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Acco 643 Lecture NotesPart IV

Other Sources of Income and Deductions in Computing Income

DIVISION B - NET INCOME SECTION 3

3(a) Income from each office or employment +Income from each business +Income from each property +Other sources of income (excluding taxable C/G) + +

3(b) Taxable capital gains +Net taxable gain on LPP + +

Less:Allowable capital losses – Less: Allowable business investment losses (–) – + 1

+

3(c)Deductions under subdivision e (–)+

3(d) Losses from an office or employment – Losses from business – Losses from property – Allowable business investment losses – –

Net income for the year + 2

__________________________________ 1 The amount at 3(b) cannot be negative; if the allowable capital losses are greater

that the taxable capital gains, the amount at 3(b) is nil but the difference is

known as "net capital losses".

2 The amount after 3(d) cannot be negative; if the amount after 3(c) is greater thanthe total amounts after 3(d), the amount is the taxpayer's net income; if theamount after 3(c) is less than the total amounts under 3(d), the net income is 0and the difference is a notional "non-capital loss".

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O THER SOURCES OF INCOME

Other sources of income which are taxable ( section 3(a) )

1) Pension income (RRSP, RRIF, RPP,)2) Old Age security

3) Benefits from CPP or QPP

4) Death benefits in excess of $10,000

5) Benefits from Employer’s DPSP

6) Retiring allowance received from an employer in recognition of long service or

court-awarded damages for loss of office7) Benefits from employment insurance plan

8) Income from Registered education savings plan

9) Amounts received as scholarships, fellowships, bursaries, etc. in certain cases.10) Research grants in excess of expenses

11) Payments received from a former spouse (including 3 rd party payments) as

alimony or maintenance provided that:

they arereceived as periodic payments (no lump sum);

pursuant tocourt order or written agreement;

to the extentthey are for the support of a former spouse (i.e. not for the support of a child,which are not taxable);

recipient hasdiscretionary use of the amounts;

paymentsare made to a spouse or former spouse who is living apart from the payer

because of the breakdown of their marriage.

Definition of Spouse

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• Person of the opposite sex who cohabits at that time with the taxpayer in a conjugalrelationship and

(i) so cohabits throughout the previous 12 months

(ii) is a parent of a child of whom the taxpayer is a parentRRSP DEDUCTION

• Annual RRSP limit• Rollover of retiring allowance• Additional $2,000 contribution

Age Limit

•

RRSP must be disposed of by the end of the year the annuitant turns age 71;• The contributor can be over age 71 if the contribution is to a spousal planand the spouse has not turned age 71 in the year.

Annual RRSP Limit

• Unused deduction room carried forward

PLUS:

• lesser of:

(1) RRSP dollar limit(2) 18% of prior year earned income

minus: Pension Adjustment (PA) of prior year.

Unused RRSP Deduction Room

• Started in 1991• Indefinite carry-forward• Annual limit minus actual contributions• Can deduct balance in any year.

RRSP Dollar Limit

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2008 $20,0002009 $ 21,0002010 $22,0002011 Indexed

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Earned Income is income from:

• Office or employment• Business income (loss)• Rental of real property – income (loss)• Royalties in respect of a work or invention• Alimony or maintenance received (paid)• Supplementary unemployment insurance benefit plan• Research grants• CPP/QPP disability benefits for previous years.

$2,000 Over-contribution

• $2,000 at any time per individual• can be carried forward indefinitely• can claim as a deduction against annual limit at any time.

Penalties for Excess Contributions

• for over-contributions in excess of $2,000• 1% per month on the excess plus tax on withdrawal• avoid penalty and tax by withdrawal of excess in year of contribution or following

year.

Retiring Allowance

• defined in 248(1)on or after retirement from employment in recognition of

long serviceon loss of office even if damages awarded by the courts

• Rollover $2,000 x pre ’96 years during which employed plus $1,500 x pre ’89 years not vested.

Direct Transfer

• From DPSP, RPP directly to RRSP

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i.e. for the years theemployee was a member of aPension Plan but theEmployer contribution hadnot vested to the employee




• Not reported in income.

