TAX NEWSLETTER August 2010 NEW CRA LOGBOOK POLICY FOR MOTOR VEHICLE EXPENSES INCOME ATTRIBUTION RULES SUPERFICIAL LOSSES TRANSFER OF LATENT CAPITAL LOSSES BETWEEN SPOUSES INVESTMENT COUNSEL FEES VS COMMISSIONS PRESCRIBED INTEREST RATES AROUND THE COURTS NEW CRA LOGBOOK POLICY FOR MOTOR VEHICLE EXPENSES Where a motor vehicle is used partly for business purposes and partly for personal purposes, only the expenses relating to business driving are deductible for income tax purposes (and eligible for input tax credits under the GST/HST). As a result, businesses are required to keep adequate records to demonstrate the use of the vehicle for business purposes, which is normally based on the relative distances driven. The Income Tax Act does not specify exactly how vehicle records are to be maintained, although a general rule requires that records must be maintained in such form and containing such information as will enable the taxes payable to be determined. The Canada Revenue Agency (CRA) has historically taken the position that the best evidence to demonstrate the business use of a vehicle is a logbook maintained for the entire taxation year, recording each business trip and the distance travelled. However, in the 2008 Federal Budget, the government announced that the CRA would consider allowing a sample logbook to determine business use for a taxation year, and would consult on this issue with various small business groups. Recently, on June 28, 2010, the CRA announced its new policy. It stated that it will allow businesses to use a sample logbook, covering 3 months of a year, to determine the business use for the entire year. The sample logbook can be used once the business has established a base year during which a logbook was maintained showing business travel for the entire year. In particular, the new CRA policy allowing a 3-month sample logbook will apply if all of the following conditions are met: The business retains a logbook covering a full 12-month period that was typical for the business travel (the base year ). The base year can be 2009 or a later year. After the base year is established, the business maintains a logbook for a sample period of at least one continuous three-month period in each subsequent year (the sample year period ). The business use of the vehicle during the three-month sample period must be within 10 percentage points of the corresponding amount for the same three-month period in the base year (the base year period ). The annual business use of the vehicle in the subsequent year cannot go up or down by more than 10 percentage points in comparison to the base year. If these criteria are met, the business use of the vehicle in each subsequent year will be calculated by multiplying the business use
of the base year by the ratio of the sample period and base year period. The CRA provides the following formula for this calculation: (Sample year period % Base year period %) Base year annual % = Calculated annual business use for the subsequent year The CRA also provided the following example. Example: An individual has completed a logbook for a full year, which showed a business use percentage in each quarter of 52%/46%/39%/67% and an annual business use of the vehicle as 49%. In a subsequent year, a logbook was maintained for the second quarter, which showed the business use as 51%. Since the percentage of business use of the vehicle for the second quarter of the base year was 46%, the business use of the vehicle for the entire subsequent year would be calculated as follows: (51% 46%) 49% = 54% Therefore, in the absence of contradictory evidence, the CRA would accept the business use for the subsequent year as 54%. If the annual business use in a subsequent year, as determined by the above formula, goes up or down by more than 10% relative to the base year, the CRA states that the base year is no longer an appropriate indicator of annual usage in that subsequent year. In such a case, the CRA will normally accept the sample period logbook only as evidence for the three-month period for which it was maintained. For the remainder of the year, the business use of the vehicle would need to be determined based on an actual record of travel or alternative records. The CRA has not provided any indication that this new policy will be available for employees who need to track their employment-related driving for tax purposes. As announced, it applies only to business deductions (including self-employed individuals). INCOME ATTRIBUTION RULES The income attribution rules under the Income Tax Act are meant to prevent income splitting among family members. For example, without the rules, a high-tax bracket spouse could purchase investments for his or her lowincome spouse so that the resulting investment income would be taxed at a lower rate. The various income attribution rules, and their exceptions, are described below. Overview of the rules The main rule provides that if you lend or transfer property to your spouse (or commonlaw partner) or to a non-arm s length child or niece or nephew under the age of 18, the resulting income (or loss) from the property is attributed to you and included in your income for tax purposes. In terms of taxable capital gains, another general rule provides that if you lend or transfer property to your spouse (or common-law partner), any taxable capital gains (or allowable capital losses) from a subsequent disposition of the property will be attributed to you and included in your income. The general rules described above can also apply if you lend or transfer property to a
