Tax Flashcards
“1.2 Test your knowledge
A taxpayer purchased a $20,000 face value bond at par on August 1, Year 1. The bond bears interest at a rate of 5% compounded annually on uncashed coupons each July 31. The taxpayer does not cash in any coupons in either of Year 2 or Year 3. If coupons are not cashed, they are added to the principal amount of the investment.”
“Calculate the interest to be included in income for Year 1, Year 2, and Year 3 given the following scenarios:
• Scenario I: The taxpayer is a corporation with a December 31 year-end.
• Scenario II: The taxpayer is an individual.”
Answer
Scenario I: The taxpayer is a corporation.
Year 1:
• Aug. 1 to Dec. 31 [$20,000 × 5% × (153/365)]
$419
Year 2:
• Jan. 1 to July 31 [$20,000 × 5% × (212/365)]
$581
• Aug. 1 to Dec. 31 [$20,000 × 1.05 × 5% × (153/365)]
440
• Total
$1,021
Year 3:
• Jan. 1 to July 31 [$20,000 × 1.05 × 5% × (212/365)]
$610
• Aug. 1 to Dec. 31 {[$20,000 × (1.05 2 )] × 5% × (153/365)}
462
• Total
$1,072
Scenario II: The taxpayer is an individual.
Year 1:
• Nil, because the first anniversary date of the contract is July 31, Year 2. As the taxpayer is an individual, he or she is not required to include any of the increased interest in income until Year 2.
Year 2:
• $20,000 × 5%
$1,000
Year 3:
• ($20,000 + $1,000) × 5% or ($20,000 × 1.05) × 5%
$1,050
What is the difference in dividend income received by an individual vs. received by a corporation?
There is no gross-up or dividend tax credit on dividends received by a corporation.
Dividends received by corporations from taxable Canadian corporations are included in net income for tax and are subsequently deducted under Division C of the Income Tax Act (ITA) in determining taxable income.
Dividends received by an individual will need to be grossed up
Non-eligible dividends
Who pays them? From what kind of income?
Are the gross-up tax rate and dividend tax credit on these higher or lower than the eligible dividends?
Non-eligible dividends are paid by Canadian-controlled private corporations (CCPCs)
They are paid out of after-tax active business income eligible for the small business deduction or from after-tax aggregate investment income.
Sources: After-tax active business income eligible for the SBD OR out of the After-tax aggregate investment income.
Since both of these types of income are taxed at preferential rates, the gross-up and dividend tax credit rates on non-eligible dividends are lower than the gross-up and dividend tax credit rates on eligible dividends.
Eligible dividends
Who pays them? From what kind of income?
Are the gross-up tax rate and dividend tax credit on these higher or lower than the eligible dividends?
- Canadian public companies out of after-tax income taxed at the general corporate tax rate
- CCPCs out of after-tax active business income not eligible for the small business deduction
- CCPCs out of eligible dividends received
Eligible dividends are paid out of the general rate income pool (GRIP).
Stock dividends
What is it?
How are they taxed?
Are they eligible for dividend tax credit for individuals?
A stock dividend is a dividend payment made in the form of additional shares rather than in cash.
Stock dividends are taxed in the same way as cash dividends (that is, grossed up and included in income) and are eligible for a dividend tax credit.
Since stock dividends are taxed but no cash is received, the actual amount of the dividend is added to the adjusted cost base of the shares.
The addition to the adjusted cost base of the shares will result in a reduction in any future gains.
Capital dividends
How are they taxed?
Are they eligible for a dividend tax credit for individuals?
Capital dividends are paid out of the capital dividend account of a CCPC and are received on a tax-free basis.
Are property taxes included in expenses against rental income?
yes.
In general, expenses include but are not limited to:
- utilities • repairs• maintenance• interests• insurance• property taxes• advertising• management fees
- capital cost allowance (CCA)
Carrying charges on vacant land
What is included?
What is the extent to which they are deductible?
What happens to the portion non-deductible?
Carrying charges include interest on loans used to acquire land and property taxes on the land.
