Year: 2024

Consequences of Emigration of a Canadian Taxpayer

Posted on by dflanagan

In a more globalized world, and especially after the COVID-19 pandemic brought about a seismic shift in our workplaces and the adoption of remote work, emigration has become a more popular option for many taxpayers in the past few years. Emigration also represents the “final departure from Canada” of a taxpayer, and potentially the final opportunity for the Canada Revenue Agency (CRA) to tax a taxpayer, which can therefore mean large tax liabilities. The purpose of this article is to explore some of the more common consequences of emigration of a Canadian taxpayer.

Determination of Residency

Any discussion of emigration pivots around the concept of residency in Canada. In Canada, the Income Tax Act (ITA) taxes Canadian residents on their worldwide income, and non-residents on their Canadian-sourced income.

Per CRA policies and technical bulletins, the most important determinants of residency are significant residential ties, or what are colloquially referred to as the “house and spouse” ties. These ties include whether you keep a dwelling place in Canada available for occupation by you, and whether your spouse or common-law partner, or other dependents, continue to be in Canada (or in a separate country).

After the significant residential ties are assessed, secondary residential ties are then assessed – these include personal property such as cars, furniture, and clothing, any economic ties (like a job or investment accounts), or insurance coverage in Canada.

It should be noted from the above that citizenship does not equal residency – a taxpayer can be a citizen of Canada but not a resident of Canada for tax purposes.

If a taxpayer leaves Canada, and they are determined to have “severed ties” with Canada, they are determined to have ceased residency on that date, i.e. emigrated from Canada.

Consequences of Ceasing Residency

If a taxpayer ceases residency in the year, they will be deemed to have disposed of certain types of capital property, the gain on which will trigger “departure tax”. Under the ITA, any securities, cryptocurrencies, or other investments held will be deemed to be disposed of at their fair market value, , potentially creating a large tax liability.. Notably, Canadian real estate is excluded from this rule.

If the taxpayer holds an RRSP, TFSA, or RRIF, these accounts will be excluded from the deemed disposition. Any withdrawals are likely to be taxed as passive income and subject to the withholding tax requirements discussed below. However, it is important to note that the other country in which the taxpayer is now resident may not recognize the RRSP or TFSA as a tax deferring vehicle, and thus tax any income earned in the plan.

Non-residents earning income in Canada

Employment or self-employment income earned in Canada as a non-resident will be subject to Part 1 tax in Canada, and a regular T1 income tax return is required to be filed.

If passive income, such as dividends, interest, or royalties, is received by a non-resident, such income will be subject to a 25% withholding tax that will be withheld and remitted to the CRA at source.  The withholding rate could be lower than 25% for residents from certain countries having tax treaties with Canada.

RRSP, RRIF, OAS, and other pension payments are also subject to a 25% withholding tax. However, an election is available to a non-resident to file a tax return with the CRA and report the income as if they were a Canadian resident, claiming certain tax credits, and enjoying lower tax brackets.

Income from a rental property is usually subject to the 25% withholding tax as well. However, an election is available for a non-resident to file a tax return with the CRA and report the income as if they were a Canadian resident, claiming rental expenses and certain tax credits, and enjoying lower tax brackets.

Note that the election to file a return does not eliminate the requirement of withholding tax at source.

If a non-resident owns a piece of Canadian real estate, or other “taxable Canadian property”, prior to or upon disposition, 25% of the net gain must be remitted to the government and a Request for a Clearance Certificate, T2062, must be filed with the CRA. Tax returns are available to be filed to receive a partial refund of this.  Of note, the government has introduced legislation to increase this withholding tax to 35% effective January 1, 2025.

Other tax considerations

There are certain provisions of the ITA that only apply to Canadian residents.  Three notable instances of this are:

  1. Capital Gains Exemption with regards to a share sale, which requires that the shares in question be held by a Canadian resident throughout the year.
  2. The definition of a Canadian-Controlled Private Corporation states that a corporation must not be controlled by a non-resident.
  3. The emigration of a trustee/beneficiary and their subsequent non-resident status has an impact on the taxation of a Trust.

Absent proper planning, running afoul of these rules can yield a significant unplanned tax liability.

Finally, as a non-resident, a taxpayer may still have social, employment, or tourism-related desires to return to Canada. Under the ITA, a non-resident who is temporarily staying (“sojourning”) in Canada for 183 days or more in a calendar year will be considered a deemed resident of Canada for the entire year. As discussed above, a resident of Canada will be taxed on their worldwide income, which can yield a significant tax liability.

Conclusion

Determining residency can be a complex endeavour, and dealing with the consequences of a change in residency can be overwhelming. Our experienced advisors at DJB are well versed in international and domestic tax and can gladly assist you with the development of an exit plan, advise on the consequences of moving, or can help advise you on any other issues that can arise with regards to emigration.