OTHER DEDUCTIONS IN COMPUTING NET INCOME

Moving expenses

• moving expenses are deductible to the extent that the following conditions aremet:

they must not have been paid on a taxpayer's behalf in respect of (in thecourse of or because of) the taxpayer's office or employment (para 62(1)(a));

they were not deductible under section 62 in the preceding taxation year (para62(1)(b)) (expenses that could not be deducted in the year of the relocation may

be deducted in the following taxation year, subject to the income limitations in paragraph 62(1)(c));the total amount claimed may

not exceed the taxpayer's employment (or business) income for the year at thenew work location; and

• all related reimbursements andallowances received by the taxpayer must be included in computing thetaxpayer's income (para 62(1)(d)).

• Individual moving within Canada to take up a new job;• Or to study full-time for post-secondary education• Can deduct eligible moving expenses incurred to move fromformer residence;• He/she must move at least 40Km closer to the new place of work or study.• Eligible moving expenses: moving expenses eligible for deduction under subsection 62(1) include those described in subsection 62(3) asfollows:

travel costs for the taxpayer and members of the taxpayer's household (para62(3)(a));

cost of moving (storing) household effects (para 62(3)(b));

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cost of meals and lodging near either residence, for up to 15 days, for thefamily members (no S.67.1 limitation); (62(3)(c))

cost of cancelling the lease, if any, for the old residence (para 62(3)(d));

selling costs relevant to the old residence (para 62(3)(e);

if the old residence is sold, legal expenses in respect of the purchase of thenew residence, and taxes, fees or duties imposed on the transfer or registrationof title to the new residence (other than any GST or VAT) (para 62(3)(f));

interest, property taxes, insurance premiums and the cost of heating andutilities, to a maximum of $5,000, for the old residence left vacant and not

rented out to any other person and incurred for a period during whichreasonable efforts are made to sell the old residence (para 62(3)(g));

the cost of revising legal documents to reflect the taxpayer's new address,replacing drivers' licenses and non-commercial vehicle permits, and obtainingutility connections and disconnections (para 62(3)(h)).

• Ss 62(3) state that moving expenses do not include costs (other than thosereferred to in paragraph 62(3)(f)) incurred by the taxpayer in respect of theacquisition of the new residence. Thus, for example, house-hunting expenseswould not be deductible as moving expenses.

• Also taxable: 50% of amounts received by an employee in excess of $15,000for a loss on a sale or reduction in value of a former house or for higher mortgageinterest payments at the new location.

Child care expenses

Section 63 is intended to provide a measure of tax relief to taxpayers who, in order to pursue a gainful occupation away from the home or undertake education or retraining,must pay someone to look after their children while they are at work or school.

Lower income spouse may claim the deduction with some exceptions;

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Attendant care expenses

Section 64 provides tax relief for an individual with a severe and prolonged mental or physical impairment who must pay an attendant for care in order to be able to perform

the duties of an office or employment, carry on a business, or carry on research or similar work for which a grant was received.

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Computation of Taxable Income and Taxes Payable for Individuals

DIVISION C - TAXABLE INCOME

Net Income for Tax Purposes (Division B)

Minus: Division C deductions

Individuals CorporationsEmployee stock option DonationsHome relocation loan Loss carry-over Loss carry-over Dividends

Capital gain deduction Northern allowance

= Taxable Income (if any)

DIVISION C DEDUCTIONS

Type of Apply against Carry overDeduction type of income Back Forward

Dividends Any type 0 0Donations Any type 0 5

Net Capital Losses Taxable capital gains 3 Indefinitely Non Capital Losses Any type 3 7 (10 years for t/y

ending after March 22, 200420 years after

2005)Restricted Farm Losses Farm income 3 10 / 20

Farm Losses Any type 3 10 / 20Application of Division C Deductions

Consider: 1. Type of income the deduction can be applied against.2. Number of years available in the carry-over period.

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3. The likelihood that the type of income needed will arise inthe carry-over period.

Generally apply most restrictive loss first.NON-CAPITAL LOSSES

3(d) losses from an office, employment, business or property plus ABIL

Add: Net capital losses claimed under Division CAdd: Dividends deducted under Division CDeduct: 3(c) income

Equals: Non-capital loss for the year

NET CAPITAL LOSSES

Allowable capital loss for the year

Less: Taxable capital gain for the year

Equals: Net capital loss for the year

Note: Net capital losses are stated using the inclusion rateIn the year they were incurred

Up to 1987: 50%1988 & 1989: 66 2/3 %1990 to Feb. 27, 2000: 75%Feb. 28,2000 to October 17, 2000: 66 2/3%October 18, 2000 and later: 50%

Adjust to today’s inclusion rate.

