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Concepts and Topics > Net Income for Tax Purposes and Taxable Income > Flashcards

Net Income for Tax Purposes and Taxable Income Flashcards

1
Q

Type of adjustment: Amounts that increase accounting net income but are not subject to tax

A

Deduct

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2
Q

Type of adjustment: Amounts that have not been included in accounting net income but are subject to tax

A

Add

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3
Q

Type of adjustment: Amounts that are deductible in determining accounting net income but are not deductible for tax purposes

A

Add

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4
Q

Type of adjustment: Amounts that have not been deducted in determining accounting net income but are
deductible for tax purposes

A

Deduct

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5
Q

What are the two general rules for adding back to net income?

A

i) ITA 18(1)(a) prohibits the deduction of expenses not incurred for the purpose of gaining or
producing income. As such, any expenses not incurred to earn business income must be
added back for tax.
ii) Section 67 indicates that expenses must be reasonable in order to be deductible.
Therefore, any unreasonable amounts are added back in the reconciliation (only the
reasonable amount may be deducted). A reasonable amount is generally considered to be the
amount that would be paid to an arm’s length party.

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6
Q

Add back or Deduct from: Income tax — current and

deferred/future taxes

A

Add back.

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7
Q

Add back or Deduct from: Interest and penalties on late

payment of income taxes

A

Add back.

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8
Q

Add back or Deduct from: Accounting amortization on

tangible capital assets

A

Add back. CCA is a permitted deduction for tax purposes, so accounting amortization is not deductible (see below).

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9
Q

Add back or Deduct from: Accounting amortization on

intangible capital assets

A

Add back. Intangible assets are treated as eligible capital expenditures (ECE) — see below. Limited life intangible assets and patents are not included in
ECE; CCA may be claimed on them.

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10
Q

Add back or Deduct from: Recapture of CCA

A

Add back.

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11
Q

Add back or Deduct from: Accounting losses on disposal of capital assets

A

Add back.

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12
Q

Add back or Deduct from: Taxable capital gains

A

Add back. See Oracle document on Capital Gains and
Losses.

For an individual earning self-employed business income as a sole proprietor, taxable capital gains are included in the taxable capital gains section of the individual’s personal tax return, not in business income.

Net income for a corporation includes business income and aggregate investment income. Taxable capital gains are classified as aggregate investment income.

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13
Q

Add back or Deduct from: Taxable gain on sale of eligible

capital property

A

Add back. See Oracle document on Cumulative Eligible

Capital.

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14
Q

Add back or Deduct from: Charitable donations

A

Add back. Not deductible when computing net income for tax purpose, but treated as: the basis for a tax credit for individuals (see Oracle document on Tax Credits)
a Division C deduction for corporations (see Oracle document on Taxable Income for Corporations), subject to 75% net income limitation

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15
Q

Add back or Deduct from: Political donations

A

Add back. Not deductible, but treated as the basis for a tax credit for individuals (see Oracle document on Tax Credits). Under the Canadian Elections Act, corporations are not permitted to make federal political contributions.

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16
Q

Add back or Deduct from: Scientific research expenditures deducted for accounting purposes

A

Add back. See Oracle document on Scientific Research and Experimental Development.

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17
Q

Add back or Deduct from: Reserves and contingent liabilities

A

Add back. The general rule under ITA 18(1)(e) is that reserves and contingent liabilities are not deductible for tax purposes. There are some exceptions, which are discussed below.

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18
Q

Add back or Deduct from: Warranties

A

Add back. A warranty liability is an example of a reserve that is not deductible for tax purposes. Amounts paid
to satisfy warranties are deductible on a cash basis for tax purposes.

There are two ways to make the required adjustments for warranties:

 * Add back warranty expense deducted in 
   determining accounting income, and deduct cash 
   paid for warranties.
 * Add back the warranty liability at the end of the
   year, and deduct the warranty liability at the
   beginning of the year.
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19
Q

Add back or Deduct from: Pensions

A

Add back. A pension liability is another example of a reserve that is not deductible for tax purposes.
Contributions to a company pension plan are deductible on a cash basis if made within 120 days of the end of the taxation year.
There are two ways to make the required adjustments for pensions:
* Add back the pension expense deducted in determining accounting income, and deduct cash transferred to the trustee of plan assets.
* Add back the pension liability at the end of the year, and deduct the pension liability at the beginning of the year.

