Archive: Personal Tax

Valuations for Income Tax Purposes

income-tax

This article is from the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America. These articles are meant to pursue our mission of being the best partner in your success by keeping you aware of the latest business news.

Valuations for Income Tax Purposes – What Does the Canada Revenue Agency (“CRA”) think?

Tax planning and corporate restructuring have become an integral part of the services provided by professional advisors to their clients. A key component of any plan is establishing the fair market value (“FMV”) as the valuation represents the first step towards assessing the tax consequences of any transaction.

Given the increased level of complexity in many tax plans, “cutting corners” by not obtaining independent valuation advise may lead to unintended consequences such as income tax penalties or failure to achieve the desired after tax results.

In practice, a Chartered Business Valuator (“CBV”) may be engaged to assist you in the following tax related situations:

  • Estate Freezes where the FMV of various classes of shares may need to be determined;
  • Corporate Reorganizations where business assets and related debt are being transferred from one entity to another;
  • Death of a shareholder where FMV of assets is required for the Terminal Tax Return;
  • Emigration, where under certain circumstances a taxpayer is deemed to dispose of their worldwide assets at FMV;
  • Defending a FMV previously filed in a tax return under audit by CRA.

So what is CRA’s position on valuation?

Information Circular 89-3 (“IC 89-3”), Policy Statement on Business Equity Valuations, outlines the general valuation principles and policies adopted by CRA in the valuation of securities and intangible property of closely held corporations for income tax purposes.

There are no formal requirements in IC 89-3 for a valuation by a CBV, however this should not be taken as a recommendation to apply a “do-it-yourself” approach to valuation, as IC 89-3 requires:

  • The standard of value to be used is FMV;
  • All relevant factors of the entity being valued must be considered;
  • The approach to valuation must be justified;
  • Factors used in determining the valuation multiple applied must be disclosed;
  • Reasonable Judgement and Objectivity must be used.

In addition to IC 89-3, IT Folio S4-F3-CI provides CRA’s policy on Price Adjustment Clauses which states:

  • FMV must be determined by a fair and reasonable method;
  • FMV does not have to be determined by a valuation expert, BUT it is not sufficient to rely upon a generally accepted valuation method;
  • It is necessary to perform a complete examination of all relevant facts and valuation methodology must be properly applied.

Finally, there are provisions in the Income Tax Act to apply gross negligence penalties to third parties (preparers) making, or participating in the making of, false statements or omissions in matters of valuation where there is a substantial difference between the FMV as filed and the FMV attributed by CRA. These penalties can be substantial depending on the circumstances.

In light of the above, best practice dictates engaging a CBV or at least having a CBV review a non-valuation practitioner’s valuation to avoid potential pitfalls including a challenge of your FMV by CRA.

A CBV will apply the proper application of generally accepted valuation methods and use their experience and professional judgement essential in any situation where there could be doubt about the value of a private corporation.

If in doubt, consider consulting a CBV for guidance.

Contributed by Michael Frost and Andrew Dey from Mowbrey Gil. This piece was produced as a part of the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore Stephens North America.

Tax Relief for the Cost of Driving

drive

It’s something of an article of faith among Canadians that, as temperatures rise in the spring, gas prices rise along with them. In mid-May, Statistics Canada released its monthly Consumer Price Index, which showed that gasoline prices were up by 14.2%. As of the third week of May, the per-litre cost of gas across the country ranged from 125.2 cents per litre in Manitoba to 148.5 cents per litre in British Columbia. On May 23, the average price across Canada was 135.2 cents per litre, an increase of more than 25 cents per litre from last year’s average on that date.

Unfortunately, for most taxpayers, there’s no relief provided by our tax system to help alleviate the cost of driving as the cost of driving to and from work and back home. That said, there are some (fairly narrow) circumstances in which employees can claim a deduction for the cost of work-related travel.

