INCOME TAX LAW SUMMARY 2011

Transcription

1 SUMMARY 2011 LAWSKOOL CANADA

2 CONTENTS INTRODUCTION...6 STRUCTURE OF CANADIAN INCOME TAX TAXATION...6 SOURCE CONCEPT OF INCOME...7 IMPORTANT TERMINOLOGIES...7 Income Inclusion...7 Deductions...8 Exemptions...8 Tax Credits...8 INCOME FROM OFFICE OR EMPLOYMENT...9 CHARACTERIZATION...9 INCLUSIONS...10 Remuneration...11 Inducement payments Compensation for breach or waiver of contractual obligations Payments on or after termination of an office or employment Tort damages for personal injury or death Gratuitous payments Strike pay Benefits...15 General rules Specific Rules Loans or debts in connection with the employment Housing subsidies Forgiveness of debt Housing loss Stock options Allowances...18 EXCLUSIONS...19 DEDUCTIONS...20 Travel expenses Meals Legal Expenses Professional membership dues Union dues Cost of supplies consumed Office rent, and salary to an assistance or substitute Expenses of salespersons... 26

3 TIMING ISSUES...28 INCOME OR LOSS FROM BUSINESS OR PROPERTY...29 CHARACTERIZATION...29 Business VS. Hobby...30 Gain from business VS. Capital Gain...30 The Taylor Criteria Secondary intention INCLUSIONS...32 Illegal activities Damages Voluntary payments Interest payment Prizes and awards Royalties Rent Inducements, reimbursements, refunds DEDUCTIONS...39 Illegal payments Damage payments Fines and penalties Theft Promotional expenses Recreation, meals and entertainment expenses Clothing expenses Home office expenses Travel expenses Interest expenses TIMING ISSUES...46 When to include...46 When to deduct...48 Contingent payments Inventory costs Capital expenditures Reserves Unearned amounts Deferred payments Doubtful debts and Bad debts Prepaid expenses Running expenses... 57

4 TAXABLE CAPITAL GAINS AND ALLOWABLE CAPITAL LOSSES...58 CHARACTERIZATION...59 Primary VS. Secondary Intention...59 Renting VS. Selling...59 Investor VS. Trader/Dealer...59 Connection to business activities...61 COMPUTATION...62 General rules...62 Disposition Entire consideration for the transfer of ownership Inadequate consideration Warranties Allocations Adjusted cost base Expenses of disposition Reserves for capital property Special Rules...68 Personal use property Principle residence Listed personal property Deemed dispositions Rollovers Stop-loss rules... 71

