User:Scholar 49/Canadian income tax law

A. Introduction

I. Analyze tax rules based on: 1. equity: i.  Horizontal: are taxpayers who earn the same kind of income taxed the same way? ii. Vertical: are taxpayers who earn different levels of income taxed differently? iii. Goal: equalizing the sacrifice people make in paying taxes. 2. efficiency/neutrality: i. Does imposing the tax change peoples behaviour? ii. If yes, not good b/c the aim for the tax law is neutrality. 3. administrability: Can you make the rule work? 4. For tax expenditures & spending programs, ask: (1) what is the objective? (2) Does it work? (3) Ask, above 3 questions w/ less technicality 5. Sources of income: Income = Wealth + Business/Property + Capital Gains + Miscellaneous

6. Statutory Interpretation People read statutes in different ways: (left à right) Literal: Strict interpretation, look at word and use most basic definition, no room for Cts Plain Meaning: If word meaning isn’t totally obvious, can go look elsewhere for definition Golden Rule: If the plain meaning makes no sense at all, look elsewhere Mischief Rule: Statute meant to rectify something that was going wrong in common law Legislative Intent: Look to legislature to find their intent in enacting statute Purposive: What is the prupose of the section? Modern: What is the purpose of not just the section but also the Act within Cdn society Pragmatic: All of above plus consequences and effects of interpretations. B. Who is Taxable 1. Tax liability of Residents & Non-Resident [s. 2(1)(3)] Canada uses residence as its primary connecting factor to exercise domestic taxable j’d, on the theory that a person who enjoys the legal, political and economic benefits of association w/ he country should bear the appropriate share of the costs of association.
 * Up until 1984, trend from literal towards modern approach; lately, backtracking towards stricter readings of word
 * If general and specific provisions in the Act both apply, specific prevails

(i) Residents: [s. 2(1)]       1) income tax must be paid        2) as required by this Act 3) on taxable income for each taxation year       4) by every person in Canada at anytime in the year (ii) Non-residents: [s. 2(3)]       1) income tax must be paid        2) ONLY on their Canadian-source income 3) as required by this Act       4) on taxable income for the taxation year 5) by a non-resident IF               i.   employed in  Canada                ii.  carried on a business in Canada                iii. disposed of taxable Canadian Property (i.e. land) (iii) Statutory definition of a “resident” found in S. 250(1)                S. 250(3) – ‘ordinary resident’ broadens the scope of ‘resident’ to ‘at a relevant time’ (iv) CL interpretation of “resident”          1) Nexus that individual has w/ Canada 2) The sufficiency of connection factors is a question of fact that depends upon multiple criteria, including:                   nationality and background                    physical presence                    ownership of property or dwelling in Canada                    location of family home                    presence of business interests                    presence of social interest                    mode of life and family ties; and                    social connections by reason of birth or marriage           3) The relative weight that one attaches to these factors is a question of fact in each case. There are, however, certain generally accepted legal propositions 1. a taxpayer must reside somewhere 2. T need not have a fixed place or abode to be resident in j’d 3. residence requires more than mere physical presence w/in j’d 4. residence does not require constant personal presence 5. taxpayer may have more than 1 residence 6. number of days that a taxpayer spends w/in Canada is not determinative 7. residence may be established by presence w/in Canada even though the presence is compelled by the authorities, business necessity or                            otherwise 8. residing and ordinarily resident do not have special or technical meanings, and question whether a person is residing or ordinarily resident in Canada is a question of fact; and 9. intention and free choice, w/c are essential elements in domicile, are not necessarily to establish residence; residence is quite different from domicile of choice 4) following are relevant indicia in determining Canadian residence:                       1.   past and present habits of life                        2.   regularity and length of visits to Canada                        3.   ties w/ Canada                        4.   ties elsewhere                        5.   purpose of stay                        6.   ownership of a home in Canada or rental of a dwelling on a long-term basis                        7.   residence of spouse, children and other dependent family members in a dwelling that the individual maintains in Canada                        8.   memberships w/ Canadian churches or synagogues, recreational and social clubs, unions and professional organizations                        9.   registration and maintenance of automobiles, boats and airplanes in Canada                        10. credit cards issued b Canadian financial institutions and commercial entities, including stores, car rentral agencies, etc. 11. local newspaper subscriptions sent to a Canadian address 12. rental of a Canadian safety deposit box or post office box 13. subscriptions for life or general insurance, including health insurance, through a Canadian insurance company 14. mailing address in Canada 15. telephone listing in Canada 16. business cards showing a Canadian address 17. magazine & other periodical subscriptions sent to Cdn. address 18. Canadian bank accounts other than a non-resident bank accout; 19. Active securities accounts w/ Canadian brokers 20. Canadian driver’s licence 21. Membership in a Canadian pension plan 22. Frequent visits to Canada for social or business purposes 23. Burial plot in Canada 24. Will prepared in Canada 25. Legal documents indicating Canadian residence 26. Filing a Canadian income tax return as a Canadian resident 27. Ownership of a Canadian vacation property 28. Active involvement in business activities in Canada 29. Employment in Canada 30. Maintenance or storage in Canada of personal belongings, including clothing, furniture, family pets, etc 31. Landed immigrant status in Canada; and 32. Severing substantially all ties w/ former country of residence (v) Worldwide income: a resident of Canada is taxable on his worldwide income, so residents are Ss to Canadian tax on income earned outside of Canada Policy reasons: Ensures horizontal equality i.e.: A & B, both are residents of Canada, each earning 100k, but B earns ½ of her income from foreign investments. The principle of horizontal equity requires that A & B should pay an equal amount of taxes. Since they are Canadian residents, we can apply the principle ONLY if both are fully liable to tax in Canada on their worldwide income. Double taxation issue: to prevent this Canada grants a tax credit on her foreign taxes. This requires countries to negotiate their taxable j’d through tax treaties. (vi) International treaty rules ~ double taxation * an individual may be a resident of more than 1 country in the same year * the rules determine the degree of attachment that an individual has w/ a country, and are ranked in descending order of significance as follows: (1) location of permanent home: a) treaties typically deem a dual resident individual to reside in the country in w/c he has a permanent home                         b) permanence implies that the individual must have arranged and retrained the home for his permanent use or stays of short duration c) includes a house, apartment, furnished room                         d) it is the permanence of the home, rather than its size or nature of ownership or tenancy, that is the measure of attachment to the country (2) central of vital interests: where a individual has a permanent home in both the countries that considers the individual a resident under their domestic laws, the treaty deems the individual to reside in the country w/ w/c he has closer personal and economic relations (3) habitual abode: if no determination of central of vital interests, or if no permanent home in either country, treaty deems the individual to                        reside in the country in w/c he or she maintains a habitual abode

--> if individual has a permanet home available to him, a habitual abode in one rather than in the other will tip the balance towards the country where he stays more frequently (4) nationality: if none of the above work, then treaties typically deem the individual to reside in the country of w/c he or she is national (vii) Part-Year Residence (S. 114)

* An individual is a part-year resident if he gives up or takes up Canadian residence part way through the year * S. 114 provides relief to a part-year resident – exempting non-Canadian income earned during the part of the year when the taxpayer was not resident * Provides a different formula to calculate taxable income: taxable income (viii) Giving up Residence [S. 128.1(4)]

(i)  An individual must produce convincing evidence that he has severed ties w/ Canada on a fairly permanent basis in order to cease residence

(ii) No bright-line factual test to determine the minimum length of time that a individual should be out of Canada to claim non-resident status

(iii) Agency looks at 4 principal factors to determine whether an individual has given up Canadian residence: 1. permanence and purpose of stay abroad 2. residential ties w/in Canada 3. residential ties elsewhere; and 4. regularity and length of visits to Canada (iv) At the very lease, and individual who wishes to give up residence should: 1. sell or lease his dwelling in Canada 2. sell his motor vehicle 3. cancel any lease in respect of a dwelling in Canada that he occupies, or sublease the dwelling for the period of his absence, and 4. cancel bank accounts, club memberships and similar social and business connections w/in Canada

(8) Becoming a resident: 1) An incoming resident is taxable on his worldwide income only after arrival in Cnd.            2) This is more preferred than the ‘sojourner’ b/c then taxed for a the whole year (9) Residence of Corporation [s. 250(4)]             1) A corporation is a legal entity, a person and taxpayer in its own right              2) A corporation resident in Canada is taxable on its worldwide income 3) Non-resident corporation is taxable on their Canadian-source income

3) Determine residence for corporations in 1 of the 3 following ways:                      (a) statutory rules [s. 250(4)]                                 (i)  a corporation incorporated in Canada to be resident in Canada for tax purposes                                 (ii) goes by when incorporated ~ look at rule                       (b) CL rules:                                 (i)   the determination of corporate residence at CL is essentially a question of fact and circumstances                                 (ii)  The corporation is resident in the country “where the central management and control actually abides”                                               a. location of meetings of its directors                                               b. degree of independent control exercised by its directors;  &                                               c. relative influence & power that its Cnd. directors exercise, as compared w/ foreign directors (rubber stamp test) (iii) Identify central management and control w/ the control that a company’s board of directors has over its business and affairs – generally in the j’d where the board meets (c) General propositions: (i)  corporation can have more than 1 residence if its central management and control is located in more than 1 j’d (ii) central management and control refers to the exercise of power and control by the corporation’s board of directors and not to                                         the power of the corporation’s SH. Thus, the residence of SH is irrelevant for the purposes of determining corporate residence (iii) residence of a subsidiary corporation, even wholly-owned subsidiary, is determined independently of its parent corporation – the subsidiary’s residence is determined by its central management and control (iv)  a subsidiary corporation may have the same residence as its parent corporation if the parent exercises effective control over the subsidiary’s activities and management (d) International Tax Treaty provision (10) Residence of Trusts: (1) a trust is deemed to be ‘an individual’ [s. 104(2)]              (2) a trust resides where its trustee resides (3) if multiple trustee’s = resides where a majority of its trustees reside if the trust instrument permits majority decisions on all matters w/in discretion of the trustees (4) can not have dual residence (5) if not resident in Canada, the trust will be liable to Canadian tax only on the Canadian-source income (11) Provincial Residence (1) Individual: resides in a province throughout the taxation year if he resides in the province on December 31 of the year (2) corporation: allocates the income to the province in w/c the corporation has permanent establishment in the taxation year where more than 1 prov. or country, income is to be apportioned b/w j’d Cases:

Thomson v. M.N.R. (1946) SCC

Facts:

Thomson was a wealthy Canadian citizen who attempted to give up Canadian residence in order to avoid paying Canadian taxes. Sold home in NB, announced that Bermuda was new residence, and went there Ended up mainly living in the US, built a house which was kept permanently ready for occupancy and where he spent most of his time Began to return regularly to NB for 4-5 of warmer months every year, eventually building a house. Kept stay in NB to less than 183 days (to avoid sojourning rule). Wife and child accompanied him in these regular migrations. Decision: SCC held that Thomson was a resident in Canada.

Identified several relevant factors, which the court considered in holding that Mr. Thomson was a Canadian resident: (1) dwelling; (2) spouse; (3) dependents; (4) visits; and (5) lifestyle. Court also concluded that (1) the intention of a taxpayer is not determinative; (2) a person can be resident in more than one country at the same time; (3) every person is presumed to be resident somewhere Thibodeau Family Trust v. R. (1978)

F: Court applied central management and control test to determine residency of trust

H: Held that the central management and control of the trust was in Bermuda, and that the trust was not resident in Canada because:

The trust instrument altered the general rule of unanimity by authorizing a majority of trustees to make decisions binding on the trust; The day-to-day administration of the trust was carried out in Bermuda by the Bermuda trustees; There was evidence that they didn’t always follow the wishes of Canadian trustee; & The meetings of the trustees were held in Bermuda.

B. What is Taxable? 3 Fundamental questions to ask:

1. What is income? (a) income in tax law is a measure of gain (b) where the Act doesn’t use the adjective ‘net’ t qualify ‘income,’ we read this term as ‘net income’ (c) realization: we recognize income only when we realize or crystallize it in a market transaction such as a sale, exchange or disposition 2. What is the source of the income? And (a) we calculate income from each source separately and aggregate income according to the rules applicable to that particular source (b) 5 enumerated sources in the Act S. 3 (not exhaustive ~ b/c income can arise from any other unnamed source inside or outside of Cnd): i.  office ii. employment iii. business iv. property, and v. capital gain (c) capital gains and losses: arise from the sale of capital property i.  as to whether property is classified as capital depends on the nature of the property and how its dealt with by the owner ii. look at period of ownership iii. held for short time is indication it was held for resale and profit, .: income iv. held for long time is investment and gives rise to capital gains (d) evidence of carrying on a business: i.  frequency of similar transactions ii. history of extensive buying and selling of similar properties, or                            iii. quick turnovers

--> capital is a source of income but only tax the income and not the capital --> capital is only taxed when its disposed of (source needs to be disposed of to) (e) windfall i. something that has no source ii. are tax free since they are not re-recurring nor guaranteed (f) deductions ~ losses by source: i. business losses are fully deductable against any source of income * unused business losses may be carried forward for 10 years ii. capital losses are partially deductable from income and then only against taxable capital gains * unused capital losses may be carried forward indenfinitely (g) deductions may be taken against a source of income only if it may be regarded as applicable to that source i.  deduction directly reduces income ii. distinguish w/ tax credits: iii. reduces the amount of tax payable w/out reducing income iv. tax credits remain constant through all marginal tax rates v. value of a deduction increases as the marginal rate rises Courts are not useful in helping us understand the meaning of s. 3 ~ not very open to purposive interpretation, i.e. no attempt to figure out what s. 3 is trying to accomplish: R. v. Fries (1989) ~ strike pay not income

Facts:

Strike pay comes from union dues. When there is a strike, money goes to those who participate in the strike. Taxpayer was contesting the Minister’s assessment, including in his yearly income strike pay he had received from his union. Identified the source as the strike fund, a separated fund from the union dues (which is tax exempt) Court dismissed the taxpayer’s claim and found that the amounts were taxable as constituting income from a source within paragraph 3(a) of the Act. Decision:

Unanimously held that strike pay should be excluded from income and therefore fell outside the ambit of paragraph 3(a) SCC held that while income from non enumerated sources was in fact taxable under the general provision of paragraph 3(a) of the Act, the payments were not in the nature of "income ... from a source" within the meaning of paragraph 3(a) Restored the Tax Review Board’s decision which held that the strike pay was not taxable because the Act did not specifically provide for such taxation SC relied on the residual presumption and gave the benefit of the doubt to the taxpayer. R. v. Schwartz (1996) Facts:

Lawyer was to receive a salary of $250,000 annually but the company never hired him – they eventually settled on paying the lawyer damages of $360,000 plus $40,000 on account of costs CRA assessed the damages as being "retiring allowance" taxable under 56(1)(a)(ii) of the Act. Tax Court of Canada set aside the Minister’s assessment – saying it cannot be a retirement allowance if not employed by the company at time of decision to pay Federal Court of Appeal agreed that its not retiring allowance but still taxable Held that compensation received by a person through damages should be treated for tax purposes if it had been received as compensation Accordingly, the court concluded that the damages relating to lost salary and stock options were taxable under paragraph 3(a) as income from employment Decision:

Majority concluded that where there is a general provision in the act as well as a specific provision -- the specific provision prevails even if there is no conflict Since the damages do not fall under retiring allowances under S.56, they are not subject to tax. Thereby restored the decision of the Tax Court. To find that the damages received by the lawyer are taxable under the general provision of paragraph 3(a) of the Act would disregard the fact that Parliament has chosen to deal with the taxability of such payments in the provisions of the Act relating to retiring allowances Surrogatum principle – common law principle applied in this case If damages are paid in lieu of something then tax the damages in the same fashion as that thing for which the damages were paid Look beyond the reasons for payment on the contract and characterize it according to the circumstances 3. When is income taxable? (a) income tax is a tax on net gains or the increment in realized value (b) 2 aspects to the measurement of gain: (i) recovery of basis (costs), and (ii) the matching of income flows against capital (c) damages: (i) need to look at what the payment is supposed to compensate (ii) if payment is in lieu of lost income, than it is income for purposes of s. 3

Schwartz: Courts are not obligated to allocate damages, even if a portion of those damages should be taxable (iii) Damages for personal injury ~ not income a. not income for tax purposes b/c they are not from a productive source b. Includes both personal injuries and non-physical injuries (loss of dignity or reputation as a result of libel or defamation) (iv) Punitive damages ~ not income a. PD are intended to punish wrongdoer and not to compensate the victim, the victim may be considered an incidental beneficiary b. Although punitive aware may actually put the victim in a better economic position than before the harm was experienced, it is                                          not considered to be income from a source under s. 3 (d) imputed income: not income (i)  flow of benefits derived from the labor of one’s own behalf (ii) deals w/ the economic gains that a person has by doing things for himself (iii) it is not income b/c there is no source (iv) also not included in the tax base for administrative reasons

i.e.: A farmer makes $70k a year from his farming operations and consumes $10k of meat and produce that he farms. The farmer consumes what he grows and cultivates. .: farmer enhances his economic well-being & his ability to pay by consuming his own produce. (e) Gambling gains ~ not income --> Winnings from casual betting and incidental gambling are not considered income (f) Gifts & inheritances ~ not income BUT capital (i) Gift: a voluntary and gratuitous transfer of property from 1 person to another w/out any expectation of reward or return (ii) S. 5(1) explicitly includes ‘gratuities’ in computing income from employment (iii) Not considered income from a source under s. 3(a) b/c not a productive source BUT are considered capital transfers (g) Windfall gains ~ not income (i)  Income arises only from expected returns and unexpected gains are windfalls and are not taxable as income (ii) Windfall gain represents an unexpected and unplanned gain that cannot be directly linked to one of the named sources of income – office, employment, business, property, and capital gains (iii) Windfall gain is a gain that: 1. does not result from a legally enforceable claim 2. is not likely to recur 3. is not customarily a source of income for the recipient of the gain 4. is not given as consideration for services rendered, to garner favour, or anything else provided; and 5. is not earned as a result of an activity or pursuit of gain (h) barter transactions: (i) where 2 or more persons agree to a reciprocal exchange of goods or services w/out the use of money (ii) income is determined based on the value that would normally be charged for the goods or services provided

C. Employment Income 1. Three basic issues in the taxation of employment income” (1) Characterization: What is the nature of the income (2) Timing: When do we tax it? And (3) Scope: what is taxable? 2. Classification of the nature of employment: (1) 2 classifications: A. Employee: i.  Employment-related deductions: prohibited, unless Act specifically authorizes it                             ii. Taxation: calendar year basis iii. w/holds tax at the source and holds the tax in trust for the Crown iv. generally taxable on a cash basis

B. Business income ~ independent contractor: i.   Deductible: permissible, unless the statute specifically prohibits it                             ii. Taxation: fiscal period iii. No systematic w/holding at source on business income iv. Taxable on accrual, or as-earned basis, no matter when the taxpayer receives the income (2) Control Test: a) based on the degree of supervision and control b/w the parties, specifically                     b) power to select the person who renders the service c) mode and time of payment                     d) evaluation of the method and performance of work; & e) right to suspend or dismiss the person engaged to perform the work            (3) SC has shifted to a more flexible approach that looks at the total relationship of the parties

Wieber Door Services Ltd v. MNR: control test has broken down completely in relation to highly skilled and professional workers, who possess skills far beyond the ability of their employers to direct

Thus the control test is sometimes supplemented by the ‘organization & integration’ test in the case of professions (4) Organization and integration: supplements the control test a) If a highly skilled profession                      b) Is the person an intrinsic part of the organization or merely an adjunct to it                       c) Whereby, the greater number and value of ancillary benefits, the greater the likelihood of an employment relationship              (5) Total relationship test: a more broader test                       a) Supervision and control b) Ownership of assets                      c) Chance of profits, and d) Risk of loss 3. Employment Remuneration -- GR: [s. 5(1)]

(1) TP income from a taxation year from an office or employment (2) Will include the TP’s: a. salary, b. wages, c. non-cash benefits, and d. other remunerations (including gratuities) (3) Received by the TP in that year (4) TP must also include into income any benefits that TP receives or enjoy’s in the year [S. 6] 4. Value of a benefit [S. 6(1)(a)]: (1) the value of board, (2) lodging and (4) other benefits of ANY kind whatever received or enjoyed 5. Test: (1) did the employee receive or enjoy an economic advantage [list on page 238] a. payment of an individual’s personal vacation b. payment of living expenses by an employer c. grievance settlement to a unionized employee d. discharge of a mortgage upon dismissal from employment e. issuance of stock options by a person other than the employer (2) is the economic advantage measurable in monetary terms (3) tax an employee on benefits that he derives from his office (4) does not include the pleasures of pleasant working conditions (5) was the economic advantage for the benefit of the employee or for the benefit of his or her employee, and --> ask: who is the primary beneficiary of the payment if employee = taxable if employer = not taxable

--> i.e.: employer requires employee to take computer courses so he is better at his job, this is not a taxable benefit b/c it is primarily for the convenience of the employer and not employee (6) did the employer confer the economic advantage on the employee in respect of, in the course of, or by virtue of the employee relationship w/ the employer

(7) did the employer confer the economic advantage in his personal capacity? Yes = not taxable No = taxable i.e. a gift to an employee in his personal capacity is not a benefit for tax purposes --> issue of capacity [Savage] IF ALL YES: the economic advantage or material acquisition is a taxable benefit from employment UNLESS statute specifically exempts it from tax

Ransom [1967] F: taxpayer sold his residence at a loss of approximately $4k when his employer relocated him from Sarnia to Montreal. Employer compensated the taxpayer for his loss.

I: Whether the taxpayer derives an economic advantage?

H: Reimbursement for the loss was not taxable b/c the taxpayer did not benefit from the payment – it did not put any money in his pocket, but merely saved his pocket. Court applied the ‘money’s worth principle’ despite the unequivocal language of s. 6(1)(a). Canada v. Hoefele [1996]

F: Taxpayer moved from Calgary to Toronto, purchased a house in Toronto that was more expensive than the one he had left in Calgary. Employer picked up the increased mortgage interest on the differential b/w the 2 houses, thereby reducing his personal living expense.

H: The mortgage interest subsidy was not taxable b/c the taxpayer was not enriched, but merely restored to his original position.

Following case refused to extent the reasoning of Ransom to reimbursement of income tax to accommodate a differential tax burden b/w Canada and the US.

Gernhart v. MNR [1997]

F: Taxpayer, an employee of GM, moved from Ohio to Windsor. Her employer compensated for her higher income tax rates (b/c it was higher in Canada) by paying her the tax differential b/w Canadian and US rates in order to equalize her net after tax income.

H: Court characterized the reimbursement as a form of salary compensation. Hard to distinguish this case from Hoefele. In both cases, the taxpayer was not enriched, but merely restored to his or her original position. Nevertheless, the decision in Gernhar is preferable, in that the taxpayer was taxed on her benefit based on her enhanced ability to pay. Phillips v. MNR [1994]

F: Taxpayer moved from Moncton to Winnipeg. Employer paid him $10k to compensate for his increased housing costs in Winnipeg.

H: The $10k subsidy was a taxable benefit b/w it did more than save his pocket – it put money into it.

Applied the ‘money’s worth principle’ to arrive at the right decision for the wrong reasons. S. 6(20) provides special tax treatment for eligible housing losses. Where an employee moves from 1 city to another w/c causes the employee to incur a loss as a consequence of their move will not pay any taxes if the eligible housing subsidy provided by the employer is under $15k however, if above 15k: ½ of the amount above $15k is taxable as an employment benefit to the taxpayer

6. Nature of benefits ~ capacity: The Queen v. Savage [1980]

F: Taxpayer, a junior employee of a life insurance company, took 3 courses offered by the Life Office Management Association that were designed to provide a broad understanding of insurance company operations. Took courses on her own directive w/out employer pressure. Employer reimbursed the taxpayer $100 for each course she successfully completed.

I: Is money received ‘by virtue of employment’ and .: a taxable benefit? H: Yes. Reimbursement were taxable benefits b/c they were paid to the taxpayer in her capacity as an employee and primarily for her advantage.

R: Court holds that any benefit received by an employee from his employer is derived from the employment relationship, unless the employee can establish that the benefit is received in his or her own personal capacity

Test:

(1) Whether the money/benefit given was a gift (2) Did she receive the money in a personal capacity or in a capacity as an employee? (3) To be outside the scope of S. 6(1): must be a gift (tough argument to make b/c an employer cannot deduct a true gift)

7. Timing:

i.  Taxable on benefits that he receives or enjoys in that year ii. Enjoy = enlarges the benefit rule beyond actual receipt of the benefits iii. Received = (a) when it is received in cash (or the equivalent of cash) OR                   (b) when there is a constructive receipt (is an employee who had an unconditional right to receive payment voluntarily decided to defer it) iv. salary deferral arrangements (SDA) [s. 6(11)]                   (a) if employer puts money in for employee (b) employee will get taxed on the contributions in the current year 9. valuation: issue is what is the taxable amount? i.  determined based on: ii. cost to employer, iii. market price for similar products, or        iv. opportunity cost --> Agency does not tax a benefit UNLESS it can easily measure the value of the benefit in monetary terms Act prescribes valuation formation for some of the more contentious benefits i.e.: cars, stock options and low-cost loans (a) Evaluating Non-Cash compensation i.  Cash compensation = taxed ii. Non-cash compensation = not taxed, but raises the question as to whether it is a ‘benefit’ a. pursuant to S. 6 b. benefits by virtue of employment c. with value d. are income iii. Criteria ~ examining s. 6(1): a. Equitable: 1. Non-cash compensation risks throwing off horizontal equity; 2. On the other hand, could argue that it might drive incomes down through employers dropping salaries. 3. If gov’t doesn’t tax non-cash comp (ie: daycare), may also give rise to vertical inequity b/c higher tax payers will get more tax savings b/c their savings would be spent at a higher tax rate.

b. Neutrality: ie: daycare - salaries may be lower b/c the daycare costs have been offset by non-cash option

c. Administrability: No problem for non-cash compensation, just don’t tax \ don’t administer!

d. Evaluate it as a tax expenditure/gov’t spending program 1. The objective 2. Does it work? (ie: fairly, as incentive/disincentive, etc)

10. Specific Benefits: (a) Allowances [s. 6(1)(b)]: i. TX must include in his income all amounts that he receives in the year as an allowance for: 1. personal or living expenses, or                  2. as an allowance for any other purpose ii. Allowance definition: (distinguish from reimbursement) 1. an arbitrary amount 2. w/out reference to actual expense 3. for some kind of specific purpose 4. for use at the discretion of the person who receives it          iii. Exceptions: page 241 1. Special work sites 2. Part-time workers [subs. 81(3.1)] (b) Automobile Benefit [s. 6(1)(e)]

i. Automobile: a motor vehicle that is designed primarily to carry individuals on highways and that has a maximum seating capacity, including the driver, of 9 persons

ii. GR: 1. Where the TP’s employer (or someone related to the employer) 2. Makes available a car to the TP (or someone related to the TP) 3. The amount that is a reasonable stand-by charge for the car for the total number of days during the year during w/c it was made so                       available and exceeds 4. The total of all amounts (other than expenses related to operation of the car) paid in the year to employer by the TP for the use of the car iii. Reasonable standby charge: [s. 6(2)]                 1. 2% of the cost of the car to the employer, or                  2. 2/3rd of leasing cost each month that the car is available iv. Salesman ~ charges for stand-by [s. 6(2.1)]                 1. can be reduced if required to use car in context of employment 2. if all or substantially all of the use is business use v. Operating expense when employer provides car: [s. 6(1)(k)] 1. Employee will pay tax on fixed per/km rate 2. If stand-by charges apply 3. Whereby employer pays for everyday operating costs 4. w/c employee doesn’t reimburse vi. Operating expense when employee provides car: 1. A per-kilometre allowance reimbursement to employee for his business use of a personally owned car is not included in income 2. However, anything in excess of a reasonable amount will be taxable (c) Low Cost/Interest Free Loans ~ Imputed Interest:

i. GR: [s. 6(9)]                1. A low cost / interest free loan 2. Will be included in TP’s income 3. If it is determined that but for the employment, the loan would not have been made to the employee [s. 80.4(1)]                4. Does not apply if the rate at w/c an employee borrows from his employer is equal to, or greater than the prevailing commercial rate for parties dealing w/ each other at arm’s length ii. Forgiveness of loan: [s. 6(15)]                1. where an employer forgives a loan to an employee, 2. the principle amount of the loan is included in the employee’s income at the time that the employer forgives the loan 3. In that year, do not do an imputed interest benefit calculation

Imputed Interest Taxable benefit = [Prescribed rate [x] loan amount]

+ [any amounts paid by 3rd parties]

–  [amounts paid on loan]

(d) Stock option plans (S. 7):

i. GR: 1. Stock option benefits 2. are taxable as employment income 3. b/c they are in effect an alternative to cash compensation ii. employer buys out employee right to stock option: if employer cancels an employee right (in essence buys him out), the employee gets taxed, b/c they have been paid for value to buy out that option iii. 3 questions to ask: 1. Does the option benefit derive from employment? * Met regardless of where they exercise the options 2. When is the benefit taxable? * Benefit of an option is recognized when shares are acquired at a price less than their value * Taxpayer cannot acquire shares in a corporation until he pays for the shares

3. What is the value of the benefit?

GR: Determined when the shares are acquired or the option is exercised Benefit is equal to the difference b/w the cost of the option to the employee, any amount paid for the shares, and the value of the shares at the time they are acquired from the plan CCPCs May defer recognition of any benefits that he derives from the stock option until he disposes of the shares Taxable on only ½ of the value of the benefit derived, if hold onto it for at least 2 years Pre-Scribed Employee is taxable on only ½ of the value of any benefit derived at acquisition of the share

(e) Housing Loss [s. 6(19)]

GR: 1) an amount paid at any time in respect of housing loss 2) a TP or non arms-length person to TP 3) in the course of or b/c of an office or employment 4) is deemed to be a benefit received by TP 5) by virtue of office/employment Ransom F: R moves from Sarnia to Toronto, employer gives money to R for loss in value of house

R: Ct says not an advantage/benefit, just made R “whole”, returned them to original position.

