Income Tax Planning (Ch 1) PDF

Income Tax Planning Chapter 1 Introduction to Tax Planning Income Tax Basics The Canadian Government first collected income tax in 1917 as a temporary measure to help finance Cana...

Income Tax Planning Chapter 1 Introduction to Tax Planning Income Tax Basics The Canadian Government first collected income tax in 1917 as a temporary measure to help finance Canada’s costs in World War I. The federal and provincial governments collect taxes on personal income to provide revenue to cover the cost of the services provided by the government. Revenue from taxes on personal incomes has long been the main source of income for the Canadian federal and provincial governments. In 2019, income tax payable by individuals accounted for 50% of the federal government's total revenues. 1 Income Tax Basics (continued) The Canadian government uses the income tax system to encourage investment in high-risk ventures or specific industries that have the potential to stimulate the country's economy. For example, when the housing industry was in a slump, the tax rules were changed in the 1992 federal Budget to allow people to borrow from their RRSPs to buy a house. Sometimes tax rules intended to stimulate the economy have undesirable consequences. The result is often a change in the rules. Until 1994, Canadians had a lifetime capital gains exemption of $100,000. During the 1980s economic boom in Canada, this exemption encouraged investors to speculate in real estate. The result was escalating real estate prices. The federal government responded in 1992 by excluding capital gains from real estate investments from the $100,000 life-time capital gains exemption. Tax rules are sometimes changed in response to conditions in one part of the country and not others. The real estate boom in Ontario, for example, was not experienced in Atlantic Canada. Nevertheless, Atlantic Canada taxpayers were subject to the change in rules that excluded real estate from the lifetime capital gains exemption. The Canadian Tax System There are a variety of ways in which taxes can be classified. Alternative Tax Bases Income Tax A tax on the income of certain defined entities Property Tax A tax on the ownership of some particular set of goods Consumption Tax A tax levied on the consumption or use of a good or service. Also referred to as sales tax or commodity tax Value Added Tax A tax levied on the increase in value of a good or service that has been created by the taxpayer's stage of the production or distribution cycle. Tariffs or Custom Duties A tax imposed on the importation or exportation of certain goods or services. Transfer Tax A tax on the transfer of property from one owner to another User Tax A tax levied on the user of some facilities such as road or airport. Capital Tax A tax on the invested capital of a corporation Head Tax A tax on the very existence of some classified group of individuals 2 The Canadian Tax System (continued) Taxable Entities in Canada Federal Income Tax Three types of entities are subject to federal income taxation. These are: Individuals Corporations Trusts Personal Income Taxes Under the Constitution Act, the federal, provincial, and territorial governments have the power to impose taxes. The provinces and territories are limited to direct taxation as delegated in the Act, a constraint that leaves all residual taxation powers to the federal government. The provinces are further limited to the taxation of income earned in the particular province and the income of persons resident in that province. Within these limitations, all of the provinces and territories impose both personal and corporate income taxes. Corporate Income Taxes Provincial corporate income tax is levied on Taxable Income. All of the provinces, with the exception of Alberta and Quebec, use the federal income tax act to compute Taxable Income. Only Alberta and Quebec collect their own corporate income taxes. GST, HST, and PST In 1987, the federal government proposed a joint federal/provincial Goods and Services Tax (GST) but due to a lack of interest at the provincial governments, the GST was introduced only at the federal lever. Provincial Sales Tax (PST) remained in place without significant alteration. This situation was very costly and time consuming for businesses operating in more than one province as they had to file multiple sales tax returns under different sets of rules. Despite the obvious efficiencies that would result from harmonization, it has not been accepted across Canada. Quebec administers its own Quebec Sales Tax (QST). In Quebec, the HST is about 15%, which includes 5% GST and a 9.975% QST. In several provinces there is a Harmonized Sales Tax (HST) which is, in effect, a combined federal/provincial sales tax. In Ontario, we have the HST (13%), which includes 5% GST. 3 Tax Policy Concepts Taxation and Income Levels Policy makers are concerned about the relationship between income levels and rates of taxation. Regressive Taxation can be regressive resulting in lower effective rates of taxation as higher income levels are reached. Sales taxes generally fall into this regressive category as lower income individuals spend a larger portion of their total income and, as a consequence, pay a greater portion of their total income as sales taxes levied on their expenditures. Gertrude has an income of $200,000 and spends $40,000 of this amount in a province with a 13% HST, which results in $5,200 in HST. This represents a 2.6% effective tax rate on her $200,000 income. Ingrid has an income of $40,000 and spends all this amounts ($40,000) in the same province with a 13% HST, which results in $5,200 in HST. This represents a 13% effective tax rate on her $40,000 income. Progressive The federal income tax system taxes individuals using a progressive system. The more money you make the more taxes you pay. Federal Tax Rates $0 - $53,359 15% $53,359 - $106,717 20.5% $106,717 - $165,430 26% $165,430 - $235,675 29% $235,675 Plus 33% Ontario Tax Rates $0 - $49,231 5.05% $49,231 $98,463 9.15% $98,463 $150,000 11.16% $150,000 $220,000 12.16% $220,000 Plus 13.16% In Ontario, on amounts over $220K, you pay 46.16% Please note that the first $15,000 of income is tax free based on the “Basic Personal Exemption Amount”. Please note that the province of Ontario, starting in 2019, introduced the Low-income Individuals and Families Tax credit for individual net income below or family net income below $65,000. Flat Tax System o While progressive tax systems continue to be pervasive, there has been a worldwide trend towards flattening rate schedules. o As mentioned before, high bracket taxpayers tend to have better access to various types of tax concessions which can significantly reduce the effective rates for these individuals. o Given this situation, it has been suggested that we could achieve results similar to those which, in fact, prevail under the current system by applying a single or "Flat Rate" of tax to a broadened taxation base. o In this context, the term base broadening refers to the elimination of tax concessions, resulting in tax rates that are applied to a larger income figure. 4 Tax Policy Concepts (continued) Surtax o Surtax is essentially a tax on tax. o It is often calculated as a percentage of a certain amount rather than the amount of income. o For example, a surtax could be based on a percentage of the basic tax amount. o Historically, there have been surtaxes both federally and provincially. Marginal Tax Rate o The marginal tax rate (MTR) is the rate a taxpayer would pay on his or her next dollar of taxable income. o Phrased another way, the marginal tax rate is the rate of tax paid on an individual's highest dollar of income. o Understanding the marginal tax rate concept is useful when making decisions that have income tax implications. o The marginal tax rate is calculated as: ▪ Highest Federal Tax Rate + Highest Provincial Tax Rate Average Rate vs. Marginal Rate o The Canadian personal tax rates are graduated or tiered meaning the rate gets higher as taxable income increases. o As a result, the marginal tax rate for an individual will be higher than his or her average tax rate since the average tax rate accounts for portions of their income that is taxed at lower rates. o In contrast, the marginal tax rate is based on only the last dollar of income of the individual and therefore, is tied to the tax rate of his or her highest income bracket. Effective Marginal Tax Rate o The effective marginal tax rate is similar to the marginal rate, however, in addition to federal and provincial tax rates, the effective marginal tax rate also accounts for the impact of income-tested tax deductions and credits. o This could result in a much higher rate than the marginal tax rate since eligibility for many government benefits and credits are based on net income (e.g. Old Age Security benefits). o The higher the net income of an individual, the greater the chance he or she could face a loss of benefits and credits. o This in turn could result in an effective marginal tax rate in excess of 50.0% o Example: Cassandra is 67 years old and lives in Nova Scotia. She has a total income of $85,000 which includes OAS benefits of $7,384. Her regular marginal tax rate would be 39% based on total taxable income of $85,000 however, due to the OAS clawback her effective marginal rate is 49.0%. 