Motor Vehicle Allowances: Carpooling

Posted on by dflanagan

Reasonable motor vehicle allowances received by employees in the course of employment duties are non-taxable. An allowance is not reasonable (and therefore taxable) if any of the following are met:

  • the allowance is not based solely on the number of kilometres driven for employment purposes;
  • the employee is reimbursed in whole or part for expenses in respect of that use; or
  • the per-km amount is not reasonable.

A November 23, 2023, French Technical Interpretation considered the tax implications of an employer increasing the motor vehicle allowance paid to its employees by an additional per kilometre amount for each person accompanying the driver. CRA opined that the two parts of the allowance (base and additional amount per passenger) constituted a single allowance since both were intended for the same use of the vehicle. They then opined that as the allowance provided was not solely based on the number of kilometres travelled to perform the duties of employment, the entire allowance was taxable.

Ensure that allowances paid to employees meet the strict conditions for being tax-free to avoid a surprise tax bill for the recipient.

New Legislation Released Increasing the Capital Gains Inclusion Rate in Canada

Posted on by RSM US LLP

Executive summary

On June 10, 2024, the Ministry of Finance announced amendments to the Income Tax Act to increase the capital gains inclusion rate effective June 25, 2024. Corporations and trusts will see an increase from 1/2 to 2/3, while individuals realizing capital gains of more than $250,000 will also be subject to the increased rate. The upcoming legislation will maintain the principal residence exemption, prohibit tax elections or on-paper realizations, and ensure that capital gains cannot be averaged over multiple years, among other measures.

Background

On June 10, 2024, the Ministry of Finance released a Notice of Ways and Means Motion (NWMM) to amend the Income Tax Act and Income Tax Regulations to implement the Budget 2024 initiative to increase the capital gains inclusion rate. Starting June 25, 2024, the capital gains inclusion rate was originally proposed to be adjusted as follows:

  • For corporations and trusts: The capital gains inclusion rate will be increased from 1/2 to 2/3.
  • For individuals: For capital gains that exceed an annual threshold of $250,000, the capital gains inclusion rate will be increased from 1/2 to 2/3.

The NWMM provides an overview of various measures introduced by the government to implement the higher capital inclusion rate proposed in the Budget 2024. This article will focus on measures impacting middle market taxpayers.

Little relief offered despite requests from numerous interested parties

In a related press release by the Department of Finance, certain suggestions put forth by interested regulatory parties were quelled, offering the following summary of the changes:

  • No changes to the principal residence exemption.
  • No ability to elect to internally trigger capital gains in anticipation of the June 25 deadline.
  • No ability to average capital gains over multiple years to stay under the $250,000 threshold.
  • No ability to split the $250,000 threshold with corporations.
  • No exceptions for specific assets or types of corporations.
  • No distinction based on how long an asset is held or otherwise.

On top of the summary above, the Department of Finance also released a more comprehensive summary of the changes.

New draft legislation
Transitionary rules for the new capital gains inclusion rate

The draft legislation acknowledged that the inclusion rate increase date of June 25, 2024, being in the middle of many ordinary taxation years, offers complications. As a result, the draft legislation introduces transitionary measures to identify how the inclusion rate will be applied based on a taxpayer’s individual circumstances. Firstly, the draft legislation separates out a taxation year between two relevant periods:

  • The beginning of the taxation year until the end of the day June 24, 2024 (“Period 1”); and,
  • The beginning of the day June 25, 2024 until the end of a taxpayer’s taxation year (“Period 2”)

Taxpayers would then need to net capital gains against capital losses for each period to determine whether that particular period yielded either a cumulative net capital gain or net capital loss. Then, the following capital gains inclusion rates would apply:

  • If a taxpayer only has net capital gains or net capital losses in Period 1 and Period 2, a 1/2 inclusion rate would apply for gains/losses incurred in Period 1 and a 2/3 inclusion rate would apply for gains/losses incurred in Period 2.
  • If a taxpayer has no net capital gains or net capital losses in either period, a 2/3 inclusion rate would apply for all gains/losses.
  • If a taxpayer has net capital gains in Period 1 that exceed net capital losses in Period 2, a 1/2 inclusion rate would apply for all gains/losses.
  • If a taxpayer has net capital losses in Period 1 that exceed net capital gains in Period 2, a 1/2 inclusion rate would apply for all gains/losses.
  • If a taxpayer has net capital gains in Period 1 that are less than net capital losses in Period 2, a 2/3 inclusion rate would apply to all gains/losses, to the extent not sheltered by the $250,000 threshold.
  • If a taxpayer has net capital losses in Period 1 that are less than net capital gains in Period 2, a 2/3 inclusion rate would apply for all gain/losses.

