Chapter 9: Advanced Tax Concepts Flashcards
What must you first calculate to calculate the capital gain on the disposition of capital property?
The adjusted cost base (ACB)
What factors go into the calculation of the ACB for a piece of property?
- Purchase price
- Contribution of capital
- Sales charges
- Costs of acquisition
- Distributions of investment returns
- Other non-deductible costs
What does a “contribution of capital” refer to when discussing the ACB of a capital property?
When a taxpayer injects capital into a corporation and receives shares in exchange. The amount of money injected would add to the ACB of the shares received.
Is land transfer tax and fees paid to a lawyer deductible?
No, neither are deductible. They increase the ACB of the property.
How are repairs to a rental property treated for tax purposes?
Any costs that are not deductible would increase the ACB. Repair or replacement with a similar item (such as replacing carpeted floors with a similar surface) would be deductible, but replacing carpet with hardwood floors would not be.
What is the general formula for calculating ACB?
ACB = purchase price + sales charges + acquisition costs
When did capital gains become a taxable event in Canada and what is that day known as?
January 1, 1972. Known as valuation day.
What are the de minimus rules?
If the value of Personal Use Property (PUP) or Listed Personal Property (LPP) is below $1000, the ACB is assumed to be $1000.
What is Listed Personal Property?
Property that might have been purchased for personal use but could also have a collectible application (such as stamp, coin collections, antique furniture, etc.)
What are “identical properties” and how are these treated with respect to the calculation of ACB?
Primarily mutual fund units or shares of a company. ACB is averaged across all property owned. This is done to prevent investors from manipulating capital gains/losses by cherry picking which investments to sell.
Calculate the ACB:
In 2005, Paula bought 100 shares of RBC for $40 each + $30 commission. She bought a further 100 shares in 2006 for $50 each + $30 commission. In 2009, she bought her final shares for $30 each + $30 commission.
(100 x 40 + 30) + (100 x 50 + 30) + (100 x 30 + 30) / 100 + 100 + 100 = $40.30
What is the superficial loss rule?
Prevents investors from manipulating capital gains by selling shares with at a loss and then subsequently buying them back within 30 days to create a capital loss to offset capital gains on another investment.
If selling Stock A would create a $20 loss that could offset a $20 gain on Stock B, you cannot sell Stock A and then buy it back shortly after to take advantage of the loss.
What is the Alternative Minimum Tax (AMT)?
Prevents high income earners and trusts from paying little to no tax as a result of tax incentives. Certain deductions will trigger the AMT calculation.
What are AMT triggers?
Alternative minimum tax calculation triggers include:
- Certain CCA deductions
- Losses arising from investments in tax shelters or limited partnerships
- Resource expenditures and losses
- Flow-through shares
- Resource royalty income
- Capital gains
- Employee stock options
- Dividend income
- Labour sponsored funds tax credit
- Foreign investment income
- Foreign employment income
- Allowable business investment loss
What is the Lifetime Capital Gains Exemption?
Allows a taxpayer to incur up to $800K (indexing starting in 2014) of qualifying capital gains on a tax-free basis.
How much income is exempted from the AMT calculation to ensure only high income earners have to deal with it?
The first $40K of income.
What is the AMT inclusion rate for capital gains?
80%
At which tax rate is the AMT calculation based on?
The lowest marginal rate (ie. 15%), no matter how much income the taxpayer has.
What is the AMT credit?
Individuals who pay AMT tax have the ability to claim a tax credit over the next 7 years to recover AMT paid. Must have income to claim the credit or else it is lost.
Is AMT triggered in the year of death?
No.
What qualifies as a non-arm’s length relationship?
- Spouse or common-law
- Child
- Sibling
- Corporations
- Partnerships
- Trusts
- Other relationships can fit in this category if a manipulation of the tax system is occurring (example: your neighbour could qualify as non-arm’s length if you are manipulating the system with that neighbour)
Are nieces and nephews considered arm’s length or non-arm’s length parties?
Arm’s length.
What is attribution of income and when does it occur?
Income will be attributed back to a taxpayer when the taxpayer shifts income to another with the sole or primary purpose of reducing taxes.
Which factors should be considered to determine whether there will be an attribution of income?
- Relationship between the parties
- Tax savings generated
- Active or passive income
- Source of funds
When would transfer of a property to someone non-arm’s length not trigger attribution of income?
If there are no tax savings generated or the recipient uses the property to generate active business income.
Example: If a spouse transfers $100K to another spouse and the recipient invests the money and earns dividend income, all income will be attributed back to the transferor. However, if the recipient uses the money to start a business, there would be no attribution.
