Month: January 2018

INCOME SPRINKLING: Where Are We Now?

On December 13, 2017, the Department of Finance released a number of updates relating to the income sprinkling proposals (originally announced on July 18, 2017). Below is a summary of the proposals as they are currently drafted.

Individuals that receive certain types of income derived from a “related business” will be subject to Tax on Split Income (TOSI) unless an exclusion applies. TOSI is subject to the highest personal tax rate with no benefit of personal credits.

Commencing on January 1, 2018 TOSI will potentially apply in respect of amounts that are received by adults, not just those under 18 years. The application of TOSI to individuals under age 18 (commonly known as the “kiddie tax”) would not generally change.

Income Streams at Risk

Private corporation dividends, partnership allocations, trust allocations, capital gains, and income from debt may all be subject to TOSI.

 

Related Business

A related business includes any business, where another individual related to the recipient of income does any of the following:

  • personally carries on the business (this means income from a sole proprietorship to a related person can be subject to TOSI);
  • is actively engaged in the business carried on by a partnership, corporation or trust;
  • owns shares of the corporation carrying on the business;
  • owns property the value of which is derived from shares of the corporation having a fair market value not less than 10% of the fair market value of all of the shares of the corporation; or
  • is a member of a partnership which carries on the business.

The definition is broadly drafted to capture income derived directly or indirectly from the business.

 

Exceptions and Exclusions

Several exclusions from the TOSI rules for adult individuals have been introduced.

Some exclusions depend on the age of the taxpayer at the start of the taxation year. Different rules apply to taxpayers at least 17 years of age at the start of the year (i.e. these exceptions are first available in the year the taxpayer turns 18) and to those at least 24 years of age at the start of the year (i.e. these exceptions are first available in the year the taxpayer turns 25). For the purposes of this analysis, the first age group will be referred to as those “over age 17” while the second group will be referred to as those “over age 24“.

The exclusions are as follows:

  1. Excluded Business: A taxpayer over age 17 will not be subject to TOSI on amounts received from an excluded business. An excluded business is one where the taxpayer is actively engaged on a regular, continuous and substantial basis in either the year in which the income is received, or in any five previous years. The five taxation years need not be consecutive.

An individual will be deemed to be actively engaged in any year where the individual works in the business at least an average of 20 hours/week during the portion of the taxation year that the business operates. A person not meeting this bright line test may also be “actively engaged” depending on the facts, but this will carry greater risk of challenge by CRA.

  1. Excluded Shares: A taxpayer over age 24 will be exempt from TOSI in respect of income received from excluded shares, including capital gains realized on such shares.
  1. Reasonable Return: TOSI will not apply to amounts which reflect a reasonable return.
    • For taxpayers over age 24, an amount which is reasonable is based on work performed, property contributed, risks assumed, amounts paid or payable from the business, and any other factors in respect of the business which may be applicable.
    • For taxpayers over age 17, but not over age 24, the rules are more restrictive. Only a reasonable return in respect of contributions of capital will be considered. 
  1. Certain Capital Gains: Although TOSI will be expanded to apply to capital gains of interests in entities through which a related business is carried on, some gains will be excluded. For example, capital gains arising due to a deemed disposition on death. Also, capital gains on qualified farm or fishing property, or qualified small business corporation shares will generally be excluded from TOSI.
  1. Retirement Income Splitting: The TOSI rules will not apply to income received by an individual from a related business if the recipient’s spouse was age 65 in or before the year in which the amounts are received and the amount would have been excluded from TOSI had it been received by the recipient’s spouse.

This new draft legislation is a substantial change from the current rules. The provisions are lengthy, complex and nuanced, and it is likely that additional concerns and challenges will be identified. It is uncertain whether there will be further changes, given the concerns which have already been identified, as well as the recommendations of the Senate Finance Committee released on the same date as these proposals.

 

 Action Item: Review whether your earnings may be impacted. Consider whether additional documentation should be kept to prove meaningful contributions and time worked. Also, restructuring of ownership or working relationships may be beneficial in some cases.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

DYING WITHOUT A WILL: Who Can Manage the Deceased’s Tax Affairs?

Where a family member of a deceased individual would like to be recognized by CRA as the person or persons who will manage the tax affairs of the person who died without a last will and testament, they can now do so by completing a CRA Form (Affidavit for intestate situation, Forms RC549 to RC561, with no form for Quebec, and no RC554).

Only certain people can register to manage these affairs. The form lists the priority order for those that may apply to be the representative. If another person ranks higher than the applicant, consent and a signature must be obtained from the higher ranking person(s). The priority order is generally:

1) Spouse or common-law partner

2) Adult children

3) Parents

4) Siblings

5) Grandparents

 

CRA aims to process the application within 4 weeks.

