Archive: Business Tax

Foreign Corporations in Canada: Permanent Establishment and Taxes

By Howard Wasserman, Principal—Taxation at Segal LLP 

foreign-company

Any non-resident that has sales in Canada is taxable in Canada on the profit on those sales.

A number of treaties state that a non-resident corporation is only taxable in Canada if the non-resident corporation has a permanent establishment in Canada: a fixed place of business through which the business of a resident of one country is carried on.

In the Canada-US tax treaty, a permanent establishment is defined to be a place of management, a branch, an office, a factory or a workshop. Building sites or installation projects are also considered permanent establishments if they last more than 12 months. So too are people in Canada habitually exercising the authority to conclude contracts in the name of the non-resident.

And what’s not a permanent establishment?

1. The use of facilities for storage display or delivery of goods.
2. The maintenance of a stock of goods.
3. The purchase of goods or merchandise or the collection of information.
4. Advertising.
5. The use of a broker commission agent or any other independent agent.

Tax implications of permanent establishments

Once a permanent establishment has been created, the non-resident is taxable only on the profits earned in Canada, not the revenues. This can be calculated using foreign expenses that relate to the activity in Canada. For example, a non-resident corporation could allocate some management or administration costs if they can be clearly tied to the activities in Canada.

Additionally, the non-resident corporation must meet Canadian filing requirements even if no taxes are payable. More specifically, the foreign corporation should file schedule 91 and schedule 97 that would be attached to the jacket of a T2 corporate tax return. In this filing, the non-resident corporation is stating that the corporation earns Canadian revenue but is not taxable in Canada because there is no permanent establishment.

Tax implications of doing business in Canada in general

All payments to the non-resident corporation doing business in Canada are subject to 15% withholding tax on the work done in Canada. If it has been determined that the non-resident corporation is not taxable in Canada, then the non-resident corporation can file the treaty-based tax return and request a refund of the withholding taxes.

There is an opportunity to request a waiver for the 15% withholding tax on work done in Canada before the work commences. In order to get a waiver, a submission must be made to CRA, which often includes the contract related to the work being done in Canada. This gives CRA an opportunity to examine the situation to determine if the foreign corporation is taxable in Canada.

If the non-resident corporation receives a waiver, the corporation can give this waiver to its customers to ensure the no withholding tax is payable. Even if a waiver is received, the non-resident corporation must still file a treaty-based Canadian income tax return because of the Canadian revenues earned.

There are a number of issues to be dealt with on carrying on business in Canada, but the first one is always the determination of whether the company owes Canadian corporate income taxes. For help or advice, you can contact me directly.

Avert Penalties, Confirm Customer GST Registrations

When your company sells a commercial property, one party must pay a Goods and Services Tax (GST). And occasionally, the burden of responsibility can create a problem. If the buyer isn’t registered for GST, it’s your company’s responsibility to collect the GST on the sale and remit it to Canada Revenue Agency (CRA).

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The GST Advantage

Even if your company qualifies as a small supplier that may not have to register for GST, it can make economic sense to get a number.

Generally, a business doesn’t have to register for GST if it is a sole proprietorship, partnership, or corporation whose total taxable revenues before expenses are $30,000 or less annually ($50,000 for such public service bodies as charities, non-profit organizations, municipalities, or universities.)

However, registration may give your company a tax advantage: It can claim tax credits for the GST/HST paid on such operating expenses as commercial rent, utilities, office supplies, as well as meal and entertainment expenses, reimbursements to employees or partners and capital property. And that can lead to a GST refund.

But if the buyer is registered, the responsibility shifts to the buyer who must report the tax and can claim any available Input Tax Credits to offset the GST (see right-hand box). On the face of it, this is an uncomplicated transaction and your company is in the clear.

But a Tax Court ruling suggests that you might want to double check the accuracy and validity of GST numbers to avoid an unpleasant surprise.

In the court case, the buyer of a commercial property claimed the company was registered for GST and provided a number. During an audit of the sale, however, the number was discovered to be invalid. The CRA had cancelled the purchaser’s registration.