Interested parties should consider reading the draft legislation for specific timing considerations that may apply to their situation when trying to determine whether certain gains/losses arise during Period 1 or Period 2.

New $250,000 threshold for individuals

Individuals (excluding most trusts) will be able to shelter the first $250,000 of their capital gains to remain taxable at 1/2 even after June 24, 2024. This threshold would apply to all capital gains incurred on or after June 25, 2024 and will be net of any capital losses for the year, the lifetime capital gains exemption, the employee ownership trust tax exemption, and the proposed Canadian entrepreneurs’ incentive. This threshold will be algebraically determined by multiplying the threshold by 1/6 and allowed as a deduction from taxable capital gains, allowing for an effective 1/2 inclusion rate. Note that this threshold will not be prorated for 2024.

Capital gains reserves

Under certain circumstances, taxpayers are able to defer the recognition of capital gains in situations where the proceeds of the sale of capital property are received over a number of years. In these circumstances, a capital gain is realized in income with a reserve being taken based on the amount of proceeds that have not yet been received, with a minimum of 10% or 20% of the gain to be brought into income each year (depending on the type of asset sale and subject to the new draft intergenerational transfer rules). The reserve enters into taxable income in the following year.

For purposes of the capital gains inclusion rate change, reserves will be considered to enter into income on the first day of the taxation year. This means that taxation years that begin before June 25, 2024 will have that capital gain subject to a 1/2 inclusion rate. As the reserve enters into income in subsequent years, the prevailing capital gains inclusion rate for that year would apply (i.e., possibly 2/3). In other words, the capital gains inclusion rate on the actual date of sale does not get maintained as the reserve is utilized.

Net capital loss carryforwards

Net capital losses can be carried back three years and forward indefinitely to offset capital gains in other years, with adjustments made to reflect the applicable inclusion rate. For example, net capital losses incurred when the inclusion rate was 1/2 and utilized when the capital gains inclusion rate is 2/3 will be multiplied upwards to 4/3, in order to allow the relevant capital loss to offset an equivalent capital gain regardless of inclusion rates.

Employee stock option deduction

Under the current rules, when an employee exercises a stock option, the difference between the fair market value of the stock and its exercise price results in a taxable benefit (the “stock option benefit”) and is included in the employee’s income. Where the employer is a Canadian-controlled private corporation (CCPC), the stock option benefit arises at the time the shares are ultimately disposed of or exchanged by the employee. Generally, the taxation of employee stock options in Canada mirrors the taxation of capital gains and hence, the employees can claim a stock option deduction at the rate of 1/2 of the stock option benefit.

Consequent to the proposed amendment to the inclusion rate, the stock option deduction would be 1/3 of the stock option benefit for stock options exercised (or disposed of or exchanged in case of a CCPC) on or after June 25, 2024. The annual $250,000 limit described above would apply to the total amount of stock option benefit and capital gains for a particular taxation year. In a situation where the total stock option benefit and capital gains exceed $250,000, the taxpayer would have the discretion to choose the preferential tax treatment (lower inclusion rate) for allocating the amounts.

Allowable business investment losses

A business investment loss arises when bad debt arises on the amount owed by a small business corporation (SBC) or the shares of a bankrupt SBC are disposed of. 1/2 of the capital losses, referred to as allowable business investment losses (ABIL), can be used to offset other income like income from business, property, and employment. Any unused ABIL can be used to offset income from any source and can be carried back three years and carried forward 10 years. Any amount of ABIL remaining after 10 years gets converted to an ordinary capital loss that can be carried forward indefinitely and used to offset only capital gains.

With the increase in the capital gains inclusion rate, 2/3 of business investment losses realized on or after June 25, 2024, would be deductible. Furthermore, unlike other capital losses carried over, ABILs would not be adjusted in value to reflect the new inclusion rate that applies in the year the loss is claimed. In other words, ABILs realized on or after June 25, 2024 would be determined based on the 2/3 inclusion rate even if carried back and applied in any of the three previous years.

Partnership allocations and trust designations

Generally, partnerships calculate net income as if they are a taxable entity for Canadian tax purposes. The income is then allocated to the partners based on the partnership agreement. Capital gains earned in a partnership are typically transferred out as taxable capital gains for the year. For partnerships that have capital gains in a fiscal period that straddle June 25, 2024, those taxable capital gains, allowable capital losses, or ABILs will instead be grossed up back to the original amount and deemed to be realized by the relevant partner. Partnerships would be required to disclose to partners which gains arose during which period, to potentially allow access to the $250,000 threshold.