5 CASES British Columbia v. R. [2000] 1 C.T.C Abraham v. M.N.R., 24 Tax A.B.C Ace Salvage Alberta Ltd. v. M.N.R. [1985] 2 C.T.C Anjalie Enterprises Ltd. v. Canada [1995] 1 C.T.C Avis Immobilien GMBH v. The Queen [1994] 1 C.T.C Ben s Limited v. M.N.R. [1955] C.T.C Bernard v. M.N.R. [1985] 2 C.T.C Blackman v. M.N.R. [1967] Tax A.B.C. 480, 67 D.T.C. 347 (Tax Appeal Board) Bowman v. M.N.R. [1985] 1 C.T.C Bronfman Trust v. R. [1987] 1 C.T.C Burnet v. Canada [1995] 2 C.T.C. 2319D 68 Canada (A-G) v. MacDonald [1994] 2 C.T.C Canadian Kodak Sales Ltd. v. M.N.R. [1955] C.T.C Cirella v. R. [1978] C.T.C , 32 Cliffe v. M.N.R. [1957] 17 Tax A.B.C Coppley Noyes & Randall Ltd. v. R. [1991] 1 C.T.C Creighton v. M.N.R., 4 Tax A.B.C Crown Trust Co (McArdle Estate) v. M.N.R. [1965] S.C.R Cruikshank v. M.N.R. [1985] 2 C.T.C Cumming v. M.N.R. [1967] C.T.C Curran v. M.N.R. [1957] C.T.C Detchon v. R. [1996] 1 C.T.C Dominion Stores Ltd. v. M.N.R. [1966] C.T.C Duthie Estate v. Canada [1995] 2 C.T.C Espie Printing Co. v. M.N.R. [1960] C.T.C Federal Farms Ltd. v. M.N.R. [1959] C.T.C Fries (W.) v. Canada [1990] 2 C.T.C. 439 #1.14 Giffen v. Canada (M.N.R.) [1995] 2 C.T.C Goldman v. M.N.R. [1951] C.T.C Griesbach v. M.N.R. [1990] 2 C.T.C Healy v. Canada [1979] C.T.C Huffman v. R [1989] 1 C.T.C , 43 Imperial Oil Ltd. V. M.N.R. [1947] C.T.C Irrigation Industries Ltd. v. M.N.R. [1962] C.T.C Iron Ore Co. of Canada v. R. [2000] 2 C.T.C J.L. Guay Ltee. v. M.N.R. [1971] C.T.C Johns-Manville Canada Inc. v. R. [1985] 2 C.T.C Krull v. R. [1995] 2 C.T.C Locke v. M.N.R. [1965] 38 Tax A.B.C Lowe v. R. [1996] 2 C.T.C , 23 Lucas v. M.N.R. [1987] 2 C.T.C Luks v. MNR [1958] C.T.C Martyn v. M.N.R., 64 D.T.C M.N.R. v. Eldridge [1964] C.T.C , 33 M.N.R. v. Groulx [1967] C.T.C M.N.R. v. Montgomery [1970] C.T.C M.N.R. v. Morden [1961] C.T.C , 59 M.N.R. v. Taylor [1956] C.T.C

6 Morrison v. M.N.R., 37 Tax A.B.C Moss v. M.N.R. [1963] C.T.C Muller s Meats Ltd. V. M.N.R. [1969] Tax A.B.C Nelson v. M.N.R. [1981] C.T.C Neonex International Ltd. v. R. [1978] C.T.C No. 275 v. M.N.R. [1955] 13 Tax A.B.C , 39 No. 360 v. M.N.R., 16 Tax A.B.C Odyssey Industries Inc. v. R. [1996] 2 C.T.C O Neil v. M.N.R., 91 D.T.C Oxford Shopping Centres Ltd. v. R. [1980] C.T.C Perini Estate v. The Queen [1982] C.T.C Pitman V. M.N.R. [1953] C.T.C Prewer v. M.N.R. [1989] 1 C.T.C Quance v. R. [1974] C.T.C R. v. Cival [1983] C.T.C , 24 R. v. Manley [1985] 1 C.T.C R. v. Savage [1983] 2 S.C.R Re Tip Top Tailers Ltd. [1943] C.T.C Regal Heights Ltd. v. M.N.R. [1960] C.T.C Richmond v. M.N.R. [1998] 3 C.T.C Robert et al v. M.N.R. [1990] 2 C.T.C Royal Trust Company v. M.N.R. [1947] C.T.C Sterling v. R. [1983] C.T.C Taylor v. M.N.R. [1988] 2 C.T.C , 27 Thayer Lumber Co. Ltd. v. M.N.R., 18 Tax A.B.C Vancouver Art Metal Works Ltd. v. R. [1993] 1 C.T.C Verrier v. M.N.R. [1990] 1 C.T.C Werle v. R. [1995] 1 C.T.C , 23 West Kootenay Power & Light Co. v. R. [1992] 1 C.T.C Wiebe Door Services Ltd. v. M.N.R. [1986] 2 C.T.C Wood v. M.N.R. [1969] C.T.C

