝐵𝑒𝑛𝑒𝑓𝑖𝑡 = (𝑡𝑜𝑡𝑎𝑙 𝑝𝑒𝑟𝑠𝑜𝑛𝑎𝑙 𝐾𝑀 × $0. 33) − 𝑟𝑒𝑖𝑚𝑏𝑢𝑟𝑠𝑒𝑚𝑒𝑛𝑡 ​ Calculation 2: 𝐵𝑒𝑛𝑒𝑓𝑖𝑡 = (𝑠𝑡𝑎𝑛𝑑𝑏𝑦 𝑐ℎ𝑎𝑟𝑔𝑒 × 50%) − 𝑟𝑒𝑖𝑚𝑏𝑢𝑟𝑠𝑒𝑚𝑒𝑛𝑡 ○​ Must used the car 50%+ for employment ○​ Has to notify the employer in writing before YE as he/she is using this method Stock Option Benefit [7(1)] ​ Enable the employee to purchase the stock for a particular price (exercise price) ​ Inclusion: 𝐸𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 = 𝐹𝑀𝑉 𝑎𝑡 𝑒𝑥𝑒𝑟𝑐𝑖𝑠𝑒 − 𝑃𝑟𝑖𝑐𝑒 𝑝𝑎𝑖𝑑 (𝑒𝑥𝑒𝑟𝑐𝑖𝑠𝑒 𝑝𝑟𝑖𝑐𝑒) 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛/𝑙𝑜𝑠𝑠 = 𝑃𝑟𝑜𝑐𝑒𝑒𝑑𝑠 𝑜𝑛 𝑠𝑎𝑙𝑒 − 𝐹𝑀𝑉 𝑎𝑡 𝑒𝑥𝑒𝑟𝑐𝑖𝑠𝑒 ​ Public Corporation ○​ Option grant date - no tax effect ○​ Exercise date - employment benefit inclusion ​ Division C partial deduction: = ½ benefit inclusion if options were not in the money on grant date (i.e., option price allowance) ○​ Car allowance: not based on KM is deemed to be not reasonable and need to be include for income then take deduction for actual expense Travel Expenses - 8(1)(h) ​ Meals, accommodation, air travel, etc. ​ Meals: ○​ Normal - only 50% are deductible when away for 12+ hours from where normally worked ○​ Commission only - meal expenses consumed during client meeting (no hrs rule) Cost of leasing, and operating automobile - 8(1)(h.1) ​ Leasing cost, gas, license, insurance, maintenance, etc. ​ Calculation: lessor of (1) and (2) ○​ (1): [(𝐴 × 𝐵)/30] − 𝐶 − 𝐷 − 𝐸 ​ A = prescribed dollar monthly max, currently $1,050+HST ​ B = total leased days (for all years to the end of current year) ​ C = total costs deducted in all previous years ​ D = imputed interest at the prescribed rate on refundable amounts (e.g. deposits) over $1000 ​ E = total reimbursement receivable for the current year ○​ (2): [(𝐹 × 𝐺)/0. 85𝐻] − 𝐷 − 𝐸 ​ F = total lease charges payable+HST for the year ​ G = prescribed capital cost max, currently $37,000+HST ​ H = greater of: ​ (a) $37,000+HST ​ (b) manufacturer’s list price ​ Prorate the expenses between personal & employment using total KM driven approach CCA and interest on car and aircraft - 8(1)(j) ​ Normal - The only two capital expenditures for normal employee’s income tax deduction ​ Commission only - office equipment  ​ CCA Calculation: ○​ CCA rate = 30% ○​ Half-year rule freeze: full 30% rate in the first year for purchase between Jan 1, 2024 and Dec 31, 2027 ​ Interest expense Calculation: ○​ Deductible - car loan interest; not - home or equipments ○​ Lessor of: ​ (a) actual amount paid ​ (b) $350 for each 30 days Home Office Expenses and other - 8(1)(i) ​ Normal - heating cost, utilities, cleaning materials, repair costs, rents, long distance fees, dedicated telephone line for business, etc. ​ Commission only - property taxes, house insurance ​ Not - CCA or mortgage interest ​ Conditions S8(13): meet (a) or (b) ○​ (a) 50%+ of working days from home during the year (that required by employer) ○​ (b) (i) used exclusively for the purpose of earning employment income and (ii) met customers or persons at home on a regular and continuous basis for work ​ Prorate the expenses between personal & employment using sqft approach ​ Max = gross employment income (unused deduction can be carried forward indefinitely) ​ Other deductible - annual professional membership fees, union dues, salary to assistants hired as required by employer, supplies expense Sales Expenses - 8(1)(f) ​ Golden provision: must be involved in sales or negotiating contracts to qualify. Employment contract must require employee to pay their expense (not reimbursed and not included in income pursuant to 6(1)(b)(v)) ​ Max = commission income ​ Under 8(1)(f) only: ○​ Client entertainment expense (not - club dues or golfing fees) ○​ Property taxes, home insurance ○​ Rental or leasing of office equipment ○​ Meal expenses consumed during client meeting (no 50% and 12+ hrs away rule) ​ Alternative: 8(1)(f) or 8(1)(h)+8(1)(h.1) ○​ 8(1)(f) max = commission income ○​ 8(1)(h)+8(1)(h.1) max = no limit Chapter 4: Income from Business - General Concepts and Rules Division B Income ​ Net Income for Income Tax Purposes (Division B Income) = Net income (Accrual basis under GAAP) + inclusion - deduction  ○​ Income from business ○​ Property ○​ Capital gains & losses ○​ Other income ○​ Other deductions ​ Division B income ≠ Taxable Income (which includes some deductions in Division C) ​ Schedule 1 of T2 ​ Starting point of calculation: Accounting Net Income Computation Principles ​ §9: start - income for the tax year = profit from that business or property ​ §12: include - amounts receivable/received for services rendered(/to be rendered) or goods sold (/to be delivered) ​ §18: include - expenses that were not incurred to earn income and expenses that are capital in nature ​ §20: exclude - overrides S18 and allows certain specific expenses to be deducted ​ §67: include - limits certain expenses to a max also the outlay has to be reasonable Additions to NI per F/S ​ Income tax expenses - 18(1)(t) ​ Income tax penalties for late filing and interest charges - 18(1)(t) ​ Political contributions - 18(1)(n); a credit is provided in S127(3) ​ Auto expenses over the max - 18(1)(r) ​ Use of recreation facilities and club dues - 18(1)(l) ​ Prepaid expenses - 18(9) ​ Accrued bonuses unpaid within 179 days after YE - S78(4) ​ Reserve for contingencies (e.g. warranty, inventory, etc.) - 18(1)(e)  ​ 50% of meals and entertainment - §67.1 ​ Fines and penalties - §67.5, 67.6 ​ Amortization/depreciation - 18(1)(b) ​ Accounting losses ​ Donations (Division C deduction) ​ Property taxes and interest on vacant land greater than rental income - 18(2); the excess may be added to the ACB of land ​ Life insurance premiums not required as financing collateral ​ Net taxable capital gains (i.e., taxable gains - allowable losses) ​ Reserves deducted in prior years ​ Accounting and legal expenses (capital in nature) - 18(1)(b) ​ Recapture on sale of depreciable properties Deductions to NI per F/S ​ CCA - 20(1)(a) ​ ⅕ of expenses of issuing shares/borrowing money - 20(1)(e) ​ Annual filing fee or similar fee for borrowed money - 20(1)(e.1) ​ Interest paid/payable on funds borrowed to earn income - 20(1)(c) ​ Life insurance premiums used as financing collateral - 20(1)(e.2) ​ Allowable reserves (doubtful debt, other) ​ Accounting gains ​ Employer contribution to Deferred Profit Sharing Plan - 20(1)(y) ​ Employer contribution to Register Pension Plan - 20(1)(q) ​ Cancellation of lease - 20(1)(z), 20(1)(z.1) ​ Landscaping fees for business income earning purpose - 20(1)(aa) ​ Expenses of representation for licence, permit, etc. - 20(1)(cc) ​ Site investigation - 20(1)(dd) ​ Utilities service connection - 20(1)(ee) ​ Disability-related modifications & equipments - 20(1)(qq)/(rr) ​ Convention expenses (max two per year) - 20(10) ​ Provincial capital and payroll taxes ​ Terminal losses Employer’s Contribution to RPP - 20(1)(q) (Deductions) ​ Defined benefit Plan (DB): limit = 1/9 MP limit ​ Money Purchase Plan (MP): total of employer and employee contributions is lessor of: ○​ (a) 18% of employee’s employment income under Ssec 5&6 (include benefits, but no stock options, no deductions) ○​ (b) specified dollar limit 2020 2021 2022 2023 2024 2025 $27,830 $29,210 $30,780 $31,560 $32,490 $33,810 Business Income Vs. Capital Gain ​ Business Income - 100% taxable; Business Loss - 100% deductible  ​ Capital Gain - 50% taxable; Capital Loss - 50% deductible (and only on CG) ​ To determine: ○​ “Proceeds from sale of tree vs. sale of fruits” concept ○​ Primary intention vs. secondary intention ○​ Observable behavioural factors or “Badges of Trade” Chapter 5: CCA System for Depreciable Property Including Intangibles CCA Overview ​ ( CCA Common Classes [Exhibit 5-1].pdf )( CCA Full Classes [CRA].pdf ) ​ Accounting depreciation of capital assets - GAAP over useful life ​ Income tax depreciation method - CCA ​ CCA: permissive deduction under S20 - [20(1)(a)] ○​ Can choose to deduct or not, also UCC balance ○​ Considered income, not capital gain (100% taxable) ○​ Capital gain - any amount that proceeds>orginial cost (50% taxable) ​ Terminal Loss: Proceeds