CAPITAL GAIN DEDUCTION - TERMINOLOGY

100 % 50%Capital gain Taxable capital gain

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Capital loss Allowable capital lossCG Exemption CG Deduction

Total $750,000 $375,000

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CAPITAL GAINS DEDUCTION OF $375,000 (50% x $750,000)

Qualified Farm Property (QFP)

Gains on sale of QFP are eligible for the $750,000 C/G Exemption;

QFP includes real property used by the taxpayer or members of the taxpayer's family inthe course of carrying on the business of farming in Canada.

QFP also includes shares of a family farm corporation and interests in family farm partnerships or trusts, and eligible capital property such as farm quotas.

Property acquired after June 17, 1987 must have been owned throughout the 24 months

preceding its disposition and the gross revenue from the farming business must, in atleast 2 years during the period of ownership, have exceeded the individual's incomefrom all other sources.

Where the farm is owned by a corporation or partnership, the gross revenue test isinapplicable. However, the shareholder or partner must have been actively engaged inthe farming business on a regular and continuous basis during the 24-month period.

Farm property acquired before June 18,1987 is exempt from the gross revenue test andwill qualify if it is used to "carry on the business of farming" in the year of disposition or for at least 5 years during the period of ownership.

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Qualified Small Business Corporation Shares (QSBC shares)

A capital gain realized on the disposition of QSBC shares may be eligible for the$750,000 Capital Gains Exemption ($375,000 CGD) if certain conditions are met.

Single corporation

1º Test : Small Business Corporation test (SBC) at the determination time (i.e. saleor disposition)

The shares must be shares of a SBC i.e. shares of a corporation which is a CCPC whereall or substantially all (90%) of the FMV of the assets are at that time:

a) used principally (>50%) in an active business carried on primarily (>50%) in Canada by the corporation or a related corporation;

b) shares of the capital stock or indebtedness of one or more SBCs that were connectedwith the particular corporation;

c) a combination of assets described in a) and b).

2º Test : Holding Period Test

• Throughout the 24 months preceding the disposition, the shares must not be owned by anyone other than the individual, or a person or partnership related to the individual.

3º Test: Basic Asset Test (50% test)

Throughout the required 24-month period preceding the disposition, the shares wereshares of a CCPC for which more than 50% of the FMV of its assets were used

principally (50%) in an active business carried on primarily in Canada by thecorporation or related corporation.

EXAMPLE: basic asset test

A B C DActive Business Assets (FMV) 85 50 51 40

Marketable Securities (FMV) 15 50 49 10

Shares of a connected SBC – – – 50QSBC shares??? Y N Y ??

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Two levels of corporations: HOLDCO and OPCO

The 3º test (basic asset test) is modified whenever shares of OPCO are held through a

holding company (HOLDCO) that qualifies as SBC.

If HOLDCO (corporation to be sold) can meet the 50% basic active business asset testwith its own active business assets, its shares will meet the asset test.

Where the active business assets of HOLDCO are 50% or less, then the parentcorporation may still qualify by including shares and indebtedness of corporationsconnected with it (i.e. of OPCO)

If the particular corporation (HOLDCO) does not meet the 50% active asset test withoutincluding shares or indebtedness of connected corporations, these connectedcorporations are required to meet additional tests.

Additional tests: 2 situations

1º If Holdco meets the 90% test throughout the 24 months ending at the determinationtime with a combination of its own active business assets and shares and debts of aconnected corporation,

⇒ the connected corporation (OPCO) need only meet the 50% test on its assets.

⇒ the test is a 90%/50% for HOLDCO / OPCO

2º If the HOLDCO does not meet the 90% test for any period of time in the 24 monthsending at the determination time,

⇒ HOLDCO must meet the 50% test with a combination of its own active businessassets and shares and debts of a connected corporation,

⇒ the connected corporation (OPCO) must meet the 90% test.

⇒ the test is a 50%/90% for HOLDCO/OPCO.