Trusts are taxable entities for Canadian tax purposes and compute taxable income accordingly. Trusts can allocate its income to beneficiaries at the end of the trust’s taxation year, and also preserve the character of the income for beneficiaries, to allow them to take advantage of various tax preferred treatments. For trust taxation years that straddle June 25, 2024, trusts would similarly gross-up their net capital gains back to their original amount and have them deemed to be recognized by the relevant beneficiary. Trusts would be required to disclose to those beneficiaries which gains arose during which period, with certain simplifying calculations for commercial trusts.

International tax adjustments

Certain international tax measures will be adjusted to be brought in line with the change in capital gains inclusion rate, including:

  • Computing the foreign accrual property income of a foreign affiliate and deductions for dividends received from a foreign affiliate’s hybrid surplus.
  • The withholding tax rate for non-residents disposing of taxable Canadian property will increase from 25% to 35%, effective for dispositions occurring on or after Jan. 1, 2025.
Only two weeks left for implementation

Overall, the changes to the capital gains inclusion rate and related measures remain largely unchanged from when they were originally announced in Budget 2024. Despite updated draft legislation being expected at the end of July, it is not expected to affect the new measures significantly. Taxpayers are only left with two weeks to finalize any tax planning they would like to implement prior to June 25, 2024, after which they should expect a significantly different tax landscape for capital gains in Canada.

This article was written by Daniel Mahne, Chetna Thapar, Patricia Contreras and originally appeared on 2024-06-10. Reprinted with permission from RSM Canada LLP.
© 2024 RSM Canada LLP. All rights reserved. https://rsmcanada.com/insights/tax-alerts/2024/new-legislation-increasing-capital-gains-inclusion-rate-canada.html

RSM Canada LLP is a limited liability partnership that provides public accounting services and is the Canadian member firm of RSM International, a global network of independent assurance, tax and consulting firms. RSM Canada Consulting LP is a limited partnership that provides consulting services and is an affiliate of RSM US LLP, a member firm of RSM International. The member firms of RSM International collaborate to provide services to global clients but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmcanada.com/about for more information regarding RSM Canada and RSM International.

The information contained herein is general in nature and based on authorities that are subject to change. RSM Canada LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM Canada LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

Short-Term Rentals: Denial of Expenses

Posted on by dflanagan

In late 2023, the Federal government announced its intention to deny income tax deductions for expenses by non-compliant operators of short-term rental properties (such as Airbnb or VRBO properties rented for periods of less than 90 days). These rules would apply to individuals, corporations, and trusts with non-compliant short-term rentals. These rules are proposed to come into effect on January 1, 2024.

A short-term rental would be noncompliant if, at any time, either:

  • the province or municipality does not permit the short-term rental operation at the location of the residential property; or
  • the short-term rental operation is not compliant with all applicable registration, licensing, and permit requirements.

Many municipalities require a business license or permit for short-term rental operations. Where short-term rental activities are carried on without such a permit, the operator would be subject to these proposals and taxable on gross rental revenues with no deductions in 2024 and later years.

Residential property would include a house, apartment, condominium unit, cottage, mobile home, trailer, houseboat, and any other property legally permitted to be used for residential purposes.

No expenses incurred with respect to the non-compliant short-term rental would be deductible. For example, consider a short-term rental that incurred $100,000 in expenses to generate $20,000 in profit. If non-compliant, all expenses would be denied, resulting in a profit for tax purposes of $120,000. Assuming the individual owner was in the top tax bracket (53.53% in Ontario), they would pay tax of $64,236. As the actual profit was only $20,000, the effective tax rate would be 321% ($64,236/$20,000). In absolute dollars, the individual would have to pay $53,530 in additional taxes due to the denied expenses.

Where the short-term rental was non-compliant for part of the year and compliant for another part of the year, the total expenses incurred for all short-term rental activity would be pro-rated over the period of that activity to determine the nondeductible portion.
For example, assume that a property was used for long-term rental from January 1 to June 30, then converted to short-term rental on July 1. However, the owner did not obtain a business permit as required until September 1 (62 days non-compliant). Expenses for July 1 to December 31 (the short-term rental period, 184 days) would be 62/184 non-deductible. Expenses related to the long-term rental period would not be part of the calculation of non-deductible expenses.

Transitional rule

For the 2024 taxation year, if the taxpayer is compliant with all applicable registration, licensing, and permit requirements on December 31, 2024, they would be deemed compliant for the entire 2024 year and, as such, would be able to deduct all relevant expenses for 2024.

Ensure you comply with all municipal and provincial rules by December 31, 2024, to retain all deductions applicable to your short-term rental for the year.