This new procedure comes as welcome relief. Previously, when a person died without a will, the applicant would normally have to go to Court to be appointed as the Administrator. The costs of this process could cause hardship, especially if the only reason for the appointment in Court is to file tax returns.

 

Action Item: If a deceased family member dies intestate, consider this option to minimize legal costs when settling the individual’s tax affairs.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

TAX TICKLERS… some quick points to consider…

  • Of the approximately 28 million personal tax returns filed for the 2016 year, 58% got refunds. 68% received them by direct deposit. The average refund was $1,735.
  • Only the last year of CPP survivor benefits can generally be accessed for late applications. Don’t delay submission.
  • Effective December 3, 2017, parents will be able to choose to receive parental benefits under the employment insurance program, if eligible, over the standard period (12 months) or the extended period (reduced amount taken over 18 months). The total benefits would be the same regardless of the option selected.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

OPERATING A BUSINESS IN THE U.S.: The IRS is Targeting Smaller Foreign Entities

The IRS has recently noted that they are rolling out campaigns to focus on entities below the “big fish” that have historically been targeted. Such campaigns include:

  • Related party transaction campaign – a redefined focus on mid-market entities to determine compliance with U.S. transfer pricing requirements.
  • Inbound distributor campaign – reviewing whether S. affiliates distributing imports from other countries are realizing adequate returns based on their assets, risks assumed, and functions performed.
  • Form 1120-F non-filer campaign – targeting corporations (the IRS believes there are many) with a S. permanent establishment or branch which have not filed U.S. income tax returns. The IRS indicates external data sources will be used to identify these companies, commencing with a “soft letter outreach”. There is no indication of any amnesty, meaning penalties and interest are likely for Canadian corporations which have not complied with any U.S. filing obligations.

 

Action Item: If operating as a mid-market business in the U.S., be prepared for the possibility of more scrutiny from the IRS.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

PROFESSIONALS’ WORK IN PROGRESS EXCLUSION: Coming Changes?

In the past, taxpayers in certain designated professions (i.e., accountants, dentists, lawyers, medical doctors, veterinarians and chiropractors) may have elected to exclude the value of work in progress (WIP) in computing their income for tax purposes. This essentially enabled these professionals to defer tax by permitting the costs associated with WIP to be expensed without including the matching revenues.

However, the 2017 Federal Budget proposed to eliminate this election, effective for the first tax year that begins after March 22, 2017. Transitional rules have been introduced to implement the change over two years. Once fully implemented, WIP, which is valued at the lower of cost or fair market value, will need to be included in income each year.

At present, many professionals either do not account for WIP in their financial accounts or account for WIP at its expected billing amount, using staff and partner billing rates rather than cost. These professionals will be required to determine the cost of their WIP in order to comply with these new provisions. There has been some uncertainty expressed regarding how the cost of WIP is properly calculated.

CRA has stated that the proposed changes are not expected to have any impact on bona fide contingency fee arrangements. That said, some practitioners have expressed concern that this concession has little or no basis in law.

 

Action Item: If you are in one of the industries impacted, and have not previously tracked the cost of your WIP, consider doing so. Also, budget for the possible additional tax liability over the next two years due to catching up the deferral of WIP.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

ELECTRONIC T4 SLIPS: Now More Widely Available

CRA has provided commentary on its website to discuss recent changes to allow the electronic distribution of T4 slips. In the past, an employer could provide a T4 electronically only with the employee’s consent. For 2017 and subsequent tax years, employers may also satisfy their obligations by providing electronic versions without specific consent, provided other criteria are met. The employer must provide the following by the last day of February following the calendar year to which the slip relates:

  • a secure electronic portal through which the employee can access their T4 slip;
  • a secure site for printing the slip; and
  • an option to receive paper copies upon request.

Paper copies must be provided if:

  • one of the above conditions are not met (unless employee consent has been received);
  • the employee requests a paper copy;
  • the employee is on sick leave or is no longer an employee of that employer; or
  • the employee cannot be reasonably expected to have access to obtain the T4 slip electronically.

The above only applies to T4 slips. Employers cannot issue T4 slips by email due to insufficient security features.

Action Item: Consider whether these new rules allow for a more streamlined T4 distribution at your business.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

WITHHOLDINGS ON REMUNERATION TO NON-RESIDENT: Get your CRA Filings Correct

In a March 9, 2017 Technical Interpretation, CRA commented on the tax filing and withholding requirements related to a non-resident individual providing services to a Canadian company.