5 Tax Policy Concepts (continued) Tax Deductions o A tax deduction is an amount that is deducted from a taxpayer's total income and is effectively not subject to tax. o For example, an RRSP contribution of $5,000 can be deducted from the taxpayer's total income; by doing so, it essentially excludes $5,000 of income from being taxed. o The effective tax savings from a tax deduction are the taxes that would be paid on an additional taxable income equal to the amount of the deduction. o Example 1: ▪ Therese has a marginal tax rate of 38.6%. ▪ Assuming she makes a $5,000 contribution to her RRSP and this contribution does not reduce her taxable income to a lower federal or provincial tax bracket, she will reduce her taxes by $1,930, calculated as (tax deduction × MTR) or ($5,000 × 38.6%). o There are a variety of tax deductions that can reduce a taxpayer's total income. o Tax Deductions and MTR ▪ The value of a tax deduction to an individual is dependent on his or her marginal tax rate: the higher the marginal tax rate of the taxpayer, the more his or her income taxes will be reduced as a result of the tax deduction. o Example 2: ▪ In the previous example, we learned that based on a 38.6% marginal tax rate and a $5,000 RRSP contribution, ▪ Therese will reduce her taxes by $1,930. ▪ By contrast, if her husband Pierre, who earns a considerably higher income than Therese, were to make an identical $5,000 contribution to his RRSP and claim a tax deduction based on his marginal tax rate of 43.2%, he will reduce his taxes by $2,160 calculated as (tax deduction × MTR) or ($5,000 × 43.2%). Tax Credits o A tax credit is an amount that is deductible from income tax otherwise payable. o Unlike a tax deduction, a tax credit reduces the taxpayer's income tax by the same amount regardless of his or her marginal tax rate. o However, a province may have income surtax that would increase the value of a tax credit for an individual who is subject to an income surtax. o Conversion Rate for Federal Tax Credits (15%) ▪ The conversion rate for tax credits is the rate that is applied to an eligible amount to calculate the amount of the tax credit. ▪ The conversion rate has been equal to the lowest marginal tax rate or 15%. ▪ Refundable and non-refundable tax credits A non-refundable tax credit can be claimed by a taxpayer but only to the extent it reduces his or her tax liability to zero. This means, a non-refundable tax credit generally cannot be used by a taxpayer to obtain a payment from the government unless he or she has tax payable. Most tax credits can only be used to reduce the taxpayer's personal tax liability although, in limited circumstances, they can be transferred to a spouse or parent. Typically, the portion of a tax credit that cannot be claimed in a given year is lost. However, exceptions, most notably with charitable donations, permit the unused portion to be carried forward and used in a future year subject to certain conditions. 6 Tax Policy Concepts (continued) Tax Credits (continued) o Refundable Tax Credits ▪ Certain tax credits, such as the federal GST tax credit and certain provincial tax credits, are payable regardless of whether the taxpayer has any taxable income. ▪ These are called refundable tax credits. ▪ With refundable tax credits, even if the taxpayer has reduced his or her tax liability to zero, he or she will still be able to generate a refund from the government based on the excess portion of the refundable credit. ▪ Example: George has $200 in taxes owing and a refundable tax credit of $500. George can use $200 of his tax credit to reduce his taxes to zero. Since the tax credit is refundable, the unused portion will trigger a $300 refund for George when he files his income tax return calculated as ($200 - $500). Liability for Income Tax The portion of any tax legislation that specifies who is liable to pay tax is called a charging provision. Canadian income taxation is based on residence. Canadian residents are liable for Canadian income tax, without regard to their citizenship. This is in contrast to the situation in the United States where U.S. citizens are liable for U.S. income taxes, without regard to where they reside. Corporations and trusts, as well as for individuals in certain types of circumstances, determining residency can become a fairly complex process. It is also because of the large differences in tax rates in various provinces. Taxation Year The general rule, which applies to all individuals and to most trusts, is that the taxation year is a calendar year. There are, however, two exceptions to this general rule: Corporations The taxation year is defined as a "fiscal period." The Income Tax Act goes on to define a fiscal period as a period for which accounts are made up that does not exceed 53 weeks. Are NOT required to use a calendar year as their taxation year. Graduated Rate Estates It is a trust that arises at the time of an individual's death. Such trusts can continue for up to 36 months after the date of death and, during that 36-month period, such trusts can use a non-calendar taxation year. Non-residents Where are a person who is not a resident of Canada for a taxation year but was: ▪ 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, an income tax shall be paid, as required by the Income Tax Act (ITA), on the person’s taxable income earned in Canada for the year. 7 Net Income for Tax Purposes Once Net Income for tax Purposes has been established, then there are deductions that can be utilized to determine Taxable Income This Taxable Income figure provides the basis for calculating the federal income tax that is payable by individuals, corporations, and trusts that are resident in Canada. Capital Gains and Capital Losses Capital gains and losses arise when an asset that has been used to produce business or property income is sold. As was true with business and property in income, capital gains and losses can arise on dispositions by individuals, corporations, and trusts. Taxable Capital Gain Is used when referring to the taxable 50% of a capital gain. When the term capital gain (without the taxable) is used, it is reference to 100% of the gain. Allowable Capital Loss Is used when referring to the deductible 50% of a capital loss. When the term capital loss (without the allowable) is used, it is a reference to 100% of the loss. Non-Capital Losses Unused losses from an office, employment, business or property The unused portion of the taxpayer’s share of partnership losses from business or property Can be carried back 3 years and forward for up to 20 years to be applied against any source of income in those years. Net Capital Losses If a taxpayer realizes an allowable capital loss upon disposition of capital property, that loss can only be deducted from taxable capital gains. In its most basic form, it is the sum of all allowable capital losses for the year minus all taxable gains. Can be carried back for 3 years against capital gains in those years, or they can be carried forward indefinitely to be used against taxable capital gains of other years. Principles of Tax Planning Tax Avoidance or Reduction The most desirable result of tax planning is to permanently avoid the payment of some amount of tax. An outstanding example of tax avoidance is the capital gains deduction that is available on the disposition of qualified farming or fishing property, and qualified small business corporation shares. For 2024, the first $1,016,836 of capital gains on dispositions of qualified small business properties and qualified farming or fishing properties, can be received by an individual taxpayer on a completely tax-free basis. Tax Deferral The basic concept behind tax planning arrangements involving the deferral of tax payments is the very simple idea that it is better to pay taxes later rather than sooner. This is related to the time value of money and also involves the possibility that some permanent avoidance of taxes may result from the taxpayer being taxed at a lower marginal income tax rate at the time the deferred amounts are brought into taxable income. 8 Principles of Tax Planning (continued) Income Splitting Progressive rates are built into Canadian federal income tax legislation. This means that, in general, the taxes payable on a given amount of taxable income will be greater if that amount accrues to one taxpayer, than would be the case if that same total amount of taxable income is split between two or more people. Problems with Income Splitting Splitting income with children often involves losing control over assets, a process that is emotionally difficult for some individuals. Splitting income involves decisions as to which family members are worthy of receiving benefits and how much those benefits should be. The tax on split income, also known as the "kiddie tax", a high-rate tax assessed on certain types of income received by related minors can make income splitting very difficult in some situations. 9  Personal Income Tax - Introduction Learning outcomes: Understand the basic concept behind the Canadian income tax system Calculate effectively taxable income Differentiate between tax deductions and tax credit Calculate federal and provincial taxes Calculate tax credits  Personal Income Tax – Introduction (continued) Canada In Canada, you pay tax based on residency. If you are a resident of Canada, you will have to complete a tax return and potentially pay taxes based on your world-wide income. If you are a Non-resident of Canada, then you will pay tax on your taxable income earned in Canada. U.S. In the U.S., you pay tax based on citizenship. This means that regardless of where you reside in the world, if you are a U.S. citizen, you will have to complete a U.S. tax return and pay taxes based on your world-wide income.  