Law 345: Tax Law: Knowledge Objectives

Spring 2016 Outline – Kirstn Mase

Table of ContentsCHAPTER 1: INTRODUCTION TO TAX LAW....................................................................................................10

Knowledge Objectives: What is Tax?.......................................................................................................................10Provide two general definitions of a tax.....................................................................................................................10Show the difficulty in identifying a “tax” by reference to an example........................................................................10

Knowledge Objectives: Classification of Taxes........................................................................................................10Identify and briefly describe ten different types of taxes...........................................................................................10

Knowledge Objective: Role of the Income Tax........................................................................................................10Identify and describe three main roles of income taxes.............................................................................................10

Knowledge Objectives: Sources of Income Tax Law.................................................................................................11Be able to describe the history, structure and legislative process of the Income Tax Act..........................................11Be able to describe the role of the Department of Finance and the legislative process for amendments to the Income Tax Act...........................................................................................................................................................11Be able to....................................................................................................................................................................12(i) Identify and describe seven primary sources of income tax law........................................................................12(ii) Identify and describe eight secondary sources of income tax law.....................................................................12

Knowledge Objectives: The Five Basic Questions....................................................................................................131. Describe the tax collection procedure including tax returns, payment, assessment, examinations audits, reassessments, objections, appeals, the burden of proof, and settlements...............................................................132. Describe the potential penalties and the process of investigation and prosecution..........................................14

Knowledge Objective: Income Tax and Terminology Concepts................................................................................15Be able to explain the terms and concepts discussed under this heading..................................................................15

CHAPTER 2: CONSTITUTION POSITION AND HISTORY OF TAXATION.............................................................17Knowledge Objectives: The Constitutional Position................................................................................................17

1. Identify the source of the Federal power in the Constitution Act...........................................................................172. Identify the source of the Provincial Power in the Constitution Act.......................................................................173 Identify the definition of direct and indirect taxation that has been accepted and applied in Canadian cases.......17

Knowledge Objectives: Provincial Income Taxes.....................................................................................................17Indicate when provincial income taxation began.......................................................................................................17

Knowledge Objectives: Federal Income Tax............................................................................................................17Indicate when federal income taxation began...........................................................................................................17

Knowledge Objectives: Federal-Provincial Agreements...........................................................................................17Be able to describe the federal-provincial tax rental agreements that began during the WWII, the subsequent tax collection agreements and the recent 1998 changes to provincial taxation under these agreements......................17

Knowledge Objectives: The Tax Reform of 1971......................................................................................................18Be able to discuss the Carter Report recommendations and the 1971 Income Tax Act modifications in terms of base broadening, rate structure and integration................................................................................................................18

Knowledge Objective: Introduction of Indexing and MacEachen Budget.................................................................18Be able to discuss the introduction of indexing..........................................................................................................18

Knowledge Objective: Tax Reform of 1988..............................................................................................................181. Discuss the 1988 reforms........................................................................................................................................182. Explain the concept behind the shifting of certain deductions to credits...............................................................19

Knowledge Objectives: Changes 1988 – 2005..........................................................................................................19Be able to identify three significant reforms between 1988 and 2005.......................................................................19

Knowledge Objectives: 2005 to Present..................................................................................................................19Be able to identify three significant reforms in the period between 2005 and now..................................................19

Knowledge Objectives: Policy.................................................................................................................................201. Identify and briefly describe six objectives of an income tax system......................................................................202. identify and describe three evaluative criteria.......................................................................................................20

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Knowledge Objectives: Effect on Incentive and Tax Avoidance................................................................................20Be able to discuss the effect of taxes on incentives to work and invest and on incentives to engage in tax avoidance....................................................................................................................................................................................21

Knowledge Objectives: Public Scrutiny....................................................................................................................21Be able to explain the accountability problem associated with tax expenditures, how this has been addressed and the difficulties with attempts to make tax expenditures more accountable..............................................................21

CHAPTER 3: RESIDENCE................................................................................................................................23Knowledge Objective: Taxing Residents..................................................................................................................23

1. Identify the locations of sources of income that residents are taxed on................................................................232. Briefly explain how tax might be avoided through the use of foreign corporations or trusts.................................23

Knowledge Objective: Taxing Non Residents...........................................................................................................231. Identify the basis on which non-residents are taxed and describe the kinds of items taxed..................................23

Knowledge Objective: Effect of Tax Treaties...........................................................................................................241. Identify the purposes for which tax treaties are entered into................................................................................242. Identify the reasons for potential double taxation.................................................................................................243. Briefly describe the responses to the potential for double taxation.......................................................................24

Knowledge Objective: Purpose and Rationale.........................................................................................................24Identify five theoretical rationales for taxing residents on their world-wide income and for taxing non-residents on income the source of which is the taxing country......................................................................................................24

Skill Objective: Residence of Individuals.................................................................................................................25Set out principles of residence for individuals citing relevant cases and provisions of the ITA and apply those principles to a particular fact pattern to determine whether a person is “resident” in Canada for the purposes of the ITA........................................................................................................................................................................25

Knowledge Objective: Sojourning for 183 Days.......................................................................................................28Contrast “sojourning” with “residence” noting the tax effect of sojourning for less than 183 days and the tax effect of sojourning for 183 days or more............................................................................................................................28

Knowledge Objective: Residence of Corporations...................................................................................................291. Identify the main common law test of residence for a corporation.......................................................................292. Identify the deemed residence test under the Income Tax Act..............................................................................29

Skill Objectives: Residence of Corporations.............................................................................................................30Set out principles of residence for corporations citing relevant cases and provisions of the ITA and apply those principles to a particular fact pattern to determine whether a corporation is “resident” in Canada for the purposes of the ITA....................................................................................................................................................................30

Knowledge Objective: Residence of Trust...............................................................................................................30Identify the main common law test of residence for a trust......................................................................................30

Skill Objectives: Residence of Trusts.......................................................................................................................30Set out principles of residence for trusts citing relevant law and apply those principles to a particular fact pattern to determine whether a trust is “resident” in Canada for the purposes of the ITA........................................................30

Knowledge Objectives: Change in Residence Status................................................................................................311. Describe the relief provided to individuals who are resident for only part of the year and contrast residence for part of a year with sojourning in Canada for 183 days or more in a year...................................................................312. Describe the departure tax and explain the reason for it.......................................................................................31

Skill Objective.........................................................................................................................................................32Be able to assess whether the part time residence and departure tax provisions would apply in a given fact pattern citing relevant authority.............................................................................................................................................32

Skill Objective: Tax Treaties....................................................................................................................................32Be able to assess when tax treaty tie-breaker rules may need to applied and be able to apply the typical tax treaty tie-breaker rules.........................................................................................................................................................32

Knowledge Objective: Tax Treaties.........................................................................................................................32Be able to explain why the Act deems persons not to be resident where they are not resident pursuant to a tax treaty..........................................................................................................................................................................32

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Knowledge Objective:.............................................................................................................................................32Be able to describe in general terms how the allocation of provincial tax is determined for individuals and corporations...............................................................................................................................................................33

Skill Objective.........................................................................................................................................................33Be able to assess in which of two provinces a person is subject to provincial tax citing relevant authority...............33

CHAPTER 4: CONCEPT OF INCOME................................................................................................................34Knowledge Objective: Haig-Simons Theory.............................................................................................................34

Briefly describe the Haig-Simons definition of income...............................................................................................34Knowledge Objective: Carter Commission Definition..............................................................................................34

Briefly describe the Carter Commission definition of income....................................................................................34Knowledge Objective: The ITA................................................................................................................................34

Explain how the ITA deals with definition of income..................................................................................................34Knowledge Objective: Source Theory......................................................................................................................35

Explain the source theory of income in terms of the tree/fruit analogy and note and explain three possible origins of the source theory of income..................................................................................................................................35

Knowledge Objective: The Surrogatum Principle.....................................................................................................35Explain the “surrogatum” principle”...........................................................................................................................35

Knowledge Objective: Enumerated Sources............................................................................................................36Identify the enumerated sources of income in Section 3 of the Income Tax Act........................................................36

Knowledge Objective: Unenumerated Sources.......................................................................................................361. Briefly explain why unenumerated sources of income are still possible under Part I of the Income Tax Act.........362. Explain, in terms of the approach to income in the Income Tax Act, why courts may have had a tendency to stick with the enumerated sources of income in the Act....................................................................................................36

Skill Objective: Unenumerated Objectives..............................................................................................................36Using the cases below, demonstrate the reluctance of courts find unenumerated sources of income.....................36

Skill Objective: Characteristics of Income from a Source.........................................................................................37Apply the cases discussed below to assess whether a particular item may, or may not, be considered “income from a source.”....................................................................................................................................................................37

Knowledge Objective: Capital Gains........................................................................................................................38Explain the Carter Commission’s recommended approach to capital gains...............................................................38

Knowledge Objective: Statutory Inclusions and Exemptions...................................................................................39Indicate the inclusion of other specific items as income pursuant to the Income Tax Act and explain, in general terms, why there are such specific inclusions.............................................................................................................39

Knowledge Objective: Gifts and Inheritances..........................................................................................................39Describe and explain the Carter Commissions’ recommended approach to gifts and inheritances...........................39

Knowledge Objective: Windfalls.............................................................................................................................39Describe and explain the Carter Commission’s recommended approach to windfalls...............................................39

Knowledge Objective: Damages and Settlements....................................................................................................391. Explain the general approach to inclusion of damages or settlements in income..................................................392. what is the approach to an expectation-based damages award for lost profits.....................................................393. What is the approach to a reliance-based damage award?....................................................................................404. What is the approach to personal injury award for (i) cost of care; (ii) compensation for lost earning capacity; (iii) punitive damages.......................................................................................................................................................40

Knowledge Objective: Imputed Income..................................................................................................................40Describe and explain the Carter Commission’s recommended approach to imputed income from property and from services.......................................................................................................................................................................40

Knowledge Objective: Illegal Income......................................................................................................................40Describe and explain the Carter Commission’s recommended approach to illegal income.......................................40

CHAPTER 5: INCOME FROM EMPLOYMENT..................................................................................................42Legislative Scheme.................................................................................................................................................42Knowledge Objective..............................................................................................................................................42

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Describe four distinctions under the Income Tax Act between the treatment of income from employment and the treatment of income from business...........................................................................................................................42

Knowledge Objective: Policy...................................................................................................................................42Identify and explain policy considerations that influence (i) the taxation of benefits with respect to employment, and..............................................................................................................................................................................42(ii) the limits on deductions for income from employment....................................................................................42

Knowledge Objective: Office or Employment..........................................................................................................43(i) Explain the is the distinction between an “office” and “employment”..............................................................43(ii) Explain why the distinction between an “office” and “employment” is not that significant under the Income Tax Act........................................................................................................................................................................43

Knowledge Objective: Employment and Business...................................................................................................43Identify and explain five tests that have been used in the assessment of whether a person is an employee or an independent contractor.............................................................................................................................................43

Skill Objective.........................................................................................................................................................43Analyze, in a given fact pattern, citing relevant authority, whether a person is an employee or an independent contractor...................................................................................................................................................................44

Skill Objective: Employment and Business..............................................................................................................45Analyze, in a given fact pattern, citing relevant authority, whether a person is an employee or an independent contractor...................................................................................................................................................................45

Knowledge Objective: Incorporated Employees......................................................................................................46Identify and describe potential tax advantages to an employer and an employee, were it not for anti-avoidance provisions in the Income Tax Act, from having the employer contract with an employee’s corporation for services rather than contracting with the employee directly...................................................................................................46

Knowledge Objective: Timing.................................................................................................................................47(i) Explain how the provisions of the Income Tax Act treat income from employment on a cash basis.....................47(ii) Explain the concept of “constructive receipt”.......................................................................................................47

Skill Objective: Timing............................................................................................................................................48Be able to determine, in a given fact pattern, citing relevant authority, whether a particular amount is to be included as income from employment at a particular time........................................................................................48

Knowledge Objective: Salary, Wages and Other Remuneration...............................................................................48(i) Describe the distinction between salary and wages in common parlance and the significance of the distinction in the Income Tax Act.....................................................................................................................................................48(ii) Describe how the Act deals with remuneration other than salary or wages.........................................................49

Knowledge Objective: Benefits...............................................................................................................................49(i) Set out the meaning that has been given to “benefit” in s. 6(1)(a) of the Act........................................................49(ii) Discuss whether a benefit under s. 6(1)(a) must be convertible into money........................................................49(iii) Explain the scope of “in respect of” in terms of underlying policy considerations (i.e., revenue, neutrality and equity)........................................................................................................................................................................49

Skill Objectives: General Scheme............................................................................................................................49Analyze, in a particular fact situation, citing relevant authority:................................................................................50(a) whether there is a benefit to an employee;..........................................................................................................50(b) if there is a benefit to an employee, whether the benefit is likely to be considered a benefit in respect of employment; and.......................................................................................................................................................50(c) if it were considered a benefit in respect of employment, how the benefit would be valued..............................52

Knowledge Objective: Allowances..........................................................................................................................53Explain the distinction between an allowance and a reimbursement and why allowances are included in income while reimbursements generally are not included in income.....................................................................................53

Skill Objective: Allowances.....................................................................................................................................54Be able to assess, in a given fact pattern, citing relevant authority, whether a particular amount paid by an employer is an “allowance” and whether the allowance must be included in income from employment.................54

Knowledge Objectives: Automobiles.......................................................................................................................54

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Explain why there are special provisions on automobile benefits and how the special provisions address these concerns.....................................................................................................................................................................54

Knowledge Objectives: Loans.................................................................................................................................54Explain why there are special provisions on interest free loans and how they work.................................................54

Knowledge Objective: Home Relocation Benefits....................................................................................................55Explain why there are special provisions for employee home relocation?.................................................................55Case Law on Home Relocation Benefits......................................................................................................................55

Knowledge Objective: Deductions from Employment Income.................................................................................56Be able to explain, from a policy perspective, what the rationale is for tightly controlling deductions with respect to income from employment..........................................................................................................................................56

Skill Objective: Specific Deductions.........................................................................................................................56Be able to assess whether travel expenses, legal expenses, home office expenses, or other expenses permitted in those paragraphs of section 8(1) set out in the statutory supplement can be deducted from income from employment citing relevant authority........................................................................................................................56

CHAPTER 6: INCOME FROM BUSINESS OR PROPERTY – PROFIT....................................................................59Knowledge Objective: Section 9 of the ITA..............................................................................................................59

Identify and explain the starting point in s. 9 of the Income Tax Act for the determination of income from business or property.................................................................................................................................................................59

Knowledge Objective: Importance of Characterization............................................................................................59Explain the context in which the question of whether income is from a business or property source has normally arisen..........................................................................................................................................................................59

Knowledge Objectives: Business or Property Defined.............................................................................................59(i) Discuss the Income Tax Act statutory meaning of “business” and “property” as well as the common law meaning of those terms............................................................................................................................................................59(ii) Give an example of a tax shelter scheme and explain two tax advantages such a scheme can provide...............60(iii) Describe the test used prior to the Stewart case to determine whether an activity carried on by a taxpayer was a business or a hobby.................................................................................................................................................60(iv) Describe the approach in the Stewart case to determining whether an activity carried on by a taxpayer is a business or property source.......................................................................................................................................60(v) Discuss the response to the Stewart case the Minister of Finance proposed in October of 2003.........................62

Skill Objective.........................................................................................................................................................62Be able to assess, with reference to relevant authority, whether a taxpayer’s endeavor involves a “business” or “property”..................................................................................................................................................................63

Knowledge Objective: Personal Endeavors Distinguished........................................................................................63Discuss the revenue, equity and neutrality concerns with respect to taxpayers claiming a deduction for losses from hobby activities on the basis that they are losses from business or property............................................................63

Skill Objective: Personal Endeavors Distinguished...................................................................................................65Be able to apply the Stewart approach to “business” or “property” to possible personal endeavors including hobbies, rental properties, and gambling...................................................................................................................65

Knowledge Objectives: Business Distinguished from Property................................................................................66Identify and briefly explain eight differential treatments of “income from property and income from business under the Income Tax Act.....................................................................................................................................................66Explain the level of activity test for distinguishing income from business and income from property.......................66

Skill Objective: Business Distinguished from Property.............................................................................................66Be able to apply the level of activity test in a given fact pattern to distinguish between income from business and income from property................................................................................................................................................66

Knowledge Objectives: Concept of Profit................................................................................................................66Be able to describe the concept of profit...................................................................................................................67

Knowledge Objectives: Question of Law.................................................................................................................67(i) Explain how, in very general terms, “profit” been defined by the Supreme Court of Canada................................67(ii) Describe the method the taxpayer must use in determining “profit” from a business or property......................67

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(iii) Explain where generally accepted accounting principles fit in the determination of “profit” from business or property (a) according to the courts; and (b) practically speaking.............................................................................67(iv) Explain why courts do not want to define the starting place for the calculation of “profit” as “generally accepted accounting principles”................................................................................................................................................68(v) Give an example of a situation in which an accepted accounting treatment differed from the tax treatment allowed by the court and explain why the court did not follow the accepted accounting treatment........................68

Knowledge Objectives: Financial Accounting v Tax..................................................................................................68(i) Identify three factors that identify “generally accepted” accounting principles and explain the relationship of generally accepted accounting principles to the Handbook issued by the Canadian Institute of Chartered Accountants................................................................................................................................................................68(ii) Identify and explain five reasons for tax law deviations from generally accepted accounting principles..............68

Knowledge Objectives: Methods of Profit Computation (Or Methods of Accounting)..............................................68(i) Explain the distinction between the cash method of accounting and the accrual method of accounting.............68(ii) Explain the matching principle under the accrual method of accounting.............................................................69(iii) Indicate when the cash method of accounting may be used for the purposes of the Income Tax Act and when the accrual method of accounting must be used for the purposes of the Income Tax Act.........................................69

CHAPTER 7: INCOME FROM BUSINESS OR PROPERTY – INCLUSIONS............................................................69Knowledge Objectives: Characterization.................................................................................................................70

Explain why income from property does not include a return of capital....................................................................70Explain why income from property does not include capital gains on the disposition of property............................70

Knowledge Objective: “Realization Principle”.........................................................................................................70Identify the test for when an amount is included in income from business or property............................................70

Skill Objective: Realization Principle.......................................................................................................................70Assess when an amount is likely to be included in income from business or property..............................................70

Knowledge Objectives: Accrual Method of Accounting...........................................................................................70(i) Explain what s. 12(1)(b) requires in terms of when an amount is to be recognized as income..............................70(ii) Identify the test for when an amount is considered receivable and explain how it applies to holdbacks and expropriation compensation......................................................................................................................................71(iii) Explain how s. 12(1)(a), together with ss. 20(1)(m) and (m.2), compares to the accrual method of accounting and why the Act has these provisions........................................................................................................................71

Skill Objective: Accrual Method of Accounting........................................................................................................72Assess when an amount will be considered receivable including how it would apply to holdbacks and expropriation compensation.............................................................................................................................................................72

Knowledge Objective: Sale of Property...................................................................................................................72Describe the approach of the CRA to determining when an amount is receivable from the sale of goods and from the sale of real property.............................................................................................................................................72

Knowledge Objectives: Services..............................................................................................................................72Identify the test for when amounts must be included in income for services rendered............................................72Describe the exception provided for certain types of professional services...............................................................72

Knowledge Objective: Dividends ITA s. 12(1)(j), (k).................................................................................................73Describe a “dividend”, describe how it is defined in the Income Tax Act and identify the basis on which it is taxed.73

Knowledge Objectives: Rent and Royalties.............................................................................................................73Identify the basis on which rent is included in income...............................................................................................73Explain why an instalment on the sale of property that is based on the use of property, or production from property, is included in income..................................................................................................................................73

Skill Objective: Rent and Royalties..........................................................................................................................74Assess, with reference to relevant authority, when rent or royalties will be included in income..............................74

Knowledge Objectives: Interest..............................................................................................................................74(i) Define “interest”....................................................................................................................................................74(ii) Explain why the inclusion of interest in income should, in theory, be adjusted for inflation................................74(iii) Provide a possible explanation for why interest income is not adjusted for inflation..........................................74

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Knowledge Objective: Blended Payments ITA s.16(1), 20(1)(c)................................................................................74Explain how the Act deals with blended payments of interest and principal to a lender...........................................74

Skill Objective: Blended Payments..........................................................................................................................74Be able to assess in a given fact pattern, with reference to relevant authority, whether a particular payment on a loan consists partly of principal and partly of interest and how the payment is to be treated under the Income Tax Act..............................................................................................................................................................................74

Skill Objective: Original Issue Discount ITA ss 16(1), 12(3), (4), (9), Reg 7000...........................................................75Identify situations when a discount on a debt obligation must be included in income..............................................75

Skill Objective: Debts Purchased at Discount..........................................................................................................75Identify situations when a discount on a debt obligation must be included in income and situations in which it need not be included in income..........................................................................................................................................75

Knowledge Objective: Timing Rules ITA s 12(1)(c), 12(3), (4), (11)...........................................................................75Identify the basis on which interest is included in income pursuant to the Income Tax Act and explain the modifications to that basis that are made in the Income Tax Act...............................................................................75

CHAPTER 8: INCOME FROM BUSINESS OR PROPERTY – DEDUCTIONS...........................................................76Skill objective for Business or Property Deductions.................................................................................................76

Be able to assess in a given fact pattern with reference to relevant authority whether:...........................................76(i) an expense is deductible in determining income from business or property;...................................................76(ii) whether the amount of an expenses is reasonable; and...................................................................................76(iii) when an expense can be deducted...............................................................................................................76

Knowledge Objective: Deduction Rules ITA ss. 9(1); 18(1)(a), (b), (h).......................................................................76Identify the three key issues with respect to the deduction of expenses in determining income from business or property......................................................................................................................................................................76

Knowledge Objectives: Purpose and Rationale.......................................................................................................76(i) Explain the relevance of the evaluative criteria of ability to pay, equity and neutrality in the context of permitted expense deductions in determining income from business or property....................................................77(ii) Discuss the policy concerns of accurate picture of profit, certainty, controlling abuse, and public policy controls with respect to the deduction of expenses in determining income from business or property...................77

Knowledge Objective: Personal and Mixed Expenses..............................................................................................77How does the Income Tax Act deal with personal or living expenses and how does this compare with generally accepted accounting principles?.................................................................................................................................77

Knowledge Objective: Common Law Tests..............................................................................................................77What are dual purpose expenses and what two approaches have been taken to dual purpose expenses for income tax purposes under the Income Tax Act?...................................................................................................................77

Knowledge Objective: Child Care Expenses.............................................................................................................78Discuss the difficulties before the court in the Symes case in terms of discrimination on the one hand if a deduction for child care expenses was not allowed as a business expense and in terms of equity and neutrality if a deduction of child care expenses as a business expense was allowed........................................................................................78

Knowledge Objective: Food and Beverages.............................................................................................................79(i) Identify the three step approach used by the Federal Court of Appeal in the Scott case for distinguishing business expenses from personal or living expenses?................................................................................................79(ii) Explain how the test in Scott applies in the context of expenses for food and beverages?...............................79

Knowledge Objective: Entertainment Expenses ITA ss. 9(1), 18(1)(a), (h), 67.1........................................................80(i) What approach did the Royal Trust Company case take to determining whether an expense was deductible as a business or property expense under the Income Tax Act?.........................................................................................80(ii) According to the Royal Trust Company case does an expense actually have to produce income in order to be deductible? If not, what is required and what was the basis for the decision in terms of the Income Tax Act?.......80

Knowledge Objective: Commuting Expenses...........................................................................................................80Explain the circumstances under which commuting expenses can be deducted as an expense in earning income from business or property..........................................................................................................................................80

Knowledge Objective: Housekeeping Expenses.......................................................................................................81

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Explain when housekeeping expenses can be deducted in determining income from business or property.............81Knowledge Objective: Home-office Expenses ITA s. 18(12)......................................................................................81

Explain why a specific provision was added with respect to the deduction of home office expenses........................81Knowledge Objective: Damages and Similar Payments...........................................................................................81

Explain why the taxpayer does not have to show that an expense resulted in the earning of income......................82Knowledge Objective: “Reasonable” Requirement ITA s67.....................................................................................83

Be able to note and apply the reasonableness requirement in conjunction with other provisions restricting the extent of deductions...................................................................................................................................................83

CHAPTER 9: CAPITAL EXPENDITURES............................................................................................................85Skill Objective: Current Expenditure v Capital Expenditure.....................................................................................85

Be able to determine, with reference to relevant authority, whether an expenditure that is incurred for the purpose of earning income from business or property is a capital expenditure or a current expenditure................85

Knowledge Objective: Acquisition of Assets............................................................................................................87Be able to distinguish between depreciable property, intangibles, non-depreciable property, natural resources and so-called “nothings”...................................................................................................................................................87

Skill Objective: Specific Problem Areas...................................................................................................................88The specific problem areas discussed below relate to the overall skill objective of being able to determine, with reference to relevant authority, whether an expenditure that is incurred for the purpose of earning income from business or property is a capital expenditure or a current expenditure.....................................................................88

Knowledge Objectives: Depreciation and Capital Cost Allowance Compared...........................................................92(i) Identify and describe two common methods of calculating depreciation for account purposes.......................92(ii) Explain the reasons for the declining balance approach to depreciation...........................................................93(iii) Explain the reasons for the differences between the capital cost allowance rates permitted under the Income Tax Act and the normal approach to depreciation for accounting purposes.................................................93

Knowledge Objective: Key Terms............................................................................................................................93Be able to identify and explain the following defined terms: capital cost, capital cost allowance, undepreciated capital cost, proceeds of disposition, recapture and terminal loss.............................................................................93

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CHAPTER 1: INTRODUCTION TO TAX LAW

Knowledge Objectives: What is Tax?

Provide two general definitions of a tax

Definition 1: a compulsory transfer of money from private individuals or organizations to the government not paid in exchange for some specific good or benefit”

Definition 2: A tax is a levy, enforceable by law imposed under the authority of a legislature, imposed by a public body and levied for a public purpose Kempe v R (2000)

Common features of these are: o Compulsory and enforceable by lawo Transfer of money

Show the difficulty in identifying a “tax” by reference to an example

Difficulties with these definitions:1. Fine: some things are distinguished, such as penalties or fines, that are intended to deter behavior BUT these definitions

don’t distinguish fine or penalties2. Application: not always easy to apply.