7 Introduction Structure of Canadian income tax taxation The basic structure of Canadian income taxation consists of four elements tax unit, tax base or taxable income, accounting period, and tax rate. Tax unit refers to a person or persons to whom the tax applies. According to the definition under Section 248(1) of the Income tax Act ( the Act ) 1, persons include both natural persons and corporations. Section 2(1) requires that every person resident in Canada pays income tax on the taxable income at any time in the year. Residents of Canada pay income taxes on the worldwide basis, meaning that they are subject to Canadian income taxes regardless of their physical presence in Canada. Non-resident persons may also be subject to Canadian income taxes if they were employed in Canada, carried on a business in Canada, or disposed of a taxable Canadian property, pursuant to Section 2(3). Tax base or taxable income is the taxpayer s income for the year, plus the additions and minus the deductions as permitted under Division C of the Act, pursuant to Section 2(2). The Act does not define the term income; therefore, the term is subject to judicial interpretation. Accounting period refers to a period of time over which taxable income is computed. Section 249(1) provides that a taxation year is referred to as a calendar year for individuals and fiscal period for corporations. In Canada, a taxation year is usually based on an annual basis. Taxpayers are obliged to file tax returns and pay taxes yearly. Tax rates are the tax ratio of a taxable income. The current rates as provided under Section 117(2) as follows: Range of Income 0 - $40,726 15% $40,726 - $81,452 22% $81,452 - $126,264 26% Greater than $126,264 29% Tax Rate 1 Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), s. 248(1).

8 The maximum amount of tax on one s taxable income is determined according to the calculation rules set out under Section 117(2): A. If the taxable income is less than or equal to $40,726, the maximum amount of tax is 15% of that amount. B. If the taxable income is more than $40,726 but less than or equal to $81,452, the maximum amount of tax is the amount calculated in A, plus 22% of the amount exceeding $40,726. C. If the taxable income is more than $81,452 but less than or equal to $126,264, the maximum amount of tax is the amount calculated in B, plus 26% of the amount exceeding $126,264. D. If the taxable income is more than $126,264, the maximum amount of tax is the amount calculated in C, plus 29% of the amount exceeding $126, 264. Source Concept of Income Income that is taxable must be from a source such as an office, employment, or business and property. The Act does not limit the source of income. Section 3(a) states that besides from an office, employment, business and property, taxable income may be derived from a generic source. Important Terminologies Income Inclusion Although the Act does not provide a definition of income, Section 3 provides rules that determine the type of taxable income as follows: The following income or gain must be included in the computation in the taxation year: income from office, employment, business and property (paragraph (a)), and taxable capital gain from the year that the property other than listed personal property is disposed of (paragraph b(i)(a)), and taxable net gain from the year that the listed personal property is disposed of (paragraph b(i)(b)), less any allowable capital losses that exceed allowable business investment losses (paragraph b(ii)).

9 Deductions Deductions reduce the amount of taxable income by way of subtraction from the computed income. Section 3 provides rules specifying amounts that may be deducted in the computation of income. Deductible amounts include: the amount permitted by Subdivision e of Division B, Part I (paragraph (c)), and losses from an office or employment, or business or property. Note that, unlike losses from an office or employment, or business or property which are deductible against all income, allowable capital losses are deductible against capital gain from disposition of property only (See Taxable Capital Gain and Allowable Capital Loss section). Exemptions Like deductions, exemptions also reduce the amount of taxable income. However, they differ from deductions as they do not reduce taxable income by way of subtraction. Taxpayers are entitled to leave out the amount qualified as an exemption from the calculation of their taxable income. Tax Credits Tax credits reduce tax burden by giving recognition to certain amount of taxes due. The credits are subtracted directly from the amount of tax payable. Tax credits can be nonrefundable, meaning that they cannot be used to reduce tax burden if the amount taxable is below zero. On the contrary, refundable tax credits can be used even though the amount of tax owed is below zero.