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SUMMARY:

Mrs. A CASE #1 CASE #2

Holdco must meet: Holdco must meet:• 90% test or more on the • more than 50% throughout

Holdco disposition and the 24-month period and• 90% test throughout the 24- • 90% test on the disposition

month periodOpco must meet:

Opco must meet: • 90% test or more on the• more than 50% throughout disposition and

Opco the 24-month period and • 90% test throughout the 24-• 90% test on the disposition month period

Purification

Assume Mr. X owns all the shares of OPCO. The following has been the situation for OPCO for the last 24 months:

FMV of investment assets = 99 (49.5%)FMV of active assets = 101 (50.5%)Total FMV = $200

o Mr. X wants to sell his shares of OPCO.o Does the shares qualify as QSBC shares? ⇒ No, since at the determination time,the corporation must meet the 90% test (i.e. must be SBC).

Purification technique

⇒ Use investment/liquid assets to repay liabilities;⇒ Pay a dividend to Mr. X;⇒ Pay a bonus, and/or retiring allowance to Mr. X;⇒ Pay a dividend from CDA;⇒ Reduce PUC and make payment to Mr. X;⇒ Redemption of shares ⇒ deemed dividends

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Cumulative net investment losses (CNIL)

A CNIL is defined as:

a. the total of the individual's investment expense for the year or a preceding taxationyear ending after 1987

less

b. the total of the individual's investment income for the year or a preceding taxationending after 1987.

Investment income and investment expense: see B & L page 772-773.

A CNIL will in fact reduce the availability of the C/G deduction; therefore planningshould be undertaken to minimize the CNIL.

CAPITAL GAINS DEFERRAL

Section 44.1 provides rollover relief on a disposition of common shares of certainsmall business corporations, to the extent that the proceeds are reinvested in shares of another such corporation or corporations.

Only capital gains realized by individuals are eligible for rollover relief.

To improve access to capital for small businesses with high growth potential, section44.1 permits individuals to defer limited amounts of capital gains on eligible small

business investments to the extent that the proceeds are reinvested in another eligiblesmall business investment.

The rollover is available on the first $2,000,000 invested in an eligible small business,

which can have no more than $50 million immediately after the investment. Theinvestment must be in newly issued treasury shares.

The eligible business is required to be primarily carried on in Canada for 24 monthswhile the investor holds the shares

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ALTERNATIVE MINIMUM TAX (AMT)

• Compare minimum tax with regular tax

• Pay higher of the two taxes

• If minimum tax is higher, then can recover over the next seven years

• 15% x ( Adjusted taxable income - $40,000 basic exemption)

minus: non-refundable minimum tax credit

= Minimum tax

Adjusted Taxable Income

When AMT is calculated, net income and taxable income is revised to exclude certaintax preference items (you add these items back) to the extent they exceed a baseamount of $40,000.

The entire revised taxable income is then subject to a federal tax rate of 15%.

There is no dividend tax credit as there is no dividend gross-up.

If revised federal tax is greater than the normal federal tax, the former applies.

Some of the preference items which affect net income :

CONSIDER 100% of the dividend instead of 125% or 145%

CONSIDER 80% of the excess capital gains over capital losses for the year instead of 50%

CONSIDER 80% of ABIL instead of 50%

NOT losses from CCA or carrying charges on residentialALLOWED properties or Canadian films; losses on resource properties from

CEE, CDE

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Some of the preference items which impact taxable income :

CONSIDER 2/5 of the employee stock options deductions (i.e. 2/5 x 50% = 20%,net=80%, just like the capital gain inclusion)

ADD home relocation loan deduction

CONSIDER a basic exemption of $40,000

The resulting adjusted taxable income is then multiplied by 16%.