Knowledge Objectives: Classification of Taxes

Identify and briefly describe ten different types of taxes

Income Tax: a tax on the income of a tax unit Excise Tax: tax on the quantity or value of output of production – taxes on gasoline, cigarettes, alcohol

o Sales Tax: tax on the sale to the consumero Value-Added Tax: tax on the value added at a particular stage of production and usually designed to tax the overall

value added to the final consumer of the product or service ex. the goods and services ta is a value-added tax

Wealth Tax (estate or succession duties; capital gains): a ta on the wealth of a particular taxation unit – e.g. Tax on accumulated wealth such as capital gains

Tariffs (Customs Tariff Act): a type of tax levied on the import of goods Head Tax: a tax at a set amount typically applied to individuals Property Tax: tax on a regular basis on the real property owned by the taxpayer Transfer Taxes: taxes on particular transactions, such as a property transfer tax, applied on a transfer of property or stamp

duties – applied on each registration of a transfer of shares User Tax/User Fees: a tax on individual users of particular services or facilities such as highway toll fee or a bridge toll fee

Knowledge Objective: Role of the Income Tax

Identify and describe three main roles of income taxes

1. Revenue Main purpose is to raise revenue Largest source of federal/provincial revenues

2. Redistribution of Income Income tax is used to redistribute income Taxes are collected from higher income earners (higher tax rates) and redistributed through social programs

3. Regulation of Private Activity Income taxes are used to regulate private activity

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Example: to encourage the use of environmentally friendly technologies

Knowledge Objectives: Sources of Income Tax Law

Be able to describe the history, structure and legislative process of the Income Tax Act

Income Tax Act: the primary source of incomeHistory

1. 1917: War Measure Income Tax Act – was meant to be temporary but remained and was renamed Income Tax Act originally act 20 pages, now 20002. Current version enacted December 23, 1971 and came into force 1972

Current Structure

Act is divided into four parts Part I: provisions that deal with the imposition of ordinary income tax on individuals, corporations, trusts and partnerships

o Divided into sub divisions A through J A: Deals with who pays tax and on what B: deals with calculation D: deals with non-resident E: calculation of tax payable

Part I.01 to Part XIV: levy special taxes Part XV: administration3 and enforcement Part XVI and XVI.1: tax avoidance Part XVII: definitions

Be able to describe the role of the Department of Finance and the legislative process for amendments to the Income Tax Act

A. Role of the Department of Finance Responsible for tax policy

o Including amendments to the Income Tax Acto Department formulates amendments – Minister of Finance introduces themo Main policy amendments are announced in the budget

The Budgeto Presented by the Minister of Finance to Parliament every yearo Estimate of anticipated revenues and expenditures of the yearo Proposed changes in the income tax – are usually announced in the budgeto Secrecy: until presentation to prevent people profiting on knowledgeo Effective Date of Change: changes are effective from date of budget and usually made retroactive to the date

of the budget Legislative Process

o Notice of Ways and Means: prepared by the Department of Finance – lists and describes all of the proposed amendments

o Draft Legislation: notice of ways and means is followed by draft legislationo Technical Notes: draft legislation is accompanied by this – explain the purpose of the amendmentso Comments on Draft Legislation: comments on the draft legislation often result in modifications to the

legislationo Bill: after comments received, a bill is prepared and introduced in the House of Commons

There it goes through the normal parliamentary process o Time: the process sometimes takes more than one year

Forms for tax returns in the year often incorporate the proposed amendments on the assumption that they will become law

Enforcement

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o Tax Collection by the Canada Revenue Agency – through the administration of the system of tax returns, assessments, refunds, audits and enforcement

Be able to

(i) Identify and describe seven primary sources of income tax law

1. Income Tax Act2. ITARs: Income Tax Application Rules: transitional rules needed to shift from old Act to the new Act3. Income Tax Regulations: made under authority given to Governor in Council – anything to be “prescribed” will have

associated regulations4. Tax Treaties: intended to avoid double taxation – terms of treat prevail over the Act. Used where persons have residential

or other connections with more than one country or have income from more than one country5. Tax Cases: decisions of courts are set out in the Canadian Tax Cases (CTC) and Dominion Tax Cases (DTC): frequently

litigated issues include Residence Income from employment or business etc.

6. Provincial Income Tax Acts: each province has an act – but per tax agreements with the fed. gov, personal taxes are collected by the fed gov – tax base is determined by federal income tax

7. Private Law: relies on general law for various aspects such as when a person is entitled to income Whether they are an employee, independent contract, partner Often depends on aspect of provincial law

(ii) Identify and describe eight secondary sources of income tax law

1. Administrative Publications (from Canada Revenue Agency)

Issues forms and guides, information circulars and interpretation bulletins – these do not have force of law but are reliable secondary sources of in come tax law

1. Form: T4 Statement of Remuneration Paid; and T1 General Federal Tax2. Guides: “General Income Tax and Benefit guide”3. Information Circulars: intended to provide information on tax matters to the general public4. Interpretation Bulletins: directed to accountants and lawyers and provide the interpretation of IT law.

Viewed as a persuasive aid to interpreting tax law – but the courts are not bound by them They may be changed

Stickel v MNRFacts: Department of National Revenue assessed the taxpayer on a basis that contradicted the applicable IT. Taxpayer claimed to have relied on the IT.

Held: Crown is not bound by its own interpretation announced in the Information Bulletin.

5. Income Tax Folios: these have been replacing Interpretation Bulletins – and they are the CRA’s view on the law and not law itself, therefore they would not bind the CRA

6. Advance Income Tax Rulings: this is done at the request of a taxpayer. It shows what the taxation of a proposed transaction would be.

Agency likely not bound by their assessmentWoon v MNRFacts: Department made an informal ruling (this was before formal advanced rulings). The Minister then made a tax assessment far in excess of that suggested in the rulingHeld: The assessment was correct in law and the Minister was not estopped by the earlier ruling.

2. Private Publications

Numerous publications that provide assistance in keeping up with the law1. Loose-leaf Services: McCarthy Tetrault’s Canada tax Service by Carswell2. CD Rom/ DVD Services: may be provided by Carswell

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3. On Line Services: o line electronic database4. Texts: casebooks, textbooks, etc. on tax policy5. Canadian Tax Foundation Publications: Canadian Tax Foundation provides major publications every two

months and there is an annual tax conference6.

Knowledge Objectives: The Five Basic Questions

1. Who is Taxed? Persons, Corporations, Trusts, Partnership [considered a legal entity for tax purposes], Residents, Non-Residents who make income in Canada

2. What is taxed? Taxable Income – this is not straight forward, Measurement: s. 3 deals with what types of things will be included.

3. When: taxation year – for an individual that is the calendar year, fiscal period for corporation or business of individuals. A fiscal year is any 12 month period.

4. How Much? S. 117 sets out the rates for individuals and s. 123 set out the tax brackets for corporations The act also provides tax credits. There is also a calculation of the alternative minimum tax – it is a calculation, taking into account tax preferences or

expenditures, and then you pay the higher of the two 5. How?

1. Describe the tax collection procedure including tax returns, payment, assessment, examinations audits, reassessments, objections, appeals, the burden of proof, and settlements.

Who Administers the Collection of Income Tax?

CRA is responsible for the collection of tax through the system of tax, returns, assessments, refunds, audits and enforcement

DOJ provides legal advice and services for other departments of gov and is responsible for litigation in Tax Court of Canada

Collection Procedure

(a) Tax Return: process is started by the filing of a return by the tax payer Individuals: only if received sufficient income to be liable to pay tax

Must file by April 30th of the year following the taxation year Corporations: required to file whether or not they are liable to pay tax unless a registered charity

Return is due six months after the corporation’s year en33d In a prescribed form [T2 for corporations and T1 for individuals] Return shows income and expenses for the year – and requires taxpayers to estimate the tax payable(b) Payment Payment of estimate must accompany the return Employers must withhold tax liability from employment income of employees For an individual who has a source income that is not subject to withholding, there is a requirement to pay in quarterly

installments and then to pay any balance on the balance due day (April 30th of the year following the taxation year) Corporations are required to pay tax in 12 monthly installments – any balance is due within two months of the end of the

taxation year(c) Assessment Once the return is filed the Minister is required to assess the return CRA looks to see if the return was done correctly – will request documentation where necessary

Refund: may be entitled to a refund where the estimate was too high or where taxes withheld are higher then the amount of tax liability a year

Notice Assessment: when the review process is complete the taxpayer is mailed a “notice of assessment” Interest: interest is paid on overdue taxes at a “prescribed rate”. The rate is more for individuals than the CRA

(d) Examinations Once assessment is complete the CRA does a more detailed examination by cross-checking information filed by employers

and employees(e) Audit

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Some returns will be audited – audits are normally done at the place of business and can demand information or documents from the taxpayer or other persons. They cannot enter a dwelling house without a warrant

(f) Reassessment Further examination or audit may result in reassessment Minister may reassess within three years – cannot reassess after this period unless fraud or the taxpayer files a waiver to

allow for reassessment (g) Objection Resolution of Dispute by Discussion: taxpayer disagree with a notice assessment – contract the district office and discuss Formal Notice of Objection: still disagrees then TP can file a notice of objection, the deadline is one year after the filing due

date for the return and 90s days after the notice of assessment. TP must set out reasons Objection Process: notice is served by filing with the chief of appeals in the relevant district taxation office. TP is contacted

and given an opportunity to make representations – at the end the Minister will decide whether to confirm or vary the assessment

(h) Appeal If the TP is unsatisfied with the Minister’s decision, thy can appeal to the Tax Court of Canada via (1) informal procedure or

(2) General Procedure Informal Procedure

o (i) amount of tax is less than 12,000o (ii) amount of loss claimed is less than 24,000; ando (iii) interest is the only issue

judgment rendered in 60 days, may be represented by an agent who is not a lawyer General Procedure

o (i) amount of tax is more than 12,000o (ii) loss involved is more than 24,000o (iii) TP does not elect the informal procedure for lesser amounts

must be represented by a lawyer costs may be awarded – more formal proceedings no time limit on judgment can be appeal to FCA and then to SCC

(i) Burden of Proof BoP is on the TP to show that factual findings on which they were assessed are wrong; Johnson v MNR Minister does have the responsibility to disclose the facts upon which the assessment was based – it is then the TP’s onus

to rebut the facts

Exceptions: o Civil Penalties: act imposes penalties on TPs when they (I) repeatedly fail to report income; or (ii) knowingly or

negligently make false statements or omission in a return Onus is then on the Minister to justify the facts for the penalty

o Reassess Outside the 3 year Period for Fraud: BoP on Minister to establish misrepresentation or fraudo Criminal Offence: where charged with a criminal offence – Crown must establish proof beyond a reasonable doubt

(j) Settlement Effect of case law Smerchanski v MNR (TP bound to agreement) AND Cohen v The Queen (Minister NOT bound) is that the

overall effect is the TP is bound while the Minister is not3

(k) Remission Order Governor in council can provide a remission order waiving a tax – this is rarely used2. Describe the potential penalties and the process of investigation and prosecution.

Audit When an audit is complete the CRA may reassess the tax payer (often results in payment of further tax)

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Johnson v MNRFacts: TP did not sustain the burden of proving that he was supporting his wifePrinciple: Onus is on tax payer. This is because the TP has the best access to evidence to establish the facts

Reassessment If reassessment results in further tax payable – the amount must be paid with interest from the date it would have been

due If the minister is of the opinion that a breach of the Act has occurred, then a civil penalty may be applied pursuant to s. 162

and 163Civil Penalties

Ss. 162 – 163o (I) the late filing of a tax return, o (ii) the failure to file a return, o (iii) a repeated failure to file a return, o (iv) the failure to provide information on a prescribed form, o (v) the failure to report an item of income or the making of a false statement or omission in a return, and o (vi) the misrepresentation of another person’s tax matters by a third party [per s. 163.2]

imposed by the Minister in assessment processCriminal Matters

Prosecutions for tax evasion in violation of penal provisions of the Act are dealt with by the courts of the provinces following the procedure in the Criminal Code

s. 238 offence to fail to file a tax return or to fail to comply with other provisions of the Act – these are offences of strict liability thus without a specific mens rea element but with a due diligence defense available to the taxpayer

s. 239 makes it an offence to falsify records or to evade compliance with the Act or payment in other ways – these offences have specific mens rea elements

Investigator Powers CRA has powers – audits, demand documents, inquiries, etc.

Knowledge Objective: Income Tax and Terminology Concepts

Be able to explain the terms and concepts discussed under this heading

Realization and Recognition

A gain or loss is not recognized (included in calculation of tax income) until it is realized Realized when it is “earned” – when the TP has a legal right to be paid (accrual method) or when it is received (case

method) Cost/expensive is realized when it is payable or has been paid

Cost and Expense

Recognized in computing income or loss

Business Entities Different forms through which a business can be carried on. Corporation: treated in law as a separate legal person and has all the powers of an individual person. Treated as a separate

taxpayer under the ITA. Pays tax at a separate flat rate rather then the progressive structure of individuals Partnership: two or more persons carry on a business in common with a view of profit. Does not treat as a separate legal

entity. ITA does not treat as a separate legal entity. Any business income is treated as the income of the partners – personal income

Sole Proprietorship: form for carrying business in which a person carries on business solely and directly without carrying on the business through a corporation. Any income earned in carrying out the business is treated as the SP’s personal income in their personal ta return.

Trust: not a separate legal entity but treated as a separate taxpayer under the ITA.

Characterization Character of transaction is important as to how it will be taxed – it is only taxed if has a character of “income from a source”

for tax purposes. Not all gains or losses are taxed in the same wayTiming

Timing is important – generally one wants to defer the recognition of income while recognizing losses sooner

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Cash Method: revenue is including income when received and an expense is deducted when paid – used for employment, office, property, farming income.

Accrual Method: item is included in revenue when it is receivable and an expense is deductible when it is payable (legal obligation to pay) – standing method for computing income from business

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CHAPTER 2: CONSTITUTION POSITION AND HISTORY OF TAXATION

Knowledge Objectives: The Constitutional Position

1. Identify the source of the Federal power in the Constitution Act

The right to collect customs and excise taxes (indirect taxes) were assigned to the federal government [BNA (now Constitution Act) s. 122]

o The government was given the right to raise funds “by any mode or system of taxation” [BNA s. 91(3)]

2. Identify the source of the Provincial Power in the Constitution Act

The provinces were assigned the right to “direct” taxation and license fees [BNA 92(2)]

3 Identify the definition of direct and indirect taxation that has been accepted and applied in Canadian cases

Direct Taxation: demanded from the very person who it is intended or desired should pay it. o Income Tax: an example because you cannot pass the tax onto another person

Indirect Taxation: demanded from one person in the expectation and intention that he shall indemnify himself at the expense of another.

o Customs or excise tax: an example because you may be able to pass all or part of the tax onto the consumer

Knowledge Objectives: Provincial Income Taxes

Indicate when provincial income taxation began

• BC and PEI introduced income taxes in the early part of the 20th century and five other provinces followed this in between 1923-1939.

o Other three provinces started levying income taxes in 1962

Knowledge Objectives: Federal Income Tax

Indicate when federal income taxation began

• Federal government first started imposing income tax in 1917

Knowledge Objectives: Federal-Provincial Agreements

Be able to describe the federal-provincial tax rental agreements that began during the WWII, the subsequent tax collection agreements and the recent 1998 changes to provincial taxation under these agreements.

Tax Rental Agreement

• 1941: provinces agreed to abandon their income taxes and allow the federal government to collect income taxo provinces were compensated by grants from the federal government

• this was to last for the duration of the war but in 1947 the feds convinced the province (except Ontario and QC) to enter into 5-year tax-rental agreements

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Bank of Toronto v LambePrinciple: sets out the definition of direct and indirect taxes

Tax Collection Agreements

• 1962 tax rental agreements replaced by tax collection agreementso provinces impose own income taxes at their own rateso however federal government would collect the taxes with the provincial rate being expressed as a percentage of

federal • 1997 – new collection agreement allows province to compute provincial tax directly on taxable income rather than as a

percentage of federal tax

Knowledge Objectives: The Tax Reform of 1971

Be able to discuss the Carter Report recommendations and the 1971 Income Tax Act modifications in terms of base broadening, rate structure and integration.

The Carter Commission Report

major revisions in 1945 and 1952 1962 – widespread agreement that further revision necessary 1966 - commission reported in a six volume report known as the Carter Report

o philosophy: all gains in wealth should be taxed strong opposition to these proposals led to further review resulting in White Paper of 1969

White Paper 1969: accepted some of the Carter proposals, including full taxation on capital gains Income Tax 1971: final proposals resulted in this

o the 1971 Act (i) broadened the tax base; (ii) restructured tax rates; and (iii) altered the taxation of corporations and shareholders to partially integrate corporate and personal income taxes

Base Broadening

main broadening: inclusion of one half of capital gainso added adult training allowances, research grants, scholarships

deductions increased increased deductibility of pension and savings plan contributions, capital losses, unemployment insurance premiums child

care expenses and moving expenses

Rate Structure

increased personal and spousal exemptions creating a tax-free bracket and a reduction of rates at the top taxable income rose for highest bracket because of capital gains

Integration of Corporate and Personal Taxes

• 25% rate of tax on investment income of private corporations and business income of Canadian Controlled Private Corporations vs. 50% tax rate on corporations

• partial integration by taxing dividends through a gross-up and deduction scheme – concept of integration was to achieve neutrality between earning income through a corporation or through sole proprietorship or partnership (i.e., tax law should not affect the decision of whether to incorporate or not)

Knowledge Objective: Introduction of Indexing and MacEachen Budget

Be able to discuss the introduction of indexing

1971-88: introduction of indexing that indexed deductions and tax brackets (i.e. increased them) 1986: partial de-indexing – only index for inflation above 3% - allowed gov revenues to increase w/out increasing tax rates

Knowledge Objective: Tax Reform of 1988

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1. Discuss the 1988 reforms

1987 White Paper Recommendations: (i) flattening of the rate structure; (ii) broadening of the tax base; (iii) the conversion of many deductions into tax credits; (iv) the introduction of a new general anti-avoidance rule

Rate Structure: number of tax brackets reduced from 10 to 3 Base Broadening: capital gains inclusion changes, raised to 2/3rd and then to 3/4s and then back to ½ in 2001

o Eliminations of some deductions and limitations on business expense deductions Deductions and Credits General Anti-Avoidance Rule: introduced in 88

2. Explain the concept behind the shifting of certain deductions to credits

Deductions and Credits: converted most deductions into credits so it gave the same reduction in tax to all taxpayers regardless of their income – improving equity of the system

o The pre 88 deductions favoured higher income taxpayers more than lower income taxpayers – intended to cover anti-avoidance behavior not covered under specific provisions of the Act

Knowledge Objectives: Changes 1988 – 2005

Be able to identify three significant reforms between 1988 and 2005

1. Rate Changes: lower existing brackets and added a fourth bracket. 2. Lowered Capital Gains Tax: from ½ to ¾ 3. Amended Act to Cover Same Sex Spouses4. Added Income tested GST credit and child tax benefit5. Doubled penalties for repeat offences of failure to file a return6. added a “kiddie” tax to reduce income splitting fro children

Knowledge Objectives: 2005 to Present

Be able to identify three significant reforms in the period between 2005 and now

GST reduced to 6% then 5% lowest tax bracket reduced: 16 – 15.5 – 15% increase in basic personal and spousal tax credits and return of under 18 dependent tax credit corporate tax rates further reduced increase in tax depreciation rates for buildings and certain types of equipment increase in life-time capital gains exemption for small business and farm business shares to $750,000 exemption for capital gains on public company shares donated to charities and on employee stock options fixed up the dividend gross-up and tax credit to fully integrate it for publicly-held companies (and added “Specified Income

Flow Through” (“SIFT”) taxation imposing corporate tax rate on income of certain income trusts and limited partnerships) for seniors they increased the age credit, increased pension credit, added pension income splitting and increased age when

income must be received from RRSPs introduction of a $100 per month child care benefit for children under 7 2014 added Family Tax Cut that allowed credit of up to $2,000 for two income family with one or more minor children based

on splitting income between two income couples [Liberal government has announced intention to eliminate this for 2016 taxation year and beyond]

increased tax relief for low income earners increased the textbook credit; increased RESP limits, and tax exemption for scholarships higher depreciation rates for environmentally friendly energy generation equipment (e.g., class 43.1 first introduced in 1994

but with amendments to add new energy saving technologies – 30% CCA for equipment that generates electricity or heat

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using renewable energy source – amended 2011 to add equipment to generate electricity from waste heat; and 2005 added cl. 43.2 that for adds 50% class for further types of environmentally efficient equipment)

Knowledge Objectives: Policy

1. Identify and briefly describe six objectives of an income tax system

Roles of the income tax raising revenue redistribution of income regulation of private activity

Regulation of private activity stabilizing the economy pursuing economic growth correcting market failures promoting international competitiveness promoting particular activities or industries

2. identify and describe three evaluative criteria

Equity

Benefit Principle persons should contribute to revenues of government in proportion to the benefits they derive from the government

expenditure o benefits: legal system, health care, education, public safety, highways or other infrastructureo argument is that people benefit from these in roughly equal quantities and therefore all should pay a similar

amountAbility to Pay Principle

usually broken down into horizontal and vertical equity

Vertical Equity persons with greater ability to pay pay higher amounts of tax

Horizontal Equity persons in similar circumstances should be treated in similar ways just a corollary of vertical equity – persons with higher income should pay greater proportion of income in taxes then

persons with same income should pay the same proportion of their income in taxes

Neutrality

Definition

a neutral tax system is one that is “designed to bring about a minimum change in the allocation of resources within the private sector of the economy”

Simplicity

should be administratively workable simplicity must be broken down into: comprehensibility, certainty, compliance convenience, administrative convenience,

difficult to evade and avoido tends to encourage complianceo keep administrative costs low

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Knowledge Objectives: Effect on Incentive and Tax Avoidance

Be able to discuss the effect of taxes on incentives to work and invest and on incentives to engage in tax avoidance

Work Incentives

minimal effect on the incentive to work argument that there is less incentive to work since more of one’s income goes to government (i.e. less reward for addition

work) vs. need to work harder to maintain same level of income to pay for things

Investment Incentives

tax system allows deduction of losses thereby sharing risk of less with government – this is in response to the idea that you might expect decline in the incentive to take risks (make investments) due to reduced reward

also consider tax expenditures designed to stimulate economic growth

Distortion of Allocation of Resources

even if the overall effect on work and investment is neutral, there will be the effect on the allocation of resources in the economy

Costs of Avoidance Effects

increased tax rates may increase diversion of resources to avoidance efforts

Flat Rate

same rate for everyone regardless of level of income reduced avoidance incentive

Dual Rates

progressive rate for labour income sand flat rate tax on income from capital Canada is a semi-dual system since in Canada Tax on capital gains is only half of the two on other income

Knowledge Objectives: Public Scrutiny

Be able to explain the accountability problem associated with tax expenditures, how this has been addressed and the difficulties with attempts to make tax expenditures more accountable

Tax Expenditures

Tax concessions cost government in that revenues are forgone, this costs the government in the same way as if the government made a direct subsidy

There is an accountability problem with tax expenditures – they were not accounted for in the federal budget There were rarely examinations into whether a tax concession was achieving its objective or who was benefiting from it In 1979 – an attempt to id and measure tax concession began – which led to new government budgeting in which tax

expenditures were taken into account in addition to other expenditures

Be able to identify the bases on which tax expenditures should probably be assessed.

1. Identification

There are some deductions or credits that may really be expenditures for generating income and thus not really preference bust just party of determine income

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2. Negative Tax Expenditures

Some tax measures are designed to discourage certain behavior by taxing that behavior more heavily. These measures are referred to as “negative tax expenditures” because they lead to more tax revenue, not less)

There are noted on the memorandum as separate from positive tax expenditures

3. Estimating the Cost of Tax Expenditures

This is a cost estimated by simulating the change in federal revenues as if that provision alone was eliminated and all other provisions kept in place – however the concern is that if a tax concession were removed it would affect behavior and thus the resulting impact on revenues would not be clear

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CHAPTER 3: RESIDENCE

Section 2 of the Income Tax Act divides persons paying tax in Canada into two groups – residents and non residents. S. 2(1) refers to “persons resident in Canada” and section 2(3) refers to persons other than those referred to in s. 2(1) and

therefore to non-residents

Knowledge Objective: Taxing Residents

1. Identify the locations of sources of income that residents are taxed on.

A person that is resident in Canada is taxed under s. 3 on their income “from a source inside or outside Canada”. This means that persons that are resident in Canada are taxed on world wide income.

This is different for individual residents in Canada for only part of the year – they are only taxed on worldwide income for part of year individual is resident in Canada – for the other part of the year they are taxed as a “non-resident”

o Residents are taxed on the income they make in Canada but also on their world wide income – the other countries can tax on that income too, causing double taxation

2. Briefly explain how tax might be avoided through the use of foreign corporations or trusts.

There are differing tax systems which may leave a gap in taxation – especially where there are tax havens that impose little tax. This gives the potential for diverting income through tax havens to avoid tax by either establishing residence in a tax haven or channeling income to a tax haven corporation

Rules ss. 91 to 95 require Canadian residents to report the income earned by and held in the offshore corporation or trust Foreign holding reporting requirements in s. 233.2 and 233.7 (Canadian residents must report ownership of investments

outside Canada with a total cost exceeding 100,000 – to allow keeping track of income from sources outside of Canada)

Knowledge Objective: Taxing Non Residents

1. Identify the basis on which non-residents are taxed and describe the kinds of items taxed.

Non-resident is not taxed on their world-wide income – they are purely taxed on source in Canada based (“taxable income earned in Canada”)

S. 2(3) provides that persons not taxed under s. 2(1) (non-residents) are subject to tax under part I of the ITA, if at any time in the taxation year (or previous year):

o They were employed in Canada,o Carried on business in Canada, oro Disposed of a taxable Canadian property

s. 115 defines “taxable income earned in Canada” to include employment income earned in Canada, business income earned in Canada, and taxable capital gains (net of allowable capital losses) from dispositions of “taxable Canadian property”

s. 116 (also in part I of the Act) deals with inclusion of a gain from the disposition of taxable Canadian property

s 248(1): defines taxable Canadian property as essentially property that has a reasonably permanent connection to Canada and where it is administratively feasible to collect the tax – this includes:

o taxable Canadian property excludes investment income such as: dividends interest rent royalties trust income maintenance pensions alimony

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annuitieso however, these classes of income are subject to a flat 25% rate which is imposed by s. 212 (Part XIII tax) – this is on

the resident who pays these amounts to the non resident

Knowledge Objective: Effect of Tax Treaties

1. Identify the purposes for which tax treaties are entered into.

Tax treaties deal with such matters as: (i) double taxation, (ii) the sharing of information between party states to assist in mutual enforcement of tax laws, and (iii) the reduction of withholding taxes on amounts paid to non-residents

Treaties bought into effect under Canadian law by implementing statutes that provide that the treaty takes precedence over the Income Tax Act

2. Identify the reasons for potential double taxation.

Double taxation may arise because:o (i) persons can be resident in more than one country;o (ii) taxes are imposed on non-residents (i.e. source income – like Canada does in s. 115 and 116 re Canadian source

income);o (iii) some countries (like US) tax on basis different than residence

3. Briefly describe the responses to the potential for double taxation.

Treaties address double taxation by, among other things, having tie-breaker rules where a person would be considered resident in both countries or where, in the case of the United States, a person is either a citizen of the US resident in Canada or is resident in both Canada and the US

Knowledge Objective: Purpose and Rationale

Identify five theoretical rationales for taxing residents on their world-wide income and for taxing non-residents on income the source of which is the taxing country.

Economic Allegiance Theory

You tax cross-border transactions on the basis that the taxpayer has a sufficient economic connection to the country based on (i) where value added activity is taking place; (ii) where the suppliers of capital are located; and (iii) where the consumers of the goods and services are located.

Benefit Theory

Those who benefit from public services of a country should pay tax to cover the costs of those services

Ability to Pay

The taxation of Canadian residents on their world wide income is based on this principle – you need to measure the world wide income to be able to properly measure one’s ability to pay.

Neutrality

• residents should be taxed on income from property in Canada on same basis as income from property outside of Canada – if taxation on domestically earned income from property different from the taxation of income earned from property held in foreign jurisdictions residents would have a tax incentive to invest either domestically or abroad on the basis of which gave the better tax treatment

Enforceability

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a taxpayer that is located in the country and has connections to Canada would allow for enforcement of taxes, in Canada you can get the funds before they leave the country, if they are employed then you can withhold them and if the taxpayer

carries on business in Canada then they will likely have assets in Canada that can be seized

Identify four different bases for determining which persons should pay a tax on income and note advantages and disadvantages of each.