Legislature responds to Ransom with amended s.6(19):

if employer reimburses for housing loss the first $15k is free, and anything above $15k, employee pay tax on half. move has to fit following criteria Employed in new work location Ordinarily lived in old residence and ordinarily resident in new residence New residence has to be at least 40 km closer to new work location --> Calculating Housing Loss: [s. 6(20)]                   * anything up to $15k is tax free * anything over $15k is taxed ~ take amount above and divided it in half 11. Non-Taxable Benefits a. Uniforms b. Employee discounts generally available to all employees if at least cost charged c. Reimbursement of reasonable relocation expenses except for loss on sale of house d. Subsidized meals if at least the cost of the food and preparation is covered; e. Max 2 two gifts per year (non cash and non near cash) not exceeding $500 total and a maximum or 2 awards per year (not exceeding $500 in total can be cash) f. Memberships in social clubs principally for the employer’s advantage rather than the employees; g. Reasonable business trip expenses h. Tuition paid for courses taken primarily for employer’s benefit i. Auto allowance - using personal car for employment purposes (based on km) j. Employer contributions to RPP, private health care, supplementary unemployment, deferred profit sharing plan are not taxable. (payout from DPSP are taxable) 12. Deductions From Employee Income [s.8] (a) all deductions are set out in s. 8 ~ so if you don’t find it there, no deduction for item exists! (b) If item last longer than 1 year, the item does not fall under s. 8 (1) Travel: (i) GR: [s. 8(1)(h)] 1. Employees can deduct traveling expenses IF                  2. Employee ordinarily is required to carry on their employment duties away from their employer’s regular place of business 3. Are required to pay their own travelling expenses, and 4. Do not receive a tax-free allowance (ii) Nelson “Ordinarily Required”

F: N is lawyer/architect, head office in Toronto, hired for project in Aylmer. Lives in TO and commutes to Aylmer, has expenses for travel time I: Can he deduct costs associated with Aylmer-TO commute? R:No A: In looking at place of business, Ct looks from Ee’s perspective- where they usually go to work- Ct says in this case that place is Aylmer b/c he goes there every day \ he is not being required to go “elsewhere” when going to Aylmer b/c Aylmer is place of business. Ct gives “Ordinary” a broad construction. Very factually driven determination

(iii) Meals: [s. 8(4)]                     1. employee may claim 50% of meal expense as part of travel costs 2. if he consumes the meal while away 3. for at least 12 hours from the municipality in w/c his employer is located

(2) legal expenses: [s.8(1)(b)] 1. employee allowed to deduct amounts paid 2. in the year 3. on account of legal expenses incurred to collect or establish a right to salary owned to TP by employer/former employer (3) Salesperson (s. 8(1)(f)]

(a) GR: 1. A salesperson may deduct expenses from employment income if he is 2. Employed to sell property or negotiate contracts 3. Required to pay his business expense 4. Ordinarily required to carry out his duties away from the employer’s regular place of business 5. Remunerated, at least in part, by commissions related to the volume of sales; and 6. Not in receipt of a tax-free allowance for travelling expenses that is excluded from income 7. Employee must file a prescribed form where the employer certifies that employee has satisfied the above conditions 8. required to pay own expense 9. limitation: deduction is limited to the commission income that he receives in the year

(4) Other deductions available:

1. clergy residence under paragraph (c), 2. teachers’ exchange fund contribution under paragraph (d), 3. expenses of railway employees under paragraph (e), 4. interest expenses and capital cost allowances (tax depreciation) in respect to automobiles and planes under paragraph (j), and union dues, professional membership dues, and contributions to a registered pension plan under paragraph (m) 5. In cases where an employee is required by the K of employment to pay office rent, or to hire an assistant, or to purchase supplies, those expenses are 6. deductible under s. 8(1)(i)

D. Income from Business & Property

1. Orientation of Act: (a) Income from Business & Property: TP’s profit from the business (property) for the year [s. 9(1)] (b) Income/Loss from property does NOT include capital gains from disposition of property [s. 9(3)]

2. Definition of business: includes profession, trade, calling manufacture or undertaking – an adventure or concern in the nature of trade w/c does not include office/employment [s. 248]       (i) Distinguish ‘business income’ from ‘property income’ (ii) Activity test: a. Look at the activity – the more activity you do related to the income, the more likely it will be a business (equivalent to Weiber test) (iii) business income a. definition of ‘business’ [S. 248(1)] includes the following: 1. profession 2. calling 3. trade 4. manufacture or undertaking of any kind whatever, and 5. for most purposes, also includes an adventure or concern in the nature of trade 6. generally ‘business’ refers to economic, industrial, commercial or financial activity b. An organized activity of any kind carried on for the purpose of making a profit

2. Distinctions b/w: (i) Business income & capital gain income (ii) Business income & windfall gain (no tax) 3. Pursuit of profit test: (i)  where the TP’s activity has some personal of hobby element to it        (ii)  see whether the TP undertakes the activity in pursuit of profit or as a personal endeavour or hobby (iii) based on intention of TP ~ was it TP’s intention to engage in an enterprise of commercial character or is it primarily for entertainment?

--> if pursuit of profit = business, taxable --> if personal endeavour or hobby = not business, not taxable --> side-note: irrelevant whether there is actual realization of profit

Taylor ~ What does it mean to be “an adventure in the nature of trade”? (s.248)

F: TP works for a company that requires lead. The company can’t buy the lead more than 3 days ahead, big hassle, etc. TP decides to go buy the lead personally for the company - sets the price – and then price goes up and TP makes a profit on the deal

I: Is TP’s profit business profit or capital gains?

R: A business adventure in the nature of trade CAN be a discrete, one-time event, if speculating rather than investing, or acting like a trader.

--> Nature of quantity does matter - clearly this lead was not for personal use

--> Nature of deal also considered

--> 4 Negative Propositions

1. If happens only once, this may suggest CG, but not determinative 2. Don’t need any type of organization for something to be characterized a business 3. Doesn’t matter if taxpayer doesn’t usually engage in this type of enterprise 4. Intention need not be lined up with results --> 3 Positive Propositions

1. Consider the character and circumstances of the transaction 2. If person is acting like a trader, it is considered business 3. Consider the nature and quantity of the subject matter --> So TP intended to resell the lead, had no personal use for it, was acting like a dealer/trader, even though he doesn’t normally engage in this type of activity

4. property income ~ GR:

(1) means property of any kind whatever (whether real, personal corporeal or incorporeal), and (2) without restricting the generality of the foregoing, includes: (3) a right of any kind whatever, a share or a close in action (4) unless a contrary intention is evidence, money, (5) a timber resource property, and (6) the work in progress of a business that is a profession Steward v. Canada: Reasonable Expectation of Profit (REOP)

F: TP purchases 4 condos and experiences a loss despite prospectuses and wants to deduct it as a business loss. TP borrowed almost all the money to pay for the condos. Plan is to deduct the interest he pays to the bank as interest so as to offset rental income; then sell condos off as capital gain.

I: Does TP have a personal or business loss? Need REOP to characterize something as a business loss.

Background: Moldowan ~ created the concept of REOP in business ~ objective test looks at: profit/loss experiences in last years TP’s training TP’s intended course of action Capability of venture to show a profit Courts have had a hard time applying this test b/c of the confusion b/w personal sources, business sources, and business sources w/ no REOP REOP doctrine has been misinterpreted in the past b/c:

1) Runs contrary to the idea that judges shouldn’t be making law (REOP = judge made)   2) Used more broadly than intended in the Act 3) REOP too imprecise   4) Requires that judges make business judgment in hindsight R: Court creates a 2 part test:

1) is TP’s activity in pursuit of profit or personal?   2) Is it income from property or business? Middle ground no longer exists – creates residual application of the Moldowan test for when this distinction is unclear This was not applied in this case, b/c it didn’t apply here, but it is now available for when use is mixed, etc. Overruled the REOP test b/c:

1) it cannot be maintained as an independent source test 2) it is imprecise, causing an unfortunate degree of uncertainty for taxpayers, and 3) nature of the test has encouraged a hindsight assessment of the business judgment of taxpayers in order to deny losses incurred in bona fide, 4) unsuccessful commercial ventures --> Application "Pursuit of Profit" Test – developed in Stewart and applied in Walls by the SCC

Is the activity undertaken in a pursuit of profit or as a personal endeavour?

If not a personal endeavour: is the source business or property? Difference between business and property income is the level of activity

GR: (i) High level of activity surrounding the property income is from a business (ii) Low level of activity surrounding the property income is from property No need to analyze the taxpayers business decisions – once it passes this test its in the pursuit of profit despite any level of loss it may suffer Subjective intention supported by objective evidence Profit and loss experience in past, training, intended course of action to convert present losses to future profits, potential to show profit after CCA

Walker v. MNR (1951) – court held that the gambling activity of the taxpayer was sufficiently extensive and systematic to constitute income from a business 5. Distinguish business income vs. Capital Gains --> Fruit tree illustration: You own a tree that produces fruit. If you sell the fruit, the fruit is business profit. If you sell the tree, it will be a capital gain b/c it is the tree that produces the fruit (unless you have a lot of trees, it will be probably be considered a business profit)

--> capital gains: derive from sale or realization of the investment (i.e. a building) --> investment = implies acquiring and holding an asset for its potential yield, but w/ the possibility that the investment may, at some point, be                sold for a profit --> business income: derives from trading or the periodic yield of an investment (i.e. rent derived from the building) --> trade = implies a profit-making scheme to earn income by buying and selling property a) question of fact:          b) no single factor is conclusively determinative of a taxpayer’s intention c) look to the circumstances of the transaction          d) taxpayer’s credibility is always an issue e) secondary intentions: crts also look to see if TP had any secondary intention to trade if so then treated as a business income (or loss where applicable) NOT secondary intention: an intention at the time of acquiring an asset that one will sell the asset if the purchase proves unprofitable merely indicates a prudent investment decision             (1) primary intention at the time of entering into the transaction was to make an investment; and             (2) there was no secondary intention at the time to trade in the particular property  --> criteria used to determine taxpayer intention ~ whether primary or secondary               (i) number of similar transactions                        a) greater number of similar transactions in the past = greater likelihood that the gain or loss in issue is business income or loss b) evidence that a taxpayer engaged in similar transactions to the one at issue = provides proof that taxpayer is a trader and                             engages in a business              (ii) nature of the assets                        a) raw land = viewed suspiciously as trading b) quick flip of shares = may suggested a trading intention, unless it can be explained on other grounds                       c) commodities that cannot possibly provide an investment yield = suspect as trading assets d) assets w/ potential (even if a somewhat remote possibility) of yielding income = seen as investment assets ~ capital gains                       e) corporate shares = capital gains (b/c have potential to yield dividends)
 * distinction b/w 2 depends on the TP’s intention at the time he purchases the property
 * Test to claim that a gain is ‘capital gain’ ~ TP must show on a balance of probabilities:

Irrigation Industries Ltd. v. MNR

Corporate shares are in a different position b/c they constitute something the purchase of w/c is, in itself, an investment. They are not, in themselves articles of commerce, but represent an interest in a corporation w/c is itself created for the purpose of doing business. Their acquision is a well recognized method of investing capital in a business enterprise.


 * Consider the following 4:

1. by itself, nothing conclusive can be determined from the fact that a transaction is an isolated one in the taxpayer’s experience 2. if there are other factors indicative of trade, a profit from an isolated transaction will be taxable as ordinary income resulting from an adventure in the nature of the trade 3. even if there are no other business attributes, a transaction may still give rise to business income if the asset traded is of a trading, and not of an investment nature; and 4. if the asset in question is an investment asset (i.e. corporate shares) and there are no other factors indicative of trading, the transaction will usually (not inevitably) be viewed as a capital transaction. This is so even though the investment asset is acquired for the purpose of resale at a profit. (a) strong presumption that it is business income if the transaction is connected in any way w/ taxpayer’s usual business (b) rebuttable: through evidence that the transaction was not part of the taxpayer’s ordinary business, but was an unrelated capital investment (a) corporate income is characterized according to the intention and secondary intention tests and not according to any stipulations in the corporation’s (b) constating documents There are rules to this – page. 292-293 6. Distinguish b/w ‘business income’ & ‘investment income’ (a) a question of fact (b) ask: does the income flow from property or from business (c) income from property: is the investment yield on an asset (d) income from business: implies activity in the earning process – business generates from the use of property as part of a process that combines labour and capital 7. Timing of Revenue Recognition (s. 12) (a) Sale of goods: the revenue from the sale of goods of personal property is legally receivable when the goods are delivered. This is normally the date when attributes of ownership (primarily possession, use, and risk) passes to the purchaser. (b) Sale of property: the revenue from the sale of property is legally receivable on the date stipulated in the contract – if no date is stipulated then amount is receivable when the attributes of ownership passes (possession, use and risk). (c) Sale of services: payments for services generally become receivable when the performance of the services is completed. At such time, the taxpayer acquires the absolute and unconditional although not necessarily immediate, legal right to demand payment, and the amount is reasonably ascertainable. (d) Timing of invoicing: usually a good indicator but s. 12(1)(b) contains a deeming rule in respect of services rendered to become receivable on the earlier of the day w/c the account was rendered (date of billing) and the day on w/c it would have been rendered had there been no undue delay. (e) Questions to ask: i.  was there a right to receive the compensation? ii. Was there a binding agreement b/w the parties? iii. Does it matter if don’t know exact amount received? No, it can be an estimate w/ some accuracy.
 * related activity
 * corporate objects and powers, and
 * degree of organization: whether the operations involved in are of the same kind, and carried on in the same way, as those w/c are characteristic of ordinary trading in the line of business in w/c the venture was made
 * Electing capital gains – Act allows taxpayers to elect ‘guaranteed’ capital gains or capital loss treatment on a disposition of certain types of properties

8. Inclusions in business and investment income (a) Illegal Activity: Still taxed on profit even if carrying on illegal activity [i.e. prostitution] (b) Damages: if TP receives damages in lieu of something that was meant to be paid to TP = taxable -->look at what the damages intended to replace (c) Voluntary Payment

Federal Farms LTD

F: TP is farmer in Holland Marsh who loses his crops due to natural disaster. Community sets up relief fund and gives him some money (short of what crops would have earned).