But it wasn’t the buyer who wound up having to pay the GST — it was the seller. The Tax Court ordered the seller not only to pay the tax that should have been collected, but also to pay penalties and interest, despite the buyer’s misrepresentation in the deed of the sale about the validity of its GST number. (Lee Hutton Kaye Maloff & Paul Henriksen v. The Queen)

In theory, of course, the seller could bring a civil court action against the buyer to recover the GST it was forced to pay. In practice, however, that would mean incurring more expenses for legal fees. Moreover, the seller would still be liable for the penalties and interest. The Excise Tax Law doesn’t provide for the recovery of those costs.

A simple way to avoid this problem is to request CRA confirmation of a purchaser’s GST registration status.

There are other tax and GST issues involved in the sale of real estate and other commercial goods, so consult with your professional advisor before your company completes a major sale to make sure everyone understands the consequences of the transaction.

Properly Account for Asset Transfers

lores_hr_employee_business_man_reading_paper_work_amIf you are incorporating a partnership or a sole proprietorship, you will likely transfer assets. When you do that, take precautions so you don’t pay too much in taxes.

The transfer of physical assets into a corporation is considered a disposition at fair market value (FMV). You cannot assign little or no value to the assets. If you do, Canada Revenue Agency can later determine that you not only owe taxes but also must pay penalties and interest. Transfers of assets can generate gains or losses, and the tax treatment depends largely on whether the property has been previously used in a business.

Income Taxes

Gains: The transfer of assets that were not previously used in a business will generally produce capital gains, in which case fifty per cent of the difference between FMV and the original cost will be taxable income.

In cases where the property had already been used in a business, the transfer is taxed in two steps:

1. The gain is first accounted for as a recapture of previously claimed Capital Cost Allowance (CCA) and taxed as business income.

2. If the FMV of the asset exceeds the original purchase price plus improvements, the excess will be a capital gain.

Losses: If an asset was not already used in a business, a loss from the transaction won’t be deductible because it will be considered a loss on a personal-use asset.

Property that was used in a business can generate two types of losses, depending on the nature of the asset. For example, land will produce a deductible capital loss while buildings vehicles, equipment or tools will produce a terminal loss.

Stop-loss rules may apply when transferring assets. Consult with your accountant before transferring any assets.

Section 85 Elections: To avoid taxes immediately on asset transfers, you can make an Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation. This allows many, although not all, assets to be transferred to a corporation without triggering taxes.

The corporation is deemed to have acquired the assets at the original cost and to have taken Capital Cost Allowance in prior years. If the corporation later disposes of the assets, it will add the CCA recapture to income and either pay a capital gains tax, deduct a terminal loss or claim a capital loss, depending on the situation.

Excise Taxes

The Excise Tax Act allows for a tax-free transfer of the assets of one business to another, as long as both are GST/HST registrants. You must file an Election Concerning the Acquisition of a Business or Part of a Business.

Personal assets not used for business purposes before transferring them to a corporation or using them in a proprietorship aren’t subject to GST/HST on the transfer. These assets may qualify for input tax credits when the business starts to use them. The most common example of this is when you start to use your personal vehicle for commercial purposes.

The tax implications of asset transfers can be complicated. Talk to your accountant about the transaction before you incorporate. Waiting until it’s time to file a tax return could cost you money.

When Expectation Becomes Intention

Owning rental property has long been a popular investment, particularly when losses from the property can be deducted against other income. However, Canada Revenue Agency (CRA) sometimes attacks rental-related expenses and denies the deductions.

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The Landmark Cases Stewart v. The Queen.

The taxpayer invested in four condominium units and the investment had no element of personal use.

He incurred losses from the beginning because the purchase was financed almost entirely with debt and he had significant interest expenses. Losses were projected to continue for up to 10 years. The CRA disallowed the losses using the “reasonable expectation of profit” test, arguing there was no source of income. The deduction for interest expenses was also disallowed.

The Supreme Court of Canada ruled that Stewart was entitled to deduct his losses since his rental property lacked any element of personal use and was clearly a commercial activity.

Walls v. The Queen. A limited partnership invested in a warehouse business. The partnership paid service charges, management fees, and 24% annual interest on the purchase price of $2.2 million.

The taxpayers then deducted their share of the losses. The CRA again disallowed the losses based on real expectation of profit but the Supreme Court ruled:

” . . . there was no evidence of any element of personal use or benefit in the operation. Where, as here, the activities have no personal aspect, reasonable expectation of profit does not arise for consideration. Although the respondents were clearly motivated by tax considerations when they purchased their interests in the partnership, this does not detract from the commercial nature of the storage park operation or its characterization as a source of income.”