Those circumstances exist where an employee is required, as part of his or her terms of employment, to use a personal vehicle for work-related travel. For instance, an employee might be required to see clients at their premises for meetings or other work-related activities and be expected to use his or her own vehicle to get there. If the employer is prepared to certify on a Form T2200 that the employee was ordinarily required to work away from his employer’s place of business or in different places, that he or she is required to pay his or her own motor vehicle expenses and that no tax-free allowance was provided, the employee can deduct actual expenses incurred for such work-related travel. Those deductible expenses include:

  • fuel (gasoline, propane, oil);
  • maintenance and repairs;
  • insurance;
  • license and registration fees;
  • interest paid on a loan to purchase the vehicle;
  • eligible leasing costs for the vehicle; and
  • depreciation, in the form of capital cost allowance.

In almost all instances, a taxpayer will use the same vehicle for both personal and work-related driving. Where that’s the case, only the portion of expenses incurred for work-related driving can be deducted and the employee must keep a record of both the total kilometres driven and the kilometres driven for work-related purposes. As well, receipts must be kept to document all expenses incurred and claimed.

While no limits (other than the general limit of reasonableness) are placed on the amount of costs that can be deducted in the first four categories listed above, limits and restrictions do exist with respect to allowable deductions for interest, eligible leasing costs and depreciation claims. The rules governing those claims and the tax treatment of employee automobile allowances and available deductions for employment-related automobile use generally are outlined on the Canada Revenue Agency website.

No amount of tax relief is going to make driving, especially for a lengthy daily commute, an inexpensive proposition. But seeking out and claiming every possible deduction and credit available under our tax rules can at least help to minimize the pain.

Pension Income Splitting — Getting Something for Nothing

pension

Any taxpayer hearing of a tax planning opportunity that offered the possibility of saving hundreds or even thousands of dollars in tax while at the same time increasing his or her eligibility for government benefits, while requiring no advance planning, no expenditure of funds or substantial investment of time could be forgiven for thinking that what was being proposed was an illegal tax scam. In fact, that description applies to pension income splitting which, far from being a tax scam, is a government-sanctioned strategy to allow married taxpayers over the age of 65 (or, in some cases, age 60) to minimize their combined tax bill by dividing their private pension income in a way which creates the best possible tax result.

Many Canadians, even those who can benefit from pension income splitting, have never heard of it. In large part, that’s because the strategy gets very little coverage in the media. While Canadians are inundated during the first two months of the year with advertisements extolling the virtues of making contributions to registered retirement savings plans (RRSPs) or tax-free savings accounts (TFSAs), pension income splitting is never mentioned. The reason for that is that it is one of the very few tax planning strategies in which only the taxpayer gains a financial benefit.

The information provided with the annual tax return form issued by the Canada Revenue Agency (CRA) also doesn’t highlight the benefits of pension income splitting, and the form needed to carry out a pension income splitting strategy isn’t included in the General Income Tax Return package — it must be ordered from the CRA or downloaded from the Agency’s website. The Income Tax and Benefit Guide issued by the CRA for 2017 returns does flag the pension income splitting option, in the same manner as all other tax tips on deductions and credits which may be claimed.  However, the material on income splitting included in the Guide addresses only the mechanics of filing — which number goes where — with no significant explanation of the tax-saving benefits which can be obtained. Consequently, unless eligible taxpayers are getting good tax planning or tax return preparation advice, it’s likely that they could overlook a significant opportunity to reduce their overall tax burden.

Dividing income between spouses makes for a lower overall tax bill because of the way our tax system is structured. Canada’s tax system is what is known as a “progressive” tax system, in which the rate of tax levied as income rises. In very general terms, for 2017, the first $46,000 of taxable income attracts a combined federal-provincial rate of around 25%. The next $46,000 of such income, however, is taxed at a rate of just under 35%. When taxable income exceeds $142,000, the tax rate imposed can approach 50%. While those percentages and income thresholds will vary by province, provincial and territorial tax rates will, in nearly every province or territory, increase as taxable income goes up. (The one exception to that rule is the province of Alberta, which imposes a flat 10% tax rate on all individual taxable income. However, Alberta taxpayers, like those in other provinces, will still pay increasing federal rates as income rises.) Dividing income allows a greater proportion of that income to be taxed at lower rates. Of course, that means that the total tax payable (and therefore government tax revenues) will be reduced. Consequently, our tax laws include a set of rules known as the “attribution rules” which seek to prevent strategies to divide income in this way. Pension income splitting is a government-sanctioned exception to those attribution rules.