I: Are these voluntary payments by community taxable?

R: Yes, these payments are equivalent to what he would have earned from farm, just a different form.

Distinguished in this case b/c it is a one time gift, unlikely to recur [This is difficult for Cts to apply. If have insurance, for example, will get taxed on payments from insurance co. b/c directly meant to replace the income, not “gift” like a relief fund]

(d) Prizes/Awards (a) if prize won by pure chance = not income .: not taxable (b) s. 56(1)(n): amount received as prize in field or endeavor normally carried out in course of business is taxable – this wouldn’t include a price b/c it is totally random (e) Interest [s. 12(1)(c)]

(1)  Interest: defined as the return or material consideration given for the use of money belonging to another person (2) Gives the choice of cash method or accrual method (3) Can not postpone income to the end of the K [s. 12(3) and s. 12(4)] (4) S. 12(3): applies to business entities and requires that all interest that accrues to the end of year be reported annually, whether its received, receivable or merely accrued. Has the effect of ensuring mandatory annual reporting of interest. (5) S. 12(4) applies to individuals -- all interest on an investment K that has accured to each anniversary day of the K be reported annually

(6) Investment K: is broadly defined under s. 12(11) to cover the standard forms of debt obligations with some exclusions (7) Aniversay date: defined under s. 12(11) as the annual anniversary of the day immediately preceeding the date of the issue of the K        (8) Receivable = means ‘legally receivable’ – when the taxpayer has a clear legal right to it and legal right to enforce it         (9) Rate adjustments: the discount on a bond is considered a capital gain NOT interest (10) Tax-exempt organizations: a. where a tax-exempt organization, non-resident person not carrying on business in Canada or a gov’t body b. issues a bond at a deep discount c. a deep discount if the effective rate of interest on the bond exceeds the nominal rate by more than 1/3 d. the entire discount is INCOME in the hands of the first taxable Canadian resident to hold the bond (11) Taxable entities: a. Where a taxable entity b. Issues a bond at a discount c. A purchaser of the bond can treat the difference b/w the issue price and its par value as CAPITAL GAIN d. If deep discount = taxable entity issuing the bond can deduct only ½ of the discount as intrest expense e. If discount shallow = effective rate of interest does not exceed the nominal rate by more than 1/3 and is not issued at less than 97% of                           its maturity value, the taxable entity can deduct the entire discount (12) Blended payments [s. 16(1)]                   a. Payments that combine income and capital (residential mortgage) b. Where an amount that is payable under K or other arrangement can reasonably regarded as in part interest and in part capital, then the part that can reasonably be regarded as interest shall be deemed to be interest c. Where property is sold for a price that is payable in installments are genuinely interest-free, the installments have been held not to attract s. 16(1) (e) Variations from accounting principles (1) Payments based on production or use of property [s. 12(1)(g)] a. Taxpayer must include in income b. all amounts that he receives and that depend upon c. the use of, or production from, property (2) Stock dividends: [s. 12(1)(j)] a. Dividends are income property in the hands of a passive investor, and income from business in the hands of a taxpayer who is in the investment business b. GR: dividends on the shares of a corporation must be included in income on a cash basis (3) Inducement payments: a. is an economic incentive that is intended to lead or persuade a person to perform a particular action or decision b. it is taxable as income c. however, may elect to treat it as a reduction in the cost or capital cost of any property that he acquires w/ the payment – effect allows a                                     d. deferred recognition of the income until such time as he disposes of the property

9. Deductions – from business and investment property (a) Income from business and property is taxable based on NET PROFIT (i)  We need to determine w/c expenses are deductible from revenues in order to calculate net profit for tax purposes (ii) Income means ‘gross income,’ therefore an expense is deductable even if it results in a loss (b) General limitations on deductions ~ can not deduct the following: [s. 18(1)]          (1) outlay/expense EXCEPT to the extent that it was made/incurred for the purpose of gaining/producing income from the business/property (2) capital outlay or loss [instead do CCA calculations] (3) no expenses deductible for yacht, camp, lodge, or golf course (4) no expenses deductible for membership fees, dues at a club that provides dining, sporting, recreational facilities to its members (5) bribes, corruptions, fraud & conspiracy [s. 67.5(1)] ~ not deductable (6) non-deductibility of illegal payments to bribe public officials (cannot deduct the fine) [s. 67.5]          (7) levies, fines & penalties [s. 676]: ~ not deductable (8) prohibits deductions for fines and penalties imposed by any law of a country or of a political subdivision of a country --> only applies to fines imposed after March 22, 2004 (c) not constitute ‘abusive’ tax avoidance (i) anti-avoidance rules: is any transaction or series of transactions that gives rise to a tax benefit, unless the transaction is one that is undertaken for bona fide purposes other than that of obtaining a tax benefit (ii) CRA can ignore an offensive avoidance transaction and re-determine its income tax consequences in certain circumstances (d) not be a personal expenditure (i) can not deduct personal or living expenses in computing income from business or property (ii) so need to determine was it for ‘profit or pleasure’ Scott v. Canada ~ provided the distinction

H: provided distinction in allowing a ‘foot and transit courier’ to deduct the cost of his ‘incremental food and water’ required to perform his job.

R: The incremental food and drink were the equivalent of the incremental gas that a person uses in his car for business purposes

(e) s. 20: list of deductions specifically allowed

--> To be deductable from revenue, an expense MUST satisfy the following:

1. be income nature and not a capital expenditure [s. 18(a)] a. 3 part test: (1) must incur the expenditure for the purpose of gaining or producing income from a business or property; and i.  question of fact ii. dual purpose – mixed personal and commercial elements to an activity ~ must determine w/c is the predominate one iii. purpose test: * what did the taxpayer expend the payment for * emphasis is on purpose not result * purpose test not outcome drive: no need to show causation b/w spending money & actually producing profit * taxpayer must incur the outlay or expense for the purpose of gaining or producing income from the business * business must exist at the time that the taxpayer incurs the expenditure * only the primary purpose needs to meet this test ~ expenditure does not have to be wholly and exclusively expended for business purposes (2) expense must be relevant to the current, and some future period (3) must be reasonable a amount [s. 67]                                     a. what is ‘reasonable’ is a question of fact b. one determines ‘reasonable’ by comparing the expense in question w/ amounts paid in similar circumstances in comparable businesses c. 5 factors to interpret s. 67: i.  size of business ii. patronage to be expected in future iii. form of advertising iv. locality where it is done v. size of population reached d. does the size of the business justify the type of expenditure e. Court’s concern is that money is being spent personally and deducted as a business expense f. Crt’s however are very reluctant to 2nd guess business judgment, will only step in usually when ‘personally’ concern is at play. (f) Characterization of a business expense involves 3 questions: 1. what is the need that the expense must meet? 2. Would the need exist apart from the business? 3. Is the need intrinsic to the business? --> ASK the following questions:

1. the character of the advantage or the duration of the benefit (the more enduring the benefit the more likely that the expenditure is on account of              capital); 2. recurrence and frequency of the expenditure (the more frequent the expenditure the less enduring the benefit); and 3. identification of the payment as a surrogatum for expenditures that would be on account of capital or revenue (a substitute for a capital              expenditure is more likely a capital expenditure) --> benefits:benefiting more than 1 accounting period = generally capital outlays --> enduring benefit: benefits that endure in the sense that some assets have a life longer than 1 year = may cause it to be considered a capital outlay --> direct v. indirect consequences * must decide each case on its own factual circumstances to determine if the expenditure ‘brings into existence an asset of enduring value’ * look to the direct and immediate consequences of an expenditure or its ultimate effect on the taxpayer’s business (g) goodwill:

(i) 2 issues: 1. did the expenditures bring into existence an asset of enduring value? and 2. was enduring value to be tested by looking to the immediate or ultimate consequences of the expenditure? (ii) Capital: an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such entity, structure or organization (iii) Revenue account: an expenditure in the process of operation of a profit-making entity or organization (h) legal expenses:

(i) to preserve a capital asset = capital, not deductable (ii) to preserve a revenue aspect = income, deductable (i) recreational, meals, entertainment

(i) usually a dual benefit (personal and business) (ii) how to draw the line b/w personal, business meals and entertainment (iii) bright line test: just deduct 50% Royal Trust:

F: Company makes payments to social clubs on behalf of the employees.

I: Deductible under s. 18(1)(a)?

F: Yes, the social clubs clearly resulted in income from the employer, these memberships are standard for the industry.

Look at GAAP – accounting practice says yes, normally deductible. Is it denied under s. 18(1)(a) general limitations (no deduction except to the extent that it was an outlay for the purpose of gaining/producing income) HOWEVER – statutory amendment since Royal Trust – s. 18(1)(l) specifically states NO MORE CLUBS.

Clothing:

Same issues as w/ inclusion of benefits for employees – Huffman If employees have to include, then business people should get no deduction so systems are parallel (in reality business people usually do better) Despite Huffman, the GR is that there is no deduction on clothing NO. 360

F: TP is an actress, has to wear good clothes for work, specific colors, designers, etc. I: Is it a personal living expense and thus denied a deduction under s. 18(1)(h)? R: YES – ALL clothing is a personal expense and therefore a personal living expense.

(j) Home Office [s. 18(2)]

(a) Home office expense limits: 1. no amount can be deductible with respect to        2. Interest on debt related to the acquisition of land Property taxes 3. UNLESS the land can reasonably be considered to have been, in the year: i. Used in the course of business, other than if the business was primarily for the resale or development of the land ii. Held primarily for the purpose of gaining/producing income from the land

Locke F: L is lawyer, builds addition /office in his home. Takes calls at night, once in a while has customers in. L tries to deduct 1/6 of costs.

I: Is it deductible?

R: No

A: Ct applies reasoning applied in Heath, 6 factors: 1) Was the office/room completely separate from family space?

2) Was an appreciable amount of its purpose for business, or just convenience?

3) Was house municipally assessed for business?

4) Business phone line?

5) Business sign out front?

6) If another office is the main office, is this a 2nd branch?

(k) Travel Expenses F: C is a doctor in a hospital, has a home office where he does his accounting. He has no office in the hospital, even has to share cot he naps on. I: Is his home-hospital travel deductible ?

R: Yes- b/c he has no “base” at the hospital, his home is his business base and the hospital is a 2nd branch of this business. Ct distinguishes facts from British case Newman where no deduction was allowe

Ct notes that if his home and the hospital were really far away, might not be deductible

(l) Interest: [s. 20(1)(c)(i)] (a) provides that interest on money borrowed by the taxpayer to earn income from a business or property is deductible (b) Taxpayer may deduct interest if the interest: 1. is paid or payable in the year 2. arises from a legal obligation 3. is payable on borrowed money that is used for the purpose of earning income from a business or property, and a. use + purpose b. distinguish b/w ‘for profit’ and ‘for pleasure’ activities c. capital gains = interest not deductable d. ‘use test traces’ = direct flow of funds to determine how one applies the borrowed money e. it is the actual & not the alleged uses of borrowed money that determines the deductability of interest payable on the funds f. we determine the purpose of borrowing by tracing the direct and immediate use of the borrowed funds into the income earning process g. interest is deductable ONLY if there is a sufficiently direct link b/w the borrowed money and the current eligible use h. tax minimization as a motive is not a bar to the deduction of an expense i. taxpayers can arrange their affairs for the sole purpose of achieving favourable tax results 4. is reasonable in amount (c) Interest expense is deductible when the interest is paid or payable (determined by the method that is regularly followed)

(d) S.9(3) capital gains are not property income therefore interest on borrowed funds used to earn capital gains is not deductible (i.e. shares not               paying dividends           (e) For items bought with a dual purpose (personal and income earning) the courts have looked to the primary purpose test

(f) Current use: it is the current use and not the original, use of funds that determine the deductability of interest expense ~ hence change of use can affect deductibility

Bronfman Trust

F: B is a trust set up for a capital beneficiary. Trustees want to distribute some assets to the beneficiary (take some value out of the trust). It is a bad time to sell the shares of the trust, so get a bank loan, give money from bank loan to capital beneficiary, a few years later sell off stock and use profit to pay off the loan.

I: is the interest on loan deductible?

H: No. Court traces the funds and determines that there is no valid deduction. R:

TP argued that they were doing exactly what was being done in Transprairie case. There the corporation issued preferred shares, then got a loan and redeemed them (bought them back). Court said interest on the loan deductible b/c it is just to fill in a capital hole,’ a valid business purpose. Court made the following distinctions:

eligible/ineligible distinction: need to earn income, not a CG. Money borrowed cannot be used for capital gain. Have to be able to trace the use of the borrowed funds. Original/current use analysis: it is the current, not original use of the borrowed funds that matter (i.e. can begin as ineligible but then become eligible by current use). Direct/indirect use analysis: if the case is one of ineligible direct use, courts shouldn’t go looking for an eligible indirect use – would get too complicated, let too many people into deduction loop.

Singleton:

F: TP a partner in a law firm, had to invest $200k to be partner. Takes money out, buys a house, then takes out a loan and puts it bck into the firm, deducts interest as being used to make a profit. Effectively deducting the interest on his house.

I: Whether amount borrowed was used to make income?

H: Court says this is okay b/c it adheres to Bronfman principles – he is working the system over legally and effectively.

(m) repairs, maintenance and alterations: (a) prolongs the life = capital (b) merely maintains an asset or restores to original condition = income (n) Contingent liabilities [s. 18(1)(e)] (a) Contingent liabilities w/c depend upon an event w/c may or may not happen = not deductable (b) Determine if contingent ask “whether the legal obligation has come into existence at that time, or whether no obligation will come into existence until the occurrence of an event that may not occur” (c) Deductions cannot be taken until this condition is met (o) reserve: an amount that one sets aside for future use (a) doubtful debt reserves [20(1)(l)] 1. deductions permitted for a reasonable amount previously included in income that is receivable but more likely than not collectible 2. reserve must be added back to income the following year [12(1)(d)] 3. if debt remains uncollectable it can be taken in a reserve again that year or can be deducted under 20(1)(p) (b) deferred payment reserve [20(1)(m)] 1. postpones the realization of income when part of the amount is not due until 2 years time (income cannot relate to sale of real property) 2. 3 conditions must be met: a. amount from the sale of property must be included in income b. property must be an inventory property; and c. all or part of the purchase price must not be due until at least 2 years after the time of the sale 3. reserve must be added back to income in the following year (d) unearned amounts reserve [20(1)(n)] 1. May deduct a reasonable amount in respect of "goods" that will be delivered, or services that will be rendered, in a subsequent year. 2. Available only in respect of amounts included in the taxpayer’s income from a business under s. 12(1)(a), which includes incomes amounts received by a taxpayer that have not yet been earned (or realized). 3. Like the two other reserves, the amount of reserve must be "reasonable". What is "reasonable" is a question of fact depending upon the circumstances. 4. The reserve completely offsets the inclusion under s. 12(1)(a), and no profit will be taxable until the future year in which the income is                         earned

--> S. 12(1)(e)(ii) - Reserve must be added back to income in the following year

E. Capital Expenditures [S. 18(1)(b)]

1. Definitions:

(a) Capital Cost = price TP paid for something.