Personal Income Tax - Introduction Taxpayers can save large sums of money using intelligent strategies. Tax Evasion; is illegal and involves misstatement or omission of facts. Evaders are subject to fines, interest & penalty costs, & possible imprisonment Tax Avoidance; in contrast, is the legal use of tax laws to reduce one’s tax burden. Tax Planning; is using acceptable strategies to pay the least amount of legal taxes  Personal Income Tax Planning Approximately 40% of every dollar earned goes to taxes The Federal government has unlimited powers to levy taxes, provincial government has limited powers to levy taxes. The departments in the Canadian government taxation system; ▪ The Finance Department - drafting and amending the Income Tax Act ▪ Canada Revenue Agency – administering the act and collecting taxes ▪ Department of Justice – handles any litigation issues  Personal Income Tax – Tax Policy Concepts Progressive Tax System The federal and provincial income tax system taxes individuals using a progressive system. This means that “the more money you make the more taxes you pay”. Regressive Tax System A regressive tax, such as sales taxes (GST/HST), is a type of tax that is assessed regardless of income, in which Low-and-High income earners pay the same dollar amount. This kind of tax is a bigger burden on Low-income earners than High-income earners, for which the same dollar equates to a much larger percentage of total income earned. Flat Tax System There has been a worldwide trend towards flattening tax rates. A flat tax system applies the same tax rate to every taxpayer regardless of income.  Federal Tax Rates $0 - $48,535 15% $48,536 - $97,069 20.5% $97,070 - $150,473 $150,474 - $214,368 26% 29% Federal and Ontario Tax $214,369 Plus 33% Ontario Tax Rates $0 - $42,961 - $42,960 $85,923 $85,924 - $150,000 5.05% 9.15% 11.16% Brackets $150,001 - $220,000 12.16% $220,001 Plus 13.16% Taxation Year 2020 $220,001 + in Ontario you pay 46.16%  Personal Income Tax – Tax Deductions Tax Deductions A tax deduction reduces your taxable income The value of a deduction depends on your marginal tax rate. Examples: Registered Retirement Savings Plan (RRSP) contributions. Annual union, professional or like dues. Child-care expenses. Business investment loss. Carrying charges and interest expenses. Non-capital losses. Net-capital losses.  Personal Income Tax – Tax Credits Tax Credits Tax credits reduces tax payable dollar for dollar. Tax credits are different than tax deductions and come in two forms: Non-Refundable Tax Credit and Refundable Tax Credit. Non-Refundable Tax Credits It is applied directly against your tax payable. They are designed to reduce your federal tax payable but they do NOT create a tax refund. That means if you have tax owing of $1,000 and have a tax credit for $1,000, you now owe nothing. If you don’t owe any tax, non-refundable tax credits are of NO benefit to you. Refundable Tax Credits They not only reduce the amount of tax you pay, but they can generate a tax refund.  Personal Income Tax – Tax Credits (continued) Examples of Tax Credits Non-Refundable Tax Credits Basic personal amount Age amount Canada Pension Plan (CPP) Employment Insurance (EI) Medical Expenses Refundable Tax Credits GST/HST credit Working Income Tax credit (now known as Canada Workers Benefit)  Calculating Personal Taxes Owing 1. The taxpayer records their Gross (Total) Income from all sources such as salary, commissions, self-employment income, tips, capital gains, grossed-up dividends, passive income, rental income. 2. From the Gross Income; tax deductions are applied (lowers the amount of income that will be taxed on a dollar-for-dollar basis to arrive at Net Income. Then, any additional deductions such as capital losses are applied to arrive at “Taxable Income”. 3. Taxes are calculated using tax brackets for both federal and provincial governments. The tax bracket are progressive each higher bracket charging a greater percentage than the previous. It is at this point that taxes owing are calculated. 4. Tax Credits are then applied as applicable. Once they are subtracted the final amount of taxes owing (or refund) is produced.  Example: Income Tax Return Example: Joe earns $88,000 gross annually, how much federal tax will he be subject to? Federal Income Tax Rates Tax Rate Tax Bracket 15.00% up to $48,535 20.50% 48,536-97,069 29.00% 97,070-150,473 Federal Tax owing; On the first $48,535 X.15 = $7,280.25 (88,000 – 48,535) = $39,465 X.205 = $8,090.33 TOTAL FED TAX PAYABLE = $15,370.58  Income Splitting Income Splitting Progressive rates are built into Canadian federal income tax legislation. This means that, in general, the taxes payable on a given amount of taxable income will be greater if that amount accrues to one taxpayer, than would be the case if that same total amount of taxable income is split between two or more people. Problems with Splitting Income Splitting income with children often involves losing control over assets. The tax on split income, also known as the “kiddie tax”, a high rate of tax assessed on certain types of income received by related minors can make income splitting very difficult in some situations.  Income Splitting – (continued) Income Splitting Example 2020:  Income Tax Planning Procedures and Administration (Chapter 2) Returns and Payments - Individuals Requirement to File o A general rule that requires all persons (individuals, corporations, and trusts) to file a tax return. o Here are some reasons why an individual would be required to file an individual tax return (T1 General). ▪ Has Tax Payable ▪ Person requested by the CRA to file a tax return ▪ Person has disposed of a capital property, or realized a taxable capital gain; ▪ And his spouse or common-law partner have elected to split pension; or ▪ Person has to contribute to the Canada Pension Plan or pay Employment Insurance premiums o In addition to these requirements for residents, non-resident individuals must generally file a T1 tax return if, during the year, they have a taxable capital gain or dispose of a Taxable Canadian Property. o Even when there is no requirement to file, if an individual is entitled to a refund, it will only be available if a return is filed. o Further, it is beneficial for others to file, especially low-income tax taxpayers, in order to be eligible for income-based benefits such as: ▪ Canada Child Tax Benefit ▪ GST credit ▪ Guaranteed Income Supplement (GIS) o Individuals can either file a paper form or, alternatively, use an electronic method (E-File). Due Date for Individual Returns o General Rule ▪ Individuals must use the calendar year (December 31) as their taxation year. ▪ Individuals must file their tax return for a particular year on or before April 30 of the following year. ▪ Although the filing due date is extended to the next business day if the due date falls on a weekend. o Individual Who Are Partners or Sole Proprietors ▪ Recognizing that individuals who are involved in an unincorporated business may need more time to determine their income for a taxation year, the Income Tax Act (ITA) provides a deferral of the filing deadline. ▪ The due date is extended for filing to June 15 of the calendar year following the relevant taxation year. ▪ An interesting feature of this provision is that, while the return does not have to be filed until June 15, payment of all taxes owing is required by the usual date of April 30. 1 Returns and Payments – Individuals (continued) Due Date for Individual Returns (continued) o Deceased Taxpayers ▪ In order to provide the deceased individual’s representatives with sufficient time to deal with these complications. ▪ In the case of an individual who dies after October of the year and before the day that would be the individual’s filing due date for the year if the individual had not died, (a return must be filed) by the individual’s legal representatives on or before the day that is the later of the day on or before which the return would otherwise be required to be filed and the day that is 6 months after the day of death. ▪ For an individual whose filing due date is April 30, this provision means that if death occurs between November 1 of the previous year and April 30 of the current year, the return for the previous year does not have to be filed until 6 months after the date of death. Withholdings for Income Tax o A large portion of the income taxes paid by individuals employed in Canada is collected through source deductions. o Under the ITA, any individual who earns employment income will have the estimated taxes on this income withheld from gross pay through payroll deductions made by their employer. o The amount withheld by an employer is based on a form that is filled out by each employee, form "TD1" (Personal Tax Credits Return). o This form lists personal and other credits that are available to an individual and asks the employee to indicate which of these he will be claiming. o Also, on Form TD1, an individual can request to have the amount withheld increased beyond the required amount. Non-Residents o While the general rate of tax on the Canadian source income of non-residents is established in the Income Tax Act (ITA) as 25%, the amount that will actually be withheld is usually modified by international tax treaties. Instalment Payments for Individuals o For many individuals, particularly those earning employment income, the withholding of taxes constitutes the major form of tax payment in any taxation year o However, in situations where an individual has large amounts of income that are not subject to withholding (e.g., self-employment income, or investment income), quarterly instalment payments may have to be made towards the current year's tax liability o In provinces other than Quebec, "net tax owing" is the amount, if any, by which the total federal and provincial tax owing for a particular year, exceeds all tax withheld for that year o An "individual's instalment threshold" is defined in the ITA as $3,000 (In Quebec the instalment threshold is $1,800) o You have to make instalment payments for 2023 if your net tax owing is more than $3,000: ▪ In 2022; and ▪ In either 2022 or 2021 o Note that net tax owing is not equal to Tax Payable if any income tax has been withheld. 