The general rule with respect to pension income splitting is that taxpayers who receive private pension income during the year are entitled to allocate up to half that income with a spouse for tax purposes. In this context, private pension income means a pension received from a former employer and, where the income recipient is over the age of 65, payments from an annuity, an RRSP, or a registered retirement income fund (RRIF). Government source pensions, like payments from the Canada Pension Plan, Quebec Pension Plan, or Old Age Security payments do not qualify for pension income splitting, regardless of the age of the recipient or his or her spouse.

The mechanics of pension income splitting are relatively simple. There is no need to transfer funds between spouses or to make any change in the actual payment or receipt of qualifying pension amounts, and no need to notify a pension plan administrator.

Taxpayers who wish to split eligible pension income received by either of them must each file Form T1032(E)17, Joint Election to Split Pension Income for 2017, with their annual tax return. If you are filing electronically, retain a copy of the completed form should the CRA request a copy.

On the T1032(E), the taxpayer receiving the private pension income and the spouse with whom that income is to be split must make a joint election to be filed with their respective tax returns for the tax year. Since the splitting of pension income affects both the income and the tax liability of both spouses, the election must be made and the form filed by both spouses — an election filed by only one spouse or the other won’t suffice. In addition to filing the T1032(E), the spouse who receives the pension income must deduct from income the pension income amount allocated to his or her spouse. That deduction is taken on line 210 of his or her return for the year. And, conversely, the spouse to whom the pension income is being allocated is required to add that amount to his or her income on the return, this time on line 116. Essentially, to benefit from pension income splitting, all that is needed is to for each spouse to file a single form with the CRA and to make a single entry on his or her tax return for the year.

Generally, when taxpayers sit down to complete their income tax returns this spring, it will be too late to take any action which will reduce taxes payable for the 2017 tax year — in most cases, such actions needed to be taken before the end of the 2017 calendar year (or, for RRSP contributions, by March 1, 2018). One of the best attributes of income splitting as a tax planning strategy is that it doesn’t have be addressed until it’s time to file the return for 2017. By the end of February or early March, taxpayers will have received the information slips which summarize their income for the year from various sources. At that time, couples who might benefit from this strategy can review those information slips and calculate the extent to which they can make a dent in their overall tax bill for the year through a little judicious income splitting.

Looking ahead to 2018

2018

For most Canadians, income tax, along with other statutory deductions like Canada Pension Plan contributions and Employment Insurance premiums, are paid periodically throughout the year by means of deductions remitted to the Canada Revenue Agency (CRA) on the taxpayer’s behalf by their employer.

Each taxpayer’s situation is unique and so the employer must have some guidance as to how much to deduct and remit on behalf of each employee. That guidance is provided by the employee/taxpayer in the form of TD1 forms which are completed and signed by each employee, sometimes at the start of each year, but minimally at the time employment commences. Each employee must, complete two TD1 forms – one for federal tax purposes and the other for provincial tax. Federal and provincial TD1 forms for 2018 list the most common statutory credits claimed by taxpayers, including the basic personal credit, the spousal credit amount, and the age amount.

While the TD1 completed by the employee will have accurately reflected the credits claimable, everyone’s life circumstances change. Where a baby is born, or a child starts post-secondary education, a taxpayer turns 65 years of age, or an elderly parent comes to live with their children, the affected taxpayer will be become eligible to claim tax credits not previously available. And, since the employer can only calculate source deductions based on information provided to it by the employee, those new credit claims won’t be reflected in the amounts deducted at source from the employee’s paycheque.