If an individual is employed solely outside of Canada, and is not, and has never been, a resident of Canada, no withholdings on payments are required. However, the corporation would generally be required to file a T4 in respect of the non-resident individual’s total remuneration. One exception to this rule, would be where the total remuneration for the year is less than $500. This requirement to file a T4 is not conditional upon the payee being taxable in Canada.

CRA also opined that participation in meetings using the Internet or telephone from outside of Canada would not constitute performing the services in Canada.

 

Action Item: Ensure you are filing T4s in respect of non-resident employees providing services outside of Canada.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

2017 REMUNERATION

Higher levels of personal income are taxed at higher personal rates, while lower levels are taxed at lower rates. Therefore, individuals may want to, where possible, adjust income out of high income years and into low income years. This is particularly useful if the taxpayer is expecting a large fluctuation in income, due to, for example,

  • taking maternity/paternity leave;
  • receiving a large bonus/dividend; or
  • selling a company or investment assets.

In addition to increases in marginal tax rates, individuals should consider other costs of additional income. For example, an individual with a child may lose financial support in the form of reduced Canada Child Benefit (CCB) payments. Likewise, excessive personal income may reduce receipts of OAS, GIS, GST/HST credit and other provincial/ territorial programs.

There are a variety of different ways to legally smooth income over a number of years to ensure an individual is maximizing access to the lowest marginal tax rates. For example,

  • In owner/managed companies, owners may take more, or less, earnings out of the company.
  • Realizing investments with a capital gain/loss.
  • Deciding whether to claim RRSP contributions made in the current year, or carry-forward the contributions.
  • Withdrawing funds from an RRSP to increase income. Care should be given, however, to the loss in RRSP room based on the withdrawal.
  • Deciding on whether or not to claim CCA on assets used to earn rental income.

While the above is generally true, in certain cases some individuals may wish to pay out additional dividends in 2017. Effective in 2018, there are proposals to increase the tax cost of dividends paid out to shareholders of a corporation that do not “meaningfully contribute” to the business. As such, individuals who may be subject to this higher tax rate in future years may consider increasing dividend payments in 2017. Details on this proposed change are expected to be released by December 21, 2017.

Prior to paying increased dividends, consideration should be given to a number of factors (in addition to the items noted above related to increases in income), such as the impact on the business operations, cashflow, and other agreements (like bank covenants), and whether the dividend can be paid under corporate law.

Three different types of dividends can be paid from a corporation depending on the attributes and earnings of a corporation: eligible, non-eligible and tax-free capital dividends. Due to tax rate changes, the tax cost of non-eligible dividends will likely be increasing in 2018 and 2019. As such, some may consider declaring non-eligible dividends in 2017 to access current tax rates. Changes in provincial/ territorial rates may also impact the above decision.

Year-end planning considerations not specifically related to changes in income levels and marginal tax rates include:

1)      Corporate earnings in excess of personal requirements could be left in the company to obtain a tax deferral (the personal tax is paid when cash is withdrawn from the company).

         The effect on the “Qualified Small Business Corporation” status should be reviewed before selling the shares where large amounts of capital have accumulated.

2)      Consider paying taxable dividends to obtain a refund from the “Refundable Dividend Tax on Hand” account in the Corporation.

3)      Individuals that wish to contribute to the CPP or a RRSP may require a salary to create “earned income”. RRSP contribution room increases by 18% of the previous years’ “earned income” up to a yearly prescribed maximum ($26,010 for 2017; $26,230 for 2018).

4)      Dividend income, as opposed to a salary, will reduce an individual’s cumulative net investment loss balance thereby possibly providing greater access to the capital gain exemption.

5)      Recent tax changes may make it costlier to earn income in a corporation from sales to other private corporations in which the seller or a non-arm’s length person has an interest. As such, consideration may be given to paying a bonus to the shareholder and specifically tracking it to those higher taxed sales. Such a payment may reduce the total income taxed at higher rates.

6)      Proposed changes to the tax regime will likely require more careful tracking of an individual shareholder’s labour and capital contribution to the business, as well as risk assumed in respect of the business. Inputs should be tracked in a permanent file.

7)      If you are providing services to a small number of clients through a corporation (which would otherwise be considered your employer), CRA could classify the corporation as a Personal Services Business. There are significant negative tax implications of such a classification. In such scenarios, consider discussing risk and exposure minimization strategies (such as paying a salary to the incorporated employee) with your professional advisor.

 

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a blog such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this blog accepts any contractual, tortious, or any other form of liability for its contents.

For any questions… give us a call.

Marsha MacLean Professional Corporation