10 Income from Office or Employment Section 3(a) requires that income from an office or employment be included in the computation in the taxation year. In some circumstances, it is unclear whether the income is derived from an office or employment. This turns on the characterization problem discussed below: Characterization The court has dealt with the issue of unclear income characterization in various cases. In Wiebe Door, the taxpayer hired several workers to provide services of installing and repairing doors. The taxpayer and his workers agreed that each worker performed the service as an independent contractor who was responsible for his own work and taxes. As such, the taxpayer did not deduct the Canada Pension Plan (CCP) and Unemployment Insurance (UI) premiums required as part of the worker s contribution. At issue was whether these workers were employees whose CCP and UI contributions were subject to deductions by the employer, or independent contractors who were responsible for their own taxes and contributions. 2 The court in Wiebe Door set out criteria to determine whether an individual is an employee or independent contractor. A worker is likely to be an independent contractor if his work obtains most of the following characteristics: 1. has a significant degree of control over the work. 2. owns his own tool and vehicle for work (which indicate the worker s own expenses). 3. has a great chance of making profits. 4. responsible for his own carelessness or the risk of loss. Each criterion above is not determinative, meaning that fulfilling one of the criteria does not suffice to demonstrate a quality of being an independent contractor. All factors must be taken into account. 2 Wiebe Door Services Ltd. v. M.N.R. [1986] 2 C.T.C. 200.

11 Inclusions The relevant provisions regarding the income from office or employment are Section 5 8 of the Act. Section 5(1) lists general forms of income from an office or employment, which includes salary, wages and other remuneration including gratuities, received by the taxpayer in the year. Fringe benefits must also be included as income from office or employment, pursuant to Section 6(1). These benefits include: value of board, lodging, and any kind of benefits enjoyed by the taxpayer in the course of an office or employment, an allowance for personal or living expenses, or allowance for any purpose except expenses listed under subsection i to xi, and director s fees or other fees that the taxpayer received by virtue of an office or employment. If it is unclear whether a payment should be included as income from an office or employment, Section 6(3) provides the rules that require payments that meet the following inquiries be included in the computation: the amount that is paid during a period while the payee is an officer or in the employment of the payer (Section 6(3)(a)), or the amount that is paid immediately before, during, or immediately after a period that the payee was an officer or in the employment as a result of satisfaction of an agreement made by the payer and payee (Section 6(3)(b)). However, the amount cannot be included as income from an office or employment if, regardless of the agreement between the payer and payee, the amount is not considered as: consideration or partial consideration for accepting or entering into a contract of employment (Section 6(3)(c)), remuneration for services (Section 6(3)(d)), or consideration or partial consideration for a covenant ((Section 6(3)(e)).

12 The language of Section 6(3) suggests that the amount included must fall within either Section 6(3)(a) or (b), and one of the categories (c), (d) or (e). Therefore, the amount that is not included in the income computation pursuant to Section 6(3) is the one that does not fall within Section 6(3)(a) or (b), or the amount that falls within (a) or (b), but cannot be categorized as an amount listed in (c), (d) or (e). The concept of income under Section 6(3) is larger than that under Section 5(1). Not only does Section 6(3) include payments for services rendered, it includes payments made prior to the rendering of services. Section 6(3) expands the scope of Section 5(1). Note that income that does not fall within Section 6(3) categories can still be included in the computation of income if it was derived from a generic source, pursuant to Section 3(a). There has been a number of case law that deal with the issues of whether certain payments should be included as income from an office or employment. The Act does not define the term salary, wages, remuneration, and gratuities. Therefore, it is subject to the court s interpretation whether certain type of payment falls within the taxable categories mentioned above. The principle is that if the payment is made for services rendered during the office or in the employment, it is taxable under Section 5(1). If it is connected to employment, it may be subject to tax under Section 6(3). Section 5-8 specifically deal with remuneration, benefits and allowances as discussed below. To order the complete version of the lawskool Income Tax Law Summary please visit