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20
Q

Add back or Deduct from: Meals and entertainment

expenses

A

Add back. 50% of meals and entertainment are not
deductible and must be added back.
The 50% rule does not apply in any of the following situations:
* Food and beverages are provided in the ordinary
course of the taxpayer’s business (such as
restaurants).
* The expense is billed to the client.
* The meals or entertainment are included in an
employee’s income as a taxable benefit.
* All employees benefit (such as a Christmas party) —
maximum six events per year.

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21
Q

Add back or Deduct from: Club dues and recreation fees

A

Add back. No deduction is allowed for the following:
* amounts to maintain a yacht, camp, lodge, golf
course or facility
* membership fees or dues for dining, sporting or
recreational facilities

22
Q

Add back or Deduct from: Bond discount amortization

A

Add back. Interest on bonds is deductible to the extent that it is legally payable in the year (based on par value
and coupon rate).

Bond discounts are added back to income over the debt term and deducted in the year the bond liability is extinguished.

23
Q

Add back or Deduct from: Automobile mileage allowances, unless the allowances are a taxable benefit to the employee, in which case no adjustment is required

A

Add back. Automobile mileage payments to employees and shareholders are limited to:
$0.54 for the first 5,000 kilometres
$0.48 for each additional kilometre after that

24
Q

Add back or Deduct from: Lease costs on a passenger

vehicle in excess of permitted amount

A

Add back.

25
Q

Add back or Deduct from: Equity losses on investments

accounted for using the equity method of accounting

A

Add back.

26
Q

Add back or Deduct from: Dividends received on investments accounted for using the equity method

A

Add back.

27
Q

Add back or Deduct from: Asset write-downs (including

impairments)

A

Add back.

28
Q

Add back or Deduct from: Illegal payments, fines and

penalties

A

Add back. No deduction is allowed for an illegal payment, fine or penalty:
* that constitutes an offense under the Corruption
of Foreign Public Officials Act or Canada’s Criminal
Code, or
* is imposed under the law of a country or a political
subdivision of a country

29
Q

Add back or Deduct from: Foreign advertising

A

Add back. Not deductible for tax purpose if the expenditures are made for advertising in foreign print or foreign broadcast media and the advertising is directed
primarily at the Canadian market.

Deductible if the advertising is directed to a non-
Canadian market.

30
Q

Add back or Deduct from: Personal or living expenses

A

Add back. Not deductible for tax purposes, as they are not incurred to earn business income.

31
Q

Add back or Deduct from: Life insurance where the
corporation is the beneficiary (If the employee is the beneficiary of the life insurance policy, the cost
of the life insurance is a taxable benefit to the employee; therefore, it is deductible to the corporation.)

A

Add back. Not deductible unless the following requirements are met:

 * It is required by the lender as collateral for a loan.
 * The lender is a “restricted financial institution.”
 * Interest payable on the loan is deductible.

If these requirements are met, the amount deductible is the lesser of:

 * premiums paid
 * the net cost of “pure insurance”

In addition, the deduction is the portion of the
amount above that reasonably relates to the loan.

32
Q

Add back or Deduct from: Convention expenses

A

Add back. Not deductible unless all of the following criteria apply:
* It is held by a business or professional organization.
* It is attended in connection with the taxpayer’s
business or professional practice.
* It is held at a location that may reasonably be
regarded as consistent with the territorial scope of
the organization.

Limited to two conventions per year.

33
Q

Add back or Deduct from: Foreign taxes paid

A

Add back. Not deductible to the extent they are claimed as a tax credit.

34
Q

Add back or Deduct from: Unpaid amounts in a non-arm’s length transaction

A

Add back. If an amount remains unpaid at the end of two years after the end of the taxation year in which it
was accrued, it is required to be brought back into
income in the third taxation year.

35
Q

Add back or Deduct from: Carrying charges on vacant land (including interest and property taxes)

A

Add back. Deductible to the extent of income earned on the vacant land. Non-deductible portion is added to
the cost base of the land.

36
Q

Add back or Deduct from: Soft costs on construction or

renovation of a building

A

Add back. Soft costs incurred during the period of
construction, renovation or alteration of a building
are not deductible. Because they are not deductible, they are added to the cost base of the building.

Soft costs include interest, professional fees,
insurance and property taxes.