trust of which your spouse or minor children are beneficiaries. Therefore, you cannot normally get around the income attribution rules simply by putting the property in a trust for your spouse or children instead of transferring them. For loans or transfers to your spouse, the attribution rules do not apply if you are no longer spouses (or common-law partners). For loans or transfers to minor children, the rules do not apply in the year in which the child turns 18 years of age and in later years. Exceptions to the rules Fortunately, there are various exceptions to the attribution rules, so that some forms of income splitting between family members are allowed. For loans or transfers of property to minors, there is no attribution of subsequent capital gains, meaning that you can legitimately split capital gains with your minor children. For example, you could purchase common shares or equity mutual funds for your children, and any subsequent taxable capital gains would be included in their income, not yours. (You do have to determine whether, under provincial law, your children are legally able to directly own securities.) Another exception is the "fair market loan" exception. Under this exception, the attribution rules do not apply if you lend money using the prescribed rate of interest in effect at the time of the loan, and the borrower (e.g. your spouse or minor child) pays the interest every year in which the loan is outstanding or by January 30 of the following year. However, if they miss even one payment or are late with one payment, this exception ceases to apply. Currently, the prescribed interest rate for the above exception is 1%. Thus, for example, if you make a loan at 1% interest to your spouse and he or she uses it to earn a 5% return, the net amount of 4% (5% minus 1% interest paid to you) will be included in their income, while you would report the 1% interest paid to you. Another exception to the attribution rules applies where you transfer property and receive back at least fair market value consideration for the property. If the consideration is indebtedness, it must bear the prescribed rate of interest and the interest must be paid each year or by January 30 of the following year as noted above. Furthermore, if the transfer is to your spouse (or common-law partner), you must elect out of the tax-free rollover that normally applies to such transfers. This means that any accrued gain on the transfer would be included in your income. As a result, it usually makes sense to transfer property with little or no accrued gain. Unfortunately, any accrued loss on a transfer to your spouse will normally be denied under the "superficial loss" rules (discussed in the next section of this letter). However, an accrued loss on a transfer to your minor child can be recognized by you and will not be subject to the superficial loss rules. Gifts of property to relatives (other than spouses) who are at least 18 years old are not subject to the attribution rules. Thus, for example, you can give your adult child an investment property and the resulting income will not be subject to attribution. The rules do not apply to income from reinvested income. Thus, for example, if you
give money to your spouse and he or she reinvests the income from the money, the income earned by reinvesting the (initial) income will not be subject to attribution. The attribution rules do not apply to business income. As a result, you can provide your spouse with money or property to be used in earning income from business and the resulting business income will not be subject to attribution. The attribution rules do not apply to income that is earned by investing the child tax benefit (which is available to certain lowincome families) or the Universal Child Care Benefit (which is available for all families with children under the age of 6). There is no attribution for dividends from private corporations (actually, any corporation not listed on a designated stock exchange) received by your children under the age of 18. Unfortunately, the so-called kiddie tax applies to such dividends at the highest marginal rate of tax, so income splitting in this regard is of no tax benefit. SUPERFICIAL LOSSES The intent of the superficial loss rules under the Income Tax Act is to deny a capital loss on the disposition of property where your loss is considered superficial, in that either you or someone close to you has retained or acquired the property or an identical property within a specified time period, as described in more detail below. In particular, the superficial loss rules apply to a loss realized on your disposition of a capital property, where either you or an affiliated person acquired or reacquired the property or an identical property within the period