GIFTS AND AWARDS

In a new CCRA website (www.ccra-adrc.gc.ca/tax/business/payroll/gifts/examples-e.html), CCRA includes a five-page explanation of the new policy effective January 1, 2001 on non-taxable/tax deductible gifts or awards of up to $500.  For example, a wedding gift (crystal vase of $230) and an award for twenty-five years of service (a watch of $350) would both be non-taxable because the gift and the award are each under $500.  They would be deductible to the employer.  This implies that an employee may receive up to $500 of bona fide gifts and, up to $500 of bona fide awards on a non-taxable basis each year.

However, a gift certificate would be taxable because it is considered to be near-cash and not subject to this policy.

Also, ten other questions and answers on gifts and awards are included on CCRA website www.ccra-adrc.gc.ca/tax/business/payroll/gifts/faq-e.html.

Caution

In a January 10, 2002 Technical Interpretation, CCRA notes that this new policy may not apply to gifts and awards given by closely held corporations to their shareholders or their relatives, since these gifts and awards are normally considered to be received in their capacity as shareholders - not employees.

EMPLOYEE VS. INDEPENDENT CONTRACTOR

An article in the