If an individual borrows funds for the purposes of investing and has their spouse co-sign the loan, what would happen?
Any income would be attributed back to the co-signor.
When would investment income in a joint account be attributed to one investor?
If one investor earns income and puts it into a joint account and the joint owner contributes nothing to the account.
List ways to create income in a lower income earner’s hands without triggering attribution rules…
- Transfer or sale for fair value of property
- Spousal loan
- Second generation investment income through reinvesting
- Business income
- Spending appropriately (have higher income earner pay bills so lower income earner can do all investing)
- Ownership of shares in a business
- Employing family members
- Legislated income splitting opportunities (CPP retirement benefits, RRSP, etc.)
If a spousal loan is employed as an income splitting strategy, which interest rate must be used?
At least the CRA’s current prescribed rate at the time of the loan.
What are the tax consequences of a spousal loan?
The spouse who loans funds or shares will “collect” interest income that is fully taxable. The spouse who receives the loan will be able to deduct the interest “paid” as an expense. The lower income spouse will claim all investment income from the property, which should (if done properly) result in a higher overall net benefit. Then, any capital gain that accrues from the date of the loan onward is attributable to the lower income spouse. Any capital gain that had already accrued is still attributable to the higher income spouse.
If a spousal loan is being employed as an income splitting strategy and the CRA’s prescribed rate falls, what may the spouses be inclined to do? What would the consequences be?
The lower income spouse may consider “repaying” the loan to the higher income spouse, then re-borrow at the new, lower rate. This repayment will trigger any capital gains from the lower income spouse.
What happens if property (such as shares) is transferred from a higher income spouse to a lower income spouse?
Income would be attributed back to the higher income spouse. However, if the lower income spouse reinvests the income, all “second generation income” would be taxable in his hands.
If one spouse has a high income and the other spouse has a low income, how can they easily invest (non-registered) and pay tax at the lower income spouse’s rate without risk of attribution back to higher income spouse? (Not complex)
Spend appropriately. Have the higher income spouse take care of all family expenses which frees up the lower income spouse to use all their income for investing. There will be no risk of attribution back to the higher income spouse.
What happens (in terms of attribution of income) if a couple has separated or divorced?
If there is a formal separation agreement in place, there will be no attribution of income. (Although the validity of a separation agreement could be challenged). There is no attribution after a divorce.
What would happen if a low income spouse sets up a corporation to avoid attribution?
If a low income spouse sets up a corp so the high income spouse can lend money to it and the low income spouse can take dividends, this will trigger very complex tax rules known as corporate attribution rules.
Is driving to and from work in an automobile considered personal or business use?
Personal use, and is therefore a taxable benefit.
What are the two separate taxable benefits that can apply when an employee has a car available for personal use?
- Standby charge - assessed based on the ability of the employee to use the car for personal use
- Operating expense benefit - assessed based on an employer paying the expenses associated with maintaining the automobile
How do you calculate standby charges for owned company cars and what can reduce these charges?
Varies depending on whether the employer owns or leases the vehicle. For owned cars, the amount of taxable benefit is based on the purchase price of the car (including taxes) times 2%, times the number of months the car is used. Can be reduced by any amounts that the employee pays the employer for the vehicle.
How do you calculate standby charges for leased company cars?
Based on 2/3rds (66.67%) of the monthly lease payment, including taxes.
How is the operating cost benefit for a company car calculated and does it change depending on whether the car is leased or owned? Can this benefit be reduced?
Based on the kms driven. Usually $0.27 per personal km driven. Reduced by any amounts that the employee pays for maintenance. This calculation is the same for cars that are leased and owned.
What happens if an employee primarily uses an company-provided car for work use? What defines “primarily for work use”?
If personal use is 50% of the kms driven or less than 20,004 km per year, the car is being used primarily for work use. Reduced standby charge benefit is calculated on a pro-rata basis using the kms driven for personal use against the maximum of 1667 per month.
Calculate the pro-rated standby charge for a company car that’s leased at $300/month where the employee only drives 1000km per month for personal use?
$300 x 66.67% (taxable benefit for leasing) x 1000/1667 (max personal km) = $119.98/month
If that employee drove more than 1667km per month for personal use, the taxable benefit would be $200/month.
How will an employer depreciate expenses associated with purchasing a vehicle? How are leasing costs treated?
Using the capital cost allowance.
Leasing costs are fully deductible within limits.
What is the primary advantage of an employer paying an employee for use of their own car rather than using an employer-owned car?
The allowance paid by the employer is tax-free to the employee if properly structured.