Residence

the most common approach to jurisdiction is residence this probably gives the largest class of taxpayers with strong social and economic connections to the country (benefit

theory) enforcement is also practical on the basis since the person has sufficient connection to the country and they are likely to be

physical present in the country

Citizenship

benefit: justified that all citizens derive benefits from the government, even if they are not in the country enforcement: citizenship test allows this but the potential problem is that is sweeps in too many people with tenuous links to the country

Domicile

Domicile of origin: determined by the father’s domicile Domicile of dependence: by a woman who assume the domicile of her husband Domicile of choice: involves residing in a country with intention to remain permanently Domicile is a term that has been subject to unclear court decision

Source

Could tax based on the source of income – where did the income come from Source income would be difficult – under the ability to pay because you could have your income come in through various

sources.

Skill Objective: Residence of Individuals

Set out principles of residence for individuals citing relevant cases and provisions of the ITA and apply those principles to a particular fact pattern to determine whether a person is “resident” in Canada for the purposes of the ITA.

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Thomson v MNRFacts: Sold home in New Brunswick and announced4 Bermuda as residence – but then spent little time in Bermuda. He spent most of his time in the US where had a home available for occupancy year round. He began to regularly return to NB for 4 to 5 months every year and built a house that he kept available all year long. His wife and children accompanied him on his regular visits. Principles: he is a “home: - and the mere limitation of times does not qualify that fact. Held: Majority clearly felt that Thomason was resident in the US and CanadaKey Points: (1) for the purposes of income tax legislation, it must be assumed that every person has at all times a residence(2) it is not necessary for residence that a person have a home, place of abode or shelter. (3) one is “ordinarily resident” in the place where in the settled routine of his life he regularly, normally or customarily lives(4) there may be more than one place where a person normally or customarily lives(5) the intention of a taxpayer (to be resident in Bermuda) is perhaps relevant but not determinative

VERSUS

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Beament v MNRFacts: Taxpayer posted overseas with the Canadian army at the beginning of WWII in 1939. Stayed till 1945 with one short visit to Canada for a few weeks in 1941. Married in English, had children there and established a matrimonial home there. Held: the taxpayer was NOT resident in Canada until he returned in 1946.Principles: (1) absence of any home in Canada which could return as of right was a factor tending to indicate he was not resident in Canada. (2) intention is not determinative – the taxpayer had always regarded his absence from Canada as temporary – but still not held to be a resident.

Russell v MNRFacts: Taxpayer absent from Canada for several years on war service but maintained a matrimonial home and family in Canada. Held: Resident in CanadaPrinciple: physical presence in Canada not necessary to be found to be a residentNote: this case suggests that having a home in Canada tends to be a strong factor suggesting residence in Canada.

Allchin v RFacts: Taxpayer worked in the US from 1992 – 1997. She stayed with friends in the US, set up a US bank account, had credit cards sent to the US address and attempted to move her family to the US BUT her husband and children lived in Canada, she continued to have on Ontario driver’s license, Ontario health insurance, club membership in Ontario, her husband swore an affidavit that she was resident when they purchase the property.Held: Resident in Canada from 1993 - 1995

Shih v RFacts: S immigrated to Canada with wife and three sons and purchased a home in Canada BUT he returned to Taiwan. S visited Canada but with stays totaling at most 59 days in any given year. He had residential ties to Taiwan, a family member in Taiwan and a job in Taiwan. Held: wife and sons in Canada not strong enough in light of other factors to make him resident in Canada

Schujahn v MNRFacts: Transferred to US Aug 2, 1957. Left Canada and put house up for sale but wife and child stayed in house until it was sold in February of 1958. Issue: Was the taxpayer resident for the whole of 1957 or just until Aug 2, 1957?Held: taxpayer had given up residence on August 2, 1957 – wife and children in house until sold was reasonable for purposes of facilitating sale of house.

The Definition of Residence:

(1) "a matter of the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living with its accessories in social relations, interests and conveniences at or in the place in question."(2) “one is ‘ordinarily resident’ in the place where in the settled routine of his life he regularly, normally or customarily lives”.

Factors considered by the Court in the Definition of Resident

“The residential ties of an individual that will almost always be significant residential ties for the purpose of determining residence status are the individual's:

Dwelling place (or places); Spouse or common-law partner; and Dependents

Other factors courts have considered include:

personal property in Canada (such as furniture, clothing, automobiles and recreational vehicles), social ties with Canada (such as memberships in Canadian recreational and religious organizations), economic ties with Canada (such as employment with a Canadian employer and active involvement in a Canadian business,

and Canadian bank accounts, retirement savings plans, credit cards, and securities accounts), landed immigrant status or appropriate work permits in Canada, hospitalization and medical insurance coverage from a province or territory of Canada, a driver’s license from a province or territory of Canada, a vehicle registered in a province or territory of Canada, a seasonal dwelling place in Canada or a leased dwelling place referred a Canadian passport, and memberships in Canadian unions or professional organizations. the retention of a Canadian mailing address, post office box, or safety deposit box, personal stationery (including business cards) showing a Canadian address, telephone listings in Canada, and local (Canadian) newspaper and magazine subscriptions

ITA Definition or Ordinarily Resident

s. 250(3) : includes “ordinarily resident”27

Hauser v RFacts:

• Air Canada pilot 1992-1995 worked as a flight instructor in Florida• 1996 divorced and returned to Canada renting an apt. briefly in Cambridge• 1997 gets residence permit for the Bahamas and moves there with new wife• shipped household goods, car and boat to Bahamas• opened a bank account in the Bahamas• couple spent Christmas holidays in Canada - wife spent hurricane season in Canada• Hauser remained an Air Canada pilot• held a Transport Canada license• belonged to a Canadian chapter of an international pilot’s union• kept joint bank account in Cambridge, Ont. where his Air Canada salary deposited

Held: He remained resident in CanadaPrinciples to remember:

If one is trying to abandon Canadian residence, then ties to foreign jurisdiction relevant to establishing residence outside Canada – where there are limited ties to Canada then evidence of settled routine of life elsewhere is relevant.

BUT proof of residence elsewhere does not mean one is not resident in Canada (because one can be resident in more than one country)

o this word is considered superfluous – but it perhaps reinforces the notion that a temporary absence from Canada does not mean a loss of residence in Canada

if a taxpayer maintains ties to Canada then they will be considered to be ordinarily resident of Canada

Income Tax Folio S5-F1-C1 on Giving up Canadian Residence

paragraph 1.10 says that “unless an individual severs all significant residential ties with Canada upon leaving Canada, the individual will continue to be a factual resident of Canada…”

Date of Departure

• establishing date of departure (or end of residence in Canada) can be important for determining end of obligation to report world-wide income and for obligation to pay departure tax

Knowledge Objective: Sojourning for 183 Days

Contrast “sojourning” with “residence” noting the tax effect of sojourning for less than 183 days and the tax effect of sojourning for 183 days or more.

Sojourning Deemed Residence Rule

s. 250(1)(a) deems a person to be resident in Canada if the person “sojourns” in Canada for a period of 183 days or more “sojourn” per OED means a “temporary stay” ss. 250(1)(b)-(f) deem certain other persons to be resident in Canada including members of the armed forces and federal

and provincial servants stationed outside Canada

Meaning of Sojourn

The meaning of “sojourn” is something less than “residence” – you are present in Canada but on a more transient basis – you lack a settled him in Canada

Effect of Sojourning for > 182 days

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McFayden v RFacts: Engineer – spouse posted to Japan for 3-4 years, so they sold their house and two cars. He had no fixed plan to return to Canada - as he had found a job in Japan. He was not able to keep the job and couldn’t find a new job so he returned to Canada in Sept 1995. He had kept a house in Canada, maintained two joint bank accounts, maintained his professional membership, stored furniture items in Canada, retained a safety deposit box, retained RRSP and credit card, kept his driver’s license Held: taxpayer resident in Canada during those yearsPrinciple: ties to Canada during the three years were significant.

Nicholson v RFacts:

Recruited by the US corporation Newark = moved to UK (1995) Returns to Canada in 1996 – offered a position in Canada Separated form his wife in 1993 – his wife and kids remained in Canada he was still on joint title as security for equalization payment in division of property got 36-month work permit for U.K continue to use Ontario driver’s license until it expired kept bank account I Canada but opened one in England only one visit to Canada

Held: when he left he had no intention of returning to Canada except to visit friends and family – the settled nature of his life was in the UK – he was ordinarily resident there and his presence was not temporary.

per s. 250(1)(a): if you sojourn for more than 182 days then you are a resident of the country and taxed on world-wide income, presumably on the basis that a person who spends that much time in Canada should contribute to the services provided by the government

Comparison to Residence

• in Canada for <183 days does not mean one is not resident – can still be resident if one is in Canada for less than 183 days (e.g. Thomson was present in Canada for < 183 days but still found to be resident)

• physical presence not necessary to finding residence as per Russell case – but physical presence is necessary for sojourning – sojourning has no relevance for tax purposes unless it is for > 182 days

Knowledge Objective: Residence of Corporations

1. Identify the main common law test of residence for a corporation.

• The basic taxing provisions are ss. 2 & 3 – these refer to a tax on persons• under s. 248(1) – persons include corporations – and therefore you need to determine the residence of a corporation• tests developed by courts in the UK – were followed in Canada – and a corporation is resident “where the central

management and control actually resides”

Corporate Law Residence

it is the directors who manage the affairs of the corporation – thus the place of management and control (and thus the residence of the corporation) is where the directors meet

Residence of Controlling Shareholders

corporate law rule is that the directors manage the corporation and thus the residence of the share holders is normally irrelevant

sometimes a major shareholder may be able to exert significant control through the ability to elect (or remove) directors and thereby in the decisions of directors

Canadian cases have been unwilling to acknowledge de facto share holder control.

2. Identify the deemed residence test under the Income Tax Act.

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De Beers Consolidated Mines v HowerFacts:

corporation incorporated in South Africa head office in SA carried on mining business in SA majority of board of directors lived in England, met in England and managed all policy decisions in England

Held: the corporation was resident in England. Note: This was the case that first set out the test that a corporation was resident where its control and management resided.

Unit Construction Co v BullockFacts:

three corporations were incorporated in Kenya – carried on business in Kenya – directors resided and met in Kenya the three corporations were subsidiaries of an English corporation and were effectively controlled from England by the

directors of the parent corporationHeld: location of central management and control was a question of fact – the location of central management and control was England.

• Act has a deeming provision for residence of corporations – the residence of management and control test is too uncertain and makes it easy for corporations to change their residence by moving the residence of the management and control – this is particularly easy for the larger multinational corporations

ITA s. 250(4): Deems all corporations incorporated in Canada after April 26, 1965 to be resident in Canada

S. 250(4)(c): deals with corporations incorporated in Canada before April 26, 1965 – they are deemed to be residents in Canada if, at any time after April 26, 1965 they were (a) resident in Canada or (b) carried on business in Canada

thus most corporations incorporated in Canada will be resident in Canada corporations not incorporated in Canada will be resident in Canada if their management and control resides in Canada deemed residence of corporations provisions also make it possible for a corporation to be resident in more than one

country (e.g., controlled in U.S. but incorporated in Canada after April 26, 1965)

Skill Objectives: Residence of Corporations

Set out principles of residence for corporations citing relevant cases and provisions of the ITA and apply those principles to a particular fact pattern to determine whether a corporation is “resident” in Canada for the purposes of the ITA.

Knowledge Objective: Residence of Trust

Identify the main common law test of residence for a trust.

• CRA position “a trust resides where the management and control of the trust resides”• With individual trustees it will depend on the residence of the individual

Trustees Resident in Different Countries

• s. 104(1) – “ownership or control of the trust property” • if there is more than one trustee and the trustees reside in different countries, then which of the trustees owns or controls

the trust property? • trustees jointly own the trust property per law of trusts and, unless the trust instrument provides otherwise, the trustees

must act unanimously – thus no trustee, or even a majority of trustees, owns or controls the trust property• perhaps one could use the corporate law approach from the Bullock case and look to the residence of the de facto control

of the trust

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Thibodeau Family trust v The QueenFacts:

three trustees – two lived in Bermuda – third lived in Canada Minister assessed the trust as a Canadian resident – reason was that Canadian trustee was a member of the family for

whom the trust had been established – was chief executive officer of a corporation owned by the trust and was active and influential in the investment program of the trust

BUT the trust instrument allowed a majority of the trustees to make decisions binding on the trust – the day to day management was carried out in Bermuda by the Bermuda trustees and evidence that they did not always follow the wishes of the Canadian trustee

Meetings of the trustee held in BermudaHeld: the trust was resident in Bermuda, not Canada, because the trust decisions were, per the trust deed, to be made by a majority of the the trustees and 2/3 trustees resided in Bermuda.

• the trustees in Bermuda actually did control the trust because they held meetings in Bermuda, made decisions by majority, and did not always follow wishes of the Canadian trustee

Notes: “The [de facto central management and control test], in my view, cannot apply to trustees because trustees cannot delegate any of their authority to co-trustees. A trustee cannot adopt a ‘policy of masterly inactivity’ …”

Skill Objectives: Residence of Trusts

Set out principles of residence for trusts citing relevant law and apply those principles to a particular fact pattern to determine whether a trust is “resident” in Canada for the purposes of the ITA.

Relevant Provisions

s. 104(2) provides that a trust is deemed to be an individual s. 248(1) “individual” – defined to mean a person other than a corporation

o thus a trust is a person and a taxpayer per ss. 2 & 3 and need to act does not supply rules for determining residence of a trust

Knowledge Objectives: Change in Residence Status

1. Describe the relief provided to individuals who are resident for only part of the year and contrast residence for part of a year with sojourning in Canada for 183 days or more in a year.

Part-Year Resident

s. 114: corporations resident in Canada for part of the year are subject to tax on their world-wide income for the whole year – there is no relieving provision

for individuals resident in Canada for only part of the year s. 114 provides some relief from taxation on world-wide income for the whole year – income for the part of the year the individual was resident is world-wide income while income for the part of the year while not resident is “taxable income earned in Canada”

Problems with the application of s. 114

if you are a resident there is relief available under s.114 – which states that where a person is resident for less than the whole year- the person is only taxed on world-wide income for the part of the year the person was resident

however, where s. 250(1)(a) applies (that is sojourning for > 182 days) then you are deemed a resident for the whole year – thus. 114 relief does not apply and taxpayer is liable to pay tax on their world wide income for the whole year, even though they may have stayed in Canada for just over six months

the text says that s. 114 and s. 250(1)(a) [the sojourning rule] don’t interact well – the argument is that if one is sojourning in Canada for 183 days then one is taxed for the whole year on worldwide income but if one is resident for a 183 day period only in the year then one is taxed on one’s worldwide income for only roughly one-half a year

2. Describe the departure tax and explain the reason for it.

The Departure Tax• so-called “departure tax” is imposed by deeming a disposition of capital property on persons who give up Canadian

residence – on ceasing to be resident deemed to have disposed of property at fair market value immediately before ceasing to be resident – immediately before to ensure that accrued capital gains are recognized for tax purposes during the period of Canadian residence

Purpose of the Departure Tax• purpose is to tax accumulated capital gains when person departs since after departure it can be difficult to tax the capital

gain on a person outside the country

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Garon v the Queen Principle : held that test of residence of a trust should be determined by the principle that a trust resides for the purposes of the Act where, borrowing the language from De Beers, “its real business is carried on” and saying that that “is where the central management and control of the trust actually takes place”

Some Property is Excluded• but excluded deemed disposition of property that was taxable Canadian property – taxable Canadian property defined in s.

115(1)(b) is property that has a reasonably permanent connection to Canada and where the collection of the tax is administratively feasible – i.e., we don’t need to collect the tax on this kind of property on departure because we can collect it later

Amendments changes made for emigration after October 1, 1996 there was an amendment to redefine the kinds of property that are excluded from deemed disposition – there is no longer

a reference to taxable Canadian property – instead there are specific items set out that are excluded from the deemed disposition. These items do not include shares of non-listed Canadian corporations

Exceptions Include real property in Canada capital property used in a business in Canada rights to receive payments from an RRSP, reg. pension plan, the CPP and other pension plans no deemed disposition for residents who were resident for 60 months or less during the previous ten years for any property

they owned when they became resident and any property acquired by bequest or inheritance

if a person returns to Canada within 60 months an election can be made to undo the earlier deemed disposition for property that is still owned by individual on the individual’s return

Immigration to Canada s. 128.1(1) deems immigrants to have disposed of their properties (except taxable Canadian properties) immediately before

arrival and to have reacquired the properties at a cost equal to the fair market value – this limits a subsequent capital gains tax on disposition to the capital gains accrued while in Canada

Skill Objective

Be able to assess whether the part time residence and departure tax provisions would apply in a given fact pattern citing relevant authority.

Skill Objective: Tax Treaties

Be able to assess when tax treaty tie-breaker rules may need to applied and be able to apply the typical tax treaty tie-breaker rules.

There is the ability for a person to be found to be a resident in Canada and another country. This typically occurs when:

an individual is resident in a foreign country but also deemed to be a resident under s. 250(1)(a) [183 days sojourning] individual found to be resident in Canada and also another country corporation incorporated in Canada after April 26, 1965 – is found to have its management and control in another country

The tie-breaker rules in treaties serve to address this issue:

place of permanent home center of vital interests (where the person’s personal and economic relations are closest) habitual abode nationality mutual agreement

In regards to corporations, the tie-breaker rules typically refer to the place of management and control, the place of incorporation, or mutual agreement or taxing authorities – the Canada-US treaty says tie-breaker is where the corporation was incorporated then

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by mutual agreement – Canada – UK treaty says that we must look to the lace of management and control and then by mutual agreement.

Knowledge Objective: Tax Treaties

Be able to explain why the Act deems persons not to be resident where they are not resident pursuant to a tax treaty.

s. 250(5) makes it clear that where a person would otherwise be resident in Canada, but they are deemed not to be a resident by virtue of the tax treaty, then they are not resident in Canada for the purposes of the ITA

• this allows them to be subject to the deemed disposition departure tax and to have payments made to them that are subject to part XIII withholding tax.

Knowledge Objective: Be able to describe in general terms how the allocation of provincial tax is determined for individuals and corporations.

Reg 2601: provides that for an INDIVIDUAL, the province in which the individual was resident on the last day of the taxation year is entitled to tax the individual on the individual’s entire income for the taxation year

• individuals with business income: where the individual has a business with a permanent establishment outside the province, on the last day of the taxation year – the income from that business is attributed to the province where the permanent establishment is located

o if there is more than one permanent establishment (province-wise), then reg. 2603 provides rules for apportioning the income between provinces

Reg 2607: where the individual is a resident in more than one province on the last day of the taxation year, the individual is to be deemed to have resided on that day, only in the province which may reasonably regarded as his principal place of residence.

Reg. 402 (Corporations): allocates the income to the province in which the corporation had a permanent establishment in the taxation year – where it had a permanent establishment in more than one province, then there are rules for apportioning the income between provinces.

Trusts: the regulations do not provide for trust residence allocation between provinces but trusts are treated as individuals by s. 104(2) thus the rules re: individuals are applicable.

Skill Objective

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Mandrusiak v the Queen (British Columbia)Facts:

Mandrusiak was originally a resident of Alberta but moved to BC, at behest of his employer. He maintained a home in BC and Alberta Performed consultant work for employer in BC in 2000 (110 days), 2001 (4.5 days), and 2002 (0 days) Also maintained a farm in Alberta Assessed as a resident in BC for those years – arguing he was principally resident of BC M appealed

Issue: while Mandrusiak was resident in both B.C. and Alberta, question was where he was principally resident per BC ITA and Fed. ITA Reg. 2607Held: M was principally resident in Alberta. Factors that were considered:

(a) Maintained an Alberta’s driver’s license(b) Spent Christmas and new years eve with family in Alberta(c) Chief source of income was farming in Alberta(d) Family located in Alberta(e) Overall his social contacts in Alberta were stronger

Be able to assess in which of two provinces a person is subject to provincial tax citing relevant authority.

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CHAPTER 4: CONCEPT OF INCOME

The concept of income is important in determining the tax base. It is important in terms of calculating income and for determining and measuring one’s ability to pay.

Knowledge Objective: Haig-Simons Theory

Briefly describe the Haig-Simons definition of income.

Haig’s Definition• “the money value of the accretion to one’s economic power between two points of time” • per this approach, any accretion to wealth counts as income – regardless of the source

Simon’s version• “Personal income may be defined as the algebraic sum of

o (1) the market value of rights exercised in consumption and o (2) the change in the value of the store of property rights between the beginning and the end of the period in

question.” • This explicitly includes consumption

Knowledge Objective: Carter Commission Definition

 Briefly describe the Carter Commission definition of income.

Carter Commission restated this as:

• “The comprehensive tax base has been defined as the sum of the market value of the goods and services consumed or given away in the taxation year by the tax unit [the taxpayer], plus the annual change in the market value of the assets held by the unit.”

• This means that income equals consumption (including gifts given) plus gain in net worth over the taxation year. • can include payments for salary, wages, business income or property income, capital gains from the sale of property, or

transfers such as gifts, inheritances, gambling winnings or the products of one’s own labour (e.g., vegetable gardens or car repair)

• includes realized or accrued gains and gains in cash or in kindo overall this approach to income would provide a better measure of ability to pay

Knowledge Objective: The ITA

 Explain how the ITA deals with definition of income

• “Income” is not defined in the Act• income is not a straight forward term – much of the act deals with the question of what constitutes income for the

purposes of the Acto currently the tax base in the Act includes rule concerning the measurement of income, inclusions, exemptions and

deductions • section 3(a): income from sources listed in 3(a) include four sources: office, employment, business or property however the

sources are “without restricting the generality of the foregoing: so this means that it could extend beyond the four listed sources – but for it to be income, it must have a source.

• S. 3(b): deals with capital gains• S. 3(d): these might not be considered incomes from a source but are included for policy reasons (incomes that increase

ability to pay and so should be included in terms of equity)

Summary

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(i) ITA does not specifically define “income”(ii) but it does indicate that one should include all incomes generated by sources including (but not limited to) income from an office, employment, business or property(iii) the Act then contains specific rules for the calculation of income from these sources(iv) it treats capital gains separately since they involve not income from a source but the disposition of a source(v) the Act adds other types of income (s. 56) that Parliament has decided to tax that might not be generated from a “source” and thus might not fall in s. 3(a)(vi) income is a net concept – net of expenses incurred in the generation of that income

Knowledge Objective: Source Theory

Explain the source theory of income in terms of the tree/fruit analogy and note and explain three possible origins of the source theory of income.

The judicial approach to income from a source is based on the notion that there is a source of income.

Fruit – Tree Analogy: Tree as the source (or capital from which income is produced) The fruit is the income Increases in value of the tree are still capital and not income

Knowledge Objective: The Surrogatum Principle

Explain the “surrogatum” principle”

The surrogatum principles states that “a person who suffers harm caused by another may seek compensation for (a) loss of income; (b) expenses incurred; (c) property destroyed; or (d) personal injury – as well as punitive damages.

For tax purposes, damages or compensation received either pursuant to a court judgment or an out-of-court settlement, may be considered as on account of income, capital, or windfall to the recipient.

The nature of the injury or harm for which compensation is made generally determines the tax consequences or damages.

Surrogatum Principle Where, pursuant to a legal right, a trade receives from another person, compensation for the trader’s failure to receive a sum of money which, if it had been received, would have been credited to the amount of profits (if any) arising in any year form the trade carried on by him at the time when the compensation is so received, the compensation is to be treated for income tax purposes in the same way as the sum of money would have been treated if it had been received instead of the compensation.

Generally Compensation for loss of income is taxed as income Payment for loss of capital is treated on account of capital

London and Thames Haven Oil Wharves Ltd v AttwoollHeld

Lord Diplock spoke of compensation for a lost source of income as being income I.e. the compensation is a surrogate (substitute) for the lost income from the sale of goods

Tsiaprailis [2005]Facts

Taxpayer injured in a car accident. As a result, she received disability payments under employer’s disability insurance policy.

Insurer initially made payments (1985 – 1993) but then stopped alleging Tsiapralis was not entitled to them. Tsiapralis sued.

Eventually the insurer entered into a settlement paying a lumps um of $105,000 – this included:(i) Amount to compensate for previous payments the insurer had not made(ii) Amount to compensate for future payments that insurer might have been obliged to make in future years; and

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(iii) Amount to cover her legal costs, disbursements and GSTHeld

The payment was taxable.

TEST FOR SURROGATUM PRINCIPLE (London and Thames Haven Oil Wharves)

[1] “what was the payment intended to replace?”If the answer is sufficiently clear, then

[2] would the replaced amount have been taxable in the recipient’s hands?

Knowledge Objective: Enumerated Sources

Identify the enumerated sources of income in Section 3 of the Income Tax Act

The Act contains no comprehensive definition of income. Section 3 comes the closet and simply refers to “income form a source inside or outside Canada”.

The act specifically deals with income from office, employment, business or property. Courts have been reluctant to expand this, they instead tend to try to fit income into one of the enumerated sources

because then the Act provides a set of rules for determination of income from each of the sources.

Knowledge Objective: Unenumerated Sources

1. Briefly explain why unenumerated sources of income are still possible under Part I of the Income Tax Act

Section 3(a) says that “without restricting the generality of the foregoing” and s. 56 says that other sources of income listed there do not restrict the generality of s. 3.

This means that the Act is not limited in terms of the potential sources of income However, courts have been reluctant to extend the sources beyond those specifically listed in the Act

2. Explain, in terms of the approach to income in the Income Tax Act, why courts may have had a tendency to stick with the enumerated sources of income in the Act

Skill Objective: Unenumerated Objectives

Using the cases below, demonstrate the reluctance of courts find unenumerated sources of income

Canada v FriesFacts

Fries was an employee of the Saskatchewan Liquor Board and a member of the Saskatchewan Government Emplyoee’s Union

Went on strike and received strike pay equal in amount to his normal net take home. Held

Strike pay is NOT ‘income from a source’ per s. 3 (employment, property, business) Court is hesitant to add it as income form another unenumerated source

Schwartz v CanadaFacts

Taxpayer agreed to take senior position with Dynacare under written employment contract. Before the employment commenced Dynacare advised that Schwartz’s services would not be needed. Taxpayer accepted a lump sum payment of $360,000 plus $40,000 in legal costs. Minister included the compensation as a retiring allowance

Key Points1. explicit recognition of unenumerated sources2. payment of damages for breach of contract was not income from a source caught by the Act

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Held Majority agreed that s 3(a) list of sources is not exhaustive – unenumerated sources are included Payment of damages for breach of contract is NOT taxable The payment is not income from an enumerated source of employment – it is a non taxable windfall. However, did agree that office, employment and business, property are not the only sources of income.

Fortino v the QueenFacts

Taxpayers sold shares in Fortino’s Supermarket Ltd to Loblaws and entered into non-competition agreement restricting taxpayers from competing with Loblaws within a specified area for five years.

Minister initially assessed the payment for the NCA as payment of the shares – minister argued it was income from an independent source.

Held Non-compete payments received under a restrictive covenant undertaken on the sale of a business did not constitute

income from a source. There were not included as income in this case per s. 3(a) because payments for covenants were specifically dealt with

under s. 42 and this was not covered there. Including under general words of s. 3(a) would amount to an implicit overruling of s. 42 limits

Manrell v the QueenFacts

Manrell was ¼ shareholders who sold shares in companies that produce plastic bottles and caps Sellers entered into non-competition agreement Payment for noncompetition was approx. $4 million. Manrell argued that property should be given its common law meaning under which his right to compete was not

property so he had not disposed of property giving rise to capital gains. Held

Since property under s. 248(1) of the Act was defined as “property of any kind whatsoever…”. The meaning of “property” was not limited to the common law meaning

S. 248(1) means property of any kind whatsoever – brings within the statutory definition everything that is within the broadest ordinary meaning of the word “property” – nothing in that stat. definition requires a non-exclusive, commonly held right to carry on a business to be treated as “property” for income tax purposes.

