Tax Tips and Traps

CLARK
POLLARD
GAGLIARDI

FOR THIRD QUARTER 2003

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IN THIS ISSUE:: PERSONAL TAX; EMPLOYMENT INCOME; BUSINESS/PROPERTY INCOME; CAPITAL GAINS; CORPORATE TAX; CCRA; MARRIAGE BREAKDOWN; CHARITIES; FARMING; WEB TIPS

DISABILITY TAX CREDIT (DTC) - PROSTHETIC DEVICE

In an April 8, 2003 Tax Court of Canada case, the taxpayer suffered from a congenital birth defect that required him to wear a prosthetic device - a partial artificial left leg. The device may only be worn for ten to twelve hours a day and, even while worn, the taxpayer feels a certain amount of pain.

The Court permitted the DTC and noted that Mr. R could not use the prosthesis at all times and, even when it was used, his ability to walk could not be compared favourably to an able-bodied person.

EMPLOYMENT INCOME

DEFENSIVE DRIVING COURSE

In a March 25, 2003 Technical Interpretation, Canada Customs and Revenue Agency (CCRA) notes that where an employer pays for a defensive driving course for an employee whose duties involve a lot of driving, this likely will not be a taxable benefit to the employee but will be deductible to the employer.

Editor’s Comment

In owner-manager situations, this beneficial treatment may only apply to Aemployment@ rather than Ashareholder@ based benefits. Documentation is important.

RETIRING ALLOWANCE

In a March 20, 2003 Technical Interpretation, CCRA notes that where employment has ceased and the former employees go into business and some of their business income is earned from their former employer, the severance payments paid to the former employees would qualify as retiring allowances eligible to be rolled over to an RRSP.

The maximum amount that may be rolled over is $2,000 for each year employed prior to 1996 and an additional $1,500 for each year prior to 1989 for which the employer’s contributions to a pension plan or deferred profit sharing plan had not vested at the time the retiring allowance is paid.

EXPENSES

In a February 5, 2003 Tax Court of Canada case, the taxpayer was an investment advisor for Wood Gundy and incurred expenses in earning his commission employment income. The Court permitted a deduction for out-of-pocket costs - such as donuts that he purchased by the dozen and dropped off in various lunch rooms of clients. Also, he was permitted to deduct small tools.

Unfortunately, computer capital cost allowance (CCA) was not allowed as the Income Tax Act only permits employees to claim CCA on automobiles, aircraft and musical instruments.

Editor’s Comment

Alternatively, leasing computers is deductible.

SHORT-TERM DISABILITY INSURANCE

In a May 21, 2003 Technical Interpretation, CCRA notes that when an employer provides a short-term disability insurance plan or a paid sick leave plan for its employees that meets certain conditions, the employer can apply for a reduction of employment insurance (EI) premiums. If this is approved, 5/12 of the reduction must be given to the employees.

Editor’s Comment

For details, see website www.hrdc-drhc.gc.ca/prp-prtc.

TEACHERS

In a May 29, 2003 Correspondence, CCRA remind teachers that they may deduct supplies required to be purchased in their employment. This requirement could be through a written contract with the employer or be understood that the employee was to make such payments. Therefore, a teacher may deduct the cost of supplies, whether there is an express or an implied requirement to provide the supplies, if the employer has certified that the employee qualifies for the deduction by completing Form T2200.

BUSINESS/PROPERTY INCOME

REASONABLE EXPECTATION OF PROFIT (REOP) - RENTAL PROPERTY

In a May 26, 2003 Federal Court of Appeal case, the Tax Court had previously disallowed the losses on a rental house in Edmonton, Alberta on the basis that there was no REOP because there was a non-deductible personal element. The property had formerly been the Appellant’s home, the Appellant used the property as collateral for a line of credit for his realty business, and the Appellant acknowledged retaining pride in maintaining the home as an asset to the neighbourhood.

Good News!

The Federal Court overturned the Tax Court decision and found that these elements are not sufficient to make the property something other than a commercial activity.