How would an employee receive tax-free treatment on a personally-owned automobile for business use?
If a personal-use automobile is required for business-use by an employer, the employee would submit for reimbursement on a per-km basis by the employer.
Would be fully taxable if the employer simply pays a flat-rate allowance.
What is the maximum annual per km reimbursement amount (for 2021) for business-use of personally-owned automobiles?
$0.59 per km for the first 5000 then $0.53 thereafter.
What are the maximum CCA claims for vehicles?
$30,000 for any passenger vehicle, but $55,000 for zero-emission vehicles. Maximum monthly lease that can be used for business expenses is $800/month.
How can shareholders of a corporation use vehicles as a tax planning opportunity?
If the shareholder has a controlling interest in the business and requires a car for business use, the shareholder can take an interest-free loan from the corporation with a written loan agreement in place and repayment over a reasonable period of time. This loan does not result in a taxable benefit to the shareholder.
When is farming income deductible?
Only when the farmer earns income primarily from a farming business. For example, hobby farmers who earn primary income from other sources can only deduct a limited amount ($17,500 in 2019).
What qualifies a business loss?
Loss of invested capital in a Canadian Controlled Private Corporation (CCPC) which also must be a Small Business Corporation (SBC). Must be a deemed disposition or a sale to an arm’s length party.
How are capital business losses treated for tax purposes? What is the formal name?
Formally called ABIL (Allowable Business Investment Loss). 50% capital gains inclusion rate applied to the loss, loss can be applied against any sort of income. Can be carried back 3 years or forward 20 years if there is no income in the year of loss. An ABIL that is unused after 10 years becomes an ordinary capital loss which can only be used against capital gains.
Explain what would happen to an individual who invests $100,000 in a business and the business fails.
If the business is a CCPC (Canadian Controlled Private Corp) and meets the SBC (Small Business Corp) test, that individual will realize a $100K loss. The 50% inclusion rate is applied, leaving the individual with a $50K ABIL (Allowable Business Investment Loss). If the individual makes $80K of income the following year, they would only have to pay tax on $30K (assuming they apply the full ABIL). The ABIL can be carried back 3 years or forward 20. After 10 years, the ABIL can only be applied to capital gains, not all income.
How do capital losses differ from business losses?
Business losses create an Allowable Business Investment Loss (ABIL) which can be applied against any type of income (up to 10 years following the loss). Capital losses can generally only be applied against capital gains.
The key word here is ALLOWABLE.
Which type of capital losses can generally be applied against all types of income?
Allowable capital losses.
What is the difference between a capital gain and a taxable capital gain?
Capital gain is the difference between the FMV and ACB. Taxable capital gain is the amount that is taxable after the 50% inclusion rate has been applied.
How long can capital losses be carried forward and backward?
Indefinitely forward, three years backward.
Why might someone not want to apply a capital loss against a previous capital gain?
Applying capital losses retroactively will require an adjustment of those previous years’ taxes.
Are capital losses deductions from taxable income or net income and why is that important?
They are deductions from net income. As such, they don’t reduce net income for the purposes of OAS or Canada Child Benefit calculations.
What is the one exception to the rule that a capital loss can only be applied against a capital gain?
In the year of death, capital losses can be applied against any sort of income. If this wipes out all income, any remaining losses can be carried back to the year prior to death.
What happens if a deceased taxpayer’s estate realizes capital losses in the year following death?
Those capital losses can be carried back and applied against the deceased taxpayer’s terminal tax return. This only works for capital losses occurring in the year after death, not allowable for the following year.
What are the (5) categories of depreciable property?
- Personal Use Property (PUP)
- Listed Personal Property (LPP)
- Other Capital Property - depreciable or non-depreciable
- Registered Property
- Life Insurance
How is Personal Use Property treated for capital gain/loss and depreciation purposes?
Can have capital gains applied, but not losses (such as a cottage). PUP is also not depreciable.
How is Listed Personal Property treated for capital gains/losses and depreciation purposes?
LPP skirts the line between business and personal use, including collectables. The de minimus rules apply to LPP. Subject to normal capital gain rules. Capital losses are possible if used against other LPP gains within 7 years of the loss.
What are the 2 types of Other Capital Property?
- Depreciable property such as assets required for business use.
- Non-depreciable property such as most investments (mf’s, stocks, sf’s, bonds, etc.)
What would be considered other capital property that is depreciable?
Assets required for business use that lose value over time. Building or leasehold improvements to an office. Intangible assets such as an FP’s book of business, or trademarks/patents etc when purchased from another entity. Assets can also be partially depreciable such as a car used for both business and personal use.