Taxable as capital gains.

Skill Objective: Characteristics of Income from a Source

Apply the cases discussed below to assess whether a particular item may, or may not, be considered “income from a source.”

Test for Income from A Source

[1] Decision: the payment was unusual and unexpected – not the kind that one could set out to earn as income from shares[2] List of Criteria: the court set out a list of indicia that could be applied in assessing whether a receipt constitutes income from a source; (Cranswick)

The taxpayer has no enforceable claim to the payment There was no organized effort on the part of the taxpayer to receive payment The payment was not sought after or solicited by the taxpayer in any manner The payment was not expected by the taxpayer either specifically (i.e. in specific circumstances) or customarily (people

would not normally expect this in similar circumstances) The payment had no foreseeable element of recurrence The payor was not a customary source of income to the taxpayer The payment was not in consideration for or in recognition of property, services or anything else provided or to be provided

by the taxpayer, or was not earned by the taxpayer either as a result of any activity or pursuit of gain carried on by the taxpayer

In the case of business or property there is a pursuit of profIt (Stewart) Productive source (Bellingham)

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R v CranswickFacts

Canadian corporation has American parent corporation that owned less than 100% of the shares of the Canadian corporation

This caused the Canadian corporation to sell its assets for less than their book value to another subsidiary Canadian corporation for $6mil. Less than fair market value

Payment made by American parent corporation to minority shareholders to discourage the shareholders from pursuing possible litigation against American parent corporation

Respondent taxpayer received 2,144 – testified that the payment came as a huge surprise. Held[1] Decision: the payment was unusual and unexpected – not the kind that one could set out to earn as income from shares[2] List of Criteria: the court set out a list of indicia that could be applied in assessing whether a receipt constitutes income from a source; (Cranswick)

The taxpayer has no enforceable claim to the payment There was no organized effort on the part of the taxpayer to receive payment The payment was not sought after or solicited by the taxpayer in any manner The payment was not expected by the taxpayer either specifically (i.e. in specific circumstances) or customarily (people

would not normally expect this in similar circumstances) The payment had no foreseeable element of recurrence The payor was not a customary source of income to the taxpayer The payment was not in consideration for or in recognition of property, services or anything else provided or to be

provided by the taxpayer, or was not earned by the taxpayer either as a result of any activity or pursuit of gain carried on by the taxpayer

In the case of business or property there is a pursuit of profIt (Stewart) Productive source (Bellingham)

Bellingham v R [1996]Facts

Taxpayer’s land expropriated by the Town. Town makes expropriation offer which is challenged by taxpayer. The challenge is made to the Land Compensation Board. The Board makes an award of almost six times what the town offered. Subsequent litigation over award by the Board resulted in taxpayer accepting settlement offer by town.

Held Proceeds of disposition are income The interest given, arising form the legislation that required such interest to be charged to discourage town from

behaviour of giving a clearly lower award of compensation than it should have, it tantamount to punitive damages. It is NOT income under s. 9(1) nor is it income under s. 3(a)

Ratio:Income stems from a “productive source” (a source capable of producing income) and a punitive damage award is not a productive source.

Stewart v The Queen (2002)Principle:Source is not defined and so it is left to the courts to determine the nature and scope of various sources of income in the Act

It is a source if there is a pursuit of profit

Knowledge Objective: Capital Gains

Explain the Carter Commission’s recommended approach to capital gains

The Carter Commission wanted to include capital gains because it increases wealth and thus the ability to pay. Capital gains are a small part of low-income taxpayers and a large part of high-income individuals.

Ultimately only taxed at 50% of capital gains.

Knowledge Objective: Statutory Inclusions and Exemptions

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Indicate the inclusion of other specific items as income pursuant to the Income Tax Act and explain, in general terms, why there are such specific inclusions

Other items are specifically included in s. 56 where it may not be clear that they come from a source but it is felt that the items should be included.

S. 56: items which are under this section are arguably justified as inclusion since they are amounts that would increase a person’s ability to pay and thus should included for equity reasons.

Knowledge Objective: Gifts and Inheritances

Describe and explain the Carter Commissions’ recommended approach to gifts and inheritances.

Gifts and inheritances increase economic power or wealth and thus should be included for the purposes of measuring one’s ability to pay.

Also higher income individuals tend to receive greater proportion of gifts and inheritances and thus including them would increase progressivity

Gift and inheritances are not taxed

Knowledge Objective: Windfalls

Describe and explain the Carter Commission’s recommended approach to windfalls.

Windfalls would increase the ability to pay. CC wanted to include them but then the issue was whether gambling losses should be deducted and the CC suggested only out of gambling winnings.

Windfalls are not taxed. They are something which is unexpected, un planned and not recurring in nature. It could be income from a source if there is an organized activity that could lead to an expectation of getting a net gain from

the activity. Consider the Queen v Cranswick test

Knowledge Objective: Damages and Settlements

1. Explain the general approach to inclusion of damages or settlements in income

Damages and settlements can replace lost income from a source – therefore you apply the surrogatum principles.

[1] “what was the payment intended to replace?”If the answer is sufficiently clear, then

[2] would the replaced amount have been taxable in the recipient’s hands?Consider:

Enumerated sources Added items in subdivision d (i.e. s 56)

Consider whether the replaced amount would have been from an unenumerated source

2. what is the approach to an expectation-based damages award for lost profits

Expectation Damages: put the person in the position he or should have been in had the promise been fulfilled Expectation damages or settlements would increase one’s ability to pay (i.e. it is the replacement of an expected gain) so

should be taxed

3. What is the approach to a reliance-based damage award?

Reliance Damages: put the person in the position he would have been in but for the act of the defendant Reliance damages generally just restore a person to the position they were in before so there is no increase in the persons’

wealth/ability to pay - and should not be included in income

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4. What is the approach to personal injury award for (i) cost of care; (ii) compensation for lost earning capacity; (iii) punitive damages

Cost of Care: not a source, getting someone to injure you to make a gain is not something you set out to do in an organized way. Not a gain since it just restored you to the prior position before cost incurred due to the negligence.

Compensation for Lost Earning Capacity: taxpayer gets the lump sum to replace lost income between the date of jury and the date of trial and is NOT taxed on it (Cirella v The Queen)

Punitive Damages: not considered to be an income from source under s. 3(a) – see Bellingham

Knowledge Objective: Imputed Income

Describe and explain the Carter Commission’s recommended approach to imputed income from property and from services

The benefit received from personal services or from your own property does increase one’s wealth and thus one’s ability to pay. However, CC recommended that it NOT be taxed because there would be practical difficulties.

Computing income from services (home made clothes) and own property would have too many administrative difficulties.

Knowledge Objective: Illegal Income

Describe and explain the Carter Commission’s recommended approach to illegal income

The case law says that it is taxable i.e. income from stealing, embezzlement, etc. There is concern that the person already pays for crime through fines and imprisonment and that the government is

benefitting from a criminal act However, the government is not a party to the criminal act and taxing illegal income removes disparity of income for legal

activities taxed while income from illegal activities not taxed

Buckman v CanadaFacts:

Solicitor used money in client trust accounts for his own use Solicitor paid interest to the clients The minister treated the misappropriated trust funds as income form business and allowed solicitor to deduct the

interest payments to client Trustee said that they shouldn’t be treated as income from business and therefore tax should not have been paid on

these amountsHeld

Derived from income – thus taxable It was to be included as income because it was derived by the solicitor through his business.

The Queen v Poynton Facts:

The taxpayer was a director and secretary-treasurer of a contracting company and in charge of the company’s financial operations

Fraudulently obtained 21,000 of company funds by having subcontractors submit invoices for fictitious work and also of the company to be invoiced for work don on his own home

He did not report the fraudulently obtained income on his ta returns for 1966 and ‘67Held

The amounts were “income” under the act The amounts came to him “in respect of, or by virtue of, his office or employment” It was a material acquisition that conferred an economic benefit on him and it came to him by virtue of his position with

the company

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Eldridge Facts: Ran a call-girl businessHeld: held to be income from business

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CHAPTER 5: INCOME FROM EMPLOYMENT

Legislative Scheme

S. 3(a) income from office or employment specifically included S. 5 basic inclusion S. 6 and 7 include other benefits from employment S. 8 sets out permitted deductions

Knowledge Objective

Describe four distinctions under the Income Tax Act between the treatment of income from employment and the treatment of income from business.

There are several distinctions between income from employment and income from business under the ITA

(1) Employment is calculated on a calendar yearly basis (as opposed to business income which is calculated on a fiscal basis)(2) Tax on your employment income is withheld at the source – from you pay cheque (as opposed to business income where

there are payments of quarterly installments on an estimate of tax payable) (3) Income is taxed on a cash basis (when it is received) rather than on an accrual basis (which is where for businesses or

property income – it is when the income is earned, regardless of when it has been received)(4) Deductions are tightly controlled on employment income – s. 8(2) prohibits deductions unless specifically provided for

(versus business or property where deductions are more open ended)

Knowledge Objective: Policy

Identify and explain policy considerations that influence (i) the taxation of benefits with respect to employment, and

Tax Base Protection

Tax on employment income is the largest source of revenue for the government. A small leak may have significant revenue consequences especially re benefits. There would be a significant loss of revenue if employers and employees could convert payments into non-taxable benefits.

This would allow the employer to pay a lower amount since it would result in the same net of tax benefit to the employee – the employee is receiving the same “amount” but the employer is only being taxed on the income, not the income that has been shifted to non-taxable benefits.

Neutrality

The incentive to shift to non-taxable benefits would be contrary to neutrality

Equity

Horizontal Equity: If employers are able to shift to non-taxable benefits – persons getting paid the same amount for work done would be getting different net taxa mounts if one employee gets more non-taxable benefits then the other.

Vertical Equity: high income (senior) employees are paid more of their remuneration in the form of non-taxable benefits

(ii) the limits on deductions for income from employment.

Administrative Efficiency

Deductions are tightly controlled due to

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(a) the administrative cost of compliance to taxpayers (having to keep many receipts) (b) administrative cost of CRA to double check all the expenses and dealing with receipts(c) lost revenue due to excessive expense deductions (d) may be difficult to value some benefits

Social Policy

Important source of income – and is useful instrument for government social policies because it is influential there are deductions under s. 8 for policy reasons – e.g. deduction of clergy residence expenses; musician deduction of cost

of instruments; artist expenses

Balancing Policy Concerns

Gifford v R• Gifford would have been able to take deductions if carrying on a business but as an employee he was not allowed to deduct

the interest expense and was not allowed to add ¾ of the $100,000 to a cumulative eligible capital account and deduct 7% thereafter

Knowledge Objective: Office or Employment

(i) Explain the is the distinction between an “office” and “employment”.

ITA ss. 5(1), 248(1) “office,” “employment”

• s. 5(1) provides that:“Subject to this Part, a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year.”

S. 248(1 ) “office” – position of an individual entitling individual to a fixed or ascertainable stipend or remunerationo also defined to include e.g., judicial office, Minister, member of Senate, House of Commons, or a legislative

assembly … or “any other office, the incumbent of which is … elected or appointed in a representative capacity”

s. 248(1) “employment” – position of an individual in the service of some other person … s. 5(1) refers to a tax payer – and can include a corporation: office and employment both use the world individual so

s. 5(1) only applies to individuals, not corporations

The distinction between these two. Office involves a “fixed or ascertainable stipend or remuneration” however employment usually involves that too The key difference is the phrase in the service of some other person – there must be a contract of service

(ii) Explain why the distinction between an “office” and “employment” is not that significant under the Income Tax Act.

The distinction is not that importance since subdivision A lumps income from office and employment together and applies the same set of rules to each

definitions and distinction important in distinguishing income from “office or employment” from income “business or property” – different set of rules for income from business or property

Knowledge Objective: Employment and Business

Identify and explain five tests that have been used in the assessment of whether a person is an employee or an independent contractor.

Skill Objective

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Analyze, in a given fact pattern, citing relevant authority, whether a person is an employee or an independent contractor.

The basic concept of the distinction between employment and business. The distinction is between contract of service and contract for services (person not an employee but an independent contractor).

In the context of tax, the person who is in contract of service receives income from employment where as the person having contract for services receives business income

Key to distinction – s. 248(1) “employment” in the service of some other person

Case Law

Test 1 Sagaz The Control Test

This is known as the “control tests” and is looks at the degree of control that the entity has over the work that is to be performed by the worker and the manner of work.

If the employer has a right of power to control the work and the manner of doing the work, this would indicate that the worker is an employee. Examples of this are:

Specifying the hours of work Where the work will be done Providing the place of work or any required equipment etc.

If, on the other hand, the worker works independently, free of control and merely undertakes to produce a specified result, this would indicate that the worker is an independent contractor.

The difference is that in (a) contract for service – employee: the employer has a good deal of control: the employer has the power to specify not only the result to be accomplished by the employee, but also the manner o doing the work, where as in (b) contract for services – the employer will specify the result to be accomplished by the independent contactor but it will be left to the independent contractor to determine the manner to achieve the result.

The SCC held that the test is “control test” plus non-exhaustive list of factors:

(i) whether worker provides own equipment;(ii) whether the worker hires his or her own helpers;(iii) the degree of financial risk taken by the worker;(iv) the degree of responsibility for investment and management held by the worker; and(v) the worker’s opportunity for profit in the performance of his or her tasks

BUT post-Sagaz is an FCA case Wolf stated that factors developed in case law are still valid – so the older tests of Wiebe Door are relevant

Wiebe Door provided a range of tests (4) that provide a framework for analyzing the “non-exhaustive list of factors” that the SCC referred to in Sagaz

And then stated that one must look at the total relationship

However, case law has stated that Pletch v Rwe must consider other factors when the control test does not yield clear results.

Royal Winnipeg Ballet: found that the control test was not decisive.

Wiebe Door 4 Tests

• The Weibe door case discussed a range of tests that provide more of a framework for analyzing the “non-exhaustive list of factors that are referred to in Sagaz. Weib Door canvased four tests and then finished my saying one must look at the “total relationship.”

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Test 1: The Control Test

Looks at degree of control possessed by employer over work to be performed Contract of service employer has significant degree of control

o He specifies result of work to be done and in what manner it is to be done Example: start and stop times, equipment to be used and employees who will assist in the work

Independent Contractor - Person engaging services will not determine hours of work, equipment to be used or persons who will assist in completing the work – this is left to the discretion of the contractor

Test 2: The Integration Test

Asks whether person whose status is at issue is “an integral part of employer’s business” Ask whether “the employer’s alleged business could survive without engagement by person who has engaged

worker’s services” I.e. economically dependent on employer’s business

Test 3: The Economic Reality test, and

Whether there is a chance of profit or risk of loss; look to ownership of tools

Control Ownership of tools Risk of loss Chance of profit

All indicate – less likely to be an employee

Test 4: The Specified Result Test

Whether person has:o (i) placed his or her services at the disposal of the person engaging the services for a period of time; ando (ii) without reference to a specified result

employeeo versus specified result to be produced by an independent contractor who devotes time to the project as the

independent contractor determines should be devoted to the project

Test 5: Total Relationship Test

none of the tests are decisive so look at all the tests “examining the whole of the various elements which constitutes the relationship between the parties”

Skill Objective: Employment and Business

Analyze, in a given fact pattern, citing relevant authority, whether a person is an employee or an independent contractor.

Pletch v R (2005), 2006 D.T.C. 2065 (T.C.C.)Facts:

• Pletch Co owned by Mr. Pletch and his wife – Corp. formed to carry on operations previously carried on personally by Mr. Pletch

• Pletch was also an employee of Armor Elevator• Later he joined Northern Elevator which was taken over by Thyssen elevator Ltd. Agreement with Thyssen that T

would K with WB Pletch to obtain the services of Mr. Pletch• Mr. P was also the president of Thyssen – received general instructions but otherwise made all decisions concerning the

business of Thyssen – chose his own hours• Thyssen paid Pletch Co for Pletch’s services and Pletch go claimed the small business deduction

Issue: the Act does not allow for small business deduction where the business is a “personal services business”

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s. 125(7): Personal Services Business define:“a business of providing services where (a) an individual who performs services on behalf of the corporation (in this definition and paragraph 18(1)(p) referred to as an “incorporated employee”), or (b) any person related to the incorporated employeeis a specified shareholder of the corporation and the incorporated employee would reasonably be regarded as an officer or employee of the person or partnership to whom or to which the services were provided but for the existence of the corporation, …” Issue: is the individual (Mr. Pletch) performing the services regarded as an officer or employee, and not an independent contractor? If so then the business is a personal services business. Held: there was a problem with the degree of control Mr. Pletch had. In spite of the finding on the control test, Mr. Pletch was not an independent contractor.

Royal Winnipeg Ballet v RPrinciple:

(1) Always need to be interpreting a contract to examine the intent of the parties – so intent is relative but not determinative – it is simply a factor to be taken into account.

(2) If other tests not determinative then the intention of the parties, borne out by the nature of the legal relationship, determines the outcome

Application: in this case, they were intended to be contractors, not employees, so they wereWhat must first be considered is whether there is a mutual understanding or common intention between the parties regarding their relationship but this does not mean that the parties’ statements as to what they intended to must result in a finding that their intention has been realized.

1392644 Ontario v. MNR “The Connor Homes” case• Facts: 1392644 Ontario Inc. operating as Connor Homes• workers were care givers at foster homes and group homes providing care for children with behavioural or development

disorders• contract said the care givers were independent contractors • worked for hourly rate at places they were sent to by Connor Homes• Tax Court of Canada judge said the care givers were employees• Connor Homes said TCC judge erred by “not considering and misapplying the test to determine whether a worker is an

employee or an independent contractor, particularly by not giving proper weight to the intention of the parties as expressed in the contracts they signed”

Principle: You must:

(1) First look to parties’ expressed intention; and THEN(2) Test whether the intention fits with the objective evidence using the control plus of Sagaz, or similarly, the “total

relationship” four part subtest (control, integration, economic reality, and specified result tests) form Wiebe Door

Knowledge Objective: Incorporated Employees

Identify and describe potential tax advantages to an employer and an employee, were it not for anti-avoidance provisions in the Income Tax Act, from having the employer contract with an employee’s corporation for services rather than contracting with the employee directly.

Temptation: There is different treatment of employment income – there is temptation for employees to form corporations to provide services because it will be business income not employment income

Benefits to Employee and Employer: (i) employee corporation (if made) would be able to deduct a broader range of expenses incurred in their business income (ii) employee corporation could qualify for small business deductions (iiI) capital gains exemption for shares of a small business corporation (iv) employee corporation could be used to split income among family members by using shares to family members and by having family members provide services to the employee corporation (

Benefits to Former Employer: (i) former employer no longer has to do withholding of income tax from employee – administration of which can be costly to the employer (ii) employer no longer has to pay payroll taxes such as CPP and EI

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Knowledge Objective: Timing

(i) Explain how the provisions of the Income Tax Act treat income from employment on a cash basis.

S. 5(1) : Income from an office or employment must be received by the taxpayer in the year S. 6 and 7 : Benefits are to be included in income when received S. 8 : Deductions should be claimed when paid

o Therefore, the Act provides for “cash basis” treatment of income from employment You include amounts in income when you actually receive the cash Deductions can only be made when you actually pay out cash (or its equivalent) to cover a deductible

expenseReceived

Per s. 248(&): The day items were mailed Earned in year 1 but not received until year 2 – the pay will be taxed in year 2

Income Earned in Year but Paid in Subsequent Year If payment earned in year 1 but not received until year 2 – the payment will be taxed in the year that it is received

Advance of Income Opposite is true of advancement of income – if payment is made on December 15th of year 1 for work to be done over

the period from Dec 16th to Jan 15th (yr. 2) – then the payment would have to be included in income yr. 1, even though it covers in party income from Jan yr. 2.

more common – employee struggling with a cash shortfall asks employer for advance payment – in Dec. yr. 1 employee asks employer if the employer could please provide Jan. paycheque in advance (i.e., in Dec., yr. 1)

payment would have to be included in yr. 1 income even though income not actually “earned” until year two when employee actually did work to earn the income

might be better if employee asked employer for a loan until January of year two (although have to be careful about interest since interest-free, or low-interest, loan will likely be treated as a benefit in respect of employment)

Contrast with Income from Business cash basis for employment income different from normal accrual basis for income from business therefore, the employer may record expense in year (accrued due or “owing”) even though employee not paid until the

next year – while employee would record as income in year receivedo e.g., payment on 15th of every month – employer could make deduction for payroll in yr. 1 for amount due to

employee for work done from Dec. 16th to Dec. 31st yr. 1 – employee would not include that amount in income until yr. 2 when employee actually receives payment (Jan. 15, yr. 2

in example of retroactive pay increase, employer would take payroll deduction in yr. 1 for amount of retroactive pay increase that related to Dec. yr. 1

Long Delay of Payment difference in treatment creates potential opportunity for employer and employee to avoid tax (though it would take

employee who could accept long deferral of payment or setting up of a loan) employer could deduct the payroll expense because it can make deduction when employment income has been

“earned” (i.e., work has been done) but make deal with employee that payment does not have to be made for a long time (say two years) then employer has been able to deduct reducing employer’s taxes but employee does not have to include in income until payment made and therefore does not pay tax on amount until two years later when amount is paid

but s. 78(4) deals with this by requiring any remuneration deducted by employer that remains unpaid for 180 days after year-end must be added back to employer’s income – result is that employer will pay before 180 days of year-end

(ii) Explain the concept of “constructive receipt”

Where an employee has an accretion to wealth by i.e. when an employee has his roof fixed instead of being paid directly – this is saying that the employee has “constructively received” the income

constructive receipt “applies only when a payment has been made by a payor to a party who is not the payee, but was made for the benefit of the payee in satisfaction of an obligation contracted by him.”

if money paid out by an employer to a third party for the benefit of a taxpayer then the payment constitutes constructive receipt in the hands of the taxpayer

Markman v. M.N.R., [1989] 1 C.T.C. 2381, 89 D.T.C. 253 (T.C.C.)48

Facts: • taxpayer got back pay awarded effective Apr. 1, 1985 but not paid until Jan. 2, 1986 despite intention of employer to pay

it sooner• taxpayer wanted to include it in 1985 tax return (apparently better for taxpayer in this situation) [i.e., argument that

since the employer intended to pay it in 1985 employee had “constructively received” it]Principle:

(1) Constructive receipt applies only when a payment has been made by a payor to a party who is NOT the payee – but was made for the benefit of the payee in satisfaction of an obligation

Held: Employer did not pay a third party on behalf of employee – paid the employee at a later did, thus the payment was not “constructively” received.

Blenkarn v. M.N.R. (1963), 32 Tax A.B.C. 321 (T.A.B.)Facts:

• employee was paid a portion of 1960 wages in 1961 – but payment available to employee in 1960 and he had voluntarily chosen not to requisition a cheque to which he was entitled (employee was the paymaster)

Held: payment was received as soon as he had an unconditional right to be paid. Note: if employee was entitled to be paid for work done in December on Dec. 31st yr. 1 but instructed employer not to pay amount until Jan. yr. 2, employee would be considered to have “constructively received” the amount in yr. 1

Skill Objective: Timing

Be able to determine, in a given fact pattern, citing relevant authority, whether a particular amount is to be included as income from employment at a particular time.

Vegso v. M.N.R., (1956) 14 Tax A.B.C. 451 (T.A.B.)Facts:

• A father employed his daughter to work on his father’s tobacco farm fro $800 per year (roughly 8,000 + in 2016)• Daughter was entitled to be paid only $100 per year – the arrangement was that she was entitled to the balance when

she was married• Daughter did eventually marry and got $8,262 of employment income at that time• Minister assessed entire sum as income for the year

Held: As income from employment – it was thus taxable in year of receipt and not in years in which it had been earned.

Jean-Paul Morin v. The Queen (1974), 75 D.T.C. 5061 (Fed. T.D.)Facts:

• taxpayer says he did not receive the $16,268.00 from employer (Government of Quebec) he was taxed on since employer deducted $1,628.15 in taxes so he never actually received the $16,268.00 but only received $14,639.85

Held: it is not necessary for employee to “actually touch or feel it, or to have it in his bank account”. Receive means to get or to derive benefit from something, to enjoy its advantages without necessarily having it in one’s hands.

Knowledge Objective: Salary, Wages and Other Remuneration

(i) Describe the distinction between salary and wages in common parlance and the significance of the distinction in the Income Tax Act.

These two terms are not defined in the ITA but common parlance says that ITA ss. 5(1) brings in:

Salary: usually is computed on longer periods such as a year Wages: computed for shorter periods such as hourly or weekly

o The different is not important because both have the same treatment under the Acts. 248(1)

salary or wages” defined as “income of a taxpayer from an office or employment as computed under subdivision A of Division B of Part I …” but this definition does not apply to ss. 5 and 63 (definition says except in sections 5 and 63)]

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(ii) Describe how the Act deals with remuneration other than salary or wages.

Remuneration: S 5(1) includes commissions and other amounts similar to wageso S. 6(1): of the act brings in other specific types of remuneration included for greater certainty - it may include

benefits in respect of employment amounts received by taxpayer as an allowance for personal or living expenses or other purposes director’s fees or other fees received by the taxpayer in the year in respect of employment amounts that cover for losses to income from office or employment pursuant to a sickness or accident

insurance plan or a disability insurance plan s. 6(1) includes a number of specific items that are included in income s. 6(3) brings in signing bonuses and non-compete payments to employees

Knowledge Objective: Benefits

there are three issues that determine whether something received or enjoyed by an employee will be considered a taxable benefit

o 1. One is what constitutes a “benefit”o 2. Whether the item is convertible into moneyo 3. Whether a benefit is actually conferred on the employee, and, in particular, whether the amount is an allowance

or a reimbursement of an expense once one has determined a benefit is to be included in income from employment because:

o (i) it provides a benefit to the employee; ando (ii) it is in respect of employment

one must after that determine the value of the benefit because s. 6(1) calls for inclusion of the “value” received

(i) Set out the meaning that has been given to “benefit” in s. 6(1)(a) of the Act.

S. 6(1)(a) states that inclusion in income of benefits received or enjoyed by the taxpayer is “in respect of, in the course of, or by virtue of an office or employment”

Case Law

Seymour v Reed: was it provided by way of remuneration? If not, then it will not be subject to tax Laidler v Perry: whether the benefit could be said to be merely a personal gift – this is not followed in Canada

(ii) Discuss whether a benefit under s. 6(1)(a) must be convertible into money.

The notion that a benefit had to be convertible into money before it was taxable was rejected in Canada by the Exchequer Court in Waffle v MNR

Benefits that cannot be converted into money may be concluded under “other benefits of any kind whatsoever”

(iii) Explain the scope of “in respect of” in terms of underlying policy considerations (i.e., revenue, neutrality and equity).

the words “in respect of” in s. 6(1)(a) have “the broadest possible meaning in terms of connecting the benefit to the employment” effectively creates a presumption that a payment by an employer is in respect of employment

o this makes sense in term of the policy concern about preventing payment of employees through non-taxable benefits – with the broad meaning of “benefit”, it makes it difficult to avoid tax by paying employees with non-taxable benefits

the words are broad enough to include benefits provided to employees by third parties

Skill Objectives: General Scheme

The steps for evaluation:

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One must determine that a benefit is to be included in income from employment because:

(1) it provides a benefit to the employee; and (2) it is in respect of employment

once that is determined, one must determine the value of the benefit because s. 6(1)(a) calls for inclusion of the “value” of benefits received or enjoyed.

