Category: Domestic Tax

Often taxpayers are audited by the Canada Revenue Agency (CRA) and end up being surprised when some or all of their expenses are disallowed.  Many times this could have been avoided with proper documentation.  In this article, we will look at some common issues the CRA has with respect to claiming of expenses and the related documentation.

In general, expenses are deductible if they are incurred for the purpose of earning income from business or property, and are reasonable in the circumstances.  Too often taxpayers attempt to deduct personal expenses from their business income.

Bank statements and credit card statements are not sufficient evidence for a CRA auditor.  You need to keep invoices that detail what was purchased.

Meals and entertainment

Receipts are the major supporting documents because they provide information such as the date/time, location, and the amount paid.  Since there can be a definite personal aspect to these expenditures, the CRA also expects an explanation on how those meals and entertainment expenses relate to your business income. Therefore, you should document the following information on each receipt:

• Who attended the event
• Their relationship to your business
• What client matter or income it relates to

If you do not have adequate supporting documents, the CRA could disallow the expense.

Automobile expenses

When you have self-employed income, the CRA allows you to take a deduction for costs associated with your vehicle.  The deduction is based on the number of kilometres you travel in your vehicle for business-related activities.

To calculate your deduction properly, you will need to keep track of your trips throughout the year, and also hang on to any receipts for vehicle-related purchases, in the event of a CRA review. To claim this deduction, the CRA requires you to keep a full logbook that journals your travel activities.  Your logbook should list the odometer reading on the first day of the tax year (or the odometer reading on the first day you decided to start using your vehicle for business), and the odometer reading for the last day of the tax year. Then for each trip, note the date, the kilometers travelled, the address or destination of your travel and the business purpose for the trip.  From your logbook, at the end of the year, you will be able to determine the total kilometers travelled and the number of kilometers travelled for business purposes, and thus the total percentage use for business use.  To determine your tax deduction, you apply this percentage to your total vehicle costs including:

• Fuel
• License and registration fees
• Insurance
• Lease expenses (CRA maximum lease cost may apply)
• Maintenance and repairs.
• The CRA prescribed capital cost allowance (depreciation)
• Interest costs

Home office expenses

Self-employed individuals often carry out at least a portion of their business activities at home. In order to claim home office expenses, you must meet one of the following requirements:

• Your home office must be the principal place of your business
• You use the space only to earn your business income, and you use it on a regular and ongoing basis to meet your clients, customers, or patients

If you are an employee, your employer must complete form T2200 indicating that you are required to use part of your home as an office to carry out your duties.

To determine how much you can deduct for your home office expenses, calculate the size of your office as a percentage of your home’s total size.

The rules for claiming home office expenses depend heavily on your type of employment:  Both self-employed individuals and eligible employees may both claim expenses for heat, electricity, water, maintenance, and rent (if applicable). Commission employees and the self-employed may also claim property taxes and insurance. Only self-employed taxpayers may claim mortgage interest as a home office expense.

If you have maintenance costs that are related exclusively to your home office, you can deduct the entire portion of those expenses.  Make sure that you keep all of your invoices to support your claim.

In some cases, you may not be able to claim the entire amount of your home office expenses in a single tax year.  Both employees and self-employed individuals cannot create a loss from claiming home office expenses. The excess expenses can be carried forward and in most cases can be applied to future years.

Oral audit evidence

If you do not have all of your documentation in place when the auditor calls, they may accept your oral testimony as support for the tax deductions that you’ve claimed.  However, in most cases you will lose at least a portion of your expense claim.  The better way and to reduce your stress, is to develop a habit of making sure that you have the right documentation in place from the start.

If you have any questions, or need assistance with claiming expenses, please contact one of our DJB tax professionals.

Executive summary:

Bill C-59, introduced on Nov. 30, 2023 and since receiving Royal Assent on June 20, 2024, proposes amendments to the intergenerational business transfer (IBT) rules to better accommodate genuine transfers of businesses to the next generation. These changes are intended to rectify shortcomings in the current rules, which were initially established by Bill C-208 in 2021. The new amendments introduce two options for business transfers: the Immediate IBT and the Gradual IBT, each with specific criteria to ensure compliance and authenticity in transfers. The amendments aim to exempt genuine intergenerational transfers from the “surplus stripping” rules, which typically recharacterize capital gains as fully taxable dividends. By ensuring the transfers are genuine, the new rules provide tax benefits similar to those of arm’s length sales.

New amendments to Bill C-59: strengthening genuine intergenerational transfers and tackling surplus stripping

Background

The existing intergenerational business transfer (IBT) rules, initially introduced through Bill C-208 and enacted on June 29, 2021, was an important step to encourage transfers of shares of small businesses, family farms, or fishing corporations to the next generation. These regulations were designed to better harmonize the treatment of intergenerational transfers with third-party sales.