GST/HST Returns: Mandatory Electronic Filing

Posted on by dflanagan

For reporting periods that begin in 2024 and onwards, GST/HST registrants (except charities and selected financial institutions) must file all GST/HST returns with CRA electronically. Registrants who file their GST/HST returns on paper are subject to a penalty of $100 for the first offense and $250 for each subsequent return not filed electronically. While CRA waived these penalties for monthly and quarterly filers who failed to file returns electronically for periods beginning before March 31, 2024, the relief will end shortly.

Ensure that GST/HST returns are properly filed electronically to avoid these penalties.

Do We Need an Audit? An Overview of Not-for-Profit Organizations and Their Financial Statement Requirements

Posted on by Edixon

There have been a number of changes in recent years to modernize the laws governing corporations without share capital. These corporations were previously governed by the Corporations Acts in the various jurisdictions, but the laws and regulations created for business and for-profit enterprises were not effective at times for the not-for-profit sector. In 2011, the new Canada Not-for-Profit Corporations Act (CNCA) came into force to govern the not-for-profit corporations incorporated federally. Ontario created a similar Act, the Ontario Not-for-Profit Corporations Act (ONCA) that received Royal Assent in 2010 and was finally brought into force on October 19, 2021. There is a three-year transition period during which all existing not-for-profit corporations registered in Ontario have to make any necessary changes to their incorporation and other documents to bring them into conformity with ONCA.

There are a number of various legal changes addressed in the new legislation, but we wanted to focus on the section on Financial Statements and Review. A corporation must prepare financial statements each year which comply with the requirements of the Not-for-Profit Act. The financial statements must be prepared in accordance with the Canadian Generally Accepted Accounting Principles (GAAP) as set out in the CPA Canada Handbook.

There are new guidelines introduced in both the CNCA and the ONCA on the level of public accounting assurance required. We have summarized these below in a chart and included some important definitions.

The ONCA classifies not-for-profit corporations into two categories – public benefit corporations and non-public benefit corporations. A corporation is considered to be a public benefit corporation when it is a charitable corporation or when it has received more than $10,000 in revenue from public sources in a single financial year. Public sources include gifts or donations from people who are not members, directors, officers or employees, grants from all levels of government and funds from another corporation that has also received income from public sources. A non-public benefit corporation is a corporation that has received no public funds or less than $10,000 in public funds in each of its previous three fiscal years. The CNCA has the same requirements and classifies these as soliciting and non-soliciting corporations.

The differentiation is important as the government wants to ensure that organizations receiving public funds are sufficiently transparent and accountable for that income.

Private foundations may be considered a non-public benefit corporation, depending on their revenue sources.

As a reminder, all corporations governed by the ONCA and CNCA must send a summary of their annual financial statements or a copy of a document reproducing the required financial information (such as an annual report) to the members not less than 21 days or a prescribed number of days, before the day on which the annual meeting of members is held, or the day on which a resolution in writing is signed by the members to all members who request a copy.

A soliciting corporation incorporated federally must provide its annual financial statements to Corporations Canada not less than 21 days before the annual general meeting of members or without delay in the event that the corporation’s members have signed a resolution approving the statements, instead of holding a meeting. The date must also not be later than six months after the corporation’s preceding financial year.

Incorporated Federally
Type of Corporation Gross Annual Revenue per Financial Year Appointment of Public Accountant by Members Financial Review Required
Soliciting $50,000 and less Must appoint a public accountant by ordinary resolution unless members waive appointment by annual unanimous resolution Public accountant must conduct a review engagement; but members can pass an ordinary resolution to require an audit instead. If no public Accountant is appointed, then only a compilation is necessary.
Soliciting $50,001 to $250,000 Must appoint a public accountant by ordinary resolution at each annual meeting Public accountant must conduct an audit; but members can pass a special resolution to require a review engagement instead.
Soliciting more than $250,000 Must appoint a public accountant by ordinary resolution at each annual meeting Public accountant must conduct an audit.
Non-Soliciting $1,000,000 and less Must appoint a public accountant by ordinary resolution unless members waive appointment by annual unanimous resolution Public accountant must conduct a review engagement; but members can pass an ordinary resolution to require an audit instead. If no public Accountant is appointed, then only a compilation is necessary.
Non-Soliciting more than $1,000,000 Must appoint a public accountant by ordinary resolution at each annual meeting Public accountant must conduct an audit.

These rules were effective as of October 2011 when the CNCA came into force.