Analyze, in a particular fact situation, citing relevant authority:

(a) whether there is a benefit to an employee;

• S.C.C. defined a “benefit” as “a material acquisition which confers an economic benefit on the taxpayer”

MATERIAL ACQUISITION WHICH CONFERS AN ECONOMIC BENEFIT

The Queen v. Savage, [1983] C.T.C. 393, 83 D.T.C. 5409 (S.C.C.) the S.C.C.Facts:

• TP was paid a reward by employer insurance company for taking insurance-related courses• She was not required to take the courses but the reward was provided to encourage employees to take the courses• Reward was 100 per course and she received three such awards for a total of 300.00• The 300 was a material acquisition for the taxpayer and it was one that conferred an economic benefit on her (she could

use the cash to acquire things)Principle:

(1) the SCC interpreted the word “benefit” in the context of subsection 6(1) to mean an economic advantage of material acquisition.

(2) “benefit of any kind whatever” is quite broad. In general, whether a benefit is taxable under 6(1)(a) depends on the underlying nature of the expense covered by the benefit: if it is in nature of personal or living expenses – the benefit should be taxable; or if is in the nature of expenses incurred in the course of carrying out employment duties – the benefit should not e taxable.

(b) if there is a benefit to an employee, whether the benefit is likely to be considered a benefit in respect of employment; and

BENEFIT TO EMPLOYEES

Huffman v. The Queen [1990] 2 CTC 132, 90 D.T.C. 6405 (FCA)Facts:

• plainclothes policeman needed special large-fitting clothes to cover gun holster and billy stick• clothes were subject to heavy wear and tear form gun holster• $400 allocated for – employees had to account for it with receipts• during the year amount as increased to $500 but employees just had to account for $400• Minister argued difference between amount actually accounted for (about $421) and the $500 allowed was an allowance

per s. 6(1)(b) of the Act and thus should be included in income• but taxpayer provided evidence he had spent more than $500 in the year on the clothing• also, taxpayer argued that the clothes could not be put to personal use since they were too loose fitting and due to wear

and tear on the clothesHeld: court did not require taxpayer to include the amount in incomeCommentary: Here it might be argued the clothes were a material acquisition (so to speak!), but there was no economic benefit to employee since he could not make personal use of the clothes

McGoldrick v. R. (2004), [2004] 3 C.T.C. 264, 2004 D.T.C. 6047 (F.C.A.)Facts:

• employee of casino received one free meal per shift at staff cafeteria (not permitted to bring own food onto employer’s premises, location of casino made it impractical to eat offsite and employees not allowed to leave employer’s premises

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during shifts without permission – only alternative to cafeteria was vending machines) • employer also provided employees with tickets to entertainment events and free hams and turkeys on holidays• employer reported these things on employees’ T4’s as taxable benefits (determined as total cost to employer of

providing the benefits divided by the number of employees (over 2,000) for an average cost of about $4.50 per day or just under $1,000 for the year)

• Minister included amounts in income from employment• taxpayer says he did not enjoy eating at the cafeteria

Held:(1) the free meals were a material acquisition that conferred an economic benefit. The fact that the employee did not enjoy

eating at the cafeteria was not determinative. (2) while free meals were primarily for the benefit of employer, there was a personal element that was not just merely

incidental the the benefit to employer Principle: where something is provided to an employee primarily for the benefit of the employer, it will not be a taxable benefit if any personal enjoyment is merely incidental to the business purpose.

CONVERTIBLE INTO MONEY

This doctrine was developed in Tennant v Smith. Originally it was stated that a benefit had to be convertible into money to be taxable. However, this rule changed. The Tax Court, in Waffle v MNR, Rejected the notion that a benefit had to be convertible into money, as set out in Tennant v Smith

Waffle v. M.N.R. [1968] C.T.C. 572, 69 D.T.C. 5007 (Ex.Ct.)Facts:

• Waffle was employee of a Ford automobile dealership• as a reward for his sales performance he was given a free Caribbean Cruise not by his employer but by Ford Motor Co.

(i.e., by a third party)• Waffle could not assign the right to go on the cruise and could not, in any way, convert it into cash• he either took the cruise and got the benefit or he got no benefit at all

Held: Tennant v Smith principle did not apply to s. 6(1)(a) of iTA. S. 6(1)(a) refers to the ‘value of board, lodging and other benefits of any kind whatever” Principle: the wording of s. 6(1)(a) “value of board, lodging and other benefits of any kind whatever” overrides the rule of Tennant v Smith and thus benefits that are not convertible into money may be included.

RELATIONSHIP TO EMPLOYMENT

Paragraph 6(1)(a) applies only to benefits received or enjoyed by the employee “in respect of, in the course of, or by virtue of an office or employment”

The Queen v. Savage, [1983] C.T.C. 393, 83 D.T.C. 5409 (S.C.C.)

The court accepted a test:

(i) one should look to whether benefit provided to taxpayer serves to benefit as an employee or as a person (i.e., a gift given by the boss to employee as wedding gift is arguably not a benefit to employee in respect of employment but is a gift arising out of their personal relationship) (ii) it did not accept requirement of earlier English case law that benefit be provided by way of remuneration for services (English legislation on which that test was based was different than s. 6(1)(a) of the Income Tax Act)(iii) the words “in respect of” in s. 6(1)(a) have “the broadest possible meaning in terms of connecting the benefit to the employment”

The decision in Savage creates a presumption that any benefit received by an employee from his or her employer is derived from the employment relationship. This presumption can be rebutted, but only if the employee can establish that the benefit is received in his or her personal capacity.

This may also include a benefit received from a third party. The meaning of “in respect of employment” is broad enough that it includes benefits provided to employees by third parties.

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(c) if it were considered a benefit in respect of employment, how the benefit would be valued.

VALUATION

Now supposed an employer has provided something that is arguably “a material acquisition which confers an economic benefit on the taxpayer” so that it is understood as a benefit – we must now determine what the employee could “get for the item in the market” i.e. what id add to the employee’s economic power. In the end, we need to assess what its “fair market value” would be.

What we will consider is: Cost to the Employer: this is not always determinative of the fair market value Fair Market Value: Steen v R “that which a willing buyer would pay a willing seller in an open market”

The classic test is “the price that would be willingly paid by a buyer who does not have to buy to a seller who does not have to sell” – the test is based on a hypothetical market.

Amount that can be obtained by selling it: may be determined by the amount the employee obtained from selling the benefit conferred (Wilkins v Rogerson)

Estimate of the price a willing buyer would pay to a willing seller (e.g. real estate – assessment of what other similar houses in the area have gone for)

Wilkins v. Rogerson, [1960] Ch. 437 (H.C.)Facts:

• employer gave employee new suit as a Christmas bonus• cost of suit to employer was £14.15 but employee sold it immediately and only got £5 as a second hand suit• held that the “value” of the benefit was £5• value of benefit was its “disposable value” to the employee

Giffen v. R., [1995] 2 C.T.C. 2767 (T.C.C.)Facts:

• employee did a significant amount of travel by air for the employer• employer allowed employee to use frequent flyer points obtained for his own benefit• cost to employer in terms of flights that might have been done by employee on behalf of employer for free• employee got benefit of these flights but question was what value of those frequent flyer points was• problem was that value was not the economy fare• value was considerably less since use of points was quite restricted

Held: it was given a value equal to the cost of the most restrictive economy fare

Rachfalowski v. R., 2008 D.T.C. 3626 (T.C.C. [Informal Procedure])Facts:

• free golf membership that employee didn’t want and rarely usedIssue: if something is available but not used or taken advantage of then is it “received or enjoyed” Held:

• membership was primarily for benefit of employer• even if membership not primarily for benefit of employer, benefit to employee was minimal at most and did not,

therefore, constitute a benefit under s. 6(1)(a)Principle: value of the benefit should be determined on basis of actual use rather than availability of benefit.

Adler v. R., 2007 D.T.C. 783 (F.C.A.)Facts:

• employer (TELUS, or TELUS subsidiary) provided employees with free parking pass• Minister included fair market value of parking passes in income of employees

Issue: is a parking pass a taxable benefit?Held: two appeals were allowed but for the other 14, it was held that they (employee) not the employer, received the primary benefit of the parking pass (they did not have to pay for every day parking). Fair market value was between 1500 – 2800 depending on the location of the parking spot.

APPORTIONMENT

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There are times when a payment by an employer to or for the benefit of an employee has a dual character: it (1) covers expenses incurred partly for the employer and (2) partly for the personal benefit of the employee. In these situations, it makes it difficult to ascertain the taxable value of the employee. The proportion is based on the facts of the case.

Zakoor v. M.N.R. (1964), 35 Tax. A.B.C. 388 (T.A. B)Facts:

• employer provided employee with Cadillac• car was used for employer’s purposes most of the time• but, even where car was being used for employer’s purposes a portion of capital cost of car was included in income of

employee due to the luxurious character of the car• i.e., car was more than needed for the

Knowledge Objective: Allowances

Explain the distinction between an allowance and a reimbursement and why allowances are included in income while reimbursements generally are not included in income.

The term “allowance” is not defined in the Act. It has been defined by the CRA in these terms: • “[T]he word “allowance” means any periodic or other payment that an employee receives from an employer, in addition to

salary or wages, without having to account for its use.”• Allowance was defined in Queen v Pascoe: “a limited predetermined sum of money paid to enable the recipient to provide

for certain kinds of expense, its amount is determined in advance and, once paid, it is at the complete discretion of the recipient who is not required to account for it.”

Inclusion in Income

s. 6(1)(b ) includes allowances in income except for some specific exceptions listed under s. 6(1)(b)o includes in income “all amounts received by the taxpayer in the year as an allowance for personal or living

expenses or as an allowance for any other purpose.” Allowance is not defined in the act – the CRA says that allowance means any periodic or other payment that an employee

receives from an employer, in addition to salary or wages, without having to account for its use”o Courts have referred to an ‘allowance’ as “an arbitrary amount paid in lieu of any reimbursement for the employee

to use without being required to account for it” Allowance v Reimbursement

o “A payment in satisfaction of an obligation to indemnify or reimburse someone or to defray his or her actual expenses is not an allowance; it is not a sum allowed to the recipient to be applied in his or her discretion to certain kinds of expense.”

The key question is whether the recipient has some discretion as to how it is spent – it if only defrays his or her actual expenses incurred on behalf of employer it is arguably not an allowance.

If an employee does not have to account for the expenses, then employee may well benefit to the extent the employer can cover the requirements on behalf of the employer without spending all the allowance – this could result in tax abuse and loss of revenue

Exceptions: certain allowances are permitted – where they would not be included in incomeo Reasonable allowances for travel expenseso Reasonable allowances for the use of automobiles for travelling in the performance of the duties of an office or

employment Reimbursements

o Reimbursements of Employer Expenses: these are NOT included in income because arguable this provides no benefit to the employee

o Reimbursements of Employee Personal or Living Expenses: these are taxed – if the employer pays for the gas used in a car by the employee solely for their personal use – then the amount would be included in income

o Accountable Advance: an allowance should be distinguished from an accountable advance an accountable advance is an amount paid in advance to an employee who is required to use the money

to pay for something for the employer and to account for its use and return any amount not spent

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Skill Objective: Allowances

Be able to assess, in a given fact pattern, citing relevant authority, whether a particular amount paid by an employer is an “allowance” and whether the allowance must be included in income from employment.

Knowledge Objectives: Automobiles

Explain why there are special provisions on automobile benefits and how the special provisions address these concerns.

Reason: special provisions on automobile benefits because providing an automobile is a good example of a situation in which the Act provides a formula for determining the value of the benefit

o There would be many question and issues that arise – how much the car was used for personal vs employment use, operating expenses paid by the employer, etc.

o The act provides a formula for calculating the value of the benefit Suppose that employer provides a car for an employee – that that employee can use for personal use, this would be

included in income under s. 6(1)(a)

Various Issues that Might Arise: o (i) There would be the question of how much the car was used for personal purposes as opposed to employer

business. This might be open to abuse by the employee-taxpayer and difficult for the Minister to challenge. o (ii) Then there would be the question of how much of the capital cost of the car would have to be included in

income. There might be considerable litigation over this issue and thus cost in administration of the Act. o (iii) Then there is the cost of operating expenses paid by the employer

s. 6(1)(e) says employee must include in income a “reasonable standby charge” for an automobile made available by employer and must also include in income amounts paid by employer for the operating expenses of the automobile

Employer Owns Car s. 6(2) goes on to set out the “reasonable standby charge” this is a charge for the capital cost of the car basic idea is that it is set at 2% of the capital cost of the car for every month the car is available for the taxpayer’s use during

the taxation yearEmployee Leases Car

where car is leased then the inclusion in income is 2/3rds of the leasing cost (net of insurance charges) for the period during which the car is available to the employee in the taxation year

Use in the Employer’s Business this inclusion of capital cost of the car would not be fair to the employee if car was being used exclusively or primarily in

relation to employer’s business – at the same time there is the concern for excessive or abusive claims that the car was used primarily for the employer’s business

Act makes an adjustment to amount of inclusion for use in the employer’s business but limits claims for this adjustment -- first, it provides that the adjustment for use in the employer’s business only applies where

o (i) the employee is required by the employer to use the car in connection with the employee’s office or employment; and

o (ii) the distance traveled is done “primarily” in connection with the employee’s office or employment (“primarily” would mean more than 50%)

Knowledge Objectives: Loans

Explain why there are special provisions on interest free loans and how they work.

Reason for Provision : this is another example of a situation where the Act sets out how to calculate the value of such a benefit received in respect of employment

o Where the loan is interest free or has a low rate of interests – then a benefit is conferred upon the employee

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The act requires that the interest free or low interest loan in respect of employment is included – then sets out how the benefit is to be determined – then sets out the rules relating to the computation of income

o The difficult is determining the rate of interest that the employee would have paid if not for the employer providing the loan

o S. 80.4(1) sets out the means for calculating the deemed benefit using a prescribed rate of interest (T-Bills + 4%)

Subsections 6(9) and 80.4(1) deal with loans that are interest free or low interest – in essence the transaction is recharacterized to reflect economic reality. The borrower/employer is deemed to owe market rate of interest (prescribed interest rate) and the amount of interest payment waived by the lender/employer is a taxable benefit to the employee.

Knowledge Objective: Home Relocation Benefits

Explain why there are special provisions for employee home relocation?

The difficult is determining whether the assistance – for home relocation – was just a reimbursement for loss to the employee or in fact amounted to a benefit in respect of employment

The response was amendments to the Act to set out bright line rules as to the benefits that had to be included in income for compensation for housing losses on the sale of a house prior to relocation and subsidies or financial assistance in the purchase of a new home at the new location

in effect allows employer to provide assistance in purchase of new home for relocation to extent of prescribed rate on $25,000 but any amount over that is included in income

o it must be on a “home relocation loan” defined in s. 248(1) as a loan to acquire a home at a place at least 40 kilometers closer to a new work location

ss. 6(19) to 6(22) also allow compensation for housing loss but limit it to $15,000 – one half of compensation for a housing loss above that amount must be included in income

Case Law on Home Relocation Benefits

Ransom v. M.N.R., [1967] C.T.C. 46, 67 D.T.C. 5235 (Ex. Ct.)Facts

• taxpayer was an employee of Dupont transferred from Sarnia to Montreal• housing market down in Sarnia at the time so Ransom incurred a loss on sale of his house in Sarnia• Dupont reimbursed him for the loss ($4000 in 1967)

Held: Ransom did not receive a benefit because he was just compensated for a loss caused by his employer’s decision to transfer him to Montreal.

R v PhillipsFacts

• Taxpayer CN employee was transferred from Moncton, NB to Winnipeg• CN gave him 10,000 as relocation payment to compensate him for higher costs of similar houses in Winnipeg

Held: this was different form Ransom because the taxpayer was NOT paid to compensate for a loss but was paid an amount to allow him to acquire a more expensive house

Canada v. Hoefele, [1996] 1 C.T.C. 131, 95 D.T.C. 5062 (F.C.A.)Facts

• employee was relocated from Calgary to Toronto• housing in Toronto said to be 55% more expensive at the time• instead of compensating for higher cost of housing as had been done in Phillips, employer compensated employee by

reimbursing employee the interest cost on the difference in principal sum of mortgage that would be required to acquire house in Toronto (i.e., it would require a higher principal amount of mortgage to acquire the more expensive house in Toronto)

Held: mortgage subsidy was not a taxable benefit since the net worth of the employee had not increased

Case Law Summary:

(1) compensation for a loss caused by employer’s decision to move = not taxable56

(2) payment – not for a loss – but to allow for a purchase of a more expensive house = a benefit and is taxable(3) not a taxable benefit if the net worth of an employee has not increased

Knowledge Objective: Deductions from Employment Income

Be able to explain, from a policy perspective, what the rationale is for tightly controlling deductions with respect to income from employment.

s. 8(2) limits deductions to specific amounts provided for in section 8 (and these are primarily provided for in s. 8(1)) s. 67 says the deductions must also be reasonable the constraints on deductions are partly based on the notion that many of these expenses for employees will be in small

amounts, hard to audit and hard to assess – and the revenue effect of leakage if there was room for liberal deductions [loss of revenue]

Skill Objective: Specific Deductions

Be able to assess whether travel expenses, legal expenses, home office expenses, or other expenses permitted in those paragraphs of section 8(1) set out in the statutory supplement can be deducted from income from employment citing relevant authority.

TRAVEL EXPENSES

Subsection 8(1)(h) allows a deduction: “where the taxpayer, in the year,

i. was ordinarily required to carry on the duties of the office or employment away from the employer’s place of business or in different places; and

ii. was required under the contract of employment to pay the travel expenses incurred by the taxpayer in the performance of the duties of the office or employment,

• this results in the amounts expended by the taxpayer in the year (other than motor vehicle expenses) for travelling in the course of the office of employment

A deduction is NOT ALLOWED where the taxpayer received an allowance for travel expenses that was not included in income under 6(1)(b)(v), (vi), or (vii)

Meal Expenses while Travelling• meal expenses while traveling limited by s. 8(4) and s. 67.1• s. 8(4) provides that employee cannot deduct a meal expense UNLESS employee was required by the employer to be away

from the municipality where employer’s business is located for a period of not less than twelve hours• s. 67.1 says cost for the meal must be reasonable and one can only deduct one-half of the cost of the meal

Motor Vehicle Expenses • section 8(1)(h.1) deals with motor vehicle expenses• has same two requirements as s. 8(1)(h) (i.e., ordinarily required to carry on the duties away from employer’s place of

business and required under contract of employment to pay motor vehicle expenses)• does not cover expenses incurred to get to place of employment and then back home

Delancy v. The Queen, 2004 D.T.C. 2409 (T.C.C.)Facts:

• Delancy was football player who was resident in U.S. but stayed in hotels in Canada during football season with Toronto and Calgary

• was reimbursed for games away from his home clubs but when at his home club he was required to pay his own expenses

• tried to deduct hotel expenses for home games and claimed they were travel expenses under s. 8(1)(h) (i.e., when he was with Toronto Argonauts he was charging for the cost of his hotel in Toronto (since his home was in the U.S.))

Held: s.8(1)(h) not applicable since he was at his employer’s place of business when he played in home games and was not REQUIRED to travel away from the employer’s place of business for those home games.

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• His expenses when playing away from his home team’s location – was covered by the employer.

Hogg v. R., [2002] 3 C.T.C. 177, 2002 D.T.C. 7037 (F.C.A.)Facts:

• judge who drove his car to work• said he needed to drive to work for protection • thus driving to work was essential to be able to earn income from his office

Held: deduction was not allowedPrinciple: s. 8(1)(h) applies when you travel AWAY from employer’s place of business – not when you are travelling to the place where you carry on the duties of your office.

Summary of Travel Expenses1. Applicable when you are REQUIRED to travel away from your office2. Not deductible when you are driving to your location of office/employment

LEGAL EXPENSES

• s. 8(1)(b) allows deduction of amounts paid in year for legal expenses incurred “to collect or establish a right to salary or wages owed” by the employer or former employer

Loo v. Canada, 2004 D.T.C. 6540 (F.C.A.)Facts:

• Loo was one of 55 lawyers employed by the Department of Justice in Vancouver• sued Crown for damages and a declaration that they (lawyers in Vancouver) were entitled to same salaries as paid to

lawyers employed by the DOJ in Toronto • Loo then deducted his share of legal expenses for the action• Minister disallowed deduction

Held: dedication allowed Principle: he was not trying to establish a right to promotion for a higher salary but that he was OWED MORE than he was paid i.e. “establishing a right to a salary”

Blackburn v. The Queen, 2004 D.T.C. 2409 (T.C.C.)Facts:

• police officer charged with dangerous driving while off duty• if convicted it could have a serious impact on his career as police officer• he hired a lawyer to defend him at trial and on appeal• he was convicted at trial and suspended from job• on appeal he was acquitted• he deducted the legal expenses associated with trial and appeal decisions• Minister disallowed the deduction on basis it was not to establish a right to wages or to collect wages

Held: he was entitled to deduct most of the legal fees. He was suspended and thus overturning the conviction allowed him to get wages for period of improper suspension. Principle:

1. Legal fees for overturn the conviction were allowed – to collect wages. 2. Legal fees for bail hearing were not allowed

Summary of Legal Expenses1. Deductible when you are trying to establish the right to a salary – if others in the same position are being paid more (DOJ)2. Deductible where you are collecting wages from improper suspension of salary

HOME OFFICE EXPENSES

• deduction allowed to an employee for home office expenses under s. 8(13)

LOSS FROM EMPLOYMENT

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• s. 5(2) – loss for taxation year from employment is loss from that source computed by applying ss. 5 to 8 – i.e., loss when deductions permitted under s. 8 are greater than the inclusions in ss. 5 to 7

• not common to see losses from employment given restricted deductions (s. 8(2) restricting deduction to those specifically permitted by s. 8)

• also “stop loss” limits on expense claims such as s. 8(1)(f) re sales person’s expenses and s. 8(13) re home office expenses

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CHAPTER 6: INCOME FROM BUSINESS OR PROPERTY – PROFIT

Knowledge Objective: Section 9 of the ITA

Identify and explain the starting point in s. 9 of the Income Tax Act for the determination of income from business or property.

As noted earlier, section 3(a) includes income from business or property as an enumerated source:

• ss. 9 to 37 sets out the rules for determining income form business or property• s 9(1) sets out the starting point for determining income from business or property saying,

o “subject to this part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from the business or property for the year”

o thus PROFIT is central to calculation of income• “profit” is not defined in the Act – determined per common law• s. 9(2) says that,

o “Subject to section 31, a taxpayer’s loss for a taxation year from a business or property is the amount of the taxpayer’s loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source with such modifications as the circumstances require.”

• “loss” is not defined in the Act – based on the common law• s. 9(3) : “In this Act, ‘income from property’ does not include any capital gain from the disposition of that property and ‘loss

from a property’ does not include any capital loss from the disposition of that property.”o This makes it clear that “income from property” is a separate concept from a capital gain from the disposition

property and that a “loss from a property” is separate from a capital loss on the disposition of property.

Knowledge Objective: Importance of Characterization

Explain the context in which the question of whether income is from a business or property source has normally arisen.

The characterization of income or loss is important. If it is not income from a source, then it is not taxable under 3(a).• Similarly, if the loss is not from an enumerated source (office, employment, business or property) then it is not deductible

under 3(d).

• employment vs. business – characterization important (as noted earlier) to scope of deductions available• income vs. capital gain – characterization also important since affects how much is included in income for tax purposes (if

income then all of it is included; if capital gain only one-half is included in taxable income)• income from business vs. income from property – not as important since for the most part there is no distinction in

treatment in the Act between – rules for determining income from property or business are the same (namely those contained in subdivision b)

Knowledge Objectives: Business or Property Defined

(i) Discuss the Income Tax Act statutory meaning of “business” and “property” as well as the common law meaning of those terms.

STATUTORY DEFINITIONS

ITA s. 248(1) “business”, “property”

Business

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• s. 248(1) “business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever and … an adventure or concern in the nature of trade but does not include an office or employment

o “business” definition is merely inclusive of a profession, calling, etc. – generally they are profit motivated activitieso an “adventure in the nature of trade” is usually an isolated, speculative transactiono the definition of “business” is not an exhaustive definition and therefore one must look more generally to the

ordinary meaning of the wordProperty

• s. 248(1) “property” “means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes

o (a) a right of any kind whatever, a share or a chose in action,o (b) unless a contrary intention is evident, money”

• the definition of what constitutes property is very broad.

Manrell v. R. (2003), 2003 D.T.C. 5225, [2003] 3 C.T.C. 50 (Fed. C.A.)Facts:

• a partner selling shares in a business but also entering into a contract promising not to compete – approx. $1 million in compensation

• the question was whether the $1 million was capital gain from the sale of an interest in “property”Held: non-competition payment was not subject tot capital gains tax since a right to compete was not “property”Principle: property involves a legally enforceable right to exclude others and it does NOT include a right to do something that anyone had a right to doNote: property of any kind whatever – includes on what is considered property under the CL

COMMON LAW

The common law definition of “BUSINESS” was set out in Smith v Anderson – the definition is:• “anything which occupies the time and attention and labour of a person in the pursuit of profit”• the TEST for whether an activity involves a “pursuit of profit” was recently developed by SCC decision in Stewart and Wells

(ii) Give an example of a tax shelter scheme and explain two tax advantages such a scheme can provide.

Stewart v Canada: this is an extreme example but general principle is that tax shelter can (i) serve to reduce tax liability by producing a loss to apply against other sources of income while replacing that loss with a capital gain (ii) it also defers the tax from the year to year tax on the employment, business or property income until the tax on the capital gain when the tax shelter property is disposed of

• in the process it replaces a source of income from an office, employment, business or property that is fully included in income for tax purposes with a gain only half of which is included in income for tax purposes and it defers the taxes until the disposition of the tax shelter property

(iii) Describe the test used prior to the Stewart case to determine whether an activity carried on by a taxpayer was a business or a hobby.

The test that had been used, prior to Stewart, was whether there was a “reasonable expectation of profit” (REOP test adopted in Moldowan)

• under that test one might have held that this transaction didn’t involve a business or property source (can’t be a source of income if no reasonable prospect of prospect of producing income)

(iv) Describe the approach in the Stewart case to determining whether an activity carried on by a taxpayer is a business or property source.

In Stewart it was held that there was no reasonable expectation of profit from the rental income (since it was expected to produce a loss). The effect of applying the REOP test was that the transaction didn’t involve either a “business” or “property” source and so a

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loss could not be deducted under s. 3(d) [which requires that a loss be from an office, employment, business or property in order to deduct the loss]The NEW Test/Analysis:

The following two-stage approach with respect to the source question an be employed:

(i) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavor?(ii) If it is not a personal endeavor, is the source of the income a business or property?

… it is logical to conclude that an activity undertaken in pursuit of profit, regardless of the level of taxpayer activity, will be either a business or property source of income. … We emphasize that this ‘pursuit of profit’ source test will only require analysis in situations where there is some personal or hobby element to the activity in question

• thus where an activity is said to be in pursuit of profit it is assumed that the source is business or property• further, where the activity is commercial in nature (i.e., there is no personal element to the activity) the assumption is that

it is in pursuit of profit• put another way, if it is clearly commercial in nature with no personal element then it is assumed to be in pursuit of profit

and therefore related to a business or property source

Intention to Make a Profit

1. Subjective and Objective Intent

• if activity is clearly commercial, then it is assumed to be for “pursuit of profit”• where the activity is party commercial and partly personal, one must go further to determine whether there was an

intention to profit• in Stewart the courts asks

o (1) does the taxpayer intend to carry on an activity for profit and is there evidence to support the intention? This requires the taxpayer to establish: his or her predominant intention was to make profit from the

activity and that the activity has been carried out in accordance with objective standards of businesslike behaviour

Asserting your intention was to make a profit – is NOT enough – the Taxpayers SUBJECTIVE intention must be supported by OBJECTIVE evidence

• Scc in Stewart accepted the use of the factors from Moldowan as factors to be considered as part of the assessment of objective evidence of a predominant intention to profit

Moldowan Factors for Objective Evidence to support Subjective Intention

(i) The profit and loss experience in previous years;(ii) The taxpayer’s training;(iii) The taxpayer’s intended course of action to convert present losses into future profits; and(iv) The capacity of the venture, given its capitalization, to show a profit after deduction of capital cost allowance.(v) Court always considers the amount of time the taxpayer spent on the particular activity (Sipley v R)

2. Predominant Intention: a taxpayer may have had several intentions in engaging in a particular activity – the court will search for the predominant intention

3. Reasonableness of Expectation of Profit: it is not necessary to show that there was a “reasonable expectation of profit” – whether there was a reasonable expectation of profit, is only a factor to be considered in determining whether there was an intention to make a profit.