Over the years, a number of special provisions have been introduced into the Income Tax Act to limit taxpayers’ ability to claim rental losses. For example:

Regulation 1100(11). Under this provision, a rental loss can’t be created or increased by claiming the Capital Cost Allowance (CCA). All rental properties owned are pooled for purposes of this regulation. The result is that a taxpayer can only claim the CCA if total rental revenue exceeds total rental expense, and then, only enough to reduce income to zero.

Subsection 13(21.1). When land and buildings are sold together, any terminal loss on the building is reduced to the extent of any capital gain on the land. So, you can’t manipulate the amount of the deduction of a terminal loss at 100% and report a capital gain taxable at 50%.

The tax agency also has a long history of denying rental losses due to a taxpayer having no “reasonable expectation of profit”. But in two Supreme Court rulings described in the right-hand box, the court struck down the expectation of profit test and said the tax agency should use a two-pronged approach to losses:

    • If the taxpayer’s activity is “undertaken in pursuit of profit,” the income is deemed to be from a business or property and losses will be allowed. Where there is no personal element, the CRA shouldn’t second guess a taxpayer’s business decisions.

 

  • If the enterprise has a personal element, the tax auditors must consider whether the taxpayer had an “intention to profit” from a business operated in a “sufficiently commercial manner.” (Stewart v. The Queen, 2002, SCC 46 and Walls v. The Queen, 2002, SCC 47).

While “sufficiently commercial” wasn’t defined, all circumstances surrounding the activity should be considered in making that determination.

So Finance Canada added a more restrictive and onerous test aimed at eliminating many real estate investments (including tax shelters). A loss on a property is only allowed if it is reasonable to assume that the taxpayer will realize a cumulative profit from the property during the time the taxpayer has held, or can be reasonably expected to hold, the property.

In addition, the expected profit has to come from renting the property. It can’t come from a capital gain due to the increase in value of the property. The legislation specifically provides that there is no source of income from capital gains, and therefore no profit from a capital gain.

The test is to be applied every year a loss is deducted. On the other hand, if the property starts to make a profit – even if there previously had been no reasonable expectation of profit – the profit will be taxable in the year it is made. (It doesn’t appear a taxpayer will be allowed to go back and amend prior years’ returns to deduct losses not previously deductible.)

If you have leveraged investments in real estate where the rental revenue isn’t expected to exceed the expenses for many years, consult with your advisor and review these four points:

1. Have there been profits or losses in the past?

2. How does your training and background affect the situation?

3. What is your profit intention?

4. Is there any personal element? For example, do you or family members use or reside on the property?

Is a Limited Partnership Right for You?

When you start a business, a key first step is to choose the form of business organization that most suits your business plan. Two of the structures you will likely consider are the corporation and the limited partnership.

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Questions to Help You Decide

Deciding which type of business structure to use can be difficult.

Some questions to ask when choosing among various business structures include:

1. How easy and costly is the form of business structure to organize?

2. How much capital will the business need?

3. How much capital will come from owners and how much debt financing will be needed?

4. What are the tax implications of each business structure?

5. How much personal involvement should the owners have in controlling and managing the business?

6. How much risk and liability for the business should the owners assume?

Discuss these questions and other aspects of setting up a business with your accountant.

Both entities are alike in that they each can be owned by several people. But that is typically where the similarities end. Partners in a limited partnership face issues that are diametrically different from those shareholders of a corporation must deal with and the main reason many people choose that form of partnership is tax liability.

Limited partnerships are often used where investors want the special tax treatment without incurring personal liability for all the partnership’s debts.

Limited partnerships generally are taxed on a flow-through basis. That means the partnership doesn’t pay tax on its income and doesn’t file an income tax return. Instead, the partners file their own income tax returns to report their share of the partnership’s net income or loss.

Any income the limited partnership earns is directed to and taxed in the hands of the partners. As well, any losses are allocated among the partners and may become deductions for each partner.

Limited partners are restricted in their ability to deduct losses and in aggregate can’t deduct losses that exceed the amount they have invested. This restriction can be less than the amount invested if the partner bought their interest from a former partner and not the partnership.