It is a good idea for all employees to review the TD1 form prior to the start of each taxation year and to make any changes needed to ensure that a claim is made for all credit amounts currently available to him or her. Doing so will ensure that the correct amount of tax is deducted at source throughout the year.

Where the taxpayer has available deductions, which cannot be recorded on the TD1, like RRSP contributions, deductible support payments or child care expenses, it makes things a little more complicated, but it’s still possible to have source deductions adjusted to accurately reflect the employee’s tax liability for 2018. The way to do so is to file Form T1213, Request to Reduce Tax Deductions at Source Once that form is filed with the CRA, the Agency will, after verifying that the claims made are accurate, provide the employer with a Letter of Authority authorizing that employer to reduce the amount of tax being withheld at source.

Of course, as with all things bureaucratic, having one’s source deductions reduced by filing a T1213 takes time. Consequently, the sooner a T1213 for 2018 is filed with the CRA, the sooner source deductions can be adjusted, effective for all paycheques subsequently issued in that year. Providing an employer with an updated TD1 for 2018 at the same time will ensure that source deductions made during 2018 will accurately reflect all of the employee’s current circumstances, and consequently his or her actual tax liability for the year.

When You Owe Money to the Canada Revenue Agency

canadian-dollors

The Canada Revenue Agency (CRA) doesn’t publish information or statistics on the number of individual taxpayers who owe money in the form of back taxes, interest, or penalties. Nonetheless, it’s a safe assumption that some percentage of the 28 million or so Canadians who filed a tax return this past spring either couldn’t pay their 2016 taxes when due or still owe money from past years, or both. Being unable to pay one’s bills on time obviously isn’t desirable, no matter who the creditor is, however, there are several reasons why owing money to the tax authorities is a particularly bad idea.

Start with the interest cost of carrying such debt- interest rates remain near historic lows, but the CRA, by law, charges interest at levels higher than normal commercial rates. The interest rate charged by the CRA on overdue or insufficient tax payments is set quarterly. For the third quarter of 2017, covering the months of July, August, and September, the interest rate charged on taxes owing is 5%.

While that 5% rate is still lower than the interest rate charged on many credit card balances, it is the interest calculation method used by the CRA which can really inflate the cost of having tax debts. Where an amount is owed to the CRA, interest charged is compounded daily, meaning that on each successive day, interest is being levied on the interest charged the day before. Not surprisingly, interest costs calculated in that way can add up quickly.

The CRA has a very broad range of options at its disposal to compel payment, and a very long period in which to use them. Where a taxpayer hasn’t paid an amount owed within 30 days after he or she receives a Notice of Assessment the CRA will usually contact the taxpayer, by phone or by mail, with a request for payment. If the taxpayer does not contact the CRA to make a payment or set up a payment arrangement within 90 days after the date the Notice of Assessment was mailed, the CRA will resort to its other collection options.

The CRA has the right, where there are any amounts owed to the taxpayer by any other department of the federal government (for example, a goods and services tax credit amount) to seize those amounts and apply them to the tax debt. The CRA also has the authority to intercept or garnish money which may be owing to the taxpayer from a third party, like an employer and, as a last resort, can direct that the taxpayer’s assets be seized and sold to satisfy the tax debt.

The CRA’s goal, like that of any other creditor, is to get the debt paid without having to resort to expensive and time-consuming administrative or legal processes.  It’s relatively rare for a tax debt to reach the stage of litigation or garnishment, as it is in everyone’s interest to resolve matters before things reach that point. And, perhaps contrary to popular belief, the CRA has some flexibility. When the amount of taxes due on filing can’t be paid, or can’t be paid in full, it’s in the taxpayer’s best interests to contact the CRA and let them know of that fact.

Not surprisingly, the CRA tries to make it easy for taxpayers to contact it to make such arrangements. The taxpayer can propose a payment schedule based on his or her ability to pay, and the CRA, if it is satisfied that the inability to pay is genuine, will generally be amenable to entering into some type of payment arrangement. Entering into such a payment arrangement does not, of course, stop the interest clock from running, as interest will continue to be assessed at the current rate, and compounded daily.