4. Notion of Profit Includes Potential Capital Gains: the intention to profit is to be assessed in the ordinary business persons’ sense of the term – that sense of “profit” includes capital gains. Btu Stewart states that, it motivation is purely to make capital gains it would not result in a source of income from business or property since capital gains is distinguished from income from business or property

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The NEW Test/Analysis:

Short version of what the SCC said in terms of the law concerning determining whether the source is business or property:

(i) Assess whether the activity is clearly commercial or if it has a personal element. If it is clearly commercial, then it is business or property. [clearly commercial – meaning no personal elements to it]

YES: Then it is either (a) business or (b) propertyo Ask yourself, if it is relevant whether it is business or property

NO: move on to step 2 (below)(ii) If there is a personal element then ask, based on the objective evidence, whether there was a predominant intention to profit.

Moldowan Factors

(i) The profit and loss experience in previous years;(ii) The taxpayer’s training;(iii) The taxpayer’s intended course of action to convert present losses into future profits; and(iv) The capacity of the venture, given its capitalization, to show a profit after deduction of capital cost allowance.(v) Court always considers the amount of time the taxpayer spent on the particular activity (Sipley v R)

Stewart v CanadaApplication: owning and renting condos in London, Ont. and Surrey, B.C. that Stewart never used himself was clearly commercial activity so it was business or property (thus no need to ask whether there was a predominant intention to profit)Result: There was a source and that source was “business” or “property” and losses were therefore deductible under s. 3(d)

Walls v CanadaFacts:

• taxpayer held unit in limited partnership set up standard tax shelter investment• Ltd. Ptrsp. was engaged in storage park warehouse operation• Ltd. Ptrsp. acquired storage park for $2.2m paying $1 cash with rest as a loan from vendor at 24% interest• Ltd. Ptrsp. paid vendor management services fee to operate storage park• Walls was limited partner - Ltd. Ptrsp. losses allocated to him

Held: it was evident that the activity was “commercial in nature” and that there “was no evidence of any element of personal use or benefit in the operation”Note: does not matter that the taxpayer was motived by a desire to reduce taxes.

(v) Discuss the response to the Stewart case the Minister of Finance proposed in October of 2003. The result in Stewart was that there were significant consequences with respect to tax shelter – quite often tax shelters will be clearly commercial in character and thus would be assumed to have no personal element.

Proposed amendment (October 31, 2003)

Minister of finance proposed addition of s. 3.1 to the Act on October 31, 2003:

3.1(1) Limit on loss – A taxpayer has a loss for a taxation year from a source that is a business or property only if, in the year, it is reasonable to expect that the taxpayer will realize a cumulative profit from that business or property for the period in which the taxpayer has carried on, and can reasonably be expected to carry on, that business or has held, and can reasonably be expected to hold, that property.

(2) Determination of profit – For the purpose of subsection (1), profit is determined without reference to capital gains or capital losses.

• this would have restored reasonable expectation of profit test that SCC adopted many years earlier in Moldowan (1977)

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• one would look to period of time taxpayer has carried on the business or held the property, together with period of time taxpayer can reasonably be expected to carry on the business or hold the property, and ask whether over whole period “it is reasonable to expect that the taxpayer will realize a cumulative profit”

Skill Objective

Be able to assess, with reference to relevant authority, whether a taxpayer’s endeavor involves a “business” or “property”.

Knowledge Objective: Personal Endeavors Distinguished

Discuss the revenue, equity and neutrality concerns with respect to taxpayers claiming a deduction for losses from hobby activities on the basis that they are losses from business or property.

In the past, courts have disallowed deductions for a wide variety of activities that were arguably hobbies or largely personal pursuits. This was refused on the basis of the REOP test.

1. Pursuit of Personal Pleasures [Pre Stewart Application – REOP]

Landry v. The Queen (1994), 94 D.T.C. 6624 (Fed. C.A.)Facts:

• 71 yr.-old lawyer started law again after not having practiced for 23 yrs.• had losses over 15 years; did not keep good records; didn’t have a budget; did not advertise other than listing in

telephone directory; did not always bill clients for services rendered, etc. Held: FCA held, using REOP, that lawyer was not engaged in a business so could not deduct the losses

SCC in Stewart suggested that Landry was wrongly decided on the basis that there was no personal element – there might have bene a personal element, in that he may have derived some personal satisfaction from acting as a lawyer.

Payette v. M.N.R., [1978] C.T.C. 2223, 78 D.T.C. 1811 (T.R.B.)Facts: taxpayer was author of six books – incurred losses on all the books Held: under the REOP test that he had no reasonable expectation of profit and therefore could not deduct the loss

What if the Stewart Test was Applied to the Payette Facts?

(1) This would ask whether there was, at least in part, a personal element to writing and publishing of the six booksa. If there was, then one would ask whether there was a predominant intention to profit?

(2) If no personal element to the writing and publishing of the six books, endeavor would be considered clearly commercial and so there would be no need to assess whether the taxpayer had a predominant intention to profit

Cree v. M.N.R., [1978] 2472, 78 D.T.C. 1352 (T.R.B.)Facts:

• taxpayer was full-time employee of Control Data Company Ltd. • in 1974 claimed losses of $11,600 from car racing• taxpayer says he had raced since 1968-73 as amateur but turned professional in 1974• owned a trailer, a van and a racing car and went to national racing events across the country• from ’71 to ’74 had some winnings, highest of which was $1,250 in a given year – lowest expense level over those years

was $2,503• in 1974 had winnings of $500 and expenses of $12,100• expert witness on car racing noted appellant was a licensed professional auto-racer but also testified that: “I don’t know

why they do it. There are fifty in Canada. They all have to work because they cannot make a living with auto racing.”Held: appellant’s activity before 1974 and nature of auto-racing activity in Canada at the time did not show appellant’s car racing could be carried out with a reasonable expectation of profit – so loss not deductibleNote: How would this work under Stewart?

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Sirois v. M.N.R., (1987), [1988] 1 C.T.C. 2147, 88 D.T.C. 1114 (T.C.C.)Facts:

• taxpayer operating restaurant in 1976; seats 20; only open four days a week• 1982 seats to 40 – in 1983 started opening six days a week and increased advertising expenses• 1983 and 1984 started to produce higher revenues• loss prior to 1984 but in 1984 the loss was almost eliminated

Held: No REOP for 1981 (before the expansion of the restaurant)However, the situation form 1982 to 1984, with the expansion of the restaurant, it increased operating hours and increased advertising – there was a reasonable expectation of profit in those yearsConsider the application of Stewart

Knight v. M.N.R., [1993] 2 C.T.C. 2975, 93 D.T.C. 1255 (T.C.C.)Facts:

• taxpayer was school teacher interested in metal work• acquired machines and built shop on his property• machines cost $200,000• took leave in 1986-87 to develop prototype tools for use in connection with computer software applications – i.e.,

computer software to operate machining equipment• said he was developing the “business”

Held: in 1986 – 1987 (the time that he took off) he was only engaged in research, experiment and development – he had no product to sell, no business to carry on and hence no source of income. There was no reasonable expectation of profit, thus no deduction of losses Consider the application of Stewart

Chequer v. R., [1988] 1 C.T.C. 257, 88 D.T.C. 6169 (Fed. T.D.)Facts:

• taxpayer acquired 48-foot cruiser boat• plan was to charter it out on a full-time basis• had another full-time job in 1981-82• claimed net losses in those years from the boat charter business of $31,534 and $24,608

Held: he failed to establish a reasonable expectation of profit so that he couldn’t deduct the losses

2. Rental Properties

There are instances when personal elements arise in the context of rental properties. E.g. Property may be rented to friends or relatives – or rental property is part of person’s personal residence

Maloney v. M.N.R., [1989] 1 C.T.C. 2402, 89 D.T.C. 314 (T.C.C.)Facts:

• taxpayer rented house to his mother at a low rent• rental income was less than sum of mortgage interest, property taxes and other maintenance expenses on the property• losses on rental property claimed against income from other sources

Held:(1) no reasonable expectation of profit from property – because rented house to mother a low rent(2) the annual losses were in the nature of gifts and thus were non-deductible consumption expenses

Stewart application to Maloney

First we would ask whether there was a personal element involved – which there is because the property was rented to his mother.

Second, we would ask whether the TP’s predominant intention was to make a profit objective factors: consistent losses, unlikelihood of profit given expenses in mortgage interest, property taxes and other

maintenance expenses – this suggests a subjective intention to profit but it is NOT supported by objective evidence

3. Gambling as a Regular Activity

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Even if an activity is an illegal one, income from that activity will be taxed if it constitutes income from a source, particularly a source such as business or property.

Casual betting would be a personal hobby – such losses would not be deductible under s. 3(d)versus

Persons engaged in bookmaking or operating a betting shop – these persons would be considered to be engaging in a business – they would normally end up with a profit

M.N.R. v. Morden, [1961] C.T.C. 484, 61 D.T.C. 1266 (Ex. Ct.)Facts:

• taxpayer was inveterate gambler who placed bets on outcome of baseball games, hockey games, football games and card games (whether he was a player or merely placing side bets)

Held: he did not organize his activities – or conduct it as an enterprise of commercial character – or organized these activities as to make them a business call or vocation. The gains he may have made were not subject to tax – they were windfalls.

Cohen v. R. (2011), [2011] 5 C.T.C. 2199 (T.C.C.)Facts:

• lawyer had quit practicing law to play poker full-time• played six to eight hours per day and attended several tournaments out of town• had attended a seminar on poker in Las Vegas for three days• was otherwise self-taught• for 2006 taxation year he reported $81,283.00 in revenues from his gambling activities but also reported $203,275.00 in

expenses so reported a loss from his gambling business of $121,992• had income from employment at the law firm in 2005 of $200,000 and was continuing to receive severance pay in 2006

associated with his departure from the law firm• expenses included purchases were identified as “inventory,” but this was cash spent to get into poker games• other expenses were for interest charges, money spent on books, registration fees for the Las Vegas seminar and travel

expenses• Minister assessed on basis he was not in the business of playing poker

Held: he was NOT engaged in business since (1) his training was limited to the attendance t a single seminar in Las Vegas and the reading of books/ articles and (2) he had no business plan (3) no budget and; (4) no system for winning

Walker v. M.N.R., [1951] C.T.C. 343, 52 D.T.C. 1001 (Ex. Ct.)Facts:

• taxpayer was farmer who was part-owner of several horses• moved in the racing milieu and thereby gained access to information about horse races• regularly attended horse races betting on them substantially and successfully

Held: his gambling activity was not merely a hobby but was (1) sufficiently extensive and; (2) systematic to constitute a business

Summary of Gambling as a Regular Activity

The test for these cases asks whether the activities are: organized sufficiently extensive and systematic [this is a source question “does the income come from a source – something that is

capable of producing income”o a related questions asks whether the source is business or property

Benefits of Including Gambling presumably they would also have to allow for losses – it is likely that gambling would be a zero-sum game at best and that

losses would match the gains concern that losses would tend to be reported more consistently than gains, so the net effect might be a loss in revenue

You need to distinguish between income from employment v business (because of how it is taxed) and income from business v income from capital gains (because only half of capital gains are taxed).S. 9(3): states that income from a property does not include any capital gain from disposition of that property and ‘loss from a property does not include any capital loss from the disposition of that property”

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Skill Objective: Personal Endeavors Distinguished

Be able to apply the Stewart approach to “business” or “property” to possible personal endeavors including hobbies, rental properties, and gambling.

Knowledge Objectives: Business Distinguished from Property Identify and briefly explain eight differential treatments of “income from property and income from business under the Income Tax Act. 1. Differential Tax Treatments

A. Attribution RulesB. Non resident Income from Business: non-residents pay tax on income from business carried on in Canada vs. income from property earned by non-resident is subject to Part XIII taxC. Income from Business Allocated to Provinces of Permanent Establishment: income from business for prov. Tax is allocated where the business had permanent establishment vs. income from property which is taxed based on where the owner was resident on the last day of the taxation year. D. FAPI Definition Excludes Active Business Income: definition of “foreign accrual property income” excludes income from “active businesses” [s. 95(1)]E. Capital Cost Allowance Restrictions on “Rental Property”: Capital cost allowance provisions do not allow CCA to result in losses form “rental property” F. Cumulative Eligible Capital Deductions only in respect of Business: these deductions are only permitted “in respect of business” and not for propertyG. Small Business Deduction and Investment Income Refund: Distinction made between “active business” income for which small business deduction available [s. 125] and “aggregate investment income” that excludes active business income and for which a partial refund is available [s. 129]H. Inclusion of Amount Received for Goods not Delivered or Services Not Rendered: is just for a business s. 12(1)(a)

Explain the level of activity test for distinguishing income from business and income from property. LEVEL OF ACTIVITY

The difference between business and property has been held to lie in the level of activity. The difference between the two is said to depend on whether income comes from:

mere ownership of property – income from propertyo this comes from passive holding of propertyo dividends – income from property o normally interest on a loan would be considered income from property

efforts of owner/owner’s employees (in which case it is income form business)o produced form expenditure of time, labour and effort.

What level of activity in association with rental property would make the income on the property income from business instead of income from property?

Skill Objective: Business Distinguished from Property Be able to apply the level of activity test in a given fact pattern to distinguish between income from business and income from property.

REBUTTABLE PRESUMPTION REG ARDING CORPORATE INCOME

Canadian Marconi Company v. The Queen (1986), [1986] 2 C.T.C. 465 (S.C.C.) 67

There is a presumption that a corporation earns income from business, not property – but this may be rebutted Held: in this case – the presumption was NOT rebutted. The evidence supported the presumption: (a) senior officer’s time and time of the 12 employees involved in regular trading suggested it was income from business.

Knowledge Objectives: Concept of Profit Be able to describe the concept of profit.

Profit is a net concept – which means that revenues – the expenses incurred to generate those revenues = profit this is consistent with the broader concept of “income” as an accretion to wealth, and therefore a measure of ability to pay,

since one’s wealth only increases by the net amount of revenues less expenses incurred to generate those revenues

Knowledge Objectives: Question of Law

(i) Explain how, in very general terms, “profit” been defined by the Supreme Court of Canada.

The 3 SCC cases that have dealt with the question of profit are:

1. Canderel Ltd. v. The Queen, [1998] 1 S.C.R. 1472. Toronto College Park Ltd. v. The Queen, [1998] 1 S.C.R. 1833. Ikea Ltd. v. The Queen, [1998] 1 S.C.R. 196

The question in these cases was whether Tenant Induced Payments [a payment to a tenant as an incentive for entering into a commercial lease] could be deducted in the year paid or had to be authorized (and then deducted) over the period of leases.

Canderel Ltd v the Queen [1998]There were several key points made about determining profit for the purposes of s. 9(1)Ratio:

(1) the determination of “profit” is a question of law. The calculation of profit for Income Tax Purposes may not conform to the calculation of profit for accounting purposes.

(2) “the profit of a business for a taxation year is to be determined by setting against the revenues from the business for that year the expense incurred in earning said income.”: thus profit is a net concept

(3) it was also held that the taxpayer was free to adopt any method to determine the profit as long as the method provides an “accurate picture of the taxpayer’s profit for the year” and as long as the method chosen is not inconsistent with: well-accepted business (or accounting) principles; the provisions of the Act; and established case-law principles.

(4) well-accepted business principles include but are not limited to G.A.A.P. [Generally Accepted Accounting Principles] – they are not rules of law but are only interpretive aids

(5) Burden of Proof: once the TP has shown the method chosen proves an accurate picture of income and is consistent with Act/Case-Law/Well-Accepted Business Principles – the onus shift to the Minister to show that the TP did not provide an accurate picture of profit OR that some other method would have provided a MORE accurate picture

Courts have avoided saying that profit should be determined according to GAAP – instead using various phrases that profit should be determined by “well-accepted principle of business”

(ii) Describe the method the taxpayer must use in determining “profit” from a business or property.

TP has to show that the method to determine the profit is an accurate picture of the profit for the year and it is not inconsistent with (a) well-accepted business principles (b) provisions of the act (c) case law principles

(iii) Explain where generally accepted accounting principles fit in the determination of “profit” from business or property (a) according to the courts; and (b) practically speaking.

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• Courts: said reliance should be put on “well accepted principles of business (or accounting) practice” or “well accepted principles of commercial trading”

• But they did not define these things – these expressions do not have any recognized meaning in business or accounting and thus no actual guidance.

• Practically Speaking: practically speaking businesses use GAAP to prepare financial statements and then adjust them to statements for tax purposes making adjustments specifically required by the Act

• profit for tax purposes will be GAAP unless the Act or case law modifies this

(iv) Explain why courts do not want to define the starting place for the calculation of “profit” as “generally accepted accounting principles”.

According to the court – the courts are unwilling to rely on GAAP to determine the legal question of “profit” under s.9 so as to “avoid delegating the criteria for the legal test of profit to the accounting profession”

(v) Give an example of a situation in which an accepted accounting treatment differed from the tax treatment allowed by the court and explain why the court did not follow the accepted accounting treatment.

?????

Knowledge Objectives: Financial Accounting v Tax

(i) Identify three factors that identify “generally accepted” accounting principles and explain the relationship of generally accepted accounting principles to the Handbook issued by the Canadian Institute of Chartered Accountants.

(1) Are followed in a significant number of similar situations(2) Find support in pronouncements of professional accounting bodies(3) Find support in the writing of academics

The CICA handbook set standards and recommendations. These are not conclusive sources of generally accepted accounting principles – that “no rule of general application can be phrased to suit all circumstances”; “nor is there any substitute for the exercise of professional judgment” - the recommendations may not be appropriate accounting treatment in certain situations – the court may have to resolve a dispute over the proper accounting treatment

using the evidence of accounting experts

(ii) Identify and explain five reasons for tax law deviations from generally accepted accounting principles.

(1) GAAP Variation in Treatment The GAAP allow varying treatments – however tax rules need to have a more consistent approach for reasons of equity and administrative convenience.

(2) GAAP too conservativeThe key principle in accounting is to take conservative approaches in choosing between possible accounting treatments – this would be counter to the revenue objective of income tax and equity objective (i.e. the TP actually has a greater ability to pay than the accounting treatment suggests)

(3) Pursuit of Tax IncentivesTax legislation is often used to pursue policy objectives sometimes giving incentives for particular activities

(4) Cash to Pay the TaxThe usual accounting accrual method could result in substantially recognizing revenue and inclusion – in income even though the taxpayer has not received the incomeThus in some cases the ITA may allow some revenues not to be included in income until they are received

(5) Accountants Don’t Want to Have Financial Statements Based on Tax ConcernsThere is concern that there would be misstatements if the choices were influenced by tax considerations

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Knowledge Objectives: Methods of Profit Computation (Or Methods of Accounting) (i) Explain the distinction between the cash method of accounting and the accrual method of accounting.

Cash Method: under the cash method revenue is only recognized when received (not just receivable) and expenses are only recognized when paid (not just payable

The cash method – while simple – may be inaccurate

Accrual Method: revenue is recognized when it is earned even though payment may not have been received – the revenue is said to have accrued even though payment has yet to be made. Expenses are recognized as charges against income when the expense is incurred even though the expense has not been paid for – the expense is said to have accrued even though payment has not been made

Under this method, revenues and expenses may also be deferred

(ii) Explain the matching principle under the accrual method of accounting.

Matching Principle: under the matching principle revenues are matched to the period to which they relate and expenses are matched to the revenue they generate

The principle behind the accrual method of accounting is this principle revenue is said to have accrued due when the person has completed performance of what was needed to be done to earn

the revenue – e.g., goods delivered, or lawyer’s services rendered so that bill can be rendered expenses are charged when the costs are used up in business even though they have not been paid [e.g. telephone bill –

calls made before end of accounting period but bill rendered after end of accounting period]

(iii) Indicate when the cash method of accounting may be used for the purposes of the Income Tax Act and when the accrual method of accounting must be used for the purposes of the Income Tax Act.

CASH METHOD

s. 28 permits income form farming or fishing business to be computed by the cash method cash method would be appropriate for that business under GAAP; and the cash method has been used consistently generally permitted for interest income required for royalties and dividend income income from office or employment is on a received basis

HOWEVER“as a general rule taxpayers must use the accrual method of accounting to calculate income from a business or property, unless the Income Tax Act provides otherwise in respect of specific items of income or expense.”

This is probably true since the cash method would rarely be appropriate under GAAP because of the distortions/inaccuracies of the cash method

CASH METHOD or ACCRUAL

Income from property can also be either cash or accrual as long as: (i) either method would produce an appropriate statement of income; and(ii) the method chosen is used consistently

ACCRUAL METHOD

NEITHER Separate rules for the determination of capital gains

CHAPTER 7: INCOME FROM BUSINESS OR PROPERTY – INCLUSIONS

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INCLUSION RULES

Sections 12 – 17 of the Act set out the rules for inclusion of income from business or property S. 12: deals with common types of transactions which include (i) the sale of goods, (ii) the provision of services, (iii) the

receipt of interest, (iv) dividends, (v) rent, and (vi) royalties S. 13: provides a system for depreciation (or what the ITA refers to as “capital cost allowance”) to deal with the expense

from the wear and tear on investments in plant and equipment that last longer than one year S. 14: provides a system for the amortization of capital expenditures on intangible assets such as patents, copy right, or

good will (expenditures on these intangible assets are referred to in the Act as “cumulative eligible expenditures”) sections 15 to 17 provide some anti-avoidance rules

Purpose and Rationale

• general purpose of inclusion and deduction provisions is to reinforce accrual approach to recognition of income and deduction of expenses

Knowledge Objectives: Characterization

A capital gain: arises when property is sold for more than it costs If you purchase something as an investment, then the profit on the resale is a capital gain

o If you purchase something for resale then the gain on the resale is income e.g., a car in a delivery business is an asset and if it is sold for a gain (i.e., sold for more than one paid for

it) it is a capital gain however, in a car dealership a sale of a car for more than what the dealership paid for it would be income

since the purchase and sale of cars is its business

Explain why income from property does not include a return of capital.

S. 9(1) taxes income from business or property and it taxes the profit NOT a return of capital or capital gains. A return of capital is NOT income (ex. if one loans out 100,000 – the return of that 100,000 through repayment is just a

return of capital and there is no accretion of wealth. However, the interest on the loan does increase the person’s wealth and is considered income from property)

Explain why income from property does not include capital gains on the disposition of property.

S. 9(3): says that concept of profit does not include a capital gain from the disposition of propertyo THIS IS BECAUSE it is taxed separately under capital gains tax regime

Knowledge Objective: “Realization Principle”

Identify the test for when an amount is included in income from business or property.

According to the Ikea case, an amount is included when it has the quality of income and it has the quality of income when the following question is answered in the affirmative:

Is his right to it absolute and under NO restrictions, contractual or otherwise, as to its disposition, use or enjoyment?”o It may be considered income EVEN though it is not actually received by the taxpayer but only REALIZED as income

“[a]n amount may have the quality of income even though it is not actually received by the taxpayer, but only ‘realized’ in accordance with the accrual method of accounting.”

• thus it has the quality of income if the taxpayer has an absolute right to it with no restrictions, contractual or otherwise as to its disposition, use or enjoyment

AND• “… amounts received or realized by the taxpayer, free of conditions or restrictions upon their use, are taxable in the year

realized, subject to any contrary provision of the Act or other rule of law.”

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Skill Objective: Realization Principle

Assess when an amount is likely to be included in income from business or property.

Knowledge Objectives: Accrual Method of Accounting

(i) Explain what s. 12(1)(b) requires in terms of when an amount is to be recognized as income.

Section 12(1)(b) – Receivable Amounts serves to reinforce the inclusion of income “Any amount receivable by the taxpayer in respect of property sold or services rendered in the course of a business in the

year, notwithstanding that the amount or any part thereof is not due until a subsequent year, …”o s. 9(1) requiring the inclusion of profit in income coupled with the accrual method of accounting would require the

inclusion of amounts receivable for services rendered or goods sold

12(1)(b) goes on to say that with respect to services rendered in the course of a business an amount is deemed to have become receivable on the earlier of,

o the day on which the account in respect of the services was rendered, ando the day on which the account in respect of those services would have been rendered had there been no undue

delay in rendering the account in respect of the service.”

(ii) Identify the test for when an amount is considered receivable and explain how it applies to holdbacks and expropriation compensation.

Section 12(1)(b) refers to an amount “receivable” – when is an account receivable?

M.N.R. v. Colford Contracting (1960 S.C.C.)Test: “think it is not enough that the so-called recipient has a precarious right to receive an amount in question, but he must have a clearly legal, though not necessarily immediate, right to receive it.”Note: when a person has a “clearly legal” right to receive an amount is determined by private law and will vary depending on the situation.

When the person has completed the services K’d for; or When the good sold has been delivered

At such time there is a right to receive the amount and the amount is usually known at that point

HOLDBACKS

Coldford: contractor had completed the work but was not entitled to receive the payment until certificates of satisfactory completion were issued by the architecture or engineer (It was held back)

This means that the contractor had a right to receive payment but had no “clearly legal right” – since the legal right was not until the certificate of completion

EXPROPRIATION COMPENSATION

M.N.R. v. Benaby Realties: the compensation for expropriated property becomes receivable when amount was fixed by arbitration or agreement EVEN THOUGH the right to compensation arose when the property was expropriated. One needs:

Right to compensation; and Settlement or a judgment of a court OR arbitration board determining the amount

(iii) Explain how s. 12(1)(a), together with ss. 20(1)(m) and (m.2), compares to the accrual method of accounting and why the Act has these provisions.

Normally an amount received BUT subject to requirement to fulfill contractual obligations would not be included in income per accrual method HOWEVER s. 12(1)(a) includes in income any amount received in the year in the course of a business:

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that is on account of services not rendered or goods not delivered before the end of the year or that, for any other reason, may be regarded as not having been earned in the year or a previous year, OR

under an arrangement or understanding that it is repayable in whole or in part on the return or resale to the taxpayer of articles in or by means of which goods were delivered to a customer

What this means is that with modifications in s. 12(1)(a) one is required to include in income amounts received on goods or services even though one has not completed the work necessary to fully earn the Income.

• so you have to include not only what is accrued due but also what is received (i.e., contrary to the normal accrual accounting rule which would not include amounts received in income unless recipient has done what is necessary to have an absolute legal right to retain it)

HOWEVER, s. 20(1)(m) [for the amounts included in 12(1)(a)] AND m.2 allows one to DEDUCT a reserve for amounts received but on which one has NOT earned the incomes – this serves to effectively restore the accrual method

amounts deducted under ss. 20(1)(m) and (m.2) have to be included in income in following year per s. 12(1)(e)

Skill Objective: Accrual Method of Accounting

Assess when an amount will be considered receivable including how it would apply to holdbacks and expropriation compensation.