Taxpayers wishing to transfer their corporations to the next generation oftentimes plan to sell their shares to a corporation that the children control. But for the previous wording of surplus stripping rules, these dispositions should ordinarily result in capital gains, which are subject to a reduced rate of tax (starting on or after June 25, 2024, the inclusion rates for certain capital gains will increase from 50% to 66.67%). Under certain historic “surplus stripping” provisions in the Income Tax Act (ITA), however, capital gains otherwise realized on intergenerational sales of shares structured this way would be recharacterized to fully taxable dividends instead. Taxable dividends, for individual taxpayers, are taxed less favourably than capital gains. With the implementation of the IBT rules, these gains would instead be excepted from the “surplus stripping” provisions and would thereby retain their character as capital gains.

Bill C-59, introduced on Nov. 30, 2023, encompasses the latest amendments to the IBT rules. Originally suggested in Budget 2023, these amendments aim to better accommodate the goal of encouraging intergenerational transfers first introduced in Bill C-208.

Introduction of proposed amendments:

The amendments in Bill C-59 propose two alternatives to access the exemption from the surplus stripping rules:

a. Immediate IBT: The immediate IBT option is useful for business transfers that are expedited and are based on arm’s length sale terms, with a compressed timeline of three years.

b. Gradual IBT: The gradual IBT option allows for a more protracted transition period, spanning five to ten years, providing greater flexibility for both parties involved in the transfer.

At a high level, the conditions that must be met for both options can be very generally summarized as follows:

Administration and special rules of application

In order to be eligible for the new IBT rules, both the parents and the children must file a joint election in prescribed form by the parents’ filing deadline for the year of transfer.

The Canada Revenue Agency (CRA) will have the power to monitor whether the above conditions are met over a period of time and subsequently reassess the original year of transfer when the conditions fail to be met. Both the parents and the children will be jointly and severally liable for any additional taxes payable.

Additionally, certain special rules and treatments will apply for purposes of the new IBT rules, including:

1. Nieces/nephews or grandniece/grandnephews are included in the scope of “child”.
2. Certain criteria can be deemed to met if the time periods are cut short for various reasons, such as in situations where the children sell the shares to an arm’s length party, a child experiences a prolonged impairment or dies, or if the business ceases.
3. Parents will be able to claim an extended capital gains reserve from the ordinary five years to a maximum of ten years.

Surplus stripping and the general anti-avoidance rule

As mentioned before, the new IBT rules from Bill C-59 are an exemption to the surplus stripping rules that apply in certain non-arm’s length transfers of Canadian-resident corporation shares. Courts have consistently interpreted that the purpose of these surplus stripping rules is to prevent taxpayers from performing transactions to strip a corporation of its retained earnings. This purpose is important to keep in mind, especially due to the upcoming changes to the general anti-avoidance rule (GAAR). GAAR is a provision of last resort and can apply to reverse a tax consequence in situations where a taxpayer undergoes a series of transactions to try and circumvent certain tax rules.

Draft GAAR legislative updates have just recently received royal assent in Parliament and are effective from Jan. 1, 2024. One of the changes includes further scrutiny for transactions that lack economic substance. A lack of economic substance can be found in a transaction or series of transactions, although being legally effective, that do not have real economic impact. If a lack of economic substance is found, this suggests there is a higher potential abuse in avoiding taxes.

The current IBT rules from Bill C-208 do not have significant safeguards to ensure genuine transfers take place. As a result, taxpayers will need to be cautious of the newly enacted GAAR when structuring transactions to avoid these surplus stripping rules under current IBT rules, especially if no genuine transfer took place. The proposed changes to the IBT rules would likely result in less risk of GAAR applying to intergenerational transfer transactions, since the conditions required to fall within the purview of the new rules have been significantly increased.

Navigating the challenges and tax benefits under IBT rules for business transfers

While the criteria of the new IBT rules from Bill C-59 are perhaps stricter than the current rules from Bill C-208, this represents a new planning opportunity for taxpayers that are looking to transfer their businesses to the next generation. While the costs of non-compliance can leave some taxpayers feeling uneasy, allowing taxpayers to be afforded the same tax treatment had they sold to an arm’s length party is a highly beneficial. The ability to gain the same benefit under either the immediate or gradual options, depending on taxpayer circumstance, offers some meaningful flexibility. While GAAR will always loom in situations where taxpayers aim to engage in “surplus stripping” transactions, taxpayers should feel at greater ease when structuring transactions to fall under the new IBT rules Additionally, taxpayers should anticipate further tweaks to Bill C-59, enhancing clarity and optimizing transactions structuring under the new IBT rules.

This article was written by Mamtha Shree, Daniel Mahne and originally appeared on 2024-06-26. Reprinted with permission from RSM Canada LLP.
© 2024 RSM Canada LLP. All rights reserved. https://rsmcanada.com/insights/services/business-tax-insights/new-2024-tax-changes-to-intergenerational-business-transfers-in-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.

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.

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.

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.

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.