(b) Capital Cost Allowances = amount you are allowed to deduct of the capital cost in a year

(c) Undepreciated Capital Cost = what’s left from w/c to take deductions from in following years.

(d) Proceeds of Disposition = proceeds from sale.

2. Still have to get past the business test ~ the distinction is important for HOW you take the deduction 3. Determination of whether a business expense is either Current or Capital 4. distinction b/w capital expenditures v. current expenditures a. distinction b/w the two is ‘timing’ b. benefits of capital expenditures = continue for substantial period of time c. benefits of current expenses = don’t last long beyond current accounting period 5. belief that the expenditure that produce an enduring benefit to a business should not be immediately deducted in full – such expendtirues should be amortized over the period for w/c they do confer a benefit on the business 6. a number of tests have been developed to distinguish b/w the 2: (a) enduring benefit test i.  most common test used ii. if expenditure creates benefit to the business lasting beyond the current taxation year, then shouldn’t be deducted in full in current year iii. distinguishes b/w capital and current expenditures by asking if the payment is made for the establishment or expansion of the business structure that has an enduring payment or as part of the money earning process (b) recurring expenditure test; and i.  not a conclusive test – suggests that capital expenditure is a thing that is going to be spend once and for all and an income expenditure is                        a thing that is going to recur every year ii. 1 time payment are generally capital expenditures, ongoing periodic payments are generally a current expenditures iii. test does not ask the right question – the idea that a capital expenditure is made once and for all is not always true b/c many business purchase new capital assets every year. Similarly, a current expenditure, w/c provides a benefit to the business w/c is exhausted in the current year, could be of an unusual or nonrecurring thing (c) residual test in favour of the taxpayer: i. if the 2 above tests fail to characterize an expense a residual test has been applied to characterize the expense in favour of the taxpayer ii. stands for the proposition that if one reasonable interpretation of the transaction leads to a deduction to the credit of a taxpayer and the iii. other leaves the taxpayer w/ no relief, the transaction should be characterized in favour of the taxpayer 7. classification – 3 basic questions: a. is the capital property depreciable capital property? b. To w/c class of assets does the property belong? c. What is the rate of depreciation applicable to the particular class?

Johns Mansville

F: JM owns a pit which they are “mining”. Because they keep taking stuff out and making pit and \ pit walls steeper, have to keep buying dirt to graduate the sides so that trucks can drive down them.

I: Is the dirt a current/capital expense?

[This is a tough case b/c traditionally land is always non-depreciable, explicitly excluded from CCA tables… but in this case the taxpayer is clearly eroding and depreciating the land!]

R: It is a current deduction

A: Ct looks at Dennison case, where a mining Corp was building tunnels inside their land throughout the mine. The Corp argues that the creation of the tunnels was a capital expense b/c the tunnels had enduring value, MNR argued that they were current. The Ct accepted the MNR’s characterization of the tunnels as a current expense.

Next Ct looks at BP Australia, where the question was whether the sums expended on the structure within which the profit was to be earned, or part of the money earning process?

The Ct asks whether the application of the new soil was part of the essential profit earning structure?

Act is recurring, directly incorporated into the process

NOT once and for all

Land is depreciating though

[ Ct applies the residual presumption in favour of the taxpayer here]

8. How much capital cost allowances (CCA) can be deducted?

(a) CCA allows TP to deduct actual cost of depreciable assets over a period of time (b) Statute prescribes the rate at w/c a taxpayer can claim CCA on an asset (c) Tax accounting uses: decline in balance – based on the percentage, i.e. 10% per year (d) Rate is the same for all taxpayers w/ similar assets performing similar activities (e) Rates generally allow for generous write-offs (f) Permissive – TP may claim capital cost allowance in a particular taxation year --> SO TP does not have to claim CCA if you have no use for it                --> However, it is not on a rolling basis system --> It only kicks into gear the 1st year you claim it 9. Depreciable property = property acquired by the taxpayer in respect of w/c the taxpayer has been allowed or is entitled to capital cost allowance list of items that are not eligible for capital cost allowance 10. S. 18(1)(b) denied deductions on capital costs UNLESS it is specifically allowed for in the Act (a) capital costs (i) Meaning 1. Full cost to the taxpayer of acquiring the property including purchase price, legal, accounting, engineering, freight, delivery, installation and other fees incurred

2. S.18(3.1) requires the capitalization of certain soft costs that are attributable to the period of, and relating to, the construction, renovation or alteration of the building

3. Includes amounts such as interest and other financing expenses, property taxes, mortgage insurance fees, legal and accounting expenses, site investigation fees

4. Cost of a gift is deemed to be FMV

5. Where property acquired in non arms length transaction the value to the receiver is deemed to be FMV regardless of what was paid S.69(1)(a) (ii) Apportionment: S.68 requires a single purchase price to be allocated between different categories of property where relevant for tax purposes. (i.e. building and land)

11. Capital Cost Allowance ("CCA") S.20(1)(a) a. S. 20(1)(a) states that notwithstanding s. 18(1)(b), a proportion of the capital cost to the owner of property is deductible b. Property is broadly defined under s. 248(1) c. Regulation 1100(1) which is in Part XI of the Regs deals with CCA – has 46 classes with various CCA rates for each d. Schedule II details the assets in each class ~ the kind of asset MUST be listed as depreciable property – explicity does not include land/shares e. Land is assumed to NOT be depreciable f. Regulation 1102(1) limits the scope of the CCA deduction g. Excludes certain property by which one cannot claim a CCA deduction ~ such as: (1) Inventory (2) Current expenses under s. 18(1)(b) as they have no enduring benefit h. Para. (c) to qualify for CCA need to meet the income-earning purpose test i. Half Year Rule: in the first year you acquire something, you can deduct HALF of its value, no matter when in the year you acquire it. (1) Taxpayer is only allowed to deduct 50% of the CCA for an asset in the year of acquisition (use notional UCC to calculate CCA) Class 12,14,15 excluded from this rule (2) Notional UCC = Actual UCC at year end less 50% of cost of acquisitions (3) If depreciable property of the same class was disposed of in the year, then 50% of the net figure is subtracted from the UCC. (4) If the proceeds of dispositions exceed the cost of acquisitions, then Reg. 1100(2) doesn’t apply; must have net increase in UCC amount for Reg. 1100(2) to apply j. Recapture: If you see an asset, and you have claimed more depreciation then it depreciated in reality, the balance will be recaptured by being included in your income under s. 13(1) (1) When there is a negative balance in a UCC class at the end of the taxation year include that amount in income (2) This can only happen when there is a disposition in the year for an amount greater than the balance of the UCC class immediately before the disposition (3) Recapture puts back in income the deductions that were taken in prior years which were not actually losses in the value of the asset (4) Can avoid recapture if there is a negative balance mid year by buying another asset in the that class to bring the balance to positive before year end (5) S. 13(4) provides election to defer all or part of recapture of an involuntary disposition or taxpayer acquires replacement property for a former business property by the deadline (6) Effectively proceeds of disposition are transferred to year asset is purchased k. Terminal Loss: If you sell an asset and have not claimed enough CCA deductions (the rate of depreciation is too low) you can deduct the difference as a business loss under s. 16(1) (1) Terminal loss arises if the taxpayer no longer owns any property in the class and the balance in the UCC of the class is positive. (2) A terminal loss occurs when the proceeds of disposition of all property in the class fail to recover the UCC of the class. (3) Determined at the end of a taxation year – if there is a balance in the class of UCC mid year but new assets are acquired there is no terminal loss l. Under-depreciated capital costs: To determine a taxpayer’s ‘underpreciated capital cost’ of a class of depreciable property by adding the following: (1) capital cost depreciable property of the class (2) gov’t assistance repaid by the taxpayer subsequent to the disposition of property in respect of the acquisition of w/c he or she received assistance (3) any amount recaptured in respect of the class; and (4) repayment of contributions and allowances the taxpayer received and that were previously deducted from the capital cost of that class Next deduct the aggregate of:

(1) the total capital cost allowance and terminal losses that the taxpayer has claimed for property of the class; (2) the proceeds of disposition of any property of the class disposed of (the deduction not to exceed the capital cost of the property) and (3) gov’t assistance received, or that the taxpayer is entitled to receive, as well as investment tax credits claimed, subsequent to the disposition by         (4) the taxpayer of the property to wc/ such assistance or tax credit related Can never be a negative amount.

M. CCA will be deducted from business income yearly SO if you make $199k profit in a year, deduct CCA allowance from final evenue so you aren’t taxed on it.

CCA Calculation [s. 13(21)]                  CCA = CCA rate x UCC (before making any deduction for the taxation year) UCC = (A + B) - (E + F)

A = capital cost of depreciable property of a prescribed class when acquired

B = deals with s. 13(1) recapture.

E = CCA previously claimed (cumulative)

F = Lesser of proceeds of disposition of the property and its capital cost

UCC = undepreciated capital cost – what is left to take deductions off in following year

N. Timing of Acquisition S.13(26) – Available for Use (a) S.13(26) cost of property added to UCC balance when its "available for use" or until 24 months after the actual acquisition of the property. (b) S.13(27) says property becomes available for use when "first used by the taxpayer for the purpose of earning income" (to avoid CCA on unused property)

O. Proceeds of Disposition - Defined in S.13(21) (a) Includes sale price of the property, compensation for property unlawfully taken, compensation for property destroyed, taken or damaged

(b) S.248(1) - Disposition defined as any transaction or event entitling a taxpayer to proceeds of disposition

(c) When gifted proceeds of disposition deemed at FMV, when property is destroyed or stolen without insurance coverage proceeds are deemed to be zero

P. Timing of Disposition (a) Disposition occurs when proceeds become receivable. Under the general principles of realization, proceeds of disposition become receivable when the taxpayer has acquired the legal, not necessarily immediate, right to payment (b) For involuntary dispositions (expropriation, loss, theft, or destruction), s. 44(2) deems a property to be disposed of at the earliest of the following times: 1. Date of an agreement fixing the full amount of compensation; 2. Date a board, tribunal or court determines the amount of compensation; 3. 2 years after the loss if the taxpayer does not commence legal proceeding (c) Separate classes for similar properties = must calculate capital cost allowance for each business separately

(d) Rental buildings over 50k ~ Each rental building that costs 50k or more must be placed in a separate class Q. Specific Costs and their classification (a) Repair of Tangible Assets

i. Regularly recurring costs maintaining asset or bring it back to regular condition is an operating expense and * Canada Steamship lines (1979) – replaced floors and walls of cargo area of boat – court held these were current expenses (necessitated by                    normal wear and tear) ii. irregular cost, improving an asset substantially beyond its original condition, then the cost will be treated as a capital expenditure * Cost of new roof: Earl v. MNR (1993) – cost of a new roof is a capital expenditure as it improved the building – provided improvement and enduring benefit * Shabro Investments (1979) – replacement of concrete floor in commercial building after old one sank – court held that it was not recurring and despite bringing it back to normal condition it’s a capital expenditure

(b) Protection of Intangible Assets

i. Lawsuits to protect an intangible & bring it back to original state are current expenses

* Canada Starch Co. (1968) – lawsuit to settle co.’s ability to use a trademark was held to be a current expense because it was related to the process of earning income rather than the business entity or structure of the organization ii. while improving the status if an intangible or improving its state would be a capital expenditure * MNR v. Dominion Natural Gas (1940) – legal cost to defend licence to supply gas had enduring benefit and should be capitalized (c) Websites and Domain Names EIC 118

i. Cost of hardware, software and original graphics should be capitalized ii. Where domain name is equivalent to a trademark, trade name or serve mark and would have an enduring benefit, the cost is likely a capital expenditure --> If domain name has limited life, cost of acquisition is likely current expenditure (d) Corporate Takeovers

i. Courts view cost incurred in fighting hostile takeover bids to be capital

* Neonex International (1978) – legal expenses incurred in an effort to complete a takeover are outlays associated with an investment transaction and made on capital account

ii. while they view those incurred during friendly takeovers to be current expenses for target co.

--> Expenses incurred by taxpayer making takeover are generally capital expenses

(e) Goodwill

i. Cost incurred by a business that results in goodwill are generally current expenses (i.e. advertising, market surveys & industrial design studies)

ii. Costs incurred to purchase goodwill when a company is being acquired is a capital expenditure (e.g. buying a client list) – See ECE page 40 (f) Expenses with respect to a new business

i. Start-up costs incurred prior to entering a new business are capitalized and costs of earning income or performing operations are current expenses Bowater Power (1971) – engineering costs to expand existing plant are current expenses (incurred while the business operating and is              cost of business) ii. If expense incurred to change or expand new business, generally capitalized * Firestone (1987) – costs associated with finding a co. to buy are capitalized

(g) Eligible Capital Expenditure (ECE)

- s.14 comes into force 1972

- Same as CCA, except: Only include 75% of cost and depreciation rate set at 7%

- ECE = An expense that is incurred for the purpose of gaining or producing taxable income, that is not otherwise deductible, the deduction of which is not disallowed under any provision other than s.18(1)(b), and that is not incurred in order to acquire tangible property or intangible property that is depreciable property.

- This is a residual category- check if it is a CCA first, then, if not, maybe ECE (ie: would include something like goodwill, fees to broker to sell shares [ Royal Trust])

- s.20(1)(b)- Must show that it relates to business (can’t be property income)

Royal Trust F: Trust Co. wants to issue shares. Goes to broker. The broker buys all the shares, then sells them on the market. Trust Co. pays the broker a commission on the sale of each share.

I: Is the commission an ECE?

MNR says: 1) No ECE deduction b/c the commission is not an outlay/expense, rather they are giving the broker a discount/rebate of the shares

2) No ECE deduction b/c cannot deduct this under s.20(1)(e) [Statutory interpretation issue] 3) No ECE deduction b/c expense not incurred for the purpose of gaining/producing income R: YES, commission is an allowable ECE deduction.

1) A commission is not a rebate. The broker had to work to sell the shares on the market, thus

the payment of the commission is compensation for services rendered.