What is considered non-depreciable property? How is it treated for capital losses/gains?
Most investments such as stocks, bonds, mutual funds, seg funds, ETFs. Land is also non-depreciable. Subject to normal treatment of capital gains and losses.
What is considered Registered Property?
Registered assets such as RRSPs, RRIFs, TFSAs, DPSPs, RESPs, RDSPs, etc.
What is the Climate Action Incentive (CAI)?
How does it work in Ontario?
Form of carbon tax put into effect in 2019. This is the federal version that applies to taxpayers in Alberta, Manitoba, Ontario and Saskatchewan. It is a refundable tax credit, which means that anyone can collect it even if they don’t have income tax payable.
In Ontario, each adult received $300. The second adult in a couple or first child of a single parent receives $150. Each child under 18 thereafter receives $75. There is a 10% supplement for residents of small and rural communities, this is 10% of the $300 and $150 amounts, does not apply to the $75 amounts for children.
What are carrying charges?
Any cost associated with carrying an investment with the most common being interest on a loan for investment purposes.
What does the term “expectation of profit” imply when it comes to carrying charges?
Carrying charges are deductible if proceeds of a loan are used to purchase/fund an investment that has the potential to provide regular income. For example, common shares, rental property, and mutual funds all have an expectation of profit. Vacant land purchased for speculative reasons would not meet the test, but common shares that have the potential to provide dividend income would meet the profit test.
What happens if a taxpayer borrows money for mixed investment and personal uses and then repays a portion of their loan?
They are assumed to have repaid their personal borrowings before their investment borrowings.
What is the child care deduction?
A deduction available for parents (unless one parent earns little or no income).
Child 6 or younger: $8,000 maximum
Child aged 7 to 16: $5,000 maximum
Child, any age, and eligible for disability amount: $11,000 maximum
Child age 16+ with a mental/physical impairment not eligible for disability amount: $5,000 maximum.
Claimable amount (claimed by lower income spouse) is limited to the least of 2/3rds of the taxpayer’s income or the amount spent.
Can cover costs of…
- Care by an eligible child care provider
- Day care
- Day camp
- Day sports school
- Boarding school or camp (subject to certain limits)
- Educational institution providing childcare
How does the child care deduction work in the case of a separation or divorce?
Only a custodial parent can claim child care expenses. If shared custody, each parent can claim child care expenses.
In which situation(s) could a higher income spouse deduct child care expenses?
If the lower income earner is disabled (long-term), attending post-secondary, or incarcerated.
Is it possible to pay a family member to provide child care expenses and use the childcare deduction?
Yes, if the family member providing care is 18+ and not a dependent for tax purposes. The taxpayer cannot claim the caregiver amount for that family member and also deduct child care expenses paid to that person. The recipient of the payment must claim it as income.
When must an executor or administrator of an estate file and pay taxes?
180 days to file. For payment, it is the later of the tax filing deadline and 180 days.
For example, if a person dies on August 10th, they have until April 30th to pay taxes since it’s more than 180 days. If they die on February 15th, they would have until August 15th to file taxes (180 days).
What is the spousal rollover provision?
All property can be transferred from one spouse to the other on a spouse’s death without a deemed disposition arising.
Transferor faces no tax consequences, recipient receives property at the transferor’s ACB.
What are the 4 tax returns that can be filed upon a taxpayer’s death?
- Terminal return (required)
- Rights and things return (optional)
- Partnership income (optional)
- Testamentary trust (optional)
Which tax credits can be applied on all four tax returns upon the death of a taxpayer?
Basic personal amount, age amount, spouse/CL partner amount, amount for an eligible dependent, amount for an infirm dependent, caregiver amount.
What is the Rights and Things Return?
An optional return for deceased taxpayers who received certain things as income in the year of death simply due to unfortunate timing.
If filed, it must include all rights and things…
- Salary/commissions earned but not paid prior to death (vacation pay)
- Matured bond coupons not yet paid
- Dividends declared prior to death but not paid
- Harvested crops, inventory, A/R for farmers and fishermen using the cash accounting method
- WIP for professionals who defer WIP until completion
Example: if a person passes away with $10,000 vacation pay owing, their death will trigger payment of the amount. Can include this on a Rights and Things return and it will likely not lead to any tax payable as it’s less than the Basic Personal Amount.
What is the Partnership Income Tax Return?
Rare, optional return for deceased taxpayers in a partnership with a year-end other than Dec 31. Estate has the option of filing an extra return dealing with partnership income earned between the partnership’s year-end and date of death. If a partnership is wound up on the death of one partner, any income would have to be included on the terminal return instead.