HAWAIIAN CONDOMINIUM

In a May 20, 2003 Tax Court of Canada case, a corporation acquired a Hawaiian condominium in 1985 and rented it out until 1992 at which time it was simply used by the owner and employees and clients for promotional purposes.

The Court disallowed the owner’s travel expenses to the Hawaiian Condominium as personal in nature. However, with respect to the costs related to the condo, such as interest expense, utilities and condo fees, the Court found that 20% of the days used were by the owner and the balance were by customers or employees. Therefore, 20% of the expenses were disallowed as an expense to the company and were taxable to the owner.

CAPITAL GAINS

QSBC SHARE

In an April 23, 2003 Technical Interpretation, CCRA notes that for the capital gain on the sale of a qualified small business corporation share (QSBC) to be eligible for the capital gain exemption, criteria must be met including that the share must not have been owned by anyone other than the individual, or a related person, throughout the twenty-four months immediately preceding the disposition. Also, the Income Tax Act deems shares that were issued after June 13, 1988 to have been owned immediately before their issue by a non-related person unless they meet specific circumstances, such as being issued as part of a transaction in which the person disposes of "all or substantially all" of the assets used in an active business.

In this Technical Interpretation, the taxpayer carried on a trucking proprietorship. He had two different buyers for his trucks and, therefore, wished to transfer some trucks on a rollover basis to one corporation and the other trucks to the other corporation and then sell the shares of each corporation and claim the capital gain exemption.

Not surprisingly, CCRA concluded that the shares would not be eligible for the capital gain exemption because "all or substantially all" of the assets used in active business proprietorship were not transferred to each corporation.

REPLACEMENT PROPERTY

In a May 22, 2003 Technical Interpretation, CCRA notes that a taxpayer may elect to defer the income or capital gains where a “former property” is involuntarily disposed of or, a “former business property” is voluntarily disposed of, and “replacement property” is acquired.

NON-COMPETITION PAYMENTS

The Federal Court recently found that amounts received for signing a non-competition agreement were tax-free. Consider this:

1. Until there is future legislative or jurisprudential developments, the seller of shares of a corporation may receive a tax-free receipt for signing a reasonable non-competition agreement.

2. The result may be different for a person receiving the payments who carried on the business, such as a sole proprietor, partner, or corporation.

3. It may be prudent to engage an expert to determine the value to be assigned to the non-competition amount.

Editor’s Comment

Caution - If a current, former, or future employer of the recipient makes the payment, it could be considered employment income.

TRANSFER OF CAPITAL LOSS TO A SPOUSE

In a May 27, 2003 Technical Interpretation, CCRA reviewed a situation where Mr. X owns shares with an adjusted cost base of $100,000 and a fair market value of $5,000. As Mr. X has never had any capital gains, the capital loss will be of little value to him. However, Mr. X’s wife had substantial capital gains and would like to use Mr. X’s accrued capital losses.

The Technical Interpretation discusses how the losses could be transferred to Mrs. X.

CORPORATE TAX

THE SMALL BUSINESS DEDUCTION

The federal small business deduction for a Canadian-controlled private corporation (CCPC) is 16% times the lesser of the active business income, taxable income - modified by foreign tax credits, and the corporation’s “business limit”. The “business limit” is proposed to increase in 2003 from $200,000 to $225,000, to $250,000 in 2004, to $275,000 in 2005 and to $300,000 in 2006.

Also, these limits must be allocated among associated corporations.

SCIENTIFIC RESEARCH (SR&ED)

CCPCs are also eligible to earn investment tax credits at an enhanced rate of 35% on up to $2 million of SR&ED expenditures. As a consequence of the proposal to increase the “business limit”, the Budget also proposes that the $2 million expenditure limit be phased out where taxable income in the previous year is between $300,000 and $500,000.

CCRA

DIRECTOR LIABILITY

In a December 31, 2002 Tax Court of Canada case, the taxpayer was the sole director of T Inc., and was held personally liable by CCRA for unremitted source deductions and GST.

The taxpayer argued that he was statute-barred as he was unable to act as a director due to a severe computer failure which resulted in the termination of the company’s business and the appointment of a receiver manager. Two years expired from this date to the date of the issuance of the assessment.