The alternative to making a payment arrangement and becoming subject to the CRA’s punitive interest assessment practices is sometimes to borrow the required funds at a lesser rate from a third party.  One final blow: interest paid on tax debts, whether paid to the CRA or to a third-party lender, is not deductible from income.

Your TFSA – Mid-Year Checkup

TFSA

Tax-free savings accounts (TFSAs) have been part of the Canadian tax system for nearly a decade, and millions of Canadians utilize them as a savings vehicle, whether for short-term or long-term purposes.

Of all tax-deferral or tax-savings plans available to Canadians, TFSAs undoubtedly provide the greatest flexibility, as the TFSA rules allow taxpayers to carryover allowable contribution room to future years and to re-contribute amounts withdrawn. However, that very flexibility, especially the ability to re-contribute previous withdrawals, also has the potential to cause taxpayers to run afoul of the rules by getting into an inadvertent overcontribution position, resulting in the imposition of penalty taxes.

A brief recap of the TFSA rules: every Canadian aged 18 years of age and older can contribute a specified annual amount to a TFSA ($5,500 for 2017). Funds contributed to the TFSA are not deductible from income, but investment income earned by those funds is not taxed, either as it accrues or on withdrawal. Where a taxpayer does not contribute to a TFSA within a particular year, the contribution not made can be carried forward and made in any subsequent year. TFSA holders can withdraw funds from their plan at any time, free of tax, and funds withdrawn can be re-contributed, but not until the following year.

Calculating one’s current year contribution room can be complex. The Canada Revenue Agency does not provide taxpayers of their current year TFSA contribution limit on the annual Notice of Assessment; taxpayers can access that information through the CRA’s automated telephone service, online portal or have their service provider do the calculation for them.

Once the taxpayer knows their contribution limit for 2017, it’s necessary to calculate how much has already been contributed in 2017. The difference between those two figures represents the balance which can be contributed before the end of the year without getting into an overcontribution position and incurring penalties. It is important to remember that if withdrawals have been or will be made during 2017, those amounts cannot be re-contributed until after the end of this year.

If it’s necessary to adjust regular contributions in order not to go “offside” by the end of the year, the best time to do it is obviously before getting into that overcontribution position. As soon as a taxpayer is in an overcontribution position, the 1% penalty tax is imposed for that month, even if the excess funds are withdrawn before the end of the month -  in other words, as explained in the Canada Revenue Agency guide to TFSAs “[I]f, at any time in a month, you have an excess TFSA amount, you are liable to a tax of 1% on your highest excess TFSA amount in that month.”

Especially where TFSA contributions are set up to occur regularly, by automatic deposit or bank transfer, it’s easy to assume that everything has been taken care of and nothing further needs to be done with respect to such arrangements. However, an “out of sight and out of mind” approach rarely makes for good financial and tax planning, and checking on the status of one’s TFSA on a periodic, at least quarterly,  basis can help to ensure that everything is as it should be, and that unnecessary penalties are avoided.

File Timely Returns or Risk Losing Refunds

lores_hourglass_blue_timer_bzFailing to file a tax return is not an option in Canada when you owe taxes.

Eventually Canada Revenue Agency (CRA) will ask for the returns to be sent in. Sometimes, taxpayers simply ignore the requests. If this goes on long enough, the CRA will mail an arbitrary estimated assessment of income earned and taxes owed. The assessments can be quite generous in favour of the agency and eye-opening for the taxpayer.

At that point, taxpayers usually start to make payments on their arrears to avoid collection proceedings. By making payments the taxpayers get time to file their late returns and correct the balances owed to the actual tax liability, which is generally lower than the assessment.

On the surface, this seems like a good strategy: The CRA starts getting some of the money it is owed and the wage earner avoids collections calls. Once the returns are filed the balance owed is adjusted, usually down to the actual amount you owed. And all is right with the world. Or is it?