2 Returns and Payments – Individuals (continued) Due Dates for Individuals o For individuals required to pay instalments, the quarterly payments are due: ▪ March 15, June 15, September 15, and December 15. Determining Amounts of Instalments o In determining the amount to be paid as instalments, individuals have a choice of three alternatives for calculating the required quarterly instalments. o These alternatives are as follows: ▪ Current Year 1/4 of the estimated net tax owing (which is not necessarily equal to Tax Payable). ▪ Preceding Year 1/4 of the net tax owing for the immediately preceding taxation year. ▪ Second and First Preceding Year The first two instalments (March 15 and June 15) based on 1/4 of the net tax owing for the second preceding taxation year. The remaining two instalments (Sep 15 & Dec 15) equal the excess of the net tax owing for the preceding year, divided by two. Note that 50% of the net tax owing for the second preceding year is the amount that should have been paid in the first two instalments under this approach. Determining Amounts of Instalments (continued) o The individual taxpayer can select the most advantageous of these alternatives o The basic rules for this selection are as follows: ▪ If the net tax owing is Lowest in the Current year (Alternative 1 is Best) ▪ If the net tax owing is Lowest in the Preceding year (Alternative 2 is Best) ▪ If the net tax owing is Lowest in the Second Preceding year: And the net tax owing in the first preceding year is higher than the current year, Alternative 1 is best And the net tax owing in the in the first preceding year is lower than the current year, Alternative 3 is best While the total amount of the instalments will be the same as in Alternative 2, their present value will be less because of the reduced amount for the first two payments o For example: Mr. Hruba is not subject to any withholding and has the following amounts of net tax owing ▪ 2022: $20,000 ▪ 2023: $32,000 ▪ 2024 (Estimated) $24,000 Alternative 1 (Current Year (2024) o ($24,000 ÷ 4) = $6,000 in quarterly instalments Alternative 2 (Preceding Year (2023) o ($32,000 ÷ 4) = $8,000 in quarterly instalments Alternative 3 (2nd and 1st Preceding Year) o Instalments 1 and 2 ▪ ($20,000 ÷ 4) = $5,000 o Instalments 3 and 4 ▪ {($32,000 - $10,000) ÷ 2) = $11,000 o This alternative would result in a total of $32,000 3 Returns and Payments – Individuals (continued) Interest o Interest is assessed on any amounts that are not paid when they are due. o For individuals, this would include: ▪ Any balance owing on April 30th of the current year for the taxes of the preceding year. The amount owing is due on April 30th, without regard to whether the taxpayer's filing due date is April 30 or June 15. ▪ Any portion of a required instalment payment that is not remitted on the required instalment due date. ▪ On some penalties, interest is charged on penalties for the late filing. o Compound daily interest is charged on these amounts. o For the deficient instalment amounts, the interest clock starts ticking on the date the instalment is due. Prescribed Rates of Interest o There are a number of provisions in the Income Tax Act which require the use of an assumed rate of interest. o What we refer to as the prescribed base rate is an annual rate that is calculated each quarter, based on the effective yield on three-month Government of Canada treasury bills during the first month of the preceding quarter. o The CRA announces this prescribed base rate for each quarter a few weeks before the start of the quarter. o Many years ago, there was a single prescribed rate, however, the government felt that this rate was sufficiently low that too many taxpayers chose not to make required tax payments. o To try to solve this problem, on amounts owing to the government, 4 percentage points were added to the prescribed base rate. o At the same time, a third rate was established for amounts owed to taxpayers o As a result, there are now multiple prescribed interest rates. ▪ Base Rate This rate is applicable for all purposes except amounts owing to and from the CRA. For example, the determination of the taxable benefit for an employee who receives an interest free loan from an employer. For the fourth quarter of 2023, this rate was 5%. ▪ Base Rate Plus 2% This rate is applicable when calculating interest on refunds to individuals and trusts, but not corporations. For the fourth quarter of 2023, this rate was 7%. In recent years, interest rates on short term investments have been much lower than the prescribed rate plus 2%. To prevent corporations from overpaying instalments to take advantage of the higher interest rates paid by the CRA. The rate on amounts owed to corporations is only the base rate and does not include the extra 2%. 4 Returns and Payments – Individuals (continued) Prescribed Rates of Interest (continued) o Base Rate Plus 4% ▪ This rate is applicable when calculating interest on late or deficient instalments, unpaid source deductions, and other amounts owing to the CRA by all taxpayers ▪ For the fourth quarter of 2023, this rate was 9% ▪ Note that amounts paid to the CRA under this provision are not deductible for any taxpayer Penalties o Late-filing penalty ▪ If the deadline for filing an income tax return is not met, the CRA assesses a penalty. ▪ For a first offence, this penalty amounts to: ▪ 5% of the tax owing at the time the return was due; plus ▪ 1% of the tax owing times the number of complete months the return is not filed, to a maximum of 12 ▪ This penalty would be in addition to interest on the amounts due. ▪ If the taxpayer has been charged a late filing penalty in any of the three preceding taxation years, the CRA can double the penalty on the second offence to: ▪ 10% of the tax owing at the time the return was due; plus 2% of the tax owing times the number of complete months the return is not filed, to a maximum of 20. 5 Returns and Payments - Corporations Due Date for Corporate Returns o Unlike the case with individuals, the taxation year of a corporation can end on any day of the calendar year. o The filing deadline for corporations is specified as 6 months after the fiscal year end of the company. Instalment Payments for Corporations o Corporations are generally required to make monthly instalment payments throughout their taxation year. o However, this requirement is eliminated if either the estimated Tax Payable for the current year or the Tax Payable for the preceding taxation year do not exceed $3,000 (combined federal and provincial). Calculating the Amount - General Rules (Excluding Small CCPCs) o When instalments are required, they must be paid on or before the last day of each month, with the amount being calculated on the basis of one of three alternatives. ▪ 1) Current Year 12 instalments, each based on 1/12 of the estimated tax payable for the current year. ▪ 2) Preceding Year 12 instalments, each based on 1/12 of the tax that was payable in the immediately preceding year. ▪ 3) Second and First Preceding Year 2 instalments, each based on 1/12 of the tax that was payable in the second preceding year, followed by 10 instalments based on 1/10 of the amount by which the taxes paid in the immediately preceding year exceeds the sum of the first two instalments. o The choice should be the instalment base that provides the minimum total cash outflow or, in those cases where alternative bases result in the same total cash outflow, the instalment base that provides the greatest amount of deferral o For businesses that are experiencing year to year increases in their taxes payable, the third alternative will generally meet this objective. o Note, however, the total cash outflow under the third alternative will usually be the same as the total cash outflow under the second alternative. o For example: The Marshall Company, a public company, estimates that is 2024 taxes payable will be $153,000. In 2023, the Company paid taxes of $126,000. The corresponding figure for 2022 was $96,000. ▪ 1) Current Year (2024) 12 instalments of $12,750 each ($153,000 ÷ 12) totaling $153,000 ▪ 2) Preceding Year (2023) 12 instalments of $10,500 each ($126,000 ÷ 12) totaling $126,000 ▪ 3) Second (2022) and First Preceding Year (2023) 2 instalments of $8,000 each ($96,000 ÷ 12) and 10 instalments of $11,000 each {($126,000 - $16,000) ÷ 10) totaling $126,000 ▪ While the cash outflows under alternative 3 total the same amount as those under alternative 2, alternative 3 would be selected because the first two payments are smaller and provide a deferral to the last 10 payments. 6 Returns and Payments – Corporations (continued) Calculating the Amount - Small CCPCs o Small CCPCs (Canadian Controlled Private Corporations) are allowed to pay instalments on a quarterly basis. o The ITA defines a small CCPCs as one for which: ▪ The Taxable Income of the corporation and its associated corporations does not exceed $500,000 during the current or the previous taxation year; ▪ The Taxable Capital Employed in Canada of the corporation and its associated corporations does not exceed $10 million for the current or previous year; ▪ An amount has been deducted under ITA (the small business deduction) for the current or previous year; and ▪ A perfect compliance record has been maintained with respect to payments & filings (for GST, source deductions & income taxes) during last 12 months. o Due Date - Small CCPCs ▪ A CCPC that have claimed the small business deduction in the current or preceding taxation year, the due date is 3 months after their fiscal year end, provided their Taxable Income did not exceed $500,000 for the previous year. o Interest and Penalties for Corporations ▪ The basic rules for interest on corporate balances owing or receivable are generally the same as those applicable to individuals. ▪ However, interest paid to corporations on overpayments is calculated at the regular rate, not at the higher rate applicable to individuals and trusts. ▪ Note that it is especially important that corporations avoid interest on late tax or instalment payments. ▪ Since corporations can usually deduct any interest expense that they incur, the payment of non-deductible interest on late tax payments represents a high-cost source of financing. 