37
Q

Add back or Deduct from: Reserves: Bad debts

A

Add back. Reserves for bad debts (accounting allowance for doubtful accounts) are an exception to the
general rule that reserves are not deductible.

Reasonable reserves are deductible if based on anticipated bad debts. For instance, specific identified accounts, such as those unpaid over 90 days, may be deducted as a reserve. A reserve determined as an estimated percentage of the accounts receivable balance would be not deductible.

If, for accounting purposes, the allowance for
doubtful accounts is based on anticipated bad debts, no adjustment is required, as a reserve for bad debts based on anticipated bad debts is also deductible for tax.

38
Q

Add back or Deduct from: Reserves: Undelivered goods or services

A

Add back. Reserves for undelivered goods or services are an exception to the general rule that reserves are
not deductible.

Where the taxpayer receives cash in advance of providing goods or services to a customer, a reasonable reserve is deductible for goods/services that will be provided in the future.

If a reserve has been claimed for accounting purposes (amount received is included in unearned income or revenue), no adjustment is required.

39
Q

Add back or Deduct from: Reserves for an amount not due under an instalment sales contract

A

Add back. A reasonable reserve may be claimed for an
amount not due under an instalment sales contract. The reserve may be claimed for three years (including the year of the sale).

A reserve that is deducted in one year must be brought back into income in the following year, and a new reserve may be claimed if some of the proceeds are not yet due. Due means an enforceable right to immediate payment.

40
Q

Add back or Deduct from: Unpaid remuneration

A

Add back. Not deductible if remuneration remains unpaid on the day that is 180 days from the end of the fiscal year in which the expense was incurred (must be
paid within 179 days).

If not paid within this time period, the amount is not deductible until the year it is actually paid.

Exception: If a bonus is not payable for more than three years after the year end in which the bonus was declared, it is considered a salary deferral arrangement and is required to be included in the employee’s income for the year in which the bonus was declared. The corporation will deduct the bonus in the year the bonus is declared. As a result, the bonus is taxed on an accrual basis (before cash is received).

This applies to pension benefits, retiring allowances, salaries/wages and bonuses.

41
Q

Add back or Deduct from: CCA

A

Deduct from.

42
Q

Add back or Deduct from: Cumulative eligible capital

amounts (CECA)

A

Deduct from.

43
Q

Add back or Deduct from: Terminal losses

A

Deduct from.

44
Q

Add back or Deduct from: Financing expenses

A

Deduct from. Costs incurred for the purposes of issuing shares or borrowing money are deductible on a straightline basis over five years [20(1)(e) deduction].
If the loan is paid off (prior to five years), any remaining amount may be deducted in that year.

45
Q

Add back or Deduct from: Bond premium amortization

A

Deduct from. Interest on bonds is deductible to the extent it is legally payable in the year (based on par value and coupon rate of the bond).

46
Q

Add back or Deduct from: Allowable capital losses

A

Deduct from. Deduct from. See the Oracle document on Capital Gains and Losses.
* For an individual earning self-employed business income in a sole proprietorship, allowable capital losses are not deducted in determining business income. They are deductible against taxable capital gains included
in the taxable capital gains section of the individual’s personal tax return.
* Net income for a corporation includes business
income and aggregate investment income. Taxable capital gains net of allowable capital losses are classified as aggregate investment income.

47
Q

Add back or Deduct from: Scientific research expenditures deductible for tax purposes

A

Deduct from.

48
Q

Add back or Deduct from: Pension contributions to the

trustee of the pension plan assets

A

Deduct from.

49
Q

Add back or Deduct from: Cash paid for warranties

expenditures

A

Deduct from.

50
Q

Add back or Deduct from: Allowable business investment losses

A

Deduct from. See the Oracle document on Capital Gains and Capital Losses.

 * Although an allowable business investment loss realized by an individual may be deducted against any source of income, it would not be classified as a business expense.
* An allowable business investment loss realized in a corporation is also deductible against any source of income. An allowable business investment loss is used in determining aggregate investment income of a corporation.
51
Q

Add back or Deduct from: Landscaping costs that have not been deducted in determining accounting net income

A

Deduct from. Landscaping costs paid in the year are deductible for tax purposes if they are paid for landscaping around a building used in the business.

52
Q

Add back or Deduct from: Equity income on investments accounted for using the equity method of accounting

A

Deduct from.

Concepts and Topics (8 decks)

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