Incorporated in Ontario
Type of Corporation Gross Annual Revenue per Financial Year Appointment of Public Accountant by Members Financial Review Required
Public benefit corporation $100,000 and less Must appoint a public accountant by ordinary resolution unless members waive appointment by an extraordinary resolution (at least 80% approval) Public accountant must conduct a review or audit engagement. If no public accountant is appointed, then only a compilation is necessary.
Public benefit corporation $100,001 to $500,000 Must appoint a public accountant by ordinary resolution at each annual meeting Public accountant must conduct an audit; but members can pass an extraordinary resolution to require a review engagement instead.
Public benefit corporation more than $500,000 Must appoint a public accountant by ordinary resolution at each annual meeting Public accountant must conduct an audit.
Non-Public Benefit $500,000 and less Must appoint a public accountant by ordinary resolution unless members waive appointment by annual unanimous resolution Public accountant must conduct an audit or review engagement. If no public accountant is appointed, then only a compilation is necessary.
Non-Public Benefit more than $500,000 Must appoint a public accountant by ordinary resolution at each annual meeting Public accountant must conduct an audit; but members can pass an extraordinary resolution to require a review engagement instead.

These rules were effective as of October 19, 2021, when the ONCA came into force.

These rules allow members in Ontario corporations with $100,000 and less in annual revenue to pass an extraordinary resolution (80% approval) to waive both the audit and review engagement requirements.

Before a Board of Directors decides to take advantage of these new rules allowing the organization to be exempt from an audit (presumably to reduce annual professional fees), it is important to remember that an independent, external review of management’s financial reporting is an effective tool to fulfill a Board member’s governance responsibilities. We would also caution against moving away from an audit if you anticipate your organization’s revenues to exceed the minimum thresholds that require an audit in the near future. The costs of transitioning to and from an audit in a short period of time generally exceed the cost savings from moving away from an audit.

If you require any further information or explanation with regard to recent changes for your organization’s external financial reporting requirements, please contact your DJB advisor.

What do the proposed Alternative Minimum Tax changes mean for charitable giving?

Posted on by RSM US LLP

Executive summary

Individuals and trusts who benefit from tax deductions, credits and exemptions may find themselves paying a higher rate of tax under the Alternative Minimum Tax (AMT) regime. The 2023 and 2024 Federal Budgets proposed changes to the calculation of AMT by limiting the inclusion rates of some significant deductions and credits, including charitable donations.

What is AMT?

For each taxation year, individual taxpayers and certain trusts calculate their taxes payable under two methods: regular income tax and AMT. The method which yields the higher taxes payable determines the amount the taxpayer owes for the year. Compared to the regular income tax method, the AMT limits the ability to offset income earned with certain eligible deductions and credits. Typically, AMT applies in situations where high-income taxpayers substantially lowered their taxes payable due to deductions and credits.

If a taxpayer is subject to AMT in a given year, the difference between the amount calculated under the AMT method and the amount calculated under the regular tax method can be carried forward for seven years. The carry forward is treated as a credit against taxes payable calculated under the regular tax method.

Charitable Donations under the Current AMT regime

Under the regular tax system, taxpayers that make donations of publicly listed securities receive a tax receipt for the fair market value of the securities donated and an exemption on any applicable taxes on the accrued capital gain of those donated securities.

Similarly, under the current AMT regime, charitable giving does not have an impact on the AMT calculation as:

  • the full amount of all donation tax credits can be fully applied against any AMT owing and;
  • the full capital gains from donating public securities are excluded in calculating AMT owing

For high income taxpayers, the current method allows them to shelter potentially large accrued gains on the donation of publicly traded securities, as opposed to donating an equivalent cash amount.

Charitable Donations under the Proposed AMT regime
The following changes will be effective Jan. 1, 2024.

The federal government has proposed to increase the AMT flat rate from 15% to 20.5% when calculating adjusted taxable income. Moreover, it is proposed to concurrently raise the AMT exemption threshold, being the amount of adjusted taxable income to which AMT does not apply, from $40,000 to $173,000. This should result in fewer Canadians being subject to AMT.

Alongside the increased rate and exemption base, the treatment of charitable donations is proposed to be changed so that:

  • an increase in the inclusion of capital gains realized on the donation of qualifying securities from 0% to 30%, and,
  • A decrease in the recognition of the donation tax credit from 100% to 80%

For large donations of publicly traded securities, taxpayers may now find themselves with an AMT payable, when previously any accrued gains would have been exempt.

Impact on Taxpayers

The proposed changes to charitable donations will likely have a significant impact on how taxpayers subject to the new AMT make donations going forward.

Consider a taxpayer (below) that wants to make a significant donation of publicly traded securities with a large accrued capital gain. Under the proposed changes, the capital gain inclusion rate for the donated property is 30% alongside limiting the donation tax credit to 80%. This increases the taxpayer’s tax liability that they will have to personally fund even when no consideration has been received for the donated property and may result in taxpayers being less inclined to donate as a result.