This requirement for each partner to report his or her share of the partnership’s net income remains whether the share of income was received in cash or as a credit to a capital account in the partnership.

Limited partnerships are used, for the most part, as a method for structuring tax driven investment ventures. If the investment is tax driven, the limited partnership may have to register with the Canada Revenue Agency as a tax shelter.

In a corporate structure, on the other hand, the company is a separate taxable entity and pays its own taxes. Profits paid to shareholders as dividends are also taxable. This double taxation is one of the disadvantages of forming a corporation.

Other advantages of limited partnerships include:

Liability: When a limited partnership is formed, one of the partners (usually a corporation with no assets, formed and controlled by the promoter of the investment for this sole purpose) is designated as the general partner and all other investors are usually designated as limited partners. The partnership agreement then makes the general partner responsible for managing the business of the partnership. The limited partners are simply silent investors with little or no say in the business activities of the partnership.

In the event the limited partnership is unable to meet its obligations, only the general partner will be liable for the debts of the partnership. The liability of a limited partner would be limited to the amount of capital the limited partner invested in the partnership. However, if the limited partner participates in the management of the partnership, that partner would lose his or her limited liability and may become liable for the debts of the partnership, the same as the general partner.

In a corporation, shareholders can be held liable only for the amount that they invested in the company.

Management: In partnerships, the management structure is decided by the partners. Legally, a corporation must be managed by a board of directors elected by the shareholders.

Life Cycle: Limited partnerships depend on the active participation of the general partner and contributions from the others. As a result, the entities’ life cycles are limited. When the general partner dies, the partnership terminates.

Limited partnerships are usually created for one business reason or to invest in businesses. It is often difficult to transfer ownership because it is generally necessary to create a new partnership.

A corporation, on the other hand, has a virtually unlimited life cycle. Because ownership is spread among shareholders, it can be easily transferred. And if a manager dies or quits, the company can easily recruit a new one.

Record-keeping: A partnership typically isn’t required to keep records of its meetings and other administrative activities. A corporation must keep those records of these activities.

Structure: Limited partnerships must have at least one general and one limited partner. The general partners control the daily management while the limited partners generally have little control over management decisions and primarily finance the organization.

Corporations are separate legal entities usually owned by one or more people or other organizations. Typically the owners, or shareholders, elect a board of directors. That panel, in turn, hires a management team.

Essentially the board runs the organization in the interest of shareholders. To do this, it follows the company’s bylaws, which are the rules that govern how the business should be managed.

Consult with your advisor, who can help you decide the best business structure for your needs.

2016 Year-End Tax Planning Letter

We are coming to the end of 2016, and our tax team has been busy compiling a list of tax planning ideas that can increase tax savings for yourself and family members.

The topics we cover include:

  • Changes in tax rates for individuals and corporations
  • Eligible capital property
  • Trust & estates
  • Key dates

To assist you with this, click here to view the Year-End Tax Planner which includes some ideas you may want to consider.  Your Segal advisor can assist you in determining which of these ideas make sense to you.

Please do not hesitate to call your Segal advisor with any questions about this communication

Recoup the Cost of Work-Related Courses

When you or an employee returns to the classroom to follow work-related courses or obtain a higher degree, some of the costs can be deducted and others are eligible for tax credits.

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Other Considerations

Other factors to consider and discuss with your accountant include:

The tuition tax credit may be used for fees to take exams required to obtain a professional status recognized by federal or provincial statute, or to be licensed or certified in order to practice a profession or trade in Canada. Ancillary fees and charges are also eligible for the credits.

You may deduct tuition fees for auditing courses where you attend lectures but don’t take exams or receive credit.

You may claim a tax credit for transit passes generally totalling at least one month’s duration.

You may claim a GST credit if you are eligible.

In general, expenses are not deductible if they are eligible for tuition, education or other tax credits, if they are capital expenditures that produce a lasting benefit to the taxpayer or if they are personal or unreasonable. You could not, for example, deduct the costs when:

  • Medical general practitioners train to qualify as specialists;
  • Lawyers take an engineering course unrelated to their legal practice, or
  • An employee takes university or other courses leading to a degree or other certificate unrelated to your business.