7 Returns and Payments - Trusts Types of Trusts Testamentary Trust Is a trust that arises on, and as a consequence of, the death of an individual Inter-Vivos Trust Also known as a "living trust" It arises while you are alive Filing Requirements In general, a trust must file a trust income tax return (T3), if it: Has Tax Payable for the year; Is requested by the CRA to file a tax return; Has disposed of a capital property during the year; or Has a taxable capital gain during the year? Due Dates for Returns In general, all inter vivos and testamentary trusts, other than graduated rate estates, must use the calendar year as their taxation year A testamentary trust designated as a graduated rate estate can use a non-calendar fiscal period for the duration of its limited life All trusts must file their tax returns within 90 days of the end of their taxation year Payment of Taxes Legislation generally requires that all trusts, except graduated rate estates, make instalment payments In the past, the CRA has not enforced instalment requirements against any type of trust With respect to determining the amount of the instalments, the rules in ITA cover both individuals and trusts Trusts have three alternatives for calculating instalment amounts and the due dates are March 15, June 15, September 15 and December 15 Interest and Penalties Same rules as those applicable to individuals Income Tax Information Returns Income Tax Act gives the CRA the right to require certain taxpayers to file information returns in addition to the returns in which they report their taxable income T3 This form is used by trustees (which includes trustees of some mutual funds) and executors to report the allocation of the trust's income T4 This form is used by employers to report remuneration and taxable benefits paid to employees and the various amounts withheld for source deductions T5 This form is used by organizations to report interest, dividend, and royalty payments T4RSP This form is used by trustees to report payments out of RRSPs 8 Assessments Notice of Assessment After a tax return has been filed, the CRA runs a number of tests on the return, such as verifying the eligibility for various deductions and tax credits After processing a return, the CRA completes a Notice of Assessment which contains the amount, if any, of taxes to be paid or refunded, an explanation of any changes it has made to the return, and any interest and penalties that were assessed For individuals, it also contains additional information such as the taxpayer's RRSP deduction limit A somewhat longer period is normally required for corporate income tax assessments and more complicated individual returns Notice of Reassessment The Notice of Assessment does not free the taxpayer from additional scrutiny of the return The CRA will issue a Notice of Reassessment with a revised amount payable or refunded and an explanation if a change is made to a taxpayer's return for any reason such as amounts not matching or duplicate claims on a spouse's return The normal reassessment period is the period that ends 3 years after the date on the Notice of Assessment for individuals, most trusts, and CCPCs This normal reassessment period is extended to 4 years for other corporations because of the greater complexity There are a number of exceptions to this normal 3-year reassessment period that include the following: Reassessment can occur at any time: If the taxpayer or person filing the return has made any misrepresentation that is attributable to neglect, carelessness or willful default, or has committed any fraud in filing the return or in supplying information If the taxpayer has filed a waiver of the 3-year time limit ▪ Reassessment can occur outside the normal reassessment period: If an individual or testamentary trust has requested a reduction in taxes, interest, or penalties (the ability to 10 years after the particular year in question) When reassessment within the normal period affects a balance out of this period In situations where the taxpayer is claiming certain specified deductions (for example: listed personal property loss carried back to claim a refund of taxes paid) Adjustments to Income Tax Returns There is no general provision in the ITA for filing an amended return However, this does not mean that amounts included in the returns of previous years cannot be altered It simply means that the adjustment process normally takes place after the return has been processed and a Notice of Assessment has been received 9  There are many reasons why adjustments to a previously filed return would be necessary Such as omissions or errors Disputes and Appeals Representation by Others o At the initial stages of any dispute, a taxpayer may wish to represent himself o However, if complex issues are involved, or if the dispute progresses to a later stage where procedures require more formal representation, a taxpayer is likely to authorize some other party to act as their representative o Represent a Client Service ▪ Is designed to provide online access to both individual and business tax information authorized representatives registered with the CRA Informal Request for Adjustments o 1st step, if a taxpayer disagrees with an assessment or reassessment, by contacting the CRA immediately o In some cases, the proposed change is the result of a simple error on the part of the taxpayer or a lack of information and can be corrected or resolved through the telephone contact or by letter Notice of Objection o If the informal contact does not resolve the issue in question, a taxpayer has the right to file a notice of objection o There are 3 methods available for filing: ▪ By accessing My Account or My Business Account from CRA website and selecting the option “Register My Formal Dispute” (also available through Represent a Client) ▪ Using Form T400A “Objection – Income Tax Act” ▪ Writing a letter to the Chief of Appeals at the relevant Appeals Intake Centre explaining the reasons for your objection o For corporations and inter vivos trusts a notice of objection must be filed within 90 days of the date on the Notice of Assessment or Reassessment o For individuals and testamentary trusts, the rules are more generous, since for these taxpayers, the notice of objection must be filed before the later of: ▪ 90 days from the date on the Notice of Assessment or Reassessment; or ▪ 1 year from the filing due date for the return under assessment or reassessment o Death ▪ When an individual die after October of the year and before May of the following year, as you know, the filing deadline is extended to 6 months’ after ▪ the date of death, thereby extending the date for filing a notice of objection by the same number of months o After the notice of objection is received, the CRA is required to reply to the taxpayer: ▪ Vacating the assessment ▪ Confirming it (refusing to change it) ▪ Varying the amount; or ▪ Reassessing Chief of Appeals o Unresolved objections are subject to review by the Chief of Appeals 10  o These appeals sections are instructed to operate independently of the assessing divisions and should provide an unbiased second opinion o If the matter remains unresolved after this review, the taxpayer must either accept the CRA’s assessment or alternatively, continue to pursue the matter to a higher level of appeal Disputes and Appeals (continued) Rules for Large Corporations (Taxable Capital in excess of $10 million) o The CRA appears to believe that it has been the practice of certain corporate taxpayers to delay the dispute process by filing vague objections in the first place, and subsequently bringing in fresh issues as the appeal process moves forward o To prevent this perceived abuse, a corporation must specify each issue to be decided, the dollar amount of relief sought for each issue, and the facts and reasons relied on by the corporation in respect of each issue when filing a notice of objection o If the corporation objects to a reassessment or additional reassessment made by the CRA, or appeals to the Tax Court of Canada, the objection or appeal can be only with respect to issues and dollar amounts properly dealt with in the original notice of objection Tax Court of Canada o Deadline for Appeal ▪ A taxpayer who does not find satisfaction through the notice of objection procedures may then proceed to the next level of the appeal procedure, the Tax Court of Canada ▪ Appeals to the Tax Court of Canada must be made within 90 days of the date on the CRA’s response to the Notice of Objection or 90 days after the notice of objection has been filed if the CRA has not replied ▪ It is NOT possible to bypass the Tax Court of Canada and appeal directly to the Federal Court level, except in very limited circumstance o Informal Procedure ▪ On appeal to the Tax Court of Canada, the general procedure will automatically apply unless the taxpayer elects to have his case heard under the informal procedure ▪ The informal procedure can be elected for appeals in which the total amount of federal tax and penalty involved for a given year is less than $25,000, or where the loss is less than $50,000 ▪ Advantages The rules of evidence remain fairly informal, allowing the taxpayer to represent himself, or be represented by an agent other than a lawyer Under the informal procedure, even if the taxpayer is unsuccessful, he cannot be asked to pay court costs The informal procedures are designed as a fast-track procedure that is usually completed within 6 or 7 months whereas the general procedure may take many years ▪ Major Disadvantage The taxpayer generally gives up all rights to further appeals if the Court decision is unfavourable o General Procedure ▪ Formal rules of evidence must be used and the taxpayer can represent him or herself or by legal counsel ▪ If the taxpayer is unsuccessful, the Court may require that costs be paid to CRA ▪ Under either procedure, if the taxpayer is more than 50% successful (e.g., if he is claiming $10,000 and is awarded more than $5,000), the judge can order the CRA to pay all or part of the taxpayer’s costs 11 Disputes and Appeals (continued) Tax