 

Current AMT

Proposed AMT

Earned Income

1,000,000

1,000,000 (A)

Capital Gain on donated public securities

500,000

500,000

Taxable Capital Gain on donated public securities

–

150,000 (B)

Adjusted Taxable Income

1,000,000

1,150,000 (A+B)

Basic AMT exemption

(40,000)

(173,000)

Taxable Income

960,000

977,000

AMT rate

15%

20.5%

 

144,000

200,285

Donation Tax Credit

(165,000)

(132,000)

 

(21,000)

68,285
Planning Strategies

Taxpayers that consider donating significant cash or property on an annual basis need to start planning ahead to determine if these donations will result in any AMT being payable.

Perform charitable giving through a corporation

Taxpayers may consider donating publicly traded shares with accrued capital gains through a corporation, as AMT is not applicable at the corporate level. This may be advantageous as the tax-free amount of the capital gain of the donation of public securities will be added to the corporation’s Capital Dividend Account (CDA) and can be distributed to shareholders on a tax-free basis.

Spreading out the donations

Taxpayers may consider donating smaller amounts over the span of several years as opposed to one large lump-sum. This could help limit the amount calculated under the AMT method in a given year.

Managing taxable income

If taxpayers have the flexibility to do so, they may consider managing their income in future years to ensure they can get a credit from any tax paid under AMT that can be applied against regular income tax for up to seven years.

Charitable giving at death

AMT does not apply in the year of death. Taxpayers may consider charitable giving through their will at death to avoid AMT but still create the positive impact of giving.

This article was written by Farryn Cohn and originally appeared on 2024-05-29 RSM Canada, and is available online at https://rsmcanada.com/insights/tax-alerts/2024/proposed-alternative-minimum-tax-changes.html.

The information contained herein is general in nature and based on authorities that are subject to change. RSM Canada guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM Canada assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

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The 7 Most Common HST Audit Issues

Posted on by Edixon

GST/HST (aka Commodity Tax) can be complex and confusing if not dealt with by a knowledgeable professional. Oversights may trigger an audit and unnecessary penalties/interest assessed by the CRA. 

We’ve compiled a list of the most common audit issues that we’ve seen below:

  1. Claiming Input Tax Credits (ITCs) without proper documentation (see criteria table for specifics)
    • Ensure that the vendor’s GST/HST number is always on the invoice, if not, ask for another to be prepared.
    • Do not use credit card statements as your support. It is not considered acceptable proof for the CRA.
    • Also, the CRA does not allow amendments where the sole purpose is to claim additional ITCs – any additions must be claimed on a future return.
  2. Invoices made out to the wrong company
    • Holding company invoices cannot be claimed by the operating company.
  3. Intercompany transactions – Section 156 elections and form RC4616
    • Section 156 elections cannot be filed solely based on a controlling interest.
    • Most situations require 90% ownership (parent/sub).
  4. Claiming ITCs when a portion of the related revenue is exempt
    • Exempt income does not require GST/HST to be charged however no corresponding ITCs can be claimed on related expenses.
  5. Self-assessment errors on acquisition of real estate (two scenarios to be mindful of)
    a. If the real estate acquisition is primarily used for taxable activities (e.g. commercial) – full ITCs can be claimed and the amount of HST owing would be nil. If a self-assessment is not completed, the CRA can reassess and add the HST due on the HST return. Thus, not having the ability to amend a return to add additional ITCs can result in significant cash flow issues and interest assessed by the CRA.
    b. If the real estate acquisition is used for exempt activities (e.g. long-term residential) then no ITCs can be claimed and HST would be owed. In this scenario, if a self-assessment is not completed, the CRA can also reassess and include interest (same as scenario a).
  6. Claiming 100% ITCs on meals/entertainment and passenger vehicles
    • Meals/entertainment claims are only eligible at 50% of the ITCs.
    • Passenger vehicle ITCs are capped at the GST/HST on $37,000 capital cost.
  7. Failure to charge/collect GST/HST on the sale of assets
    • Commodity tax registrants are required to charge GST/HST when selling an asset used for commercial purposes.

If your business is faced with a Commodity Tax audit, we can help.  Please contact one of our taxation specialists.

 

Normalizing Earnings or Cash Flow

Posted on by dflanagan

Businesses with active operations are commonly valued based on their ability to generate earnings or cash flow. For mature businesses that demonstrate consistent earnings or cash flow, a Chartered Business Valuator (CBV) or other valuation practitioner may employ a capitalized earnings or cash flow methodology to assess the value of the business operations if future results are expected to be stable. Under this type of methodology, historical business results are analyzed to estimate a sustainable level of earnings or cash flow. A capitalization rate or multiple is then applied to determine the hypothetical amount an investor would pay for the business operations.