There can be a downside to this tactic. The CRA is becoming increasingly tough on late returns and has refused to issue refunds for tax returns that are filed after the three-year limit allowed by the Income Tax Act. So, taxpayers can still be denied a refund of overpayments when they file their returns more than three years late.

On top of that, there are filing deadlines that also apply to allow CRA to deny refunds of overpayments of Canada Pension Plan or Employment Insurance that were either a result of employer payroll deductions or CPP calculated on self-employment income.

Individual taxpayers can appeal the refund denial or to ask the CRA to consider applying overpayments to other balances owed. This is not possible for corporations, however. Corporate taxpayers must be very careful before making payments on accounts for any returns filed more than three years after the filing date.

Taxpayers can also file a formal Notice of Objection. In that case, the facts will be reviewed and the CRA may issue a reassessment. If taxpayers are still not satisfied they can take the issue to court, but the costs of battling the tax agency in court can be high.

It is also to file a request under taxpayer relief, if there were extenuating circumstances that prevented the filing the return within the three year time period if a taxpayer is experiencing financial hardship. This could result in a reduction of some penalties or interest, or the CRA could decide to pay refunds beyond the three-year limit.

If you have fallen behind in your tax filings, received a demand to file or estimated tax assessments, especially for any taxes due more than three years ago, discuss the issue with your accountant who can help assess your situation and determine the best course of action.

Consider the Benefits of EI for the Self-Employed

lores_canada_coins_currency_cash_dollars_close-up_mbIf you’re self-employed, you benefit from several tax advantages, but suffer from one big drawback: You’re not eligible for regular Employment Insurance (EI).

You can, however, voluntarily contribute to become eligible for EI special benefits, which cover 55% of your average weekly earnings for:

  • Maternity (as long as 15 weeks);
  • Parental Leave (as many as 35 weeks for either parent, or shared between spouses or common-law partners, to care for their new child);
  • Sickness or Injury (15 weeks); and
  • Compassionate Care (as long as six weeks to care for a dying family member).
  • Parents of critically ill children benefits are for parents who must be away from work to care for or support their critically ill or injured child. Either parent can receive benefits or they can share benefits between them (up to 35 weeks).

Any Canadian who runs an unincorporated business or is a shareholder of a private corporation may opt in. After paying premiums for 12 months, you will be eligible to receive the special benefits. The premiums match those paid by regularly employed individuals. You pay a set percentage of your net business income (owners of unincorporated companies) or of your wages (shareholders in private corporations). The percentage is set annually by the federal government.

You pay the premium as part of your income tax return at the end of the year. It’s worth noting that as a regular employee, not only would you have to pay your premium (deducted from your paycheque) but your employer also has to pay a larger portion for you. As a self-employed person, you only need to pay your own portion to access the special benefits.

Another important distinction for shareholders is that the premiums and benefits are based only on the uninsurable wages taken from your company. Dividends you take are not taken into account.

This program can be very attractive to people in certain life positions. For example, a self-employed woman in her 30s with income of $30,000 a year will;

  • Pay $549 in special EI premiums each year to potentially access $317 a week in EI special benefits; and
  • Receive $15,850 if she has a baby and takes a total of 50 weeks for maternity and parental leave.

Assuming her income and the EI rates remained the same, she could contribute for almost 30 years, and still be ahead.

There are downsides to the program. For instance, if you change your mind after enrolling you still must pay a full year of premiums unless you withdraw right away. An even larger downside is that if you enroll and at some point take benefits, you must remain in the program for the remainder of your self-employed career.

An example: A 25-year-old man registers while he is a self-employed painter and takes compassionate care benefits when his parents become gravely ill. Eventually his parents, die, he gets an inheritance and stops painting to attend dentistry school. When he graduates, he starts his own company and takes wages. He has no choice but to pay EI premiums on those wages and he still will qualify only for the special benefits, not regular benefits.