Court of Canada (continued) o Appeals by the Minister ▪ There are situations in which the CRA may pursue a matter because of its general implications for broad group of taxpayers ▪ The individual taxpayer is given protection from the costs associated with this type of appeal by the requirement that the CRA be responsible for the taxpayer’s reasonable legal fees when the amount of taxes payable in question does not exceed $25,000 or the loss in dispute does not exceed $50,000 ▪ This is without regard to whether the appeal is successful o Resolution ▪ Prior to the hearing by the Tax Court of Canada, discussions between the taxpayer and the CRA are likely to continue ▪ It would appear that, in the majority of cases, the dispute will be resolved prior to the actual hearing ▪ However, if a hearing proceeds, the Court may dispose of an appeal by: Dismissing it; or Allowing it and o Vacating the assessment o Varying the assessment, or o Referring the assessment back to the CRA for reconsideration and reassessment Federal Court and Supreme Court of Canada Either the CRA or the taxpayer can appeal a general procedure decision of the Tax Court of Canada to the Federal Court of Appeal The appeal must be made within 30 days of the date on which the Tax Court of Canada makes its decision It is possible to pursue a matter beyond the Federal Court to the Supreme Court of Canada This can be done if the Federal Court of Appeal refers the issue to the higher Court, or if the Supreme Court authorizes the appeal These actions will not usually happen unless there are new issues or legal precedents to be dealt with and, as a result, such appeals are not common Collection and Enforcement Other Penalties o Repeated Failure to Report Income ▪ This penalty applies when there is a failure to report at least $500 in income in the current year, and in any of the preceding years ▪ This penalty is the lesser of: 10% of the unreported amount (NOT the taxes owing; and An amount equal to 50% of the difference between the understatement of related to the omission and the amount of any tax paid in respect of the unreported amount (e.g., withholdings by an employer) o False Statements or Omissions ▪ This penalty applies in cases of gross negligence where there is an intention to disregard the Income Tax Act. ▪ The penalty is the greater of $100 and 50% of the understated tax o Evasion ▪ Penalties here range from 50% to 200% of the relevant tax and, in addition, imprisonment for a period not exceeding 2 years. 12 Collection and Enforcement (continued) Penalty for Misrepresenting a Tax Planning Arrangement o Is to be applied to every advisor who makes, or causes another person to make, a statement that the advisor knows, or would reasonable be expected to know, but for circumstances amounting to culpable conduct, is a false statement that could be used by another person for the purpose of the ITA o If the statement is made in the course of a planning or valuation activity, the greater of $1000 and the total of the person'’ gross entitlements arising from the false statement o In any other case, $1000 Penalty for Participating in a Misrepresentation o Applies if the advisor knowingly participates in, assents to or acquiesces in the making of a false statement by or on behalf of another person, or a statement that the advisor should have known was a false statement but for circumstances amounting to culpable conduct. In this case the penalty is the greater of: ▪ $1000; and ▪ the lesser of: the penalty which the other person would be liable if the other person knowingly made the statement $100 000 plus the advisor’s compensation for taking part in the scheme 13  Procedures and Administration Learning outcomes: Understand the basic concepts behind the Canadian income tax system requirement to file a tax return Know the income tax filing due dates for individuals, corporations, and trusts along with the implication of NOT filing Understand instalment payment requirements and dates for both individuals and corporations Differentiate between Prescribed Rates of Interest and Base Rate Have a good understanding of the different types of Tax Assessments Comprehend the Disputes and Appeals process all the way to the Supreme Court  Requirement to File a Tax Return Introduction A general rule requires all persons (individuals, corporations, and trusts) to file a tax return. Some Reasons to file an Individual Return You have tax payable (owe money to the government). Canada Revenue Agency (CRA) sent you a request to file. You disposed (sold) of a capital property or realized a capital gain. Your spouse or common-law partner has elected to split their pension. You have to contribute to the Canada Pension Plan (CPP) or pay Employment Insurance (E.I.) premiums.  Requirement to File a Tax Return Some Reasons to file an Individual Return (continued) Furthermore, it is beneficial to file, especially for low-income taxpayers, in order to be eligible to receive income-based benefits, such as: Canada Child Tax Benefit Goods and Services Tax (GST) credit Guaranteed Income Supplement It is also to your advantage to file in order to receive the Federal government’s Climate Action Incentive payment.  Due Dates for Individual Tax Returns General Rule Individuals must use the calendar year (December 31) as their taxation year. Individuals must file their tax return for a particular year on or before April 30 of the following year. Although the filing due date is extended to the next business day if the due date falls on a weekend.  Due Dates for Individual Tax Returns Individuals Who Are Partners or Sole Proprietors Recognizing that individuals who are involved in an unincorporated business may need more time to determine their income for a taxation year, the Income Tax Act (ITA) provides a deferral of the filing deadline. The due date is extended for filing to June 15 of the calendar year following the relevant taxation year. An interesting feature of this provision is that, while the return does not have to be filed until June 15, payment of all taxes owing is required by the usual date of April 30.  Due Dates for Individual Tax Returns Deceased Taxpayers To provide the deceased individual’s representatives with sufficient time to deal with these complications , the due dates are extended based on the date of death. Date of Death Filing Deadline Jan. 1 – Oct. 31 April 30th following year Nov. 1 – Dec. 31 6 months after date of death Trusts 90 days after Trust fiscal year end. (used to be) Now 90 days after Trust calendar year end (Dec 31) Corporations 180 days after fiscal year end  Withholdings for Income Tax Introduction A large portion of the income taxes paid by individuals employed in Canada is collected through source deductions. Under the ITA, any individual who earns employment income will have the estimated taxes on this income withheld from gross pay through payroll deductions made by their employer. The amount withheld by an employer is based on a form that is filled out by each employee, form "TD1" (Personal Tax Credits Return). This form lists personal and other credits that are available to an individual and asks the employee to indicate which of these he will be claiming. Also, on Form TD1, an individual can request to have the amount withheld increased beyond the required amount.  Withholdings for Income Tax TD 1 (Federal) TD 1 (Ontario)  Withholdings for Income Tax Non-Residents While the general rate of tax on the Canadian source income of non- residents is established in the Income Tax Act (ITA) as 25%, the amount that will be withheld is usually modified by international tax treaties.  Instalment Payments - Individuals Instalment Payments for Individuals For many individuals, particularly those earning employment income, the withholding of taxes constitutes the major form of tax payment in any taxation year However, in situations where an individual has large amounts of income that are not subject to withholding (e.g., self-employment income, or investment income), quarterly instalment payments may have to be made towards the current year's tax liability. An "individual's instalment threshold" is defined in the ITA as $3,000 (In Quebec the instalment threshold is $1,800) You have to make instalment payments for 2023 if your net tax owing is more than $3,000: In 2022; and In either 2022 or 2021 For individuals required to pay instalments, the quarterly payments are due: March 15, June 15, September 15, and December 15.  Instalment Payments - Individuals Determining Amounts of Instalments In determining the amount to be paid as instalments, individuals have a choice of three alternatives for calculating the required quarterly instalments. 1) Current Year 1/4 of the estimated net tax owing (which is not necessarily equal to Tax Payable). 2) Preceding Year 1/4 of the net tax owing for the immediately preceding taxation year. 3) Second and First Preceding Year The first two instalments (March 15 and June 15) based on 1/4 of the net tax owing for the second preceding taxation year. The remaining two instalments (Sep 15 & Dec 15) equal the excess of the net tax owing for the preceding year, divided by two. Note that 50% of the net tax owing for the second preceding year is the amount that should have been paid in the first two instalments under this approach.  Instalment Payments - Individuals Determining Amounts of Instalments (Example) Mr. Hruba is not subject to any withholding and has the following amounts of net tax owing 2022 = $20,000, 2023 = $32,000, 2024 (Estimated) = $24,000 Alternative 1 (Current Year (2024) ($24,000 ÷ 4) = $6,000 in quarterly instalments Alternative 2 (Preceding Year (2023) ($32,000 ÷ 4) = $8,000 in quarterly instalments Alternative 3 (2nd and 1st Preceding Year) Instalments 1 and 2 ($20,000 ÷ 4) = $5,000 Instalments 3 and 4 {($32,000 - $10,000) ÷ 2) = $11,000 This alternative would result in a total of $32,000 instalments ($5,000 + $5,000 + $11,000 + $11,000).  