In order to determine the sustainable level of earnings or cash flow a business can generate, historical results are reviewed. Adjustments are made to the reported results to arrive at “normalized” earnings or cash flow, which are then considered when selecting the sustainable level or range. Below are some examples of common normalizing adjustments made to determine a business’s normalized earnings or cash flow:

Related Party Transactions

Businesses often have transactions with related individuals (such as shareholders or their family members) and companies controlled by these individuals. These transactions may involve discretionary payments or do not always reflect the economic value transferred. When normalizing earnings or cash flow, these transactions are typically adjusted to market rates that would be paid or received from an arm’s-length (unrelated) party. Examples include compensation paid to owners or their family members working in the business, rent for real estate or equipment owned by a related individual or corporation, sales or purchases with related entities, and consulting or management fees. These can be in the normal course of business, but they may sometimes be for other purposes such as tax planning.

Redundant Asset Adjustments

Businesses may own redundant assets — assets not used in active operations. Under an income approach, the value of redundant assets is considered separately from the value of business operations to avoid double counting. Income or expenses related to these redundant assets are removed from normalized earnings. Examples include dividend or interest income from marketable securities and loans, investment management fees, and life insurance premiums. If a business owns real estate not essential for operations, treating it as a redundant asset involves adjusting earnings by adding back ownership costs and deducting a “market” rental rate.

Non-Recurring and Non-Operating Adjustments

Non-recurring items are amounts that are not expected to occur in the future on a predictable basis. Examples of non-recurring items include lawsuit settlements, moving costs, discontinued operations, and revenue from one-time projects. These nonrecurring revenues and expenses are removed from normalized earnings/ cash flow. Non-operating expenses are also removed and include personal expenses paid by a business on behalf of a shareholder.

Selecting a Maintainable Level:

There is no precise method or formula to determine the maintainable earnings of a business. Normalized historical results are one factor among others considered when estimating the maintainable future earnings for valuing business operations. Other factors include short-term budgets/forecasts, industry and economic data, management input on the future business outlook, and the professional judgment of the valuation practitioner.

If you have any questions regarding your business’s earnings or cash flow, please contact a member of our Financial Services Advisory Team (FSAT) team.

 

Farm Losses can be Restricted: May Apply Even When Significant Time and Cash is Invested

Posted on by dflanagan

A November 8, 2023, Tax Court of Canada case considered whether a taxpayer’s losses from farming activities deductible against non-farming income were restricted to the $17,500 ($2,500 plus half of the next $30,000) permitted by the restricted farm loss rules for the 2014 and 2015 years. The restriction applies where the taxpayer’s chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income that is a subordinate source of income for the taxpayer.

The taxpayer was a physician but also operated a farm that produced organic beef. The taxpayer provided the following relevant details. (See chart below.)

  Medical Practice Farming
Gross Revenue $805,321 – 2014

$851,621 – 2015

 $174,433 – 2014

$31,128 – 2015
Net Income (loss $648, 480 – 2014 $697,050 – 2015 ($530,363) – 2014 ($595,904) – 2015
Staff Employed Three part-time employees Four full-time employees and three seasonal part-time employees
Taxpayers’ Work Schedule Commenced work on weekdays between 7 am and 9 am and ended between 2 pm to 5 pm Five hours/day on weekdays (before and after performing physician duties) and 8-16 hours/day on the weekends
Hours Worked by Taxpayer (approx.) 1,900 hours/year 2,500 hours/year
Capital Investment There were no significant assets. The operating facilities were rented for $250/year from the municipality, likely as an incentive to maintain a local physician. The operation included over 800 head of cattle, 5,314 acres of land, three large shelter and storage buildings, a building for processing meat, two more buildings under construction, and various pieces of equipment such as tractors, trucks, and haying equipment.
History The taxpayer commenced a continually profitable practice as a physician in 1975. The farming operation commenced shortly after 1975. Various different crops/ products were attempted. Losses were reported in all years but two.
Taxpayer loses

The Court noted that the taxpayer’s farm activities took place before and after normal working hours and gave way to her medical practice if an issue arose that required her attention. As such, the Court found that the centre of the taxpayer’s routine was her medical practice. Further, the Court noted that the farm was only commenced after the medical practice and that all of the investment in the farm came from the medical practice. The farm required the cash inflow of the medical practice to survive. The farming business had always been subordinate to the medical practice as a source of income, rather than the other way around, and there was no demonstration that this would change in the foreseeable future. As such, the Court determined that the restricted farm loss rules would apply and the taxpayer’s deduction would be limited to $17,500.

Court’s additional commentary

The Court noted that the result was most unfortunate as it resulted in the denial of a loss for a bona fide farming business that would have been available to the operator of any other business. In particular, the Court noted how this case demonstrated the difficulty in growing a viable farming business with the current restricted farm loss rule punishing those willing to put in the significant time and capital required to do so.

ACTION: If farming activities consume a significant portion of your resources but you earn income from other significant sources as well, seek consultation to determine if farming losses may be restricted.