Individuals who work for an employer are eligible for those regular benefits, which they receive if they lose their jobs through no fault of their own, such as a shortage of work or layoffs, and are available and able to work but cannot find a job. Regular benefits also generally pay out 55% of average weekly wages and last anywhere from 14 to 50 weeks, depending on:

  • The unemployment rate in the region where the person lives; and
  • The number of hours of insurable employment that the person accumulates during the 52 weeks before the start date of the claim.

Full-time employees also are eligible for the maternity, parental leave, sickness, compassionate care benefits and parents of critically ill children benefits.

Enrolling in this optional EI program is an important choice for every self-employed person. For many, the thought of deliberately paying more to the government seems preposterous, but there are those for whom this system could really be helpful when they need a financial safety net.

If you think this might be a valid option for you, speak to your financial adviser or accountant for a second perspective on your situation before you take the plunge.

Claim a Capital Gains Reserve and Defer Taxes

lores_capital_gain_kkCapital gains on sales of property other than your principal residence can be a significant tax cost in the year of the sale.

Whenever you dispose of capital or other property, principal residence aside, you need to report a capital gain when the sale price is more than the purchase price. When the property’s value is high the capital gain can add a significant amount to your tax liability. However, with some tax planning you can either defer or reduce the amount of capital gains.

Where you have a capital gain on the sale of property, you may be able to defer part of the capital gain by claiming a reserve. You may claim a reserve in cases where you receive payment of capital property over several years. The reserve allows you to defer payment of taxes on capital gains until the full proceeds are received.

For example, you sell a capital property for $100,000 and the terms of the sale prescribe that the buyer will pay $20,000 initially and the remainder in equal instalments of $20,000 over the next four years. In this case you may be able to claim a reserve.

Generally you can claim the reserve on the disposition of capital property unless you:

  • Were not a resident of Canada at the end of the tax year of the sale of at any time in the following year;
  • Were exempt from paying tax at the end of the tax year or at any time in the following year;
  • Sold the capital property to a corporation that you control in any way.

Calculating the Reserve

If you are eligible to claim a reserve, the general formula for calculating it is:

The total gain (in excess of cost) divided by the total proceeds of the disposition multiplied by the amount payable after the end of the year.

Using our example, and assuming the original cost of the property was $60,000, the reserve that can be claimed in the year of the sale is calculated as:

$40,000 (excess of original cost) divided by $100,000 (sale price) multiplied by $80,000 (amount payable in the following year, for a reserve of $32,000. [$40,000/$100.000 X $80,000 = $32,000.]

When you report the capital gain on your tax return, you calculate it as proceeds of disposition of capital or other property minus the cost of the property, which is the full $40,000. Then you deduct the reserve for the year.

The remaining amount is the portion of the capital gain that you need to report in the year you made the sale. The reserve is reported on the Form T2017, Summary of Reserves on Dispositions of Capital Property.

In the following year you will have to include the reserve in the calculation of capital gain for that year. That means you will have to include the $32,000 reserve when you calculate capital gains on the income tax return for the year after the sale. You will have to calculate a new reserve for that year.

20 Per Cent Rule

For capital and other assets disposed after November 12, 1981, reserves are permitted only for a limited number of years. The limitations are the following:

Sale of capital assets: Generally, the maximum period over which most reserves can be claimed is five years. However, the rules specify that in any year the reserve should be a lesser of the amount calculated using the general formula above and 20 per cent of the total capital gain in the year of disposition, 40 per cent of the capital gain in the following year and so on. As a result, in each year the reserve is claimed, the general calculation and the 20 per cent rule must be compared.

In other words, you do not have to claim the maximum reserve in a tax year. However, the amount you claim in a later year cannot be more than the amount you claimed for that property in the previous year.

Note: Transfers to your child of family farm property, family fishing property, and small business corporation shares, as well as gifts of non-qualifying securities have an identical rule with a 10 year period.

Sale of ordinary assets resulting in business income: If you disposed of an asset in the normal course of the business and it generates ordinary business income, the maximum period to claim the reserve is reduced to three years. In this case the reserve will be the prorated portion of the profit that is due in each of the three years.