2) s.20(1)(e) denial doesn’t necessarily mean cannot deduct as an ECE. CCRA Bulletin says that a s.20(1)(e) denial of deduction does not always imply an ECE denial of deduction.

3) Yes, the expenses were incurred for the purpose of producing income. Ct applies more recent, expanded interpretation of this principal, and rejects the old “wholly for income production” line of reasoning.

Goodwin Johnson F: TP has an agm’t to manage someone else’s timber license, receives payments based on the amount of timber cut. Dispute over contract arises. TP receives $800k settlement to give up it’s role under K.

I: Does the TP have to include the $800k as an ECE?


 * Mirror Image Rule- If you pay an amount, and it would be deductible as an ECE(expense), then you would equally have to include it in your income if you receive a similar amount.

MNR says that amount is capital, TP says it is current.

R: Amount does not have to be included in income as ECE

A: Factual analysis:

1) Action was not settled b/c tp sold their underlying business structure. The payment was purely for the breach of K (current, not capital)

2) Minutes of settlement reveal that the payment was simply for the breach of K and not for purchase of business.

3) Termination provisions in the K explicitly say that if they are triggered, the right to buy the business is activated. B/c the parties did NOT apply this provision, it can be implied that the business was not being purchased. Ct says that the payment was for the purpose of earning income b/c they did not purchase  whole business, this is an eligible deductible business expense, so not an ECE.

Dissent: Differs on factual analysis, interprets the payment as a payment for relinquishing the business which would be a capital payment.

Prepaid Expenses

- s.18(9)- If you prepay an expense, you can not deduct it until the services paid for are rendered

Running Expenses

- Exception to matching principal (recognize expenses w/ income produced by them, ie: inventory)

Oxford

F: TP pays money to municipality to build an interchange so that customers can get in to driveway of parking lot (business is the parking lot)

[Why is this not a CCA? B/c TP doesn’t own the interchange- it is intangible. All they paid for was the service of building the interchange]

TP wants to deduct the cost currently

MNR wants amortization(depreciation/deduction) over time, or no deduction

[This was caught by MNR b/c TP amortized it over 15 yrs. For financial accounting- red flag] R: Ct allows current deduction

Tax accounting doesn’t have to be the same as financial counting

Says this is a running expense

In Colliery, this was defined as an expense incurred while running the business in a whole year that is not tied as an expenditure to a line of profit. (basically, expenses that are impossible to trace to a specific profit- this goes against the matching principal)


 * Brooks says this is weird. Historically, we needed this, but now this type of expense would fall under ECE.

F. Capital Gains [ss. 38-55]

1. Why should capital gains have a preferential rate? a. Preferential rate = reduced inclusion rate b. S. 38(a) sets rate as of October 2000 à 50% c. SO, if CG is $200 at 50% ~ the taxable CG is $100, then apply your specific tax rate d. CG income: intention to invest at purchase for an extended period of time ~ when you sell it, TP will have a capital gain or capital loss --> If you turn it over very fast ~ may be characterized as business or property income e. Since CG income gets taxed at a reduced rate, w/c is why courts and statutes have created strict ‘invention to invest’ rules f. Tax CG at lower rate b/c trying to encourage long-term investments g. Some special exemptions still exist: i.e. Principle residence exemption ~ sale of house tax free h. Pros of CG preferential rate: i. Tax expenditure: increase investment in capital assets ii. Neutrality: lock-in-effect mitigated --> If locked in people do not sell their shares b/c profit will be taxed --> However, if lower ~ as CG tax rate ~ encourages selling of stocks --> Also takes into account inflation ~ compensates for the fact that CG may be lower than face value b/c of inflation iii. Equality: avoids bunching (take huge cut 1 year b/c realize a CG) i. Cons of CG Preferential rate: i. Tax expenditure: may promote over investment ii. Neutrality: encourages investment in capital assets thus affecting natural investment urges iii. Horizontal equity: a buck is a buck iv. Vertical equity: high income earners get the benefit, low income earners have no access, taxed at full rate v. Administration: difficult to draw the line 2. Inclusion in Income ~ section 3 (a) capital gain derives from an increase in the capital value of an asset --> ‘net’ refers to the excess of gains over losses (b) capital gains exemption comes into play in 2 steps: 1) capital gains are included in income, then              2) w/in specific limits, a taxpayer may deduct exempt gains in computing taxable income (c) Income includes ‘taxable capital gains’ LESS ‘allowable capital losses’ [s. 3(b)]

TCG = 50% [S. 38(a)] TCL = 50% [S. 38 (b)] TCL are deductable only against TCG

--> Can not use excess capital losses over capital gains to reduce income from another source --> Exception: may apply to business investment losses against ‘ordinary income’ 3. Capital Property [s. 54]    (a) "Capital property" is a convenient way to describe property the disposition of w/c will give rise to capital gains or losses (b) s. 54: i.  any depreciable property of the taxpayer, and ii. any property (other than depreciable property), any gain or loss from the disposition of which would, if the property were disposed of, be a                             iii. capital gain or a capital loss, as the case may be, of the taxpayer (c) exceptions ~ not capital property [page 445] (d) types of capital properties: i.  personal use property ii. listed personal property iii. business investment property, and iv. other capital properties (e) capital property if: i.  where a person disposes of all or substantially all of the assets ii. used in an active business to a corporation iii. any shares that he receives in consideration for the asset iv. is a capital asset 4. Computation of Gain or Loss Capital Gain = Proceeds of Disposition – (Adjusted Cost Basis + Expenses)

5. Reserves:

1. when a taxpayer realizes a capital gain 2. but does not collect the cash at the time of the transaction 3. the act provides some relief and allows a taxpayer to defer recognition of some of the gain on uncollected proceeds 4. technicalities: a. in year 1: taxpayer deducts a reserve b. in year 2: taxpayer must bring the amount deducted into income in the following year c. in year 3, 4, 5, etc.: taxpayer may claim a further reserve to the extent that part of proceeds of sale remain outstanding at the end of yr           5. limitations ~ reasonableness ~ max. that may be claimed in a year is limited to the lesser of 2 amounts: a. reasonable amount; and b. an amount determined by reference to a formula 6. limitation ~ time limit a. 5 years: taxpayer ay claim a reserve to a max. of 5 years b. 10 years: extended if the property that the taxpayer transfers is one of the following AND the property is transferred to the taxpayer’s child c. land and depreciable property used in a family farm d. a share in a family farm corporation e. an interest in a family farm partnership; or                     f. a share in a small business corporation 6. Selling Expenses: taxpayer can deduct expense incurred in disposing of a capital property. Only expenses that one incurs in connection w/ the disposition of capital property are deductable in calculating a capital gain or loss Fixing-up expenses, finder’s fee, sales commissions, brokers fees, surveyor’s fees, transfer taxes, title registration fees, and legal expenses that relate to the disposition are deductable 7. Depreciable Capital Property [s. 70(5)] (a) Act deems a taxpayer to dispose of his depreciable property at its FMV (b) A beneficiary who inherits property as a consequence of the death of a taxpayer is deemed to acquire the property at an amount equal to the deceased’s deemed proceeds of disposition (FMV)

8. Disposition and Proceeds of Disposition ~ recognition rules (a) "Disposition" is defined as including "any transaction or event entitling a taxpayer to proceeds of disposition of property" [S.248(1)] (i) taxpayer disposes of property when the taxpayer legally alienates his right to the property (ii) property includes: real and personal property, shares, choses in action and timber resource properties ~ virtually every possible interest a               person may have (b) "Proceeds of disposition" is defined as gross proceeds realized by disposition [S.54] (c) Disposition w/out proceeds if stolen, destroyed, lost, abandoned or confiscated without any right to compensation or insurance – proceeds would be zero for the purpose of computing the capital loss from the disposition (d) Inter vivos gift gives rise to a disposition - deemed proceeds = FMV [S.69(1)(b)] (e) Trust: deemed that everything in a trust is disposed every 21 years [s. 104(4)] (f) Moving in/out of country: at the moment you step over the border, you are deemed to have disposed of all your property, and pay tax on everything you own (and disposed of) at that moment – a snapshot [s. 128.1] (g) Bad debt (money you lent and never got back): can elect to have bad debt disposed of, so can capital loss as a deduction. If you happen to get the money back at some point in the fture, the repayment is characterized as a capital gain [s. 50] (h) Options: if you grant someone the option to acquire something, you are deemed to have disposed of it and to have received proceeds [s. 49(1)] (i) Taxpayer is deemed to have disposed, immediately before his death, of all of his capital property and to have received proceeds = FMV [S.70(5)]

(9) Adjusted Cost Base, S. 54 (a) "Adjusted cost base" = capital cost amount used for CCA under S.20(1)(a) (b) For non-depreciable capital property ACB is the cost of the property adjusted in accordance with s. 53 (c) Cost is not defined by the Act it’s the price paid plus costs of acquisition (d) S.53 provides for either upward (s. 53(1)) or downward (s. 53(2)) adjustments to actual cost designed to make the taxation of capital gains compatible with the other parts of the Act. (e) ACB of a property at the time that it is disposed of cannot be less than nil (f) Non-arm’s length transaction: (i) where a taxpayer acquires property in a non-arm’s length transaction at an amount greater than its FMV, the taxpayer is deemed to have acquired the property at its FMV at the time of acquisition

(ii) if property acquired at less than its FMV, the adjusted cost basis of the property is the taxpayer’s actual cost

(10) Computation of Gain or Loss, S. 40(1)(a) (a) gain: if the proceeds of disposition exceed the adjusted cost base of the property plus the expenses of the disposition, the excess is the amount of the gain

(b) loss: If the adjusted cost base plus the expenses of the disposition exceed the proceeds of disposition, the excess is the amount of the loss

(11) Timing of Realization S.44(2) (a) Disposition occurs when proceeds become receivable. (b) Under the general principles of realization, proceeds of disposition become receivable when the taxpayer has acquired the legal, not necessarily immediate, right to payment (c) For involuntary dispositions (expropriation, loss, theft, or destruction), s. 44(2) deems a property to be disposed of at the earliest of the following times: i.  Date of an agreement fixing the full amount of compensation ii. Date a board, tribunal or court determines the amount of compensation; iii. 2 years after the loss if the taxpayer does not commence legal proceeding (12) Special Events and Deemed Dispositions (a) Death, S. 70(5) - Taxpayer is deemed to have disposed of all capital property for proceeds of disposition equal to FMV immediately before the taxpayer’s death - Recipient of the property is deemed to get it at FMV, the inherited property does not shelter any untaxed capital gains - Avoid dispositions on death when property is "rolled" to spousal trust or spouse

Mastromardi F: M is SH in Corp- Corp has $500k life insurance on him. S.70(5) says disposition “immediately prior to death”. TP’s estate wants to interpret this to mean right before death but not in contemplation of death (so that the life insurance proceeds aren’t included in Corp thereby increasing the value of the shares and the CG that will have to be paid by TP’s estate for the value of the shares)

MNR says a reasonable person would know that the $500k is about to go into Corp and raise value of shares

R: Immediate ¹ Instance of death- Valuation should not be “in contemplation of death”, \ do not include value of life insurance in stock.

(b) Gift, S. 69(1)(b): Inter vivos gifts and non-arm’s-length sales for inadequate consideration are deemed to be a FMV (S.69(1)(c) recipient deemed to receive the gift at FMV)

(c) Departure from Canada, S. 128.1(4) - When a taxpayer ceases to be a resident of Canada, there is a deemed disposition at FMV often called a "departure tax". - Similar rules when coming to Canada (d) Trust S.104(4): Deemed disposition and reacquisition every 21 years – to avoid sheltering CG that humans are subject to upon death (e) Bad debts

- Taxpayer can elect to be deemed to have disposed of the bad debt where the disposition of capital property has been uncollectible IF shares of corporation = must establish that a corporation in w/c he holds shares has become bankrupt or is Ss to a winding-up order can elect to be deemed to have disposed of any shares (f) Exchange of Property

- s.44(1): Defer gain on exchange of property if, - Property unlawfully taken, destroyed, or expropriated - Property is former business property [acts as a disincentive to making the business smaller] - Must replace property within a set time period. If Within 2 taxation years Within 1 taxation year - If you meet the conditions, you can elect to have a rollover

Say your building gets destroyed by fire and you get 500 k in insurance proceeds. You are deemed to have disposed of the property at that time for 500 k so would normally have to pay CG tax on that. But instead, if you re-invest all of the money into a replacement property, you can roll that tax liability over

The gain is deemed to be lesser. The amount of proceeds of disposition of former property exceed some of the costs of 1rst property If I buy a new property that costs only $150, I pay tax on the difference between $150 and $200 b/c otherwise have unaccounted for gain If the value is the same, do the same as with a spouse and pay tax later.

Glaxco

F: Corp buys land with the intention of expanding their operations on the new land. Corp merges with another, the expansion is put off for a while. Eventually go to use the land and realize it isn’t big enough, so sell the land and buy a new piece of land.

I: Is the property a former business property?

Definition of former business property: Capital property used by a TP for the purpose from gaining income from business. Must be real property.

TP say they’re just replacing business property should be a rollover R: Property was not used. It was intended for use, but never actually used. A: Ordinary meaning of use = Actual productive use. Purpose of s.44 is a relieving provision allowing business people to get rid of old property and get new property without tax consequences. (g) Stop Loss Rules - Try to prevent TP’s from using/twisting rules of Act to their advantage - ss.40(2)(g)(i), 43, 53(1)(f): Combined, these provisions say that if you sell property and repurchase it or identical property within 30 days, and loss on the sale cannot be claimed. - This prevents TP from timing losses to offset gains - 30 day test = Bright Line Test (h) Change of Use S.45(1): Deemed disposition and reacquisition at FMV when property is changed from income earning to non income earning Duthie Estate

F: TP has land in BC. 1981, decides he wants to develop the land into condos, hired architect, project coordinator etc. Stops work when market goes bad, land sits unused for a while, eventually he sells the land at a huge loss. TP tries to deduct both expenses in 1981 of hiring all the people and the loss on the land.

I: Was land, which he originally bought for personal use, converted to business use? (Wants to convert it retroactively b/c cannot claim loss on PUP) MNR says TP’s activities (hiring, etc) were preliminary to business and not actually business themselves

MNR also argues that if it had been converted to business use in 1981, should have been deemed to have been disposed of then- b/c TP didn’t do that then, he should be estopped from claiming now.