Good News!

The Court noted that the two year limitation period runs from the time when an individual ceases to be in a position in law and in fact to exercise the powers of a director. The taxpayer could do nothing after the receiver-manager was appointed and, therefore, he had ceased to be able to act as a director.

Editor’s Comment

A legal resignation as a director more than two years before CCRA issues the assessment is the best evidence.

MARRIAGE BREAKDOWN

ARREARS

In a January 30, 2003 Tax Court of Canada case, the taxpayer was in arrears on periodic spousal support amounts. A Court found that the taxpayer must pay $23,595, being $7,500 of costs and $16,095 for arrears as a final payment due under the said Judgment. There shall be no obligation of the husband to pay any other spousal support to the wife.

Bad News!

The Tax Court found that the payment was not deductible even though it is generally accepted that periodic payments which have fallen into arrears and subsequently paid in lump-sum are deductible in the hands of the payer and taxable to the recipient.

However, in this case, the payment did not represent the full amount of the arrears due and, more importantly, the amount paid released the taxpayer from any future obligations.

CHARITIES

CHARITABLE GIFT ANNUITIES

In a February 17, 2003 Technical Interpretation, CCRA reviewed a situation where an eighty-year old taxpayer contributes $100,000 to a charity and the charity agrees to make annual annuity payments to the taxpayer of $7,700 as long as the taxpayer lives.

CCRA notes that the Income Tax Act permits the charity to issue a donation receipt for the excess of the fair market value of the property transferred ($100,000) over the advantage provided to the donor. Assuming that $52,300 would be required to acquire an annuity paying $7,700 for the life of the donor, the donation receipt could be for $47,700 ($100,000 - $52,300).

ART FLIPS

CCRA has reassessed over 3,000 Canadians who claimed a charitable donation tax credit on the donation of art - adding up to about $7 million in unpaid taxes. CCRA looks at several aspects when it suspects an “art flip”:

1. How long the art was held. If it is purchased and sold in the same year, CCRA will be suspicious.

2. The art’s value - is there a significant difference between the amount it was bought for and the amount sold for?

3. Is there an appraisal on the art by an independent qualified appraiser?

Taxpayers that have been reassessed have the option of filing a Notice of Objection within the prescribed time.

FARMING

QUALIFIED FARM PROPERTY

In a March 28, 2003 District Office Memo, CCRA reviewed a situation where Mr. and Mrs. X bought farmland from Mrs. X’s father (Mr. A) who had previously farmed the land. Mr. and Mrs. X only farmed the land on a marginal basis. Mr. X and Mrs. X divorced and now wish to sell the farm, which they still own jointly.

CCRA confirmed that Mr. and Mrs. X’s share of the land would still be qualified farm property (QFP) eligible for the $500,000 capital gain exemption since an individual’s parent may satisfy the use tests.

WEB TIPS

COMPUTER VIRUSES

Not all anti-virus protection software packages detect viruses and solve and update systems at the same time or speed. Therefore, it may be a good idea to check your system with a secondary virus scanner either periodically or if your system feels sluggish. For a free virus scan go to:

http://housecall.trendmicro.com/

Click the link in the middle of the page ’SCAN WITHOUT REGISTERING’ and follow the instructions.

RETIREMENT INCOME

See Canadian Retirement Income Calculator - https://srv260.hrdc-drhc.gc.ca/ or go to www.hrdc.gc.ca and search for ACanadian Retirement Income Calculator@.

Hosted by H.R.D.C., this calculator provides a forecast of annual pre-tax retirement income. With the use of a seven module procedure, this tool allows users to manipulate most conditions that affect C.P.P. (i.e. taking it early or reducing the number of years paid into the plan), O.A.S, employer pensions, RRSP, and other amounts. Once the information is entered, a summary may be printed. One may then change pieces of previously entered data and print out the new summary sheet for comparison.

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a commentary such as this, a further review should be done. Every effort has been made to ensure the accuracy of the information contained in this commentary. However, because of the nature of the subject, no person or firm involved in the distribution or preparation of this commentary accepts any liability for its contents or use.

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