Instalment Payments - Individuals Returns and Payments - Individuals Interest Interest is assessed on any amounts that are not paid when they are due and compounds daily. For the deficient instalment amounts, the interest clock starts ticking on the date the instalment is due Prescribed Rates of Interest There are a number of provisions in the Income Tax Act which require the use of an assumed rate of interest. There are now multiple prescribed interest rates Base Rate This rate is applicable for all purposes except amounts owing to and from the CRA and now is 6%. Base Rate Plus 2% Rate applicable when calculating interest on refunds to individuals & trusts, but not corporations and now at 8% (6% + 2%). Base Rate Plus 4% Rate applicable when calculating interest on late or deficient instalments, unpaid source deductions, and other amounts owing to the CRA by all taxpayers., and the rate is currently 10% (6% + 4%).  Penalties for Late Filing - Individuals If the deadline for filing an income tax return is not met, the CRA assesses a penalty. For a first offence, this penalty amounts to: 5% of the tax owing at the time the return was due; plus 1% of the tax owing times the number of complete months the return is not filed, to a maximum of 12 This penalty would be in addition to interest on the amounts due. If the taxpayer has been charged a late filing penalty in any of the three preceding taxation years, the CRA can double the penalty on the second offence to: 10% of the tax owing at the time the return was due; plus 2% of the tax owing times the number of complete months the return is not filed, to a maximum of 20.  Instalment Payments - Corporations Returns and Payments – Corporations Due Date for Corporate Returns Unlike the case with individuals, the taxation year of a corporation can end on any day of the calendar year. The filing deadline for corporations is specified as 6 months after the fiscal year end of the company. Instalment Payments for Corporations Corporations are generally required to make monthly instalment payments throughout their taxation year. However, this requirement is eliminated if either the estimated Tax Payable for the current year or the Tax Payable for the preceding taxation year does not exceed $3,000 (combined federal and provincial).  Instalment Payments - Corporations Calculating the Amount - General Rules (Excluding Small CCPCs) When instalments are required, they must be paid on or before the last day of each month, with the amount being calculated on the basis of one of three alternatives. 1) Current Year 12 instalments, each based on 1/12 of the estimated tax payable for the current year. 2) Preceding Year 12 instalments, each based on 1/12 of the tax that was payable in the immediately preceding year. 3) Second and First Preceding Year 2 instalments, each based on 1/12 of the tax that was payable in the second preceding year, Followed by 10 instalments based on 1/10 of the amount by which the taxes paid in the immediately preceding year exceeds the sum of the first two instalments.  Assessments Notice of Assessment (NOA) After a tax return has been filed, the CRA runs a number of tests on the return, such as verifying the eligibility for various deductions and tax credits. After processing a return, the CRA completes a Notice of Assessment which contains the amount, if any, of taxes to be paid or refunded, an explanation of any changes it has made to the return, and any interest and penalties that were assessed.  Assessments Notice of Reassessment The Notice of Assessment does not free the taxpayer from additional scrutiny of the return. The CRA will issue a Notice of Reassessment with a revised amount payable or refunded and an explanation if a change is made to a taxpayer's return for any reason such as amounts not matching or duplicate claims on a spouse's return. The normal reassessment period is the period that ends 3 years after the date on the Notice of Assessment for individuals, most trusts, and CCPCs. This normal reassessment period is extended to 4 years for other corporations because of the greater complexity.  Disputes and Appeals Representations by Others At the initial stages of any dispute, a taxpayer may wish to represent himself. However, if complex issues are involved, or if the dispute progresses to a later stage where procedures require more formal representation, a taxpayer is likely to authorize some other party to act as their representative. Represent a Client Service This is designed to provide online access to both individual and business tax information authorized representatives registered with the CRA. Informal Request for Adjustments 1st step, if a taxpayer disagrees with an assessment or reassessment, by contacting the CRA immediately. In some cases, the proposed change is the result of a simple error on the part of the taxpayer or a lack of information and can be corrected or resolved through the telephone contact or by letter.  Disputes and Appeals Notice of Objection If the informal contact does NOT resolve the issue, a taxpayer has the right to file a notice of objection. There are 3 methods available for filing: 1) By accessing My Account from CRA website and selecting the option “Register My Formal Dispute” (also available through Represent a Client) 2) Use Form T400A “Objection – Income Tax Act” 3) Writing a letter to the Chief of Appeals at the relevant Appeals Intake Centre explaining the reasons for your objection. For individuals and testamentary trusts, the notice of objection must be filed before the later of: 90 days from the date on the Notice of Assessment or Reassessment; or 1 year from the filing due date for the return under assessment or reassessment. Death When an individual die after October of the year, the deadline is extended to 6 months after the date of death, providing extra time to file the return.  Disputes and Appeals Notice of Objection (continued) After the notice of objection is received, the CRA is required to reply to the taxpayer: Vacating the assessment (Reverse the ruling) Confirming it (refusing to change it) Varying the amount; or Reassessing Chief of Appeals Unresolved objections are subject to review by the Chief of Appeals. These appeals sections are instructed to operate independently of the assessing divisions and should provide an unbiased second opinion. If the matter remains unresolved after this review, the taxpayer must either accept the CRA’s assessment or alternatively, continue to pursue the matter to a higher level of appeal.  Disputes and Appeals Tax Court of Canada A taxpayer who does not find satisfaction through the notice of objection procedures may then proceed to the next level of the appeal procedure, the Tax Court of Canada. Appeals to the Tax Court of Canada must be made within 90 days of the date on the CRA’s response to the Notice of Objection or 90 days after the notice of objection has been filed if the CRA has not replied. It is NOT possible to bypass the Tax Court of Canada and appeal directly to the Federal Court level, except in very limited circumstance. Informal Procedure The general procedure will automatically apply unless the taxpayer elects to have his case heard under the informal procedure The informal procedure can be elected for appeals in which the total amount of federal tax and penalty involved for a given year is less than $25,000, or where the loss is less than $50,000.  Disputes and Appeals Tax Court of Canada (continued) Informal Procedure (continued) Advantages The rules of evidence remain fairly informal, allowing the taxpayers to represent themselves or by an agent or lawyer. Even if the taxpayer is unsuccessful, he/she cannot be asked to pay court costs. This is designed as a fast-track process that takes usually 6-7 months, as opposed to many for years for the General Procedures. Major Disadvantage The taxpayer generally gives up all rights to further appeals if the Court decision is unfavourable. General Procedure Formal rules of evidence must be used, and the taxpayer can represent himself or by a lawyer. If the taxpayer is unsuccessful, the Court may require that costs be paid to CRA. Under either procedure, if the taxpayer is more than 50% successful, the judge can order the CRA to pay all or part of the taxpayer’s costs.  Disputes and Appeals Tax Court of Canada (continued) Appeals by the Minister There are situations in which CRA may pursue a matter because of its general implications for a broad group of taxpayers. The individual taxpayer is given protection from the costs associated with this type of appeal and CRA will be responsible for the taxpayer’s reasonable legal fees when the amount of taxes payable: Exceed $25,000 or the loss in dispute does not exceed $50,000. This is regardless of the appeal being successful or not. Resolution Prior to the hearing by the Tax Court of Canada, discussions between the taxpayer and the CRA are likely to continue. In the majority of cases, the dispute will be resolved prior to the actual hearing. However, if a hearing proceeds, the Court may dispose of an appeal by: Dismissing it; or Allowing it or Reassessment.  Disputes and Appeals Federal Court and Supreme Court of Canada Either the CRA or the taxpayer can appeal a general procedure decision of the Tax Court of Canada to the Federal Court of Appeal. The appeal must be made within 30 days of the date on which the Tax Court of Canada makes its decision. It is possible to pursue a matter beyond the Federal Court to the Supreme Court of Canada. This can be done if the Federal Court of Appeal refers the issue to the higher Court, or if the Supreme Court authorizes the appeal. These actions will not usually happen unless there are new issues or legal precedents to be dealt with and, as a result, such appeals are not common.  