R: There was a change in use \ TP gets expenses AND loss

A: For change of use, just need a clear and unequivocal act. In this case, the TP’s 1981 activities constituted enough of an act. s.45(1)- Partial change in use of property (ie: start renting out part of house). You are deemed to have disposed of that part of the house. F. Capital Losses (a) Loss, S. 40(1)(b) - makes no provision for a reserve for future proceeds allowing full loss in year of disposition regardless of when proceeds are received - If there aren’t enough taxable capital gains to cover the allowable capital loss it can be carried back for three years and forward indefinitely - Stop loss rules exist for superficial losses and disposition of personal use property (b) Dispositions b/w Affiliated Persons (i) Affiliated person rule: [s. 251.1(1)]              1. a controlled abusive transaction occurs 2. here taxpayers trigger losses 3. w/in close economic affiliations - b/w spouses - CL partners - Corporations under common control - Partnerships and members of partnership (anyone who either along or together w/ other affiliated person, who are generally entitled                              to more than ½ of the partnership’s earnings) - Does not include: parents, siblings or children of the taxpayer or corporations controlled by those persons 4. on certain types of property or move losses from 1 person to another 5. will be denied to be used as a loss (ii) 3 things trigger this rule: 1. person disposes of property at a loss 2. person who disposes of the property or someone affiliated w/ the person must, w/in 61 days window that centres on the date of the disposition, acquire that same property or what is referred to as substituted property, and 3. the disposing person or persons affiliated w/ that person must own the property or substituted property in question on the 61st day of that same period (iii) Superficial Losses, S. 40(2)(g)(i): Arises when an individual or certain affiliated parties disposes of property and replaces it with substituted property w/in a period of 61 days (c) disposition of debt ~ capital losses from disposition – whether actual or deemed – of a debt is deemed to be nil, unless the debt was acquired for the purpose of gaining or producing income from a business or property, or as consideration for the disposition of capital property to an arm’s length person (d) Personal-Use Property Losses, S. 40(2)(g)(iii) - S. 54(a) property owned by TP that is used primarily for the personal use or enjoyment of the TP or their family --> Any dept owing to the TP for disposition of personal use property - Personal Use property includes: (1) Property owned by a taxpayer that is used primarily for the personal use or enjoyment of: i. Taxpayer ii. person related to taxpayer iii. taxpayer is a trust, a beneficiary under the trust or any person related to the beneficiary (2) debt owing to a taxpayer in respect of the disposition of personal-use property; and (3) an option to acquire property that would, if it were acquired, be personal-use property of a taxpayer or a person related to him - S.54 – Property owned by taxpayer used primarily for the personal use or enjoyment of the taxpayer or related person --> Includes such things as cottages, cars, bicycles, boats, sporting or recreational equipment, household appliances, furniture and clothing. - S. 40(2)(g)(ii) provides that a loss from the disposition of personal-use property (other than listed personal property) is deemed to be nil --> These losses are considered consumption - S.46(1): up to $1000 gain exempt, beyond $1k gain it will be taxed (that is the amount above)

Burnet

F: TP has a house. Lives in it part time, then moves out- a lot of moving in and out for various reasons. Ultimately, sell house, sustains big loss. Would be barred claiming the loss under s.40(2)(g)(iii) but he says he is using the property in a manner akin to an adventure in the nature of trade \ deductible under business loss. Ct does detailed factual analysis

R: Overall picture was that this guy naively thought he could make some business profit. He did, no matter how stupidly, have speculative intent, \ can deduct loss.

(*Brooks says this is a bad decision b/c if there were to be a gain, this ruling would stand for the reasoning that no principle residence exemption should apply- Mirror image rule)

(e) Listed Personal Property Losses S.54

- S. 54 definition w/ list – is a closed class (a) print, etching, drawing, painting, sculpture or other similar work of art, (b) jewellery, (c) rare folio, rare manuscript, or rare book, (d) stamp, or         (d) coin. - Such property have the characteristics of investments as declines in their value would not normally be attributed to use, but to changing market conditions - Can deduct losses from LPP but only against gains from LPP - 3(b)(i)(B) brings into income a taxpayer’s "taxable net gain for the year from dispositions of listed personal property" - S.41(2) - LPP losses for the year can be carried back 3 years and forward 10 years (f) Principal Residence Exemption S.40(2)(b) (a) GR: 1. principle residences are exempt from capital gains 2. if taxpayer owned the residence (outright jointly or otherwise) 3. TP or spouse or former spouse or child "ordinarily inhabited" in the year taxpayer "designated" it to be principal residence for the year, and 4. ‘ordinary inhabited’ not defined in act – inhabiting for a short time during year is sufficient as long as primary purpose of owning isn’t to                   generate income

(b) if used partially to earn income (seasonal rental or basement rental) property still qualifies as ordinary inhabited by the owner so long as          income-producing use is ancillary to the main use --> taxpayer did not make structural changes to the property to accommodate the income-producing use (c) taxpayer did not claim CCA on the property

(d) Principle Residence 1. Cts generally allow for a generous interpretation of the rules 2. Only 1 exemption per family, including children under 18 who are single 3. Includes some land 4. When doing calculations, add 1 year onto formula to compensate for maybe having 2 houses that year.

s.54- 3 Factors: a) Eligible Property

b) Surrounding Land

c) Designation

(e) Eligible Property ~ Is principle residence ordinarily inhabited?

Flanagan

F: TP inherits bare land in BC, doesn’t build house on property. Land is divided by a public road, owns a piece of property on either side. TP would go to land on weekends holidays, stayed in a trailer he brought up with him. Ran septic line from other side of road to trailer side. When he sold the land, he claimed the principle residence exemption.

I: 1) Is there a “housing unit”?

2) Was the land ordinarily inhabited?

R: Yes to both, allowed the exemption (but not allowed the exemption for the land across the street)

A: 1) Ct looks at British case (Makins), whereby a trailer with its wheels removed that has electricity, in UK is considered a “house”. CCRA Bulletin says a trailer can be a house.  The land the trailer is sitting on is contiguous enough to trailer to qualify. 2) “Ordinarily Inhabited”- Ct looks to Thomson and definition of “ordinarily resident”, where “in the course of customary life” is contrasted with special acts. Inhabitation need not be 50% of time, CCRA says a seasonal place of residence applies.

(f) Surrounding Land

- includes the land surrounding the house as long as it reasonably adds to the enjoyment of the unit as a residence - If land exceeds half a hectare (which is approximately one acre), then additional land is deemed not to contribute to the primary residence - This is overruled in municipalities that have zoning laws requiring bigger lots

Yates

F: TP owns land which is zoned in a way that he HAS to own minimum 10 acres to be able to own it. Municipality expropriates 9 acres, TP claims exemption on payment for the 9 acres. TP argues that he HAD to have more than ½ hectate to “enjoy” his house b/c not allowed to have a house without 10 acres.

R: Exemption allowed

Formula for Calculating Capital Gain for Principal Residence [s. 40(2)(b)] Capital gain = ordinary capital gain – [ordinary capital gain (x) B]

C

B = 1 + # years after 1971 the property is designated as principal residence and the taxpayer was resident in Canada.

C = # taxation years after 1971 during which the taxpayer owned the property deems a negative value to equal 0 [s. 257] can apportions the gain in situations where the property was used as income earning in some years and principal residence in other years (g) Change of Use Rules S.45(1)(a)

- Deemed disposition at FMV when property is converted from a non-income producing use to an income-producing use, and vice versa - When converted from principal residence to income earning: * no CG b/c the property had been used exclusively as principal residence * No capital loss either b/c there are stop loss rules for personal use property - 3 indirect tax consequences: (1) Property could no longer be designated as a principal residence (2) Capital cost of the property (from which CCA could be claimed) would be adjusted upwards or downwards based on FMV of building (3) FMV of the property (land and building) at the time of the change of use would become the ACB for capital gains purposes in future - Election, S. 45(2) – From non income earning to income earning - Deemed disposition on change from a non-income producing use to an income-producing use can be avoided by making an election - Will be deemed not to have begun to use the property for the purpose of gaining or producing income"; no deemed disposition until taxpayer rescinds election - Property retains existing ACB and prevent taxpayer from claiming CCA in respect of the property - as described in Reg 1102(1)(c) - Subsection (d) of the definition of "principal residence" in s. 54, provides that the designation as a principal residence can continue for only four years; at the end of four years, the designation is no longer available. - However, s. 45(3) – From income earning to non income earning - When property becomes the principal residence of the taxpayer can elect against deemed disposition otherwise caused by change of use - Election enables the taxpayer to postpone the recognition of any capital gain on the property that had accrued up to the time of the change of use - Combined with S.45(2) can rent the house for 4 years and move back in while enjoying continued principal residence status (h) Partial Change of Use, S. 45(1)(c)

- Where a property, including a principal residence, has a partial change of use, s. 45(1)(c) provides for a partial deemed disposition. - No election in the act allowing avoidance of this deemed disposition - If partial change of use is for a home office or to rent part of it out doesn’t trigger this – the income earning capacity is ancillary to the main purpose - If the taxpayer wants to claim CCA or the portion is more than ancillary then a deemed disposition under 45(1)(c) occurs - Taxpayer is deemed to have disposed of the income-producing portion of the property for proceeds equal to the proportion of FMV property which the new income-producing use of the property bears to the total use of the property - Apportionment is made on the basis of the area of the home used for each purpose - Expenses claimed against the income pertaining to the income-producing portion must be "a reasonable portion of the expenses relating to the whole property" - Drawing the line in Particular areas

Real Property

Regal Heights

F: TP Corp buys land. The original purpose of the purchase was to build a shopping center. TP lays the groundwork for getting some stores etc. Turns out that another mall going in nearby who has the flagship store the TP intended to get, so scrap project and sell the land for a profit. I: Profit from Business or CG?

R:

1) Main purpose = shopping center

2) Secondary purpose = sell land for profit

Ct says that there was not a serious enough effort to set up the shopping center business. The secondary intention to sell the land for profit means that it is income from business

(i) Tangible Personal Property

Tangible personal property = Personal property than can be seen, weighed, measured, felt or touched or that is in any way perceptible to the senses

Cdn. Kodak

F: CK sells cameras and video cameras. Originally rented out video cameras and claimed depreciation on them, then start selling the used video cameras. TP says that the profit is a CG, not income from business, MNR says income from business

R: Profit is income from business

A: Embedded is Gloucester Railway, where there were 2 business- one renting and one selling. Ct ruled that both/either income stream was income from business. In this case, characterized as business income b/c selling so many video cameras they are actually in the business of selling video cameras (selling the fruit trees)

(j) Corporate Shares Irrigation Industries

F: TP incorporated to deal in alfalfa- never did. Corp made one time investment- Got a bank loan to buy shares, sold some immediately to pay off loan, sold the rest in a few weeks

I: Is the income from business or CG?

R: Income is from a CG

A: Doesn’t matter if buy with your own money or borrowed money

Don’t have to be guaranteed dividend income to characterize and investment as an investment CCRA: did the person deal with the property in the way a dealer would?

Corp did not act like a trader Nature/Quantity: Corp. Shares typically characterized as CG investment Intention: What if Nature/Quantity and behaviour conflict with TP’s intention? (ie: He only intended a speculative venture)- should intention override “reality”? NO, nature/quantity trump.

(l) Debt Obligation

Wood

F: TP is a lawyer who buys out mortgages and assumes the risk. Bought a mortgage at a discount, then gets paid the interest and complete principal amount back.

I: What is the nature of the difference between the discounted amount paid and the full amount the TP got back?

R: The difference is a CG

A: Amount of income is small compared to the bigger business picture. The patterns of the TP’s behaviour is consistent with personal investment, as opposed to having enough activity to be a business (only bough mortgages 1-2 times a year)

(* Brooks says this is about as close as you can get without being characterized as business income)

Canadian Securities

s.39(4) Let’s you elect whether to have your Cdn. Securities characterized as a CG. If you so elect, it will definitely be CG, but once you make the election, it is for life- so if you have a big loss, can only claim 50% CG loss. s.39(5) Cannot make the election under s.39(4) if a trader/dealer in securities. s.39(6) Definition of “Canadian Security” : A security (other than a prescribed security) that is a share of the capital stock of a corporation resident in Canada, a unit of a mutual fund trust or a bond, debenture, bill, note, mortgage, hypothecary claim or similar obligation issued by a person resident in Canada

Vancouver Art Metalworks

I: To be a “trader/dealer” in securities under s.39(5), do you have to be a licensed dealer or is a broad reading of the term implied?

R: Apply a broad reading, not restricted to licensed dealers. Parliament could have chosen to explicitly state that it meant licensed- did so in other sections but not here. s.39(5) has a list with institutional flavour- too diverse a list to categorize. In deciding if person a “trader”, consider:

(i) Frequency of transactions

(ii) Duration of holdings

(iii) Intention to acquire for re-sell at profit

(iv) Nature/Quantity of securities held

(v) Time spent on activity
 * Remember “an adventure in the nature of trade” can be one-time deal!

Notes:

- CCRA interprets s.39(4) broadly, let’s almost everyone choose the election. Allows for some certainty regardless of the amount of time spent, volume of trades, etc.

Foreign Exchange

Trading in currencies- ie: Buy British pound with Cdn. $ in hopes that the pound goes up and can resell at a profit

TipTop F: TT buys cloth in UK. Set up line of credit in Br. Currency, use line of credit to buy cloth. Run up line of credit until pound favourable, then pay back with Cdn. Currency- essentially end up buying cloth more cheaply. I: Is this “profit”(\ CG) or “savings” and taxable as business income?

à MNR says the financing is so intertwined w/ the business that it is part of the business itself and \ business income- in the alternative, it is an adventure in the nature of trade.

R: Ct distinguishes b/w TT just buying pounds and reselling them- This is an integrated part of the business- there was no intention to invest \ the income is from business Dissent- Nature of foreign exchange investment should trump other factors.

Non-Competition Payments

Fortino R: Non-Competition payments are a windfall gain and not taxed

Manrell Trial Ct: Non-Comp. Payments a CG- then Fortino comes down and they appeal I: Are non-competition payments windfall gains and \ not taxable, or CG? à TP says that s.248 restricts ppty to common law definition of ppty, “a right of any kind”- at common law, right to compete is not ppty. Even if it were a ppty right, to collect payment for non-competition doesn’t mean someone has given up their right, rather they are just not exercising it?

à MNR says for it to be a windfall has to be unrecurring and not for any reason- non-comp payments don’t fit in this

R: Right to compete = Property, \ taxable as a CG. S.248 does NOT restrict definition of ppty to common law definition- “additional” phrase expands it broadly


 * Some statutory interpretation here!