Knowledge Objective: Sale of Property

Describe the approach of the CRA to determining when an amount is receivable from the sale of goods and from the sale of real property.

When the property sold is inventory for the business then the receipt is INCOME When non-inventory property is sold then the receipt is CAPITAL and is either a CAPITAL GAIN or a CAPITAL LOSS

The CRA’s position is that the amount is RECEIVABLE from the sale of goods on the date of exchange AND, where the date of exchange is not specified then when incidents of ownership pass to the purchaser.

Sale of Goods: title to property often passes on delivery – in many cases involving the sale of goods the amount will become receivable at the time of delivery

Sale of Real Property: date of inclusion would normally be closing date – that is usually the day on which title to the property passes and payment is made

Knowledge Objectives: Services

Identify the test for when amounts must be included in income for services rendered.

The GENERAL TIMING RULE is that payments for services are usually receivable when the services have been rendered.

Maritime Telegraph and Telephone Company v. The Queen [92 D.T.C. 6191 (F.C.A.)]Facts

• taxpayer’s records showed the times when services were rendered (i.e., when phone services were provided for long distance charges in the last month of the year) together with amounts chargeable for those services

Held: amounts were to be included in income even though services were provided in last month of the year and had not been paid for by the customers by the end of the year because the services had been rendered and thus Maritime Telegraph had an absolute right to the amountsRatio: Authority of the GENERAL TIMING RULE.

Where services are charged for an HOURLY or DAILY basis – the amount is to be included in the income, even though the services under the K have not been completed and this is because the amount is due to be paid through contract, even though the k is not complete.

An example of this is: legal services

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West Kootenay Power and Light Company Ltd. (1991), [1992] 1 C.T.C. 15 25, 92 D.T.C. 6023 6030Facts:

• electricity had been provided in taxation year but had not been billed for until early in following taxation year.Held: The income was earned in the year that the service was provided – the year the electricity had been provided – BECAUSE the taxpayer had done all that was needed to be done in order to have a right to the income.

S.12(1)(b): applies to all “services” because the term is not qualified in any way.

Describe the exception provided for certain types of professional services.

Professional services / business have “works in progress”. To the point that the amount would be receivable in respect of work in progress, it would be included under the genera

accrual rule or under s. 12(1)(b) as income

S. 34: this allows lawyers, dentists, veterinarians or chiropractors to elect not to include amounts that would be in respect of “work in progress”

Where a taxpayer elects to use s. 34 – they must continue to do so in the future years. They must follow the approach consistently there after and can only change the approach with the approval of the MNR.

Work in Progress: it is not defined under the ITA but it has been held to be “that part of the services rendered which have not yet been invoiced or should not have been invoiced”

In general, it is an amount for which services have been partially rendered but have not reached the stage where the taxpayer can bill the client

o if that is true then it would not be included under 12(1)(b) – but might be included under accrual method and therefore arguably under s. 9(1), so the election under s. 34 makes sense to modify this

Knowledge Objective: Dividends ITA s. 12(1)(j), (k)

Describe a “dividend”, describe how it is defined in the Income Tax Act and identify the basis on which it is taxed.

Dividend: refers to a pro rata distribution from a corporation to its shareholders s. 248(1) defines “dividend” to include a “stock dividend” – this is a dividend paid in share of the corporation instead of case dividends on shares are considered income from property and are included under s.12(1)(j) and s.12(1)(k)

o dividends are included in income on a cash basis

Knowledge Objectives: Rent and Royalties

Identify the basis on which rent is included in income.

Rents from leasing real property are usually included as income from property. However, they may be considered income from business where there is something more than just the collection of rent.

The terms “rent” and “royalty” are not defined in the Act• s. 12(1)(g) requires the inclusion in income of “any amount received by the taxpayer in the year that was dependent on the

use of or production from property” (i.e., rents and royalties are included on a cash basis)• rent is usually a fixed payment for use over a period of time• a royalty is usually a payment for the use of an intangible property or a payment for the production or use of interests in

property such as oil, gas, or minerals

Whether a transaction involves a sale of property or a royalty depends on the particular facts: when all the rights are transferred – it will be treated as sale of property where less than all the rights are transferred – it will be treated as a lease or license and the payments will be treated as

rent or royalties. The sale of intangible property is often a royalty payment because it is hard to determine the value of the property.

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Explain why an instalment on the sale of property that is based on the use of property, or production from property, is included in income.

INSTALLMENT PAYMENT BASED ON USE• s. 12(1)(g) goes on to say that amounts based on production or use are included “whether or not that amount was an

installment of the sale price of the property”• if you sell 1,000 yards of topsoil or gravel it is not a sale of the property subject to capital gains tax - it is instead

treated as income from property, even if it is part of the sale price of the property the installments as royalties (where an author assigns copyright) on sales are treated as payments based on use of the

copyright and thus included in income under s. 12(1)(g)

Skill Objective: Rent and Royalties Assess, with reference to relevant authority, when rent or royalties will be included in income.

Knowledge Objectives: Interest

(i) Define “interest”.

There is no definition of “interest” in the Act. Broadly speaking, it is the price of borrowed money (price paid to lender by borrower for the loan) Usually expressed as a percentage per annum Interest is income from property The property – is the borrower’s obligation to repay the loan

(ii) Explain why the inclusion of interest in income should, in theory, be adjusted for inflation.

The effect of inflation raises interesting tax policy issues. Lenders want compensation for inflation – a portion of the interest rate compensates for inflation

o The portion of interest rate that just compensates for inflation is the amount necessary to keep the lender’s wealth (and therefore ability to pay tax) the same

The Act taxes all of the interest, whether the portion is due to inflation or not – despite the fact that only the interest over the inflation rate really contributes to increasing wealth of lander and therefore in theory, only that portion should be taxed.

(iii) Provide a possible explanation for why interest income is not adjusted for inflation.

Knowledge Objective: Blended Payments ITA s.16(1), 20(1)(c)

Explain how the Act deals with blended payments of interest and principal to a lender.

Blended payments occur in debt instruments: ex. residential mortgage payments are part payment of interest and part payment of principal – this results in the principal of the loan being gradually reduce over the life of the loan

Thus these are blended payments of principal and interest

s.16(1): this section provides that the part of the payment that can be reasonably regarded as interest “shall…be deemed to be interest”

It is thus included in income per s. 12(1) [or deducted under s. 20(1)(c)] – thus the receipt of blended income must unblend the payment to determine the part that can reasonably be regarded as interest.

Skill Objective: Blended Payments

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Be able to assess in a given fact pattern, with reference to relevant authority, whether a particular payment on a loan consists partly of principal and partly of interest and how the payment is to be treated under the Income Tax Act.

Groulx v. M.N.R., [1967] C.T.C. 422, 67 D.T.C. 5284 (S.C.C.)Facts:

• taxpayer sold a farm for $395,000 with $85,000 payable immediately and $310,000 was payable in installments over the next six years

• no interest was payable by the purchaser• Groulx had been offered a lower amount of immediate payment but refused to accept it• the purchaser then made the offer with the higher amount but with $310,000 to be paid in installments over six years

Held: The payments over the six years could reasonably be regarded as being payments of part principal and part interest

(1) installments can be genuinely interest-free where the taxpayer and the borrower are not at arm’s length (ex. parents to child)

(2) but where parties are at arms length, it hard to see why vendor would accept a low interest or an interest-free deferred payment unless the purchaser agreed to pay more than market price

(3) an installment arrangement alleged to be “without interest” would likely arise where debtor (purchaser) is in low tax bracket or using property for personal use so that interest would not be deducted

Skill Objective: Original Issue Discount ITA ss 16(1), 12(3), (4), (9), Reg 7000

Identify situations when a discount on a debt obligation must be included in income.

Skill Objective: Debts Purchased at Discount Identify situations when a discount on a debt obligation must be included in income and situations in which it need not be included in income.

Knowledge Objective: Timing Rules ITA s 12(1)(c), 12(3), (4), (11)

Identify the basis on which interest is included in income pursuant to the Income Tax Act and explain the modifications to that basis that are made in the Income Tax Act.

s.12(1)(c): says that the taxpayer must include in income ““any amount received or receivable by the taxpayer in the year (depending on the method regularly followed by the taxpayer in computing the taxpayer’s income) as, on account of, or in lieu of payment of or in satisfaction of, interest to the extent that the interest was not included in computing the taxpayer’s income for a preceding taxation year.”

Because it says receivable or received, that taxpayer has a choice of treating interest on a cash basis or accrual basiso You must follow the same method from year to year for a particular source

12(3) and (4): limit the sue of cash method to defer tax

• s. 12(3) : requires corporations or partnerships to include in income interest accrued, received or receivable to the end of the year

• s.12(4): applies with respect to individual – it requires all interest on an “investment contract” accrued to the anniversary day of the contract be reported annually

• s.12(11): anniversary day – the day that is one year after the day immediately preceding the date of the issue of the K

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CHAPTER 8: INCOME FROM BUSINESS OR PROPERTY – DEDUCTIONS

Skill objective for Business or Property Deductions

Be able to assess in a given fact pattern with reference to relevant authority whether:(i) an expense is deductible in determining income from business or property;(ii) whether the amount of an expenses is reasonable; and(iii) when an expense can be deducted.

Knowledge Objective: Deduction Rules ITA ss. 9(1); 18(1)(a), (b), (h)

Identify the three key issues with respect to the deduction of expenses in determining income from business or property.

S.9(1) is the starting point for deduction s under income from business or property is profit. As noted earlier, this is determined using “well accepted business principles” that include GAAP

Three Key Questions are:

(1) whether an expense is deductible;

To be deductible the expense must have been incurred for purpose of earning income from business or property – expenses for personal consumption or savings are NOT deductible expenses are ONLY deductible if they are incurred to earn income fro business or property

o expenses must be reasonable in the circumstances

s. 18(1)(a) holds that no personal or living expenses …other than travel. can be deducteds. 67: expenses must be reasonable in the circumstances

The courts use all three provisions when denying a deduction.

Non-income earning expenses are those incurred for: personal consumption or personal purposes – for instance, food, shelter, clothing, personal entertainment for purpose of earning capital gains (since a different approach is taken to expenses with respect to capital gains)

There may be mixed personal and business expenses.

(2) whether the amount of the expense is reasonable;

Provisions that affect the timing of deductionss.18(1)(b) disallows the deduction of expenditures on account of capital – such expenditures cannot be fully deducted in the year which they are incurred but must be spread out over time according to the method provided in the Acts.20(1)(a) and (b): provide for the method of taking deductions for capital expenditures

(3) when is it deductible?

It is thus important to distinguish between “current expenditures” that can usually be deducted in the year of expenditure and “capital expenditures” that must be deferred

s.18(9): prohibits the deduction of prepaid expenses and defers their deduction to the year to which they relates.20(1): also permits reserves to be taken (i.e. allowing deductions for expenses in the year to which they relate but which will not be paid or incurred until a year later)

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Knowledge Objectives: Purpose and Rationale

(i) Explain the relevance of the evaluative criteria of ability to pay, equity and neutrality in the context of permitted expense deductions in determining income from business or property.

Ability to Pay: income tax based on ability to pay assessed by measuring incomeo Expenses incurred in producing income are not personal consumption – they are incurred to produce an increase

in income and it is the increase in wealth that increase a person’s ability to payo Personal expenses – do NOT contribute to wealth and also are not incurred to produce income – they are part of

consumption and so they should not be deductible in determining a person’s income for tax purposes Equity: allow some persons to deduct personal expenses and not others would result in a horizontal inequality.

o The problem is more likely to occur with respect to income from business or property versus income from employment – since deductions are limited to specific deductions in the case of employment

Neutrality: if persons could deduct personal expenses associated with a particular source of income but not with respect to other sources of income, there would be a tendency for persons to prefer to earn the type of income that gives them the scope for deducting personal expenses – this would create a tax system that is not neutral and it would affect the behavior of tax payers.

(ii) Discuss the policy concerns of accurate picture of profit, certainty, controlling abuse, and public policy controls with respect to the deduction of expenses in determining income from business or property.

Accurate Picture of Profit: a deduction of personal expenditures would also not lead to an accurate picture of profit – if an expense was not incurred for the purpose of gaining income from the business then deducting the expense against the revenues of the business will underestimate the profit from the business.

o GAAP would normally not allow for a deduction of personal expense because this would not lead to an accurate picture of profit – therefore it is not permitted under s. 9 of the Act

Certainty and Predictability: some of the provision in the Act can be explained on the basis that they provide certainty o the deduction of capital cost allowance rather than using one of the various accepted accounting methods of

calculating depreciation provides for more certainty about what can be deducted Anti-Abuse: the act also limits deductions to control against abuse

o Some of the arbitrary rules for deductions are intended to limit abuse Tax Policy as Public Policy: there are questions of whether the deductions should be limited on broader principles of public

policy

Knowledge Objective: Personal and Mixed Expenses

How does the Income Tax Act deal with personal or living expenses and how does this compare with generally accepted accounting principles?

Definition of Personal or Living Expenses: if the expense is incurred for purpose of producing income from business or property then normally it would be deductible under GAAP.

Expense for personal or living expenses normally are not deductible under GAAP or s. 18(1)(a) and would also not be deductible under s. 18(1)(h)

ITA s. 248(1): defines “personal or living expenses” as “The expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or common-law partnership or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.”

The definition only deals with expenses of properties maintained for benefit of the tax payer – the definition does not limit other kinds of expenses and so the distinction is made on a case-by-case basis

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Knowledge Objective: Common Law Tests

What are dual purpose expenses and what two approaches have been taken to dual purpose expenses for income tax purposes under the Income Tax Act?

TESTS FOR WHAT AN EXPENSE IS PERSONAL

The majority in Symes cited six tests for whether an expense is personal or for business:

(i) Whether the expense is deductible according to accounting principles or practice such as generally accepted accounting principles

(ii) Whether the expense is normally incurred by other taxpayers carry in similar business. If it is, there may be an increased likelihood that the expense is a business expense

(iii) Whether a particular expense would have been incurred if the taxpayer were not engaged in the pursuit of business or property income or whether, in absence of the business activity, the need to incur the expense (such as food, clothing and shelter) would still be there

(iv) Whether the taxpayer could have avoided the expense without affecting gross income(v) Whether the expense is an expense” of the trader” or “of the trade”. If the expense was an incident of the trade – part

of the business operation itself, it is an income-earning expense(vi) Whether a particular expense was incurred in order to approach the income-producing circle (such as clothing, child

care, housekeeping or commuting) or was incurred within the circle itself. This test may be of limited assistance n cases where the “personal circle” and “income-producing circle” overlap, such as in the case of home office expenses.

DUAL PURPOSE EXPENSES

A dual purpose expense is an expense that can be considered to be partly incurred for the purposes of producing income from business or property and partly considered personal or living expenses.

Where part of the trip or other business expense is partly personal, the personal portion cannot be deducted in determining income from business or property

APPROACHES

1. Apportion the expense between an income producing portion and a personal/living expense portion. In the case of meals and entertainment expenses the Act provides an arbitrary apportionment of 50% in s. 67.1

2. Principal: some cases have deducted the entire amount of the expense if the principal purpose was business or disallowing the entire expense if the principal purpose was personal

Knowledge Objective: Child Care Expenses

Discuss the difficulties before the court in the Symes case in terms of discrimination on the one hand if a deduction for child care expenses was not allowed as a business expense and in terms of equity and neutrality if a deduction of child care expenses as a business expense was allowed.

s. 63 allows partial deductibility of child care expenses. There are three important limitations on this section: only the lower income parent can claim the deduction the deduction cannot exceed 2/3rds of the “earned income” of the lower income parent; and the deduction is capped at $7,000 per child under the age of 7 and $4,000 per child between the ages of 7 and 16 inclusive

Symes v. Canada, [1993] 4 S.C.R. 695, [1994] 1 C.T.C. 40, 94 D.T.C. 6001Facts:

• taxpayer was a self-employed female lawyer with two small children• she paid a nanny to look after the children• she claimed that other cheaper forms of day care were not satisfactory given the irregular hours of her work in her

litigation practice• she and her husband had made a family decision that she should pay for child care expenses• the husband was employed (not in business) and earned less income than she did

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• she claimed $13,000 in 1985 as deduction for child care expenses at time when the child care expense cap was $4,000• the Minister only allowed a claim for $4,000 (the maximum allowed under s. 63 at the time)• the taxpayer argued that it could be deducted as a business expense on the basis that had she not incurred the expense

she would not have been able to earn business incomePolicy: Limiting the deduction of child care expenses creates an inventive for having a spouse stay home to take care of the child – the net benefit of taking on a job after incurring the child care expenses may make it seem not worthwhile to take the job. This arguable violates tax neutrality – and disproportionality works against women .Held:

child care expenses were NOT deductible as a business expense according to traditional tests of deductibility. Thy were not incurred as part of the income earning process but only to make the taxpayer available for business.

Cited 6 tests for determining whether an expense is a business expense as opposed to a personal expenseDissent: stated that s. 63 cannot preclude deduction of child care expenses as a business expense – if it did not then it would be contrary to s. 15 of the Charter re equality.

This case created difficulties for the court

• if one allowed deduction as a business expense then it would favour persons who earn business income over persons who earn employment income since persons earning business income would be able to deduct child care expenses in full while persons earning employment income would have limited child care expense deductions per s. 63

• this would violate both neutrality and equality – as there would be a further advantage to earning business income • horizontal equity would be violated – to the extent that a person earning business income would get a larger

deduction for child care expenses than a person earning the same level but via employment income• vertical equity would be violated – the the extent that self-employed, on average, tend to be wealthier taxpayers• it arguably discriminates against women who tend to be the primary child-care providers

Knowledge Objective: Food and Beverages

In general, consumption of food and beverages is a personal expense is not deductible per s. 18(1)(h)

(i) Identify the three step approach used by the Federal Court of Appeal in the Scott case for distinguishing business expenses from personal or living expenses?

Scott v. MNR, 98 DTC 6530 (FCA)Facts:

• however, in Scott v. MNR the Federal Court of Appeal considered the re-conceptualization referred to in Symes in a case involving a claim for food and beverages

• Scott was a courier who travelled over 150kms per day either on foot or by public transit• he carried a backpack weighing between 20-50 lbs• he worked ten hours per day• the employer considered him an independent contractor and did not provide for any break or meal times• he had to work through the day to deliver as many packages as possible to make the job viable• he had to consume an extra meal every day (at a cost of $8 per day) and extra bottled water (at a cost of $3 per day)• he claimed a deduction of this extra $11 per day as a deduction in respect of his income from his courier business• the Minister disallowed the deduction on the basis that it was of a personal nature

The court asked three questions(1) what is the need that the expense meets;(2) would the need exist apart from the business; and(3) is the need intrinsic to the business?

Held: The court noted that if the need would exist apart from the business then the expense has traditionally been regarded as a personal expense. Here, however, the extra food and beverage were consuming because of the business – he could deduct the extra food and beverage required because of the business.

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(ii) Explain how the test in Scott applies in the context of expenses for food and beverages?

Held: The court noted that if the need would exist apart from the business then the expense has traditionally been regarded as a personal expense. Here, however, the extra food and beverage were consuming because of the business – he could deduct the extra food and beverage required because of the business.

Knowledge Objective: Entertainment Expenses ITA ss. 9(1), 18(1)(a), (h), 67.1

(i) What approach did the Royal Trust Company case take to determining whether an expense was deductible as a business or property expense under the Income Tax Act?

The Royal Trust Company v. MNR, [1957] CTC 32 (Exch. Ct.)Facts:

• the taxpayer had a policy of requiring certain of its employees to join social clubs and other community organizations so they could meet prospective clients

• the company paid all the fees involved• in 1952 the company claimed $9,527 for such dues• there was evidence that the club memberships resulted in business advantage to the company and that its competitors

followed the same practice• the expert accounting evidence was that the expense would be deductible under accounting rules

Approach to Determining Whether an Amount is Deductible the court noted that the approach to determining whether an expense was deductible was to first determine whether

the deduction is permitted by accounting principles then one should look to whether the deduction is restricted under the Act

Look to Purpose Not Result the court also noted that the expenditure does not have to actually result in the production of income the Act requires only that the expenditure to be made for the purpose of earning income

Principle or Dominant Purpose the court looked to the principal purpose of the expenditures here concluded that the principal purpose was to earn income from business since the expenditures were made for the

purpose of producing business income through personal contacts at social clubs and the taxpayer even gave specific instances of where this had occurred

(ii) According to the Royal Trust Company case does an expense actually have to produce income in order to be deductible? If not, what is required and what was the basis for the decision in terms of the Income Tax Act?

The court held that the expenditures does not have to actually result in the production of income – the act requires only that the expenditure be made for the purpose of earning income. If it does not – then the courts look to the principal or dominant purpose.

Knowledge Objective: Commuting Expenses

Explain the circumstances under which commuting expenses can be deducted as an expense in earning income from business or property.

Commuting is a dual-purpose in nature – the journey to work is necessary to earn income. However, it is also partly a consumption choice of where to live.

The approach the courts have taken has been that the expenses for commuting are expenses that make a taxpayer available for work but are not incurred in the course of the business.

However, once a taxpayer has traveled to work, then any business-related travel from the office to another place, other than to home, for the purpose of business is a business expense.

Cumming v. M.N.R., [1967] C.T.C. 462, 67 D.T.C. 5312 (Ex. Ct)Facts:

• in Cumming v. M.N.R. the taxpayer was an anesthetist

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• he rendered all his professional services at a hospital near his home• however, there was no office available at the hospital for him to do the bookkeeping and paperwork of the practice or at

which he could read medical journals• he set up an office at his home that he used exclusively for his professionally related work.

Held: the court held that the home office was the base from which the practice operated and thus the trips to the hospital and bac were not commutes to work but were trips made in the course of his business – consequently the expense of the trips was deductible.

Knowledge Objective: Housekeeping Expenses

Explain when housekeeping expenses can be deducted in determining income from business or property.

The cost of housekeeping may help to earn business income – the purchase of housekeeping services may free taxpayers to do work, but on the other hand it may also be considered a personal or living expense. It is similar to commuting in that it frees the taxpayer for work but it is also for partly personal consumption.

Thomas Harry Benton v. MNR (1952), 6 Tax ABC 230, 52 DTC 196Facts:

• the approach can lead to some arbitrary results• e.g., in Benton v. MNR the taxpayer was a 62-year old farmer who owned and operated a 480-acre farm• he was a semi-invalid – he had had a slight stroke, had had an abdominal operation for cancer, had high blood pressure,

and had dizzy spells – he was not supposed to be left alone• he hired a housekeeper to whom he paid wages of $65 per month or $780 in 1949• he sought to deduct the housekeeping expense as an expense of the farm business.• the expense was disallowed in excess of $325• $325 was an amount that was related to work done by the housekeeper on the farm and therefore was reasonably

related to generating farm income• however, the remaining expense of $455 was said to be a personal or living expense

Held: the evidence indicated that Mrs. Reed was primarily a housekeeper and that her contribution to the income-earning work on the farm was necessarily of a secondary nature, however helpful it may have been to the appellant.

The only deduction that was allowed was whether Mrs. Reed’s efforts related to the production of farm income.

Knowledge Objective: Home-office Expenses ITA s. 18(12)

Explain why a specific provision was added with respect to the deduction of home office expenses.

The home office is another dual purpose expense – it may be used for business but it also forms part of the home used for personal use. Courts have been reluctant to permit any part of home expenses to be deducted unless a separate room in the house was maintained as an office and the room was used exclusively for business purposes.

In such situations a deduction of a proportion of home expenses based on a proportion of floor space devoted to the home office has been allowed

Logan v. M.N.R., 67 D.T.C. 189, [1967] Tax A.B.C. 276 (T.A.B.)Principle: a doctor was permitted to deduct a proportion of the home expenses attributable to the room in the home that was used as an office – the doctor was able to establish that the office was used exclusively for work-related activities such as “medical writing, book keeping and meeting with other doctors”

Mallouh v. M.N.R., [1985] C.T.C. 2297, 85 D.T.C. 250 (T.CC.)Principle: this doctor was denied a deduction for costs of a home office that occupied half of the basement in his home – the office was a “general study or den” in which business-related work was not the exclusive activity

Amendment in 1988 adding s. 18(12)

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S. 18(12) was added in 1988 to deal with home office expense issueo There is no deduction for a home office except to the extent that it is either

The individual’s principal place of business; or Used exclusively for the purpose of earning income from business and used on a regular and continuous basis

for meeting clients, customers or parents of the individual in respect of the business It is only deductible if it first satisfies the requirements of the cases and provision of Act – limits the deductions to the

extent there is income from the business for which the home office is used

Knowledge Objective: Damages and Similar Payments

Explain why the taxpayer does not have to show that an expense resulted in the earning of income.

Damages are generally deductible if they are incurred as part of the process of earning income from business or property

The test is simply whether the expense was incurred for the purpose of gaining or producing income from business – it is just that there may be causes where the breach is so egregious or repulsive that it is hard to see how it could have been incurred for the purpose of producing income from business [Fines and Damages]

Imperial Oil v. M.N.R. (1947), 3 D.T.C. 1090 (Ex. Ct.)Facts:

• in Imperial Oil two ships collided at sea• the taxpayer entered into a settlement with respect to the damages caused by the collision• the settlement called for the taxpayer to pay damages of $526,995• the question was whether the damages could be deducted for tax purposes• the Minister argued that the expenditure was not for the purpose of gaining or producing income as required by s. 18(1)

(a) but was incurred to discharge a legal liability Held:

(1) you cannot take s. 18(1)(a) so literally because an expense by itself could never directly accomplish the purpose of gaining income

(2) the court asked whether the expense came about “as part of the operations, transactions or services by which the taxpayer earned income” – it it does then it is part of the income-earning process and is deductible.

65302 B.C. Ltd. v. The Queen (1999), 179 D.R.L. (4th) 577 (S.C.C.)Facts:

• the taxpayer operated a poultry farm business in Prince George, B.C. (Veekens Poultry Farms) and produced eggs under a quota from the provincial government

• the quota determined the number of layer hens that the producer could keep• given the local demand the producer chose to operate over the allocated quota for the years 1984 to 1988• the taxpayer was concerned that if it did not operate over quota it would lose its major customer Overwaitea Foods• additional quota was not available for purchase around Prince George during 1984-88• the taxpayer did not inform the British Columbia Egg Marketing Board of its overproduction• in 1988 an inspector from the Board discovered about 6,700 more layers than permitted under the quota• the Board imposed an over-quota levy pursuant to the regulations under the National Products (B.C.) Marketing Act• after negotiations with the Board the taxpayer agreed to pay an over-quota levy of $269,630 and to dispose of its excess

hens• in its return for 1988 the taxpayer deducted the over-quota levy as an expense pursuant to s. 9(1) and s. 18(1)(a) of the

Act resulting in a loss of $61,879 that was carried back to its 1985 taxation year• in its 1989 tax return the taxpayer deducted $9,704 for interest paid on the unpaid balance of the levy and $3,766 of

legal expenses relating to representation with respect to the over-quota levy• the Minister disallowed the deduction of the levy, the interest, and the legal fees

Held the levy should be deductible Majority: asked whether the levy, fine or penalty was incurred for the purpose of gaining or producing income from business? Concluded that the fine was incurred for the purpose of gaining or producing income from business (ex. the expansion of

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the business to earn income from sale of eggs to its major costumer who it was afraid of losing if it was unable to supply the necessary eggs)

McNeill v. The Queen, 2000 D.T.C. 6211 (F.C.A.)Facts:

• subsequently in McNeill the taxpayer was ordered to pay damages of $465,908 for breach of a non-competition clause in the agreement under which he had sold his accounting practice

• McNeill claimed the damages as a deduction but the Minister refused the deduction

Held: the could held that the decision in 65302 [above] applied to damages as well. They allowed the deduction, presumably, on the basis that the breach of the non-competition clause was for the purpose of producing income. Ratio: Damages would be deductible if they were incurred for the purpose of gaining or producing income from business.

