Basic Rules: Bus. Income vs Capital Receipt

Question 3

Business Income Versus Capital Receipt

Explain the difference is the way income receipts and captial receipts are treated for tax purposes?

Answer 3

• income receipts are fully taxed
• capital receipts are only partially taxed as capital gains. The current inclusion rate is 50%

Question 3

Business Income Versus Capital Receipt

When can a capital sale be considered income instead of a capital gain?

Answer 3

Decision is based on the intention of the taxpayer in the transaction:

1. Did the taxpayer deliberately seek a profit of an income rather than a capital gain nature?
2. Did the taxpayer build into the transaction, at the time of purchase, a profitable alternative in the event that the primary intention is frustrated?
3. May depend on the type of property involved. (ie. real estate)

Question 4

Explain “badges of trade”

Answer 4

A set of indicators developed by the courts to determine whether an adventure or concern in the nature of the trade was present in a transaction and, hence, whether business income resulted.

• The existence of significant badges of trade suggests an intention in a profit-making scheme or an adventure in the nature of trade.
• The lack of that evidence may suggest an investment intention.

Question 4

Analytical Framework for Capital Versus Income Issue

Answer 4

Evidence of Adventure Based on Behavioual Factors or “Badges of Trade”

• relationship of transaction to taxpayer’s business;
• activity or organization associated with trade;
• nature of asset;
• number and frequency of transactions in a given period of time;
• length of period of ownership of asset;
• supplemental work on or in connection with property;
• circumstances that caused disposition;
• if transaction completed by organization, stated objectives of organization as outlined in articles of association or partnership agreement
• other factors

infers:

Intention of the Taxpayer

Primary:

Did the taxpayer intend to use the asset like an item of inventory or like a capital asset?

Secondary:

If the primary intention to use the asset like a capital asset was frustrated, did the taxpayer have, at the time of the purchase, a motivating intention to sell the property at a profit?

determination:

Issue for Determination

Is the gain (or loss) from the disposition of property a capital gain (or loss) or business income (or loss)?

Question 5

Badges of trade specifically pertaining to real estate

Answer 5

1. feasibility of the taxpayer’s stated intention;
2. geographical location and zoned use of the real estate;
3. extent to which stated intention was carried out by the taxpayer;
4. evidence of a change in stated intention after the purchase;
5. the extent to which borrowed money was used to finance the acquisition and the terms of the financing; and
6. factors that motivated the sale.

Question 6

List and describe the badges of trade

Answer 6

1. Relationship of a transaction to the taxpayers business:
   
   • transaction is similar to transactions in his normal business or profession or those of his associates
   • the taxpayer has special knowledge or expertise might indicate that a profitable “escape hatch” was known as the time of purchase
2. Activity or organization associated with trade:
   
   • nature of the activity or
   • level of organization of the transaction (Was it handled in the same way as a normal business transaction?)
3. Nature of asset involved:
   
   • fixed assets, if sold, result in a capital transaction
   • “circulating” or working capital assets, if sold, result in an income transaction. (These assets cannot produce income in such forms as interest, dividends, rents, etc. Income for these can only be earned when they are sold as inventory at a profit.)
4. Number and frequency of transactions in a given period of time:
   
   • relatively large number of transactions indicate income transactions (however, an isolated transaction may still be considered as an income transaction.)
5. Length of ownership of an asset:
   
   • The shorter the period of ownership the more likely is the gain to be regarded as business income.
6. Supplemental work on or in connection with the property:
   
   • Work done to enhance its value or to make it more marketable may indicate an adventure in the nature of trade resulting in business income. (Intensive advertising & promotion of the sale would be a similar indicator.)
7. Circumstances that caused the disposition:
   
   • An unforseen offer or unforseed need for funds indicates capital receipt because of lack of a plan to turn a profit on the sale.
8. Corporate objects or partnership agreement:
   
   • When objects of a corporation are set out in a broad manner, the courts may decide that a transaction unrelated to a taxpayer’s usual business sitll falls within the corporation’s objects.
   • objects may be ignored and decision may be simply based on the nature of the transaction rather than on what is stipulated in the objects
   • relevance of this factor is diminished because Canada Business Corporations Act and the Ontario Business Corporations Act do not provide for stated corporate objects.

Question 7

Badges of trade specifically pertaining to disposition of securities.

Answer 7

1. knowledge of or experience in securities markets;
2. time spent studying the securities markets and investigating potential purchases;
3. financing primarily by margin or other forms of debt; and
4. advertising or otherwise making it known that the taxpayer is willing to purchase securities.