Employers who pay for or reimburse employees for their tuition may deduct reasonable amounts as a business expense regardless whether the business or the individual benefits from the course. If your company provides an employee or former employee with a scholarship or bursary on the condition that the employee will return to the business, the amount paid is considered employment income.

Employees incur taxable benefits when courses are business-related and not directly related to your business (e.g. stress management, employment equity, first aid, and language courses) or when the employee develops personal interests or technical skills not related to your business.

Tax Deductions

You may deduct as a business expense the costs related to courses and training that maintain, update or upgrade an existing skill or qualification. For example, the following costs would generally be tax-deductible:

  • Professional development courses taken as required or recommended by a professional body to maintain professional standards;
  • Tax courses taken by lawyers or accountants who are qualified to do tax work, whether or not they have previously been involved in such work, and
  • Courses on electronic ignition taken by the owner of an automobile repair shop.

Eligible expenses include travel, food and beverages and lodging. They do not include tuition and other costs for which there are tax credits. Thus, if you or an employee plans to obtain an MBA, you could not deduct the costs, but they would generally be eligible for tax credits.

Tax Credits

In general, tax credits may be claimed for tuition fees if they:

  • Total more than $100 at a post-secondary school level paid to a university, college, or other educational institution in Canada;
  • Total more than $100 for a student who is at least 16 years old at the end of the taxation year with skills for (or improve the student’s skills in) an occupation, paid to an educational institution in Canada certified by the Minister of Human Resources Development;
  • Total more than $100 at a university, college or other educational institution in the United States to which a student living near the Canada-U.S. border commutes; or
  • Are for full time courses at a university outside Canada that last for at least 13 consecutive weeks and lead to a degree.

You cannot claim any amount less than $100 for the year or the costs of books, room and board, or student association fees. Otherwise, you can claim total fees. This could also include the cost of courses and seminars related to your work. Individuals taking courses as a condition of their job can claim the costs as an employment expense rather than as a tax credit.

The tuition tax credit may be claimed whether the students or the company pays the fees. However, if your business pays for or reimburses employees for all or a portion of their tuition, they may claim the credit only if the amount is included as a taxable benefit.

An education amount tax credit and a textbook credit can be claimed for each whole or part month in which a taxpayer was enrolled in a qualifying program. The amount of credits varies depending on whether the person was a full-time or part-time student. Individuals may claim the full-time credit if they attended only part-time and are eligible for the disability tax credit or would be eligible for the credit except that their disability is not severe and prolonged.

Unused Credits and Lifelong Learning

Unused tuition, education and textbook credits may be carried forward indefinitely to offset future income, or may be transferred to a spouse or common-law partner or to a parent or grandparent of you or your spouse or partner. The transfer of costs should not exceed more than the individuals can use on their tax returns. Any excess costs then can be carried forward.

If you have a Registered Retirement Savings Plan (RRSP), you may withdraw money tax-free to pay for qualifying full-time education and training for yourself or your spouse or common-law partner. However, you cannot withdraw money for both at the same time. If you are disabled, you can use the plan for both full-time and part-time education and training.

You may participate in the Lifelong Learning Plan as many times as you want, but you may not begin a new plan before the end of the year in which all previous withdrawals are repaid.

Consult with your accountant for more details.

CRA Has Its Sights on Rental Income

lores_rural_land_use_country_fence_ranch_farm_property_tkInvesting in condominiums operated as hotels — where you own individual units that are often split into one-quarter shares — can present some income-earning opportunities, but they can be complicated when it comes to GST/HST.

If you are considering one of these investments, keep in mind that you must pay 5% GST; 13% HST on the purchase price and cannot claim the GST/HST new housing rebate because neither you nor your family will occupy the unit. Nor can you claim the GST/HST Rental Property rebate, because the unit is not rented out on a long term basis.

However, if you are a GST/HST registrant, you can buy the unit without paying the GST/HST. This is because when a property is used 90 per cent or more for commercial purposes, a GST/HST-registered buyer can claim an input tax credit equal to the GST/HST paid on the purchase.