beginning 30 days before your disposition and ending 30 days after the disposition; and you or the affiliated person owns the property or an identical property on the 30 th day after your disposition. For these purposes, an affiliated person includes your spouse or common-law partner, a corporation controlled by you, a trust in which you are the sole or majority-interest beneficiary (including your RRSP or RRIF), and a partnership in which you are a majority-interest partner, among others. Interestingly, an affiliated person does not include your child or other relative, so that losses occurring in dispositions to such persons are not denied under the rules. Identical properties for the above purposes are not defined in the Income Tax Act (other than for bonds), but generally include shares of the same class of the same corporation, units in the same mutual fund, and debt instruments issued by the same issuer with the same terms and conditions. Where the superficial rules apply, your capital loss is denied. However, the amount of the loss is added to the adjusted cost base of the property of the person who owns the property at the end of the 30-day period after your disposition (i.e. you or the affiliated person). Because of the add-back of the loss to the cost of the property, the loss is not lost forever, and can usually be recognized on a future disposition of the property. As a simple example of the rules, if you sell common shares in XCorp to your spouse at a loss and she still owns them 30 days after
your sale, your loss is denied. The loss is added to the adjusted cost base of the shares for your spouse. However, as noted above, the rules can apply if the property or identical property is acquired within the 30-day period prior to or after your disposition. Thus, for example, if your RRSP acquired 100 common shares in XCorp 20 days ago and you personally sell 100 common XCorp shares today at a loss, your loss will be denied if your RRSP continues to hold its shares in XCorp 30 days after your sale. Furthermore, in this example, the add-back of the loss to the adjusted cost base of the shares owned by your RRSP would be of no benefit, because your RRSP is tax-exempt on a sale of the shares in any event. TRANSFER OF LATENT CAPITAL LOSSES BETWEEN SPOUSES It may be desirable in certain circumstances to shift accrued capital losses from one spouse to another for example, where the other spouse has current or expects future capital gains that could be offset by the capital losses. A recent CRA technical interpretation confirms that a properly constructed transaction can be used to fulfill this objective. The CRA confirmed that this is legitimate tax planning and the CRA would not apply the general anti-avoidance rule to this type of transaction. Basically, the arrangement works where one spouse (transferor) has capital property (e.g. shares or mutual funds) with an accrued capital loss. The transferor sells the property to the other spouse (transferee) for fair market value proceeds, and the parties elect out of the tax-free rollover that otherwise applies to transfers of property between spouses. The transferor s loss on the transfer will be considered a superficial loss, meaning that it is denied and the amount of the denied loss is added to the cost of the property to the transferee. (The transferee must retain the property for at least 30 days in order for the superficial loss rules to kick in, as discussed above.) Effectively, the transferee spouse takes over the property with the same cost as the transferor, meaning that the property still has the accrued loss. The transferee can then sell the property and claim any resulting capital loss. INVESTMENT COUNSEL FEES VS COMMISSIONS In computing your income, you are allowed to deduct investment counsel fees paid by you in the year, which are generally amounts, other than a commission, paid for either 1) advice as to the advisability of purchasing or selling specific shares or other securities, or 2) services in respect of the administration or management of your shares or other securities. The fees must be paid to a person whose principal business is advising others whether to buy or sell specific shares or securities, or whose principal business includes the administration or management of shares or securities. On the other hand, commissions paid on sales or purchases of securities are not deductible. Instead, on a purchase, they are added to the cost of the securities. On a sale, in the case of a capital gain they are subtracted in computing the gain, while on a capital loss they are added in computing the loss. Some taxpayers choose to have an "advisor" brokerage account, whereby their investment advisor charges a monthly fee for advice and charges no commission on