Collection and Enforcement Other Penalties Repeated Failure to Report Income This penalty applies when there is a failure to report at least $500 in income in the current year, and in any of the preceding years. This penalty is the lesser of: 10% of the unreported amount (NOT the taxes owing; and An amount equal to 50% of the difference between the understatement related to the omission and the amount of any tax paid in respect of the unreported amount (e.g., withholdings by an employer) False Statements or Omissions This penalty applies in cases of gross negligence where there is an intention to disregard the Income Tax Act. The penalty is the greater of $100 and 50% of the understated tax. Evasion Penalties here range from 50% to 200% of the relevant tax and, in addition, imprisonment for a period not exceeding 2 years.  Collection and Enforcement Penalty for Misrepresenting a Tax Planning Arrangement This is also known as “The Planner Penalty” This is more likely to be applied to those who knowingly make a false statement, where the person or persons who could make use of that false statement may not actually be identified. You as the advisor are the RINGLEADER. The penalty for making, or causing another person to make, a false statement is as follows: if the statement is made in the course of a planning or valuation activity, the greater of $1,000 and the total of the person's gross entitlements (your commission) arising from the false statement. in any other case, $1,000.  Collection and Enforcement Penalty for Participating in a Misrepresentation This is also known as “The Preparer Penalty”. This is usually applied in situations where the work was performed for a taxpayer or group of taxpayers who can be specifically identified. This applies if the advisor knowingly participates in, assents to or acquiesces in the making of a false statement by or on behalf of another person, or a statement that the advisor should have known was a false statement but for circumstances amounting to culpable conduct. In this case the penalty is the greater of: $1000; and the lesser of: The penalty which the other person would be liable if the other person knowingly made the statement. $100 000 plus the advisor’s compensation for taking part in the scheme.  INCOME TAX PLANNING Income or Loss from an Office or Employment (Chapter 3) Employment Income Employment income MUST be reported on a "cash basis" and not on an "accrual basis". o Therefore, it will be taxed as received. Tax Planning Opportunity o This fact, when combined with the fact that business income for tax purposes is calculated on an accrual basis, provides a tax planning opportunity. o A business can declare a bonus to one of its employees and, because it is on an accrual basis, deduct it for tax purposes by simply recognizing a firm obligation to pay that amount. o In contrast, the employee who has earned the bonus will not have to include it in employment income until it is actually received. Limits on Deferral o The Income Tax Act (ITA) indicates that, where such a bonus is paid more than 180 days after the employer's year end, but less than three years, the employer will not be able to deduct the amount until it is paid. Employee Versus Self-Employed An employee's ability to deduct expenses from employment income is quite limited when compared to self-employed individuals. If an individual is self-employed, any income that he earns is classified as business income, making it eligible for the wider range of deductions that is available under the ITA business income provisions. o For example, a self-employed professional can deduct the costs of driving to work. o If this individual were classified as an employee, this deduction would NOT be available. CPP Contributions o If an individual is an employee, his employer will be required to withhold a portion of his pay for Canada Pension Plan (CPP) contributions and Employment Insurance (EI). o With respect to CPP contributions, for 2024 both the employee and the employer are required to contribute 5.95% of up to $68,500 of gross wages reduced by a basic exemption of $3,500. o This results in maximum contributions by both the employee and employer of $3,867.50, or a total of $7,735.00. EI Premiums o With respect to EI premiums, the amount that will be withheld from employee earnings amounts to 1.66% of $63,200 (2024), in gross wages, with a maximum annual value of $1,049.12 (2024) o The employer is assessed 1.4 times this amount (2.2%), a maximum of $1,468.77 (2024). o Employees are generally required to participate in the EI program. ▪ One exception is for employees owning more than 40% of the shares of the employer. ▪ In that case, since no EI can be collected, no EI premiums are paid. ▪ The EI rules are complex which can make the determination of insurable employment difficult, especially in the case of an owner-manager employing family members. ▪ A non-arm's length employee (such as an adult child or a spouse) would only be eligible for participation in the EI program if it is reasonable to conclude that the owner would have hired a non-related person under a similar contract of employment. 1 Employment Income (continued) Distinction Between Employee and Self-Employed o The general approach to distinguishing between an employee and an independent contractor is the question of whether an employer/employee relationship exists. o The first step in making this distinction is to determine the intent of both parties. o Both the worker and the payer must be clear as to whether there is a contract of service (employee/employer) or alternatively, a contract for services (business relationship). o This intent may or may not be in the form of a written agreement. o Other Factors ▪ Control ▪ Owner of Tools and Equipment ▪ Ability to Subcontract or Hire Assistants ▪ Financial Risk ▪ Responsibility for Investment and Management ▪ Opportunity for Profit Inclusions - Fringe Benefits Employers often provide indirect forms of compensation to their employees, as well as direct ones. Such indirect forms of compensation are commonly referred to as “fringe benefits”; they include such items as employee pension plans, insurance programs, stock options, and automobile benefits. For employees, the tax treatment of such programs varies considerably: some fringe benefits are taxable in the year in which they are received or enjoyed; others are taxable at some future time or are not taxable at all. Most forms of compensation are, however, deductible for the employer. o Because the tax treatment varies for these indirect compensation programs, it is essential that compensation decisions be made that maximize the after-tax cash flow to the employee and minimize the after-tax cost to the employer. Taxable Benefits o The ITA also provides that most fringe benefits, including the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer by virtue of his employment or office are also taxable as employment income. o Note that taxable benefits are generally also considered to be pensionable earnings for the purpose of CPP and earned income for RRSP purposes. Frequent Flyer Benefits o Where an employee accumulates frequent flyer benefits while traveling on employer-paid business trips and uses them to obtain air travel or other benefits for himself or his family, he must include the FMV of that air travel or other benefits in his employment income. Tuition Fees o The basic idea is that employer-paid educational costs are NOT a taxable benefit if the learning experience is primarily for the benefit of the employer. o If the costs are primarily for the benefit of the employee, it will be considered a taxable benefit. o Specific Employer-Related Training ▪ Courses that are taken for maintenance or upgrading of employer-related skills will generally be considered to primarily benefit the employer and therefore be non- taxable. ▪ An example of this would be an employer who provides bookkeeping services paying the tuition fees for an employee to take an accounting course. 2 Inclusions - Fringe Benefits (continued) Tuition Fees (continued) o General Employment-Related Training ▪ Other business-related course, even if not directly related to the employer's business, will generally be considered non-taxable. ▪ Examples of Non-Taxable: General training would include stress management, employment equity, first- aid, and language skills. o Personal Interest Training ▪ Employer-paid courses for personal interest or technical skills that are not related to the employer's business are considered of primary benefit to the employee and thus taxable. ▪ For example: Fees paid for a self-interest music course would result in a taxable benefit. Non-Taxable Benefits o Discounts on merchandise, other than big ticket items such as homes or appliances, and the waiving of commissions on sales of merchandise or insurance for the personal use of the employee. o Subsidized meals provided in employer facilities. o Uniforms and special clothing. o Subsidized school services in remote areas. Inclusions Board and Lodging o An employer may provide their employees board and lodging which means that they provide them with accommodations. o If they provide free lodging, or free board and lodging, to an employee, the employee receives a taxable benefit. o As a result, you have to add to the employee’s salary the fair market value (FMV) of the board and lodging provided. o If the company provides subsidized lodging, or subsidized board and lodging, to an employee, the employee receives a taxable benefit. ▪ As a result, you have to add to the employee’s salary the FMV of the board and lodging provided, MINUS any amount the employee paid. o Exceptions: ▪ 1) If you provide board and/or lodging to players on sports teams or members of recreation programs. ▪ 2) If you provide board, lodging and/or transportation to an employee who works at a special work site or a remote location 3 Inclusions (continued) Automobile Benefits o If an employee is allowed to use an employer's vehicle for personal use, he or she may incur a taxable benefit. o The amou