Reserves that you can claim on disposition of capital property can be a useful tool in terms of tax planning. Tax deferral and reserves can be used to reduce the overall tax on a large capital gain transaction as individual tax rates increase with the amount of income earned. However, if the proceeds are deferred over a long period of time the taxes may be due before the money is received. Make sure you have enough money to pay the taxes.

If you sell a capital or other property for a capital gain, consult with your accountant about making sure that you are taking advantage of all the possible tax planning points.

Take Advantage of the Super Tax Credit

If you haven’t claimed a donation tax credit since 2007 you may want to take full advantage of the First-time Donor’s Super Credit (FDSC).

lores_calculator_canadian_flag_mb

Alternatives To Cash Gifts

Donations of Public Securities: If you have stocks or bonds, it is more efficient to donate the investment directly as this will eliminate the capital gain.

Flow-Through Tax Shelters:  If you entered into any flow-through agreement after March 21, 2011, the tax benefit relating to the capital gain is eliminated or reduced. Consult with your accountant to help ensure you don’t create an unwanted capital gain.

Estate Plan Donations: If you worry that you may at some point have to deal with medical costs or simply cover daily living expenses, you can make a bequest in your will. Donation bequests are deductible on your final tax return. For deaths that occur after 2015, donations made by will and designation donations will no longer be deemed to be made by an individual immediately before the individual’s death. Instead, these donations will be deemed to be made by the individual’s estate and where certain conditions are met, these donations will be deemed to be made by the individual’s graduated rate estate.

The nonrefundable credit is a one-time deal and adds 25% to the normal Charitable Donation Tax Credit (CDTC). To maximize this tax break you may want to avoid claiming smaller donations in the years you make them and instead carry them forward over the five years the temporary credit is available until they add up to a $1,000 threshold.

The super credit is available to you if neither you nor your spouse of common-law partner has claimed a charitable credit since 2007. You may have made charitable donations since 2007, but as long as you didn’t claim a credit for them, you remain eligible for the super credit.

The $1,000 limit applies to individuals and couples; there is no doubling of the credit. If you share your super credit in a particular year, the total amount claimed can’t exceed the maximum allowable credit. There is no age limit on eligibility.

Gifts of property don’t qualify for the super credit. Donations of property, including investments, will normally qualify for the charitable donation credit, but for donations to earn the super credit they must be made in cash only.

Also, the credit’s restricted to individual taxpayers. Corporations making donations for the first time won’t be eligible. They will be limited to the tax deduction typically available for corporate donations.

For income tax purposes, the first $200 of charitable donations qualify for the 15% CDTC and gifts over that amount qualify for a 29% credit. The super credit boosts those federal tax breaks by an additional 25% on all donations up to the $1,000 limit.

The super credit effectively adds 25% to the rates used to calculate the normal refundable tax credit for as much as $1,000 of monetary donations. That means first-time individual donors are allowed a 40% federal credit for donations of $200 or less, and a 54% on amounts exceeding $200 but not exceeding $1,000.

Example 1 – All cash: A taxpayer eligible for the credit claims $500 of charitable donations. All of the gifts are donations of money. The taxpayer’s federal super and normal charitable credits would be calculated as follows:

First $200 of donations claimed $200 times 15% = $30
Donations exceeding $200 $300 times 29%  = $87
First-Time Donor’s Super Credit $500 times 25%  = $125
Total of both credits     $2421

Example 2 – Mix of cash and investments: An eligible first-time donor claims $700 of charitable donations, but investments make up $400 of the total. Deducting that amount from the total leaves a cash donation of $300. The federal credits would be calculated as follows:

First $200 of $300 donations claimed  $200 times 15%  = $30
Donations exceeding $200 $500 times 29%  = $145
First-Time Donor’s Super Credit $300 times 25%  = $75
Total of both credits $2501

Consult with your advisor on how best to use this tax credit.

1. Provincial credits would increase these amounts.