trades. Such taxpayers take the position that all of the fees they pay are for advice. The CRA may or may not agree, but this can be a plausible filing position. PRESCRIBED INTEREST RATES The CRA recently announced the prescribed annual interest rates that will apply to amounts owed to the CRA under the Income Tax Act and to amounts the CRA owes to individuals and corporations. These rates are calculated each quarter. The July to September 2010 rates are as follows: The interest rate charged on overdue taxes, Canada Pension Plan contributions, and Employment Insurance premiums will be 5%. The interest rate paid to non-corporate taxpayers on overpayments will be 3%. The interest rate paid to corporate taxpayers on overpayments will be 1%. (Note that this rate for corporations is now 2 percentage points lower than other taxpayers, due to changes announced in the 2010 Federal Budget.) The interest rate used to calculate taxable benefits for employees and shareholders from interest-free and lowinterest loans will be 1%. AROUND THE COURTS Frequent flyer points qualified for medical expense credit The medical expense tax credit under the Income Tax Act applies to certain qualifying medical expenses. One such expense is a payment made for a taxpayer to travel from where the taxpayer lives to another place, not less than 40 kilometres away, where medical services are to be provided for the taxpayer and substantially equivalent medical services are not available where the taxpayer lives. In the recent Johnson case, the taxpayer lived in Thunder Bay, Ontario, and flew from Thunder Bay to Chicago for a certain medical treatment. He used a ticket obtained by redeeming Aeroplan frequent flyer points, and by paying $220 in taxes on the ticket. The taxpayer claimed the $2,060 value of the ticket using Air Canada equivalent fares for the flight, along with the taxes, as qualifying medical expenses. However, the CRA allowed only the taxes as a medical expense, taking the position that the redeeming frequent flyer points to pay for the ticket was not payment for the flight. On appeal to the Tax Court of Canada, the Court agreed with the taxpayer. The Court found that the frequent flyer points given up by the taxpayer had monetary value and that by redeeming such points the taxpayer effectively paid for the flight to Chicago. As a result, the $2,060 value of the flight plus the taxes qualified as medical expenses for the purposes of the credit. Legal fees not deductible in lawsuit for loss of employment Under the Income Tax Act, you are allowed to deduct legal fees incurred to collect or establish a right to salary or wages that are owed to you by your current or former employer. You can claim the deduction even if you do not actually end up receiving the salary or wages. You are also allowed to deduct legal fees incurred to collect or establish a right to a retiring allowance, which includes, among other things, damages received in respect of a loss of an employment. However, in this
case, the deduction of your legal fees is limited to the amount of the retiring allowance (if any) that you actually receive. In the recent Bonsma case, the taxpayer was a technician employed at a company ( Tesco ). He claimed that Tesco was systematically reducing his workload and his income without sufficient reason. His income was dropped to the point that he felt he had to quit the job with Tesco and find other employment. He then sued Tesco for damages for wrongful actions that led to the effective termination of his employment. In the three taxation years during which the lawsuit continued, the taxpayer attempted to deduct his legal fees for income tax purposes. The CRA denied the deduction on the grounds that the fees related to damages in respect of a loss of employment, which would have been a retiring allowance. Since he did not actually receive any such amount during those years, he could not deduct the legal fees because of the above-noted restriction relating to retiring allowances. On appeal, the Tax Court of Canada disagreed with the taxpayer's argument that the legal fees were incurred to collect or establish a right to salary or wages owed to him. The Court held that the claim for damages did not relate to any employment services he had already performed. As a result, the claim was not for salary or wages owed to him. Instead, the Court agreed with the CRA that the lawsuit related to damages claimed in respect of a loss of employment, which would have been a retiring allowance. As noted above, this meant that the taxpayer could not deduct any of the legal fees because he had not received any damages as a retiring allowance. * * * * * * Buchanan Barry LLP has served the Calgary business and non-profit community since 1960. We are a full-service chartered accounting firm providing accounting, audit, assurance, advisory, tax and valuation services to clients in the oil and gas sector, the service industry, real estate, the retail and wholesale trade, the manufacturing industry, agriculture, the non-profit sector and professionals. Should you have any questions regarding the foregoing or other tax matters, please contact our tax group at (403) 262-2116. Buchanan Barry LLP Chartered Accountants 800, 840 6 th Avenue SW Calgary, Alberta T2P 3E5 Tel (403) 262-2116 Fax (403) 265-0845 www.buchananbarry.ca This letter summarizes recent tax developments and tax planning opportunities. We recommend that you consult with an expert before embarking on any of the opportunities in this letter, which may not be appropriate to your own specific circumstances.