F. Other Sources of Income

(a) S. 56: w/out restricting the generality of s. 3, there shall be included in computing the income of a taxpayer for a taxation (b) Eligibility for one of these deductions vary and deduction is taken through S.3(c) (c) Pensions S.56 - Realization = pension is taxable on receipt - Employer contributions to employee registered pension plans = ot taxable as employment-source income - Pensions benefits from a pension plan = taxable upon w/drawal from the plan and are included in income in the year that the taxpayer receives the payment - Employee must include all pension benefits in income as he receives them - Source of pension is irrelevant * So, in the absence of special provisions in a tax treaty * Pensions received from outside Canada are income (d) Death benefits - payment on account of a death benefit is included in income in the year of receipt - death benefit for an employee’s spouse is tax free to a max. of $10k (e) support payments - payment that is deductable by the payer is required to be included in income by the payee - payment that is taxable to the recipient may be deductable b the payer (f) retiring allowances -is a payment in recognition of long service, compensation for loss of an office or employment, or damages for wrongful dismissal- - not RA: payments pursuant to the terms of an employment K b/c it is remuneration (g) scholarship, bursaries, and fellowships: generally included in income to the extent that the amount received in the year exceeds $3k (h) research grants - a sum of money given to a person to defray expenses in connection w/ a research project - research grants sometimes include remuneration for the researcher - is taxable only if received by an individual ~ that is taxpayer (i) prizes - prices included in income in year received IF the prize is for achievement in a field of endeavour ordinarily carried on by the taxpayer - prices won in game of chances or for athletic achievement are not taxable (j) assistance payments - most social assistance payments are not taxable - they must however, be included in income in determine taxable income - the taxpayer may then claim a deduction for the amount included in income

G. Deductions

Limits on Deductions

(a) Reasonable: s. 67: cannot deduct expenses that are unreasonable from any source (b) Spousal and Child Support [S. 60(b) deduction to payer] and [S. 56(1)(b) inclusion to beneficiary] - provides a calculation through which a taxpayer is to include spousal or and child support payments in income - These rules do not apply to child support payments under agreements made or varied after April 30, 1997 - If child support = no deduction for payer, no inclusion for beneficiary - If spousal support = deductions and inclusions apply - Definitions a. Support amount - in case of breakdown of marriage or common law partnership, a payment must satisfy four requirements b. Payment must be an allowance c. Must be made on a periodic basis (lump-sum payment not deductible) d. Payer and recipient must be living separate and apart from each other e. Must be made under terms of a court order or a written agreement f. Support amount - where there has been no marriage or common-law partnership g. Must satisfy the same first three requirements 1. Must have been made under a court order; a written agreement will not suffice, let alone anything less formal 2. Allowance means the recipient has discretion as to the use of the amount 3. Payments made directly to 3rd parties for benefit of the spouse (or former spouse) or children are excluded from definition of support amount - Ss.56.1(2) & 60.1(2) create exception deeming 3rd party payment to be an "allowance payable on a periodic basis" where recipient has discretion if the order or written agreement provides that these rules should apply

(c) Child Care Expenses, S 63 1. both parents need to have an income to qualify --> if one has no income, the rule effectively prevents the sole breadwinner from claiming child care expenses if only one parent works outside the home 2. normally claimed by the lower-income parent --> higher-claimed parent can in certain circumstances [page 554] 3. childcare expense must be incurred to enable the taxpayer to earn income or go to school 4. child care must be provided in Canada --> exception is living near Canada-US border and the US facility is closer to taxpayers place of residence 5. the services must be provided by a resident of Canada for whom the taxpayer or his or her spouse does not claim a dependency credit; and 6. the person providing the service must not be under 18 if a related person 7. Deduction cannot: a. exceed 2/3 of the "earned income" of the lower income parent (includes income from office or employment, business, grants and training               allowances) b. generally exceed $7,000 per child under the age of seven and $4,000 per child between the ages of seven and sixteen. (d) Moving Expenses, S. 62(3) 1. The move must be within Canada 2. The move must be 40 km or more closer to new job 3. The move must be caused by a change in the location of the taxpayer’s work (or, in the case of a student, a change of university). 4. Deduction can not have been reimbursed by the employer 5. deduction can used against income from employment, business, scholarship or research grants at the new location 6. any excess can be carried forward for one year 7. example of moving expenses covered: a. travel costs, b. transportation c. storage of household effects, d. temporary lodging and meals, e. the costs of selling an old residence f. legal expenses of buying a new residence (e) legal expenses: 1. are deductions regardless of income source 2. s. 60(o): legal fees deductible if in relation to taxes owing to employment insurance or CPP 3. s. 60(o.2): legal expenses associated with getting aforementioned benefits of a dead spouse deductible

(f) Deemed Proceeds: Non Arms Length s.69(1)(a): 1) TP           2) Acquires (gets) something

3) From a non arms length person (related to)

4) For more than FMV (you pay more than FMV)

5) TP deemed to have acquired it at FMV

This reduces the ACB of property you can get from someone related to you to it’s FMV- so that you can’t overpay your relatives for things This can be punitive b/c when TP then sells this property, cannot consider the extra amounts paid, gets taxed on full gain.

Marcantonia

F: TP is optometrist. Opens a store with eye exams (optometrist) and selling glasses frames (optician). For tax planning, sets up separate Corp with W as only SH to run the optician end of the business. When TP invoices customers, puts both prices on the optometrist invoice and deducts cost of glasses from his optometrist business.

I: Does s.69(1)(a) reduce the amount of expenses to FMV?

A:

MNR argues that TP overpaid for glasses b/c of non arms length relationship- should have paid his W’s Corp wholesale price, not retail (basically, TP is paying retail price to W where he should be paying wholesale- unrealistic that optometrist would pay retail price then sell at same retail price- TP is trying to pay W’s Corp as much as possible for income splitting purposes) s.69(1)(b):

TP Disposes (gets rid) of something To non arms length person for nothing or less than FMV or to any person as a gift when alive TP is deemed to have received FMV This makes sure that if you give something to anyone, or sell something for less than FMV to relative, you’re deemed to have received FMV s.69(1)(c):

TP Acquires (gets) property as a gift, bequest or inheritance Is deemed to have received it at FMV When you get a gift, it’s value to you is FMV. Computation of Tax

H. Apply s. 3 to determine net income (a) Once we determine the basic tax by applying a tax rate to taxable income, then apply the various: 1. Credits 2. Surtaxes, and 3. Reductions (b) Individuals:

- Basic Tax Rates – for provincial and federal – page 630

- Surtaxes 1. A surtax is a tax calculated by reference to another tax, usually the basic federal tax 2. federal has abolished the surtax 3. several provinces still charge a surtax - Tax Credits: 1. Reduces the tax that would otherwise be payable by the individual 2. Tax credits depend on: 3. Status 4. Source of income 5. Type of expenditure; and 6. Location of source of income Examples: Personal tax credits Pension income Dividends from taxable Canadian corporations Tuition and education Medical expenses Charitable donations Eligible children Overseas employment, or Foreign taxes --> Personal tax credits TP can claim credits on account of: Single status [s. 118] Every individual is entitled to $8,012 (2004) as their personal claim This amount is multiplied by the appropriate percentage [16% ~ so tax credit is $1,282] -->Spousal and CL partner status An individual who supports spouse can claim an addition amount as a tax credit Additional amount was $6,803 [total $14,815] à 16% à $2,370 --> Equivalent to spouse status 1. Dependents; and 2. A person who is not entitled to the spousal status credit but who supports a person dependent on him can claim the credit for a wholly dependent person 3. The equivalent to spouse credit is available only to an individual who maintains and lives in a self-contained domestic establishment and actually supports therein the dependent person 1. Dependency 2. Relationship b/w the TP and the individual claimed as a dependent 3. Children or grandchildren 4. Nieces or nephews 5. Brothers or sisters 6. Parents, grandparents 7. Aunts or uncles --> Residence (must reside in Canada) Age (can not be older than 18, unless dependent b/c of mental or physical infirmity, parent or grandparent) --> Age Individual who is 65 year of age or older can claim an additional amount, whereby the max. amount is 16% of $3,912
 * Criteria:

--> Pension income: 1. An individual who is 65 years or older 2. May claim a credit in respect of pension income 3. Less of: 16% of pension income or $1k Pension income includes: i.  Life annuity payments out of a supernnuation or pension fund ii. Annuity payments out of registered retirement saving plans iii. Payments out of registered retirement income funds iv. Payments out of deferred profit-sharing plans; and v. Accrued income on an annuity or life insurance policy included in income
 * credits are not refundable

--> Medical Expenses: 1. Are personal and therefore would usually be non-deductible for tax purposes 2. HOWEVER, the Act provides some relieve for extraordinary medical expenses over a minimum threshold limit to reflect the burden of such expenditures on one’s ability to pay 3. Computation of credit: 4. Apply appropriate percentage (16%) to the sum of the TP’s medical expenses in excess of a threshold amount 5. Threshold amount: lesser of $1,813 and 3% of individual’s income for the year 1. TP may deduct medical expenses incurred on behalf of: i. TP         ii. Spouse iii. Children, or a spouse’s children, who depend on TP for support, or        iv. Spouse’s parent, grandparent, brother, sister, uncle, aunt, niece, nephew who resides in Canada and depend on TP for support 2. TP must file receipts with tax return 3. Medical expenses: means expenses paid to a medical practitioner, dentist, nurse, public or licensed private hospital
 * Meaning of medical expense:

--> Corporation: [s. 123]

- Is a separate TP in its own right - Rules are more detailed and complex than the rules for individuals b/c the taxation upon corporations depends on numerous variables: 1. type and size of the corporation 2. ownership structure 3. type and source of income, and 4. amount of income earned in a year - General Tax Rate: a. federal: 38% b. w/c is reduced by a general rate reduction c. general rate reduction does not apply to the income upon w/c a CCPC claims the small business deduction - surtax: a. liable to pay a surtax of 4% of their basic federal tax b. calculate surtax on the basis of the federal corporate tax payable before deductions for the small business deduction and the manufacturing and processing deduction - tax adjustments: a. few – if any – corporations actually pay at the basic rate b. adjustments to the basic corporate tax include the following: c. provincial tax credit d. foreign tax credit e. small business deductions f. manufacturing and processing profit deduction g. logging tax deduction h. investment tax credit; and i. political contributions credit - there are many tax rules that can reach through the corporation to its SHs

i. in limited circumstances one can disregard a corporation’s separate legal existence and lift its veil to reach through the entity to its individual members

ii. one lifts the veil only for the specific purpose of the litigated issue and not for he other purposes – thus merely b/c one lifts a corporation’s veil iii. for tax purposes, does not imply that its SH’s automatically become personally liable for its debts iv. statutory piercing: legislature can also crack open the corporate shell

I. Tax Avoidance

- avoidance of tax is perfectly legitimate and indeed, even moral - one is entitled to arrange one’s affairs so as to attract the minimum amount of tax - tax avoidance falls into 2 categories: 1. tax mitigation, and 2. abusive avoidance - General Anti-Avoidance Rule (GAAR):

- Broadly stated statement of principle of statutory construction that affects both domestic and international tax planning, is at the apex of all anti-avoidance measures

- GAAR places TP at the mercy of administrative discretion

- Tax mitigation that is not Ss to GAAR is lawful avoidance

- Distinction as to what is ‘lawful’ and ‘unlawful’ depends upon: a. the purpose of the transaction, b. the rational of the particular provisions and c. the Act read as a whole - tax evasion is the commission of an act knowingly w/ the intent to deceive so that the tax reported by the TP is less than the tax payer under the law this may occur through a deliberate omission of revenue, the fraudulent claiming of expenses or allowances, or the deliberate misrepresentation, a. concealment or w/holding of material facts b. this is a mens rea criminal offence c. motive is therefore important – it determines whether a transaction constitutes an avoidance transaction under GAAR - judicial doctrines:

(1) Sham doctrine:

sham: is a fiction ~ an apparition of rights and obligations that do not really exists definition implies that parties to the transaction have deliberately set out to misrepresent the actual state of affairs may exist despite documentary appearance

CRA sometime uses the term ‘sham’ to attack transactions based on the general aroma (smell test) of a scheme that cannot otherwise be struck down on other grounds

Stubart: sham transaction conducted w/ the element of deceit so as to create an illusion calculated to lead the tax collector away from the TP or the true nature of the transaction, or simply deception whereby the TP creates a façade of reality quite different from the disguised reality (2) Ineffectual transaction doctrine:

TP is entitled to arrange his affairs to minimize tax

However, to be effective the plan must be completely and fully implemented according to the relevant law (3) Substance and form doctrine; and

substance: of transaction

form: of transaction

GR: substance prevails over form, except in those circumstances that form prevails over substance

Difficulty with this doctrine is that, despite its intuitive appeal, it does not offer any objective criteria or parameters by w/c particular facts may be measured against (4) Business purpose doctrine

has been struck down – does not require that tax transactions and arrangements have a business or economic purpose reason: by reading a business purpose test into Canadian tax law might deter taxpayers from participating in the very activities that the Act sought to promote

-->s. 245 – GAAR

enacted to restrict tax planning and curtail the Westminister principle by requiring a business type of purpose in certain circumstances GAAR attempts to draw a line b/w legitimate tax minimization and abusive tax avoidance – but not a bright line, so the debate still continues Act defines abusive tax avoidance as any transaction, or series of transactions that gives rise to a tax benefit Business purpose – transaction does not need to satisfy a business purpose test – an arrangement w/out a business purpose is a valid transaction for tax purposes if it is undertaken primarily for bona fide purposes other than obtaining a tax benefit or savings A tax benefit is any reduction, avoidance or deferral of tax or other amount payable under the Act, regulations, ITARs and tax treaties or an increase in a refund of tax or other amount under the Act A transaction is not an avoidance transaction if the TP undertakes it primarily for bona fide purposes other than obtaining the tax benefit SO to avoid GAAR TP should have substantial commercial, family or philanthropic reasons to support the transaction and tax savings should be ancillary in the overall plan Step 1: whether a transaction or arrangement constitutes lawful tax mitigation or tax avoidance – need to ascertain the purpose of the statutory provisions used to implement the tax plan.

Step 2: a factual finding whether the TP engaged in a transaction (usually objective) or series of transactions (less obvious)

Step 3: a factual finding that the TP derived a ‘tax benefit’ from the transaction or series of transactions through reduction, avoidance, or deferral of tax.

Step 4: a factual finding whether the TP arranged the transaction or series of transactions that gave rise to the benefit primarily for tax or non-tax purposes.

Step 5: if the TP derived a tax benefit from a transaction arranged primarily for tax purposes, an analysis whether the transaction (or series of transactions) misused an provisions of the act.

Step 6: GAAR applies if the transaction (or series of transactions) misuses a provision of the Act or abuses the provisions read as a whole.

Step 7: The burden of establishing misuse or abuse of statutory transactions is on the Minister. The benefit of any doubt goes to the TP.

BOP: Determining whether a transaction involves a tax benefit or is an avoidance transaction – question of fact = TP carries this burden to refute the Minister’s factual assumption

Determining whether ‘abuse’ and ‘misuse’ of the act – question of law and policy = Minister carries the burden of proof on these issues