As a general rule, property taxes and interest on vacant land are only deductible to the extent of any income earned on the land. Property taxes and interest that are not deductible because they are in excess of income earned on the land are added to the cost base of the land
Soft costs
What is included?
What are the conditions around soft costs during construction?
Soft costs are generally considered to include interest, legal, and accounting fees, insurance, and property taxes on the building or related land.
The construction, renovation, or alteration of a building is completed at the earlier of:
- the day on which the construction, renovation, or alteration is completed
- the day on which all or substantially all (90%) of the building is used for the purposes for which it was constructed, renovated, or altered
Capital property or Inventory?
What are the rules?
• Primary intention:
Did the taxpayer intend to use the asset as an item of inventory or as a capital asset?
• Secondary intention:
If the primary intention to use the asset as a capital asset was frustrated, did the taxpayer have, at the time of purchase, a motivating intention to sell the property at a profit?
Intention is a state of mind and is not observable. Courts have assessed the taxpayer’s intention by examining the taxpayer’s behaviour. Factors considered include:
- The relationship of the transaction to the taxpayer’s business — If the transaction is similar to other transactions entered into during the normal course of the taxpayer’s business operations, this factor supports a conclusion that the profit from the sale is business income.
- Nature of the asset — If the asset can be used over time to produce income, the asset can be considered a capital asset.
- Number and frequency of transactions — A large number of similar transactions over a period of time imply that the asset is inventory.
- Length of period of ownership of asset — A longer period of time implies that the asset is a capital asset, while a shorter holding period implies that the asset is inventory.
Adjusted Cost Base
What are the factors that affect it?
The following are select items that impact the ACB:
- Government grants and assistance relating to the acquisition of capital property are deducted from the ACB.
- Non-deductible property taxes and interest on vacant land are added to the ACB.
- The employee stock option benefit is added to the exercise price of the shares acquired under an option plan when determining the ACB of the shares.
- The actual amount of capital gains, dividends, and interest earned on mutual funds, where the taxpayer is issued additional units of the mutual fund in lieu of a cash payment, is added to the ACB of the mutual funds.
- Stock dividends from Canadian companies are subject to tax and thus are added to the cost base of the shares.
- Superficial losses are added to the cost base of a property.
Superficial Loss
When does it arise?
What is its treatment?
Arises when a taxpayer sells the property to trigger a loss and almost immediately repurchases the property for its growth potential.
Treatment: It is denied and added to the cost base of the property.
Superficial loss
What are the conditions to classify a loss as a superficial loss?
If the following 3 conditions hold, the loss is considered a superficial loss and is not deductible in the period realized:
- The taxpayer, the taxpayer’s spouse, or a corporation controlled by either the taxpayer or his or her spouse sells a property.
- Any of the above taxpayers acquire or reacquire the same property or an identical property in the 30-day period before or after the sale of the property.
- Any of the taxpayers referred to above still own the property at the end of the 30-day period after the sale of the property.
The taxpayer, the taxpayer’s spouse, and a corporation controlled by either the taxpayer or his or her spouse are referred to as “affiliated persons.”
Business investment losses
A business investment loss results from the actual or deemed disposition of certain capital properties.
This may arise on the disposition of shares or debt of a small business corporation (SBC).
What is a SBC
An SBC is a Canadian-controlled private corporation where all or substantially all of its assets (90%) are used in an active business carried on primarily in Canada.
- Is a CCPC
- All or substantially all (>90%) of its assets are used in active business
- Active business is carried out primarily in Canada
PRE Problem
1.1.1 Test your knowledge
In Year 1, Max and his wife, Elyse, purchased a home in Kitchener, Ontario, for $460,000. In Year 7, they acquired a cottage on Wasaga Beach, Ontario, at a cost of $300,000. In Year 13, they sold both the home and the cottage. Proceeds on the sale of the house were $544,500, while proceeds on the sale of the cottage totaled $356,000. Both Max and Elyse have worked regularly over the years and have contributed equally to the purchase of the properties.
Required
Determine the lowest capital gain that Max and Elyse can report in their tax returns for Year 13.