SUMMARY ON DEDUCTIBILITY OF DAMAGES

damages are deductible if they are incurred as part of the operations (or transactions or services) of the business [per Imperial Oil case]

but damages are not deductible if not part of the operations of the business – i.e., if not part of the normal risks of the business [per Imperial Oil case and the Poulin case]

s. 67 also requires that the expense be reasonable (therefore must satisfy the gaining or producing income test or the enduring benefit test and be reasonable)

courts will not normally disallow deduction of damages on moral or public policy grounds BUT the damages could be said to be so egregious or repulsive that it was not for the purpose of earning income from business or property [per the Poultry case and McNeill]

Knowledge Objective: “Reasonable” Requirement ITA s67

Be able to note and apply the reasonableness requirement in conjunction with other provisions restricting the extent of deductions.

Section 67: provides that an amount otherwise deductible is deductible only to the extent that the outlay or expense was reasonable in the circumstances.

S. 67 applies to all deductions – not just income from business or property deductions 3– however, it most often arises in the context of income from business/property – it is often used to reduce/prohibit a deduction

There are two main types of cases:

[1] expenses excessive in relation to purpose of expense (usually because there is a personal element to the expense);[2] non-arm’s length management fees/rents/salaries paid to artificially reduce a taxpayer’s income or for some other tax

avoidance purpose

1. Excessive in Relation to PurposeNo. 511 v MNR (1958), 19 TAX ABC 248Facts:

• In this case, the taxpayer company was sponsoring a baseball team• They spent 22,500 (more than ½ of the company’s profits) on a baseball team• The principle shareholder of the company was an avid baseball fan and appeared to sponsor the baseball team as a

hobbyHeld

While Tax Appeal Board accepted that expenditures in sponsoring a baseball team were legitimate expenditures as a form of advertising, it held that the expenses of more than ½ of the company’s profits was excessive

Board found that an expenditure of $5,000 on advertising would have been reasonable and allowed that amount

2. Unreasonable amount in Non-Arm’s Length Payments

Mulder Bros v MNR [1967] Tax ABC 761, 67 DTCFacts:

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• In this case the corporation was controlled by two brothers. They paid the salaries as follows:Brother A – 20,000Brother B – 13,000Brother B’s wife – 13,000

• Each of them worked as an employee of the corporation• Minister argued that the amount of salary to B’s wife was excessive/unreasonable and should be reduced to 6,000

Held The tax appeal board agreed it was excessive but reduce the amount to 8,5000.

Costigane v R (2003), [2003] 3 CTC 2087, 2004 DTC 254 (TCC)Facts:

• Mr. Costigane was a dentist and had a family trust known as the Costigane Family Trust. The trust operated a business called Cotigane Financial Services. CFS provided management, banking and accounting services to Mr. Costigane

• In order to this CFS hired three persons who were also employed by Mr. Costigane in his dentistry business – the CFS employees did their work in Mr. Costigane’s dentistry office

• Mr. Costigange paid a monthly fee to CFS of 2,450 or 29,400 per annum• Minister argued this is 4 x a s much as necessary – allowed 7,346 per annum• Mr. C got the numbers for the charge by CFS services from what other accounting firms would charge – 40 – 60 dollars

per hour versus he paid his employees 10-12 per hour. Held

Appeal allowed in part on evidence that it would have cost $8,000 if he hired employees directly in his dentistry office to do the same work (but not much different than Minister’s 7,346 per annum and was substantially less than the 29,400 per annum that Mr. C deducted)

Aessie v R (2004), [2004] 4 CTC 2159, 2004 DT 421 (TCC)Facts:

• Aessie was a self employed chartered accountant and provided services from his residence. • His spouse provided assistance in the form of administrative duties• Aessie deducted fees for services provided by his spouse as an employee of Mayday Management Incorporated in the

amount of 34,500 and 38,000 in the 1999 and 2000 taxation years• Minister disallowed management fees that were not reasonable in the circumstances per s. 67 – says no more than

8,850 were reasonable in those yearsHeld

The deal with mayday is a common and reasonable business deal that is not unusual or untoward in the business world. It is not appropriate for the Court to interfere in such a transaction. Therefore the appeal respecting this matter is allowed

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CHAPTER 9: CAPITAL EXPENDITURES

Current expenses incurred for the purposes of earning income form a business or property are immediately deductible, paragraph 18(1)(b) of the ITA prohibits the deduction of “an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence, or depletion except as expressly permitted by this Part”

This does not mean that capital expenditures are not recognized for tax purposes. Most are eventually deductible, just not fully in the current year

A capital expenditure is generally capitalized – added to the taxpayer’s cost of the asset with respect to which the expenditure is incurred.

o This amount will be recovered, when the asset is sold or over some period of time during which the asset is held, through a series of deduction for depreciation nor amortization.

The distinction between current and capital expenditures is purely a timing question. Question 1: Is it deductible? I.e. was it incurred for the purpose of earning income from business or property [s. 9(1) and s.

18(1)(a)] and whether it is reasonable [s. 67]. o Where it is DEDUCTIBLE and REASONABLE then the next question is:

Question 2: when can the expense be deducted [s. 18(1)(b) – Timing Issue]

Policy Considerations for Deferrals

The deferral of capital expenditures (one that provides benefits in subsequent periods) makes sense in terms of measuring accretion to wealth. To the extent that there is value left to be gained from the expenditures in periods that go beyond the end of the taxation year, the expenditure is thus an asset at the end of the period and it has provided an accretion to wealth.

This means that to the extent value remains from the expenditure, it should not be deducted in the year it was incurred.

Skill Objective: Current Expenditure v Capital Expenditure

Be able to determine, with reference to relevant authority, whether an expenditure that is incurred for the purpose of earning income from business or property is a capital expenditure or a current expenditure.

Capital Expenditure Defined

The act does not define the term “capital expenditure. The meaning is thus determined on a common law basis. Generally, it is an expenditure that “will provide a benefit that will last beyond the year and for a substantial period of time” There are several tests:

[1] enduring benefit test – the MAIN test;[2] recurring expenditures test; and [3] was the expenditure part of the “business structure” (this test is arguable essentially the same thing as the enduring benefit test)

1. ENDURING BENEFIT TEST

Principle of the Test: If an expenditure is made to produce a benefit to the business that will last beyond the current taxation year, then it should not be deducted in full in the current year. That would understate the income for the current year.

The enduring benefit test comes from British Insulated and Helsby Cables v Atherton

BrItish Insulated and Helsby Cables v Atherton, [1926] AC 205, 213Facts:

• In this case the company made a lump sum payment of 32,000 to establish a pension scheme for its employees. The company sought to deduct the whole amount of the payment in the year in which it was paid.

Held The House of Lords said that “such a payment could not be fully deducted in the year in which it was incurred. The

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expense must be spread over several years” The court held that the effect of the payment of this large sum was to enable the company to establish the pension fund

and to offer to all its existing and future employees a sure provision for their old age, and to so obtain for the company the substantial and lasting advantage of being in a position throughout its business life to secure and retain services of a contended and efficient staff.

Principle If an expenditure is made to produce a benefit to the business that will last beyond the current taxation year, then it

should not be deducted in full in the current year. That would understate the income for the current year. Deferring the deduction would be consistent with GAAP and would provide a more accurate measure of profit and,

therefore, a more accurate measure of ability to pay. So the expenditure should be amortized over a number of years deducting a portion of the expense used up in each year.

1A. BUSINESS STRUCTURE v INCOME EARNING PROCESS TEST

This test is derived from the enduring benefit test and is sometimes considered to be a separate test. This test makes the distinction between capital and current expenditures by asking this question:

Is the payment made for the establishment or expansion of the business structure that has an enduring benefit (the payment is on account of capital); OR is the payment made as “part of a money earning process” (the payment is a current expense)

A test that provides for the “establishment of expansion of the business” is one that provides an enduing benefit to the business”

Johns-Mansville Canada Inc v R (1985), [1985] 2 SCR 46Facts:

• Taxpayer had an open-pit asbestos mine. He regularly purchased land adjoining the mine sight so that it could keep the slope into the mine a gradual one and thereby prevent landslides.

• Taxpayer deducted the cost of the land as a current expense but the minister disallowed this on the basis that it was a capital expenditure.

Held SCC held that the cost of the land was a current expense.

The court in Johns-Manville treated this as a separate test. Test:

Is the payment made for the establishment or expansion of the business structure that has an enduring benefit (the payment is on account of capital); OR is the payment made as “part of a money earning process” (the payment is a current expense)

BP Australia Ltd v Commission of Taxation of Commonwealth AustraliaFacts:

In this case an inducement payment was made to a service station operator in exchange for an exclusive agency agreement under which the operator would only distribute the taxpayer’s products

Held The expense was said to be a current expense because it was made as part of the money earning process of selling

gasoline and related products.

VERSUS

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Sun Newspapers LTD v Federal Commissioner of TaxationHeld – opposite conclusion of BP Australia

A lump sum payment for a non-competition agreement was held to be capital expenditure on the basis that it was a large expenditure that was made to obtain a competitive advantage that provided an enduring benefit to the taxpayer

2. RECURRING EXPENDITURES

It has been suggested, although NOT as a conclusive test, that a “capital expenditure is a thing that is going to be spent once and for all, and an income expenditure is a thing that is going to recur every year”

Vallambrosa Rubber Co (1910 UK) Ounsworth v Vickres (1915)

This approach has been referred to in some Canadian cases.

HOWEVER This test is not conclusive. For very large businesses even large outlays for items ex. delivery vehicles may be incurred every

year in a program of replacement yet each individual vehicle may last for several years. Other payments that will not recur may provide benefits that will be exhausted in the year

o ex. severance payments will not provide an enduring benefit but it is a one-time expense the damages payment in Imperial Oil would be a large one-time payment but would provide no enduring benefit.

To conclude, this test has many problems.

3. RESIDUAL TEST

If the two above tests fail to characterize an expense, a “residual test” has been applied to characterize an expense in favour of the taxpayer.

Although the cost of land is normally treated as a capital expense, in the Johns-Manville case it was treated as a current expense. The court then articulated the “residual test”

“If the interpretation of a taxation statute is unclear and one reasonable interpretation leads to a deduction to the credit of a taxpayer and the other leaves the taxpayer with no relief from a clear bona fide expenditures in the course of his business activities,

the general rules of interpretation of taxing statues would direct the tribunal to the former interpretation”

the problem in Johns-Manville was that the value of the land was reduced since it was dug out to create a more gradual slope, so unlike land normally the use of the land did decrease its value there by reducing the taxpayer’s

unlike usual land – in this case the land depreciates in value and in fact was a real expense of the business – allowing for it to be a current expense

Knowledge Objective: Acquisition of Assets

Be able to distinguish between depreciable property, intangibles, non-depreciable property, natural resources and so-called “nothings”.

If a payment is made with a view to bringing into existence an asset for the enduring benefit of a trade or business, it is a capital expenditure. Thus, capital expenditures typically include the acquisition of business or investment assets that will last longer than the current taxation year.

Depreciable Property [s. 20(1)(a); Reg 1100]

“Depreciable property” defined in s. 248(1) which simply says it “has the meaning assigned by s. 13(2)” s. 13(21) defines “depreciable property” as property for which a deduction can be taken under s. 20(1)(a) depreciable property includes some types of tangible properties and few types of intangible properties (patent, franchise,

concession or license for a limited period – but not minerals, etc.) depreciable property, such as a computer, building, machine, or other tangible asset in which the value wastes away during

a period of time; the cost of which is recognized or recovered under the capital allowance system88

Intangibles - Eligible Capital Expenditures [s. 20(1)(b); s. 14]

Intangible properties (such as patents, trademarks, and copyright) which are used in earning income from a business (not property), the cost of which is recognized either under the capital cost allowance system or the “cumulative eligible capital amount” system

s. 20(1)(b) permits a deduction of an amount in respect of most types of intangible properties expenditures of this type are referred to as “eligible capital expenditures” 3/4s of these eligible capital expenditures are added to an account called “cumulative eligible capital” and then a deduction

of 7% of the outstanding balance of the cumulative eligible capital can be deducted every year. S. 14 provides for the rules on the cumulative eligible capital deduction

Non –Depreciable Property [ex. land]

Non-depreciable capital property (typically land), the cost of which is recovered only when the property is sold. there is no deduction under reg. Part XI

Natural Resources

s. 65 of the Act deals with the case of natural resources, such as an oil or gas well, mine or timber license. The act allows a deduction based on the depletion system

“Nothings” [e.g. S. 18(1) recreational facilities]

these are a final category of expenditures that are never deductible in computing income or capital gains. They may provide benefits in the future.

o Examples are expenditures that did not result in acquisition of any assets mentioned above, intangible property acquired to earn income from property, and expenditures that cannot be deducted because of statutory prohibitions.

Ex. expenses for recreational facilities, clubs or yachts cannot be deducted per s. 18(1)

Skill Objective: Specific Problem Areas

The specific problem areas discussed below relate to the overall skill objective of being able to determine, with reference to relevant authority, whether an expenditure that is incurred for the purpose of earning income from business or property is a capital expenditure or a current expenditure.

1. SMALL RECURRING EXPENDITURES

Sometimes it does not make sense to capitalize an items that provides an enduring benefit where the expenditure is relatively mall, tends to be recurring and tends to be a similar recurring amount from year to year.

In these instances, it will NOT distort income to just expense the item in the current year. o Example: tools purchased for a repair shop may last for several years but as long as the expense for the tools is

similar in every year it will not affect the income statement to deduct the entire amount of the expense in the year.

It would be administratively costly to keep track of the depreciation on the tools from year to year Although the Act doesn’t specifically permit expensing these items in the year in which they incurred, the CRA accepts the

practice.

2. REPAIRE OF TANGIBLE ASSETS

The cost of a repair or replacement, where it is small in relation to the asset being repair, is one that will regularly recur, and its purpose is simply to restore the original asset to its normal operating capacity – may be considered a current expense. However, where the cost is large in relation to the asset being repaired (or improved), where it is not of a kind that will regularly occur and

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where the purpose is to improve the quality of the asset substantially beyond its original condition, then the cost will be treated as capital expenditure.

Ultimately, the courts will consider(i) size: the relative size of the expenditure in comparison to the asset(ii) recurrence: whether the expenditure is a recurring expenditure; and

where the expenditures are recurring they may not make much difference to the income calculation,(iii) effect on value: whether the expenditure increases value or restore the asset to the original/normal value or

operating capacity. where it just restores the asset to its normal operating capacity, without extending its useful life, it does

not increase the enduring benefit

The key consideration here is to have a sense of where it might be argued that an expense for repair is a capital outlay versus a current expense and to be able to make arguments for either outcome on the basis of the cases.

CAPITAL EXPENDITURES

Earl v MNR (1993)Facts:

The taxpayer spent 33,069 on the purchase of a new roof for a commercial rental property. Taxpayer deducted entire amount in the year in which it was incurred.

Minister disallowed the deduction saying that the new pitched roof create an improvement to the building of an enduring nature and different in kind to than the old flat roof

Held CAPITAL IN NATURE and thus not a current expense because the new roof was an enduring benefit improvement.

Shabro Investments v the QueenFacts:

Taxpayer replaced concrete floor in a commercial building. The expense was substantial and did improve the quality of the floors – changed the quality from very poor to a floor

that was suitable for it’s intended useHeld

CAPITAL IN NATURE because it improved the floors

VERSUS

CURRENT EXPENDITURES

Canada Steamship Lines v MNRFacts:

Taxpayer replaced the floors and walls of cargo-carrying holds in its ships. The expenditures were substantial in relation to the value of the ships. They were also substantial in relation to repairs of previous years

However, the damages were due to normal wear and tear and the new floors only restored the ship to their normal full operating capacity

Taxpayer deducted the full amount in the year while the Minister disallowed the full deductionHeld

They were CURRENT EXPENDITURES and deductible in the year- restored the ship to full operating capacity.

Janota v RFacts:

Taxpayer and son spent 37,000 renovating the bottom floor of a 100-year-old duplex they bought for 419,000. Repairs were prompted by the inspection

Held They were CURRENT EXPENSES – although extensive, they were (1) relatively minor in comparison to the value of the

property; and (2) repair was required to restore the property to its original condition rather than to improve the property – since the repairs served to put the house back to its original state and not to effect structural improvement

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3. PROTECTION OF INTANGIBLE ASSETES

Another problem has arisen in the protection of intangible assets. The issue arises with respect to expenses incurred in the defense or protection of title to property, especially intellectual property and other types of intangible property. One type of costs is legal costs.

CURRENT EXPENDITURES

Canada Starch Co v MNRFacts:

Involved a payment made by the taxpayer to a competitor to settle a dispute about Canada Starch’s right to use a particular trademark. The competitor withdrew its opposition because of the payment, as a result the settlement

Taxpayer deducted the cost of the settlement in the period Held

They were CURRENT EXPENDITURES because the expenditure related to the “process of carrying on the business rather than the “business, entity, structure or organization” and id did NOT provide an enduring benefit

Kellog Co of Canada v MNR [1943]Facts:

Taxpayer deducted the cost of litigation the right of Kelloogg of Canada Ltd. to use the name “Shredded Wheat” Minister disallowed the deduction on the basis it was a capital outlay

Held They were CURRENT EXPENDITURES

VERSUS

CAPITAL EXPENDITURE

MNR v Dominion Natural GasFacts:

Taxpayer incurred legal costs in defending a challenge to its license to supply natural gas to a particular place Minister did not approve the deduction of the expense in the year in which it was incurred

Held They were CAPITAL EXPENDITURE because there was an enduring benefit. After the litigation, the taxpayer had a less vulnerable and more valuable license than it had had before – enduring

benefit

Commentary on these Cases:

May be because for these cases the expense was made to preserve capital assets (ex. the name” “Shredded Wheat”) and should be deductible as current expenditures similar to the repair of a tangible asset.

Arguably by preserving the asset the expenditure did nothing more than maintain the normal usefulness of the asset However, it may also be argued that the settlement and litigation in these two cases removed a cloud on the validity of the

use of the name – which actually then improved the quality or value of the asset and it was an improvement that would last for a period of much longer than the current year – capital expenditure?

Courts in Canada may be willing to stretch things to treat the expenditures in (Canada Starch and Kellogg) because otherwise there would be no deduction for these expenditures, even though they were clearly incurred to earn income from business

4. WEBSITES AND DOMAIN NAMES

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Corporations and other entities often incur significant costs to develop Internet websites to promote and sell their products and/or services. Many of these are deducted as current expenses but some examples of capitalized expenses include costs of hardware, software and original graphics.

The test when trying to characterize expenditures incurred in acquiring domain names for tax purposes is: “Does it have an enduring Benefit?”

CAPITAL EXPENDITURE – where the domain name is well known and is equivalent to a trade-mark, trade name or service mark and would have an enduring benefit

CURRENT EXPENDITURE – domain name has a limited life

5. CORPORATE TAKEOVERS

The enduring benefit test clearly refers to an expenditure that can bring into existence an “advantage” or an asset for these enduring benefit of the trade or business. The cost of corporate tae overs and goodwill are such expenditures.

Courts have held that the expense of defending a hostile takeover bid a CAPITAL EXPENDITURE, perhaps on the basis that it defends the continued use of the assets

An expense incurred by a target in a friendly take has been held to be a CURRENT EXPENSE

Neonex International Ltd v MNRHeld

The expenses incurred by an acquirer in an effort to complete a takeover were capital expenditures – here there will be a change in the business, the benefits of which will likely accrue over many years

6. GOODWILL

Goodwill is essentially the “capitalized value of the earning power of a going concern business over and above a reasonable return on the value of its other assets”.

It is essentially the intangible advantages possessed by an established business: its name, reputation, connections with suppliers, etc.

The cost of purchasing goodwill is a CAPITAL EXPENDITUREo When a person buys a business, he or she is concerned with the earning capacity of the business. The price of the

business will normally exceed the value of the tangible assets; otherwise the vendor would “break up the business” and sell each individual asset – rather then selling the business as a whole.

Gifford CaseFacts

Gifford bought a client list. Gifford was willing to pay for the list on the basis that there was something to be gained form being able to deal with those clients and the expectation that they would continue to be loyal clients.

Held It was treated a CAPITAL EXPENDITURE presumably because good will is an enduring benefit.

7. EXPENSES WITH RESEPCT TO NEW BUSINESS

Expenses incurred in entering a new business may be characterized as capital expenditures or current expenditures. CAPITAL COSTS: start up costs, expenditures incurred prior to entering a new business, expenses incurred to change or

expand a new business CURRENT COSTS: costs of earning the income or performing the income-earning operations

Firestone v RFactsTaxpayer was involved in a venture capital business in which he would take over existing distressed business and improve them. There were expenses to investigate the prospect of the businesses and to supervise the operation of the business Held

It was held that the investigation expenses were CAPITAL EXPENSES and the supervision expenses were CURRENT 92

EXPENSES

Bowater Power Co v MNRFacts

Company was in the business of generating electricity. Incurred engineering costs related to examining the feasibility of increasing the capacity and capability of its plants

Held There were CURRENT EXPENSES incurred while the business was operating.

Knowledge Objectives: Depreciation and Capital Cost Allowance Compared

“Capital Cost Allowance” is the tax term for the accounting concept of “depreciation”. Depreciation is an accounting device for recognizing the cost of a capital asset as an expense in each year of the useful life

of the asset. There are two common methods for estimating the decline in value each year (the depreciation); (1) the straight-line

method – often used by accountants; and (2) the declining balance method The ITA has adopted a (double) declining balance method for most types of depreciable asset.

(i) Identify and describe two common methods of calculating depreciation for account purposes

STRIAGHT LINE METHOD

The “straight line” method – under this method, the cost of the asset is allocated evenly over the useful life of the asset. Thus if a machine is useful for 5 years and is acquired for 1,000 then the amount of depreciation is 200 each year for 5

years The unused balance of the cost is recorded as the “net book value” of the machine This method is most commonly used by public companies in Canada to calculate depreciation for accounting purposes, but

not for general income tax purposes.

DECLINING-BALANCE METHOD

The “declining method” involves applying a uniform rate of depreciation to the unrecovered cost of the asset. Because the amount of unrecovered cost decreases each year, the amount of depreciation decreases accordingly.

This method calls for a higher rate of deprecation in order to recover costs. Normally about twice the straight-line rate would be used

Under this method the book value of an asset never reaches zero, reflecting perhaps the reality that there is usually some salvage value at the end of an asset’s life.

This method gives heavier depreciation (than the straight line method) in early years but lower amounts in subsequent years

DECLINING BALANCE

YEAR NET BOOK VALUE RATE (% OF NET B. VALUE) DEPRECIATION EXPENSE1 $1,000 40% $4002 $600 40% $2403 $360 40% $1444 $216 40% $86.405 $129.60 40% $51.846 $77.60

VERSUS

STRAIGHT LINE

YEAR NET BOOK VALUE RATE (% OF NET B. VALUE) DEPRECIATION EXPENSE

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1 $1,000 20% $2002 $800 20% $2003 $600 20% $2004 $400 20% $2005 $200 20% $2006 0

(ii) Explain the reasons for the declining balance approach to depreciation

Policy Considerations for Declining Balance:

[1] It provides heavier write offs in early years when the benefits of an asset are likely to be at their highest. [2] Recognizes that a fall in value is likely to be greater in the early rather than the later years, and therefore more of the cost

should be charged as an expense in the early years[3] Maintenance charges tend to be higher in later years- therefore the declining balance method evens out the total cost [4] The realizable value is greater in the early years than its later year, thus the declining balance provides for a better

representation of book value and, more importantly, a better estimate of income.

(iii) Explain the reasons for the differences between the capital cost allowance rates permitted under the Income Tax Act and the normal approach to depreciation for accounting purposes

1. Need for Uniformity Prior to 1948 there were not set rates. This meant that often taxpayers in the same position, would should pay the same

amount of tax, would end up paying different amounts of tax (i.e. a horizontal equity problem)2. Need to make Uniform Rates Acceptable

After 1948 the Act provided for uniform rates but limited the tax deduction to the amount the taxpayer had claimed for accounting purposes.

After 1954 the restriction was lifted so the tax deduction could be quite a bit higher than the deduction taken for accounting purposes.

Knowledge Objective: Key Terms

Be able to identify and explain the following defined terms: capital cost, capital cost allowance, undepreciated capital cost, proceeds of disposition, recapture and terminal loss.

CAPITAL COST

Capital cost is the price paid for the asset. This includes: Purchase price Legal, accounting engineering and other fees incurred to acquire property

Where the tax payer manufactures property for their own use, it is the cost of the material, labour and overhead costs reasonably attributed to the property.

Where the property is leased rather than purchased then it is not property acquired by the taxpayer for which Capital cost Allowance (CCA) can be deducted (but the taxpayer will be able to deduct lease payments against revenues from business or property)

The courts will look at the form of the transaction not the substance

Canada Trust Co v R94

Held Taxpayer held to have acquired property on which it could claim CCA even though it never took possession of the

property

CAPITAL COST ALLOWANCE

“Capital Cost Allowance” is the amount of a deduction one can take per year per s. 20(1)(a), Reg 1100(1) and Schedule II

UNDEPRECIATED CAPITAL COST

The “undepreciated capital cost” is the amount of the capital cost left after take CCA I.e. Capital Cost minus accumulated CCA It is defined by s. 13(21) that basically says to add:

o The capital cost of each asset of the class acquiredo Recapture taken in previous years

THEN DEDUCTo The CCA for the class taken in prior yearso Terminal losses taken in previous yearso The lesser of proceeds of disposition or capital cost of each property disposed of in prior years

PROCEEDS OF DISPOSITION

The “proceeds of disposition” is the amount an asset is sold for (less expenses incurred in disposing of the property) Disposition defined in s. 248(1) to includes “any transaction or event entitling a taxpayer to proceeds of disposition of the

property” The term “includes” can have a broader meaning than the meaning given in s. 248(1) S. 13(21) defines “proceeds of disposition” to include:

Sale price of the property Compensation for stolen property Compensation for property destroyed including an amount payable under a policy of insurance with respect to the

loss or destruction of property, Compensation for property taken under statutory authority Compensation for property injuriously affected or for property damaged and any amount payable under a policy

of insurance with respect to damage to property

R v Compagnie Immobiliere BCN Ltée Held

That the term should be given the broadest possible meaning including the destruction of tangible property or the extinction of an item of intangible property.

If property is demolished – it is a disposition If property is given away, it is also a disposition (and the proceeds of disposition are, per s. 69, the fair market value of

property) Proceeds of disposition are taken into account at the time proceeds become receivable (i.e. when the taxpayer ahs the

legal, through not necessarily immediate, right to payment) - rights to proceeds normally arises when title to property passes to the purchaser

RECAPTURE

Recapture arises where there is only one asset in the pool of a particular type of asset and that last remaining asset is sole for more than the remaining undepreciated capital cost (UCC) in the pool.

The difference between the proceeds of disposition and the UCC is called recapture This amount is included in income (not treated as capital gains) – s. 13(1) requires the inclusion of recapture of income

Undepreciated Capital cost: this is an amount determined by a formula in s. 13(21). See page 291 of textbook.

TERMINAL LOSS

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If there is only one asset in the pool and that asset is sold, then for less than its UCC then the difference between the UCC and the proceeds of the disposition are called a “terminal loss”.

S. 20(16) allows for the deduction of a terminal loss

CLASS CONCEPT

Assets are grouped in classes (generally on basis of estimated useful lives of the assets but sometimes on other bases for policy reasons)

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