Only the following basic tax credits are allowed to the individual:

1. Personal and dependants2. Age credit3. Charitable tax credit4. Medical expense credit5. Mental and physical impairment credit6. Tuition credit, and education credit7. Employment insurance and CPP (QPP) tax credits

Credits not allowed for AMT purposes:

• Pension income credit• Credits transferred from spouse• Disability credit transferred from dependant• Tuition fees and education credit transferred from dependant

AMT does not apply unless the federal tax calculation is greater than the normalfederal tax;

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MISCELLANEOUS CONCEPTS

DISPOSAL OF PROPERTY TO A MINOR

Transferor Transferee minor PROCEEDS COST

Gift 69(1) =FMV =FMV

Sale 69(1) =Greater of: =Lesser of:• Proceeds • Proceeds• FMV • FMV

Income Attribution:

Non-arm’s length Business Property Capitalor niece or nephew Income Income/loss Gain/Loss

< 18 years N/A 74.1(2) N/A

> 17 years N/A N/A N/A

DISPOSAL OF PROPERTY TO A SPOUSE*

Transferor TransfereePROCEEDS COST

Gift 73(1) =Transferor’s =Transferor’sAutomatic rollover ACB/UCC ACB/UCC

Elect out =FMV =FMVOf 73(1)

Sale 73(1) =Transferor’s =Transferor’s

Automatic rollover ACB/UCC ACB/UCCElect out =Greater of: =Lesser of:Of 73(1) • Proceeds • Proceeds

• FMV • FMV

* includes common law spouse as defined in 252(4).

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ATTRIBUTION OF INCOME ON TRANSFER BETWEEN SPOUSES

Business Property CapitalIncome Income Gain/Loss

On loans or transfers N/A 74.1(1) 74.2+ substituted property (not second

generationincome)

Exception 74.5(1)

(a) received FMV consideration(b) if debt received:

• interest rate at least equal to prescribed or commercial rate• interest is paid not later than 30 days after the endof the year

and

(c) elect out of 73(1) rollover

LOANS - SPOUSE

• attribution of: income/loss from propertycapital gains/losses

• but not if interest rate is at least equal to prescribed or commercial rate and the interest is paid not later than 30 days after the end of the year.

LOANS – MINOR

Minor < 18 (non-arm’s length or niece or nephew)

• attribution of income from property but not capital gains• but not if interest rate is at least equal to prescribed or commercial rateand the interest is paid not later than 30 days after the end of the year.

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Individual > 17 (non-arm’s length)

• attribution of income from property if one of the main purposes of theloan is to split income• but not if interest rate is at least equal to prescribed or commercial rateand the interest is paid not later than 30 days after the end of the year.

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DEATH OF A TAXPAYER

• Income tax on accrued income & gains to date of death

• Deemed Disposition 70(5)

Capital property at FMVDepreciable property at FMV

• Rollover to Spouse or Spousal Trust 70(6)

Automatic rollover at ACB or UCCCan elect out of rollover in which case proceeds equal to FMV 70(6.2)

SEPARATE TAX RETURNS

1. Final Return 150(1)

• Income accrued to date of death 70(1), IT-210R • Gains on deemed dispositions• Personal credits

Capital losses

Ss 111(2) modifies the calculation of the individual’s taxable income for theyear of death and the immediately preceding year for purposes of applying netcapital losses .

All unused net capital losses (net of amount of net capital losses used to offsetcurrent year’s taxable capital gains) arising in years up to and including the year of death may be used to the extent needed to offset any taxable income for theyear of death and the immediately preceding year.

Donations

The legal representative of the deceased may claim the tax credit for charitabledonations up to 100% of net income of the deceased.

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2. Rights & Things (Income from) 70(2)

• Definition: amounts which are receivable at the date of death but have not beenreceived. examples:

Matured, uncashed coupons;Declared but unpaid dividends;

Unpaid salary, commissions if pertaining to pay periods completed before date of death.

• Personal credits can be claimed

3. Alternative method return

Where the business of the deceased taxpayer has an off-calendar fiscal period,(i.e. the alternative method was used) and the death occurred in the year after the fiscal year of the business;

The income from the end of the fiscal period to date of death can be reportedon a separate return, if the legal representatives so elect.

Personal tax credits can be claimed

4. Trust/Estate Return 104(23)(d)

• Must file return and include income earned since date of death;• Testamentary trusts are taxed at gradual rates;• Fiscal period ends within 12 months from death;• Tax and tax return due 90 days after year end.

Personal Credits under S 118, except pension credit, can be claimed on all returnsexcept on the Trust return;

Pension credit must be claimed on return on which the related income is reported;

Personal credits :

• Basic personal credit • Age credit

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• Infirm dependant credit• Married or equivalent to married

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