There a few issues you should keep in mind related to owning short-term rental condos to help ensure you stay within tax law and survive potential audits of this favorite CRA target:

1. Rentals for fewer than 60 days aren’t characterized as residential complexes, which are exempt from GST/HST. Instead they are usually characterized as “hotel, motel, inn or boarding house, lodging house and other similar premises.” That means GST/HST is charged on the rentals and you can claim input tax credits on GST/HST paid on expenses relating to them.

2. If you or your family does stay in the unit, you will have to allocate a portion of the input tax credits as personal. That portion cannot be claimed as input tax credits, even if they are related to the purchase of the unit. When personal use is more than 50 per cent, you cannot claim any input tax credit on the purchase price.

If you do want to stay in the condominium complex, say for a vacation, you are generally better off staying in another unit and paying rent or arranging a swap with another unit holder. In the latter case, you both report rental revenue on the use of each other’s units.

3. Management companies who typically run these complexes do not claim input tax credits on expenses related to the units, although they do usually collect and remit GST/HST on the unit rentals. The companies will send you monthly reports on revenues and expenses. In addition, the management companies normally take care of renting units, the day-to-day operations of the complex and other routine matters.

Your record keeping is minimal, generally consisting of keeping the management company’s annual report to you and retaining receipts for expenses associated with the rental unit.

Here is an illustration of the types of expenses that are usually incurred and the GST/HSTrefund that would result if you were registered for GST/HST:

Expense ($)

Input Tax Credit ($)

GST/HST self assessed on purchase — $5,000

(5,000)

Unit purchase, GST/HST offset by tax credit

100,000

5,000

Net GST/HST payable on purchase price

NIL

Costs typically subject to GST/HST and refunds registered owners can claim

Cost

Claim

  • Legal costs on purchase
  • Management fees
  • Maintenance and Repairs
  • Travel
  • Strata Fees

1,500

10,300

2,900

500

2,400

75

515

145

25

120

Total

880

The refund depends on the amount of GST/HST paid out. The more expenses are subject to GST/HST, the greater the refund.

One final caution: You must be registered for GST/HST before the sale closes, or you cannot claim the input tax credit on the purchase. Talk to your tax professional before you purchase the unit if you think that you might benefit by registering for GST/HST.

Sell Your Farm Tax-Free

thmb_farm_silo_green_meadow_bzYou can realize a tax-free gain on the sale of your qualified farm property by applying the lifetime capital gains exemption to the proceeds, if you meet certain stringent criteria.

Combining Two Tax Breaks

Each individual with a stake in a farm has access to the lifetime capital gains exemption, so a common technique is to evaluate whether more than one exemption can be used in the same family.If so, you may be able to maximize the tax benefits of a property transfer within the family by combining rollover rules with the capital gains exemption. Ask your accountant for details.

The rules are complicated so we’ll first describe the basic qualifications. Qualified farm property includes:

  • A share of the capital stock of a family-farm corporation, or an interest in a family-farm partnership owned by you, your spouse or your common law partner;
  • Real property, such as land and buildings that was used in the course of carrying on a farming business; and
  • Eligible capital property used by a person, in the course of carrying on a farming business in Canada, such as milk and egg quotas.

Real or eligible capital property purchased after June 18, 1987, qualifies if the farm is run by you or:

  • Your spouse or common law partner;
  • Your parents, children, grandparents or grandchildren, as well as those of your spouse or common law partner;
  • The beneficiary of a personal trust that holds the property, or the spouse or common law partner, parent, or child of that beneficiary; or
  • A family farm corporation or partnership in which any of the above hold a share or own an interest. (However, a family farm corporation owning an interest in the partnership does not qualify.)

In addition, one of the above parties must have owned the property for the 24 months preceding the sale. In addition, the property must have been used 50 per cent or more in a farming business for at least 24 months, and meet one of the following requirements:

  • One of the people listed above was regularly and continuously active in the business, and that person’s gross income from farming exceeded all other income in the year.
  • The business was run by a family farm corporation or partnership in which you, your spouse or common law partner, child, or parent was actively engaged on a regular and ongoing basis.

Special rules apply if you bought or entered into an agreement to buy the real or eligible capital property before June 18, 1987. In that case, the property qualifies if any of the eligible people listed above, or a family farm partnership or corporation, or a personal trust that sold the property in the first place:

  • Used the property 50 per cent or more in a farming business in the year you sell it, or
  • Used the property principally in a farming business for at least five years.

If you own farm property, consult with your accountant to see if you can use the lifetime capital gains exemption to get the best tax results.

Be Aware: U.S. and Canada Share Border Crossing Information

Canadian business travelers who spend a lot of time south of the border should be aware of Canada Revenue Agency’s (CRA) efforts to crack down on tax evaders.

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Critical Residency Issues

U.S. tax residency is based not just on U.S. Citizenship and green card status but also physical presence in the U.S.

Physical presence generally includes time you physically spend in the country, including days spent on business trips or attending conferences.

Under U.S. tax law one of the determinants of residency is the substantial presence test. Many mistakenly believe that they are safe as long as they spend fewer than 183 days away in one year.

In reality the test is much more complicated: You are considered a resident of the U.S. for tax purposes if you are physically present on at least 31 days during the current year, and 183 days during the three-year period that includes the current year and the two preceding years, counting:

  • All the days you were present in the current year;
  • 1/3 of the days you were present in the first year before the current year, and
  • 1/6 of the days you were present in the second year before the current year.

Days spent in the U.S. because you are ill and unable to leave do not count.

If you are caught in this calculation you will be required to file a U.S. tax return reporting your world income, as well as a Canadian tax return. An exemption is available if you can establish a closer connection to Canada than to the U.S.

To claim closer connection exemption you must file Closer Connection Exemption Statement (IRS form 8840) each year on or before June 15 of the following year. If you don’t file this form you may lose the exemption.

Canada and the U.S share immigration entry and exit dates under the Entry/Exit Initiative of the Perimeter Security and Economic Competitiveness Action Plan. This information will help the IRS determine the number of days a Canadian spends in the U.S. This could result in Canadian business travelers having to pay U.S. taxes.

U.S. tax residency generally is based on physical presence in the country for any reason ranging from shopping excursions and holidays to business trips. Many Canadians are not aware that entering the U.S. for business on behalf of a Canadian employer or to attend conferences will count toward U.S. tax residency status. (See right-hand box.)

The increased risk of being liable for U.S. taxes significantly boosts the chances that Canadians may face an IRS audit. As well, travelers may have to file U.S. foreign compliance disclosures and report all their Canadian holdings ranging from bank accounts to ownership holdings in Canadian corporations or partnerships.

In addition to this increased scrutiny, the CRA plans to boost efforts to track down tax evaders who use aggressive tax strategies to hide money in tax havens or make questionable claims related to business travel.

In reality, there is nothing illegal about lowering the amount of taxes you owe, provided the methods used are legal. But when tax planning reduces taxes in a way that is not consistent with legal rules and regulations, the methods are considered to be tax avoidance. The CRA interpretation of tax avoidance includes transactions that:

  • Contravene specific anti-avoidance provisions, and
  • Reduce or eliminate tax through means that comply with the letter of the law but violate its spirit and intent.

This differs from tax evasion, which typically involves deliberately ignoring a specific part of the law. For example, those participating in tax evasion may under-report taxable receipts or claim expenses that are non-deductible or overstated. They might also attempt to evade taxes by willfully refusing to comply with legislated reporting requirements.

Tax evasion, unlike tax avoidance, can involve criminal prosecution.

Of course not all tax shelters are used to evade taxes. Under theIncome Tax Act, tax shelters generally include either a gifting arrangement or the acquisition of property where the tax benefits and deductions will equal or exceed the net costs of entering into the arrangement. A gifting arrangement involving limited recourse debt related to the gift is also considered a tax shelter. Generally a limited recourse debt is one where the borrower is not at risk for the repayment.

Tax-shelter promoters must have an identification number and provide the CRA with a list of investors or participants, including their names, social insurance numbers, and other prescribed information. This identification number allows the CRA to track the arrangements and the participants. All tax shelters are reviewed and, if they are considered potentially abusive, they are audited.

Of particular concern to the CRA, and arrangements you should avoid, are mass marketed gifting tax shelter arrangements. These are made for the primary purpose of avoiding taxes. They include schemes where taxpayers receive a charitable donation receipt with a higher value than what they paid. This can typically be four or five times their out of pocket cost. The CRA audits every mass-marketed tax shelter arrangement and no arrangement has been found to comply with the Income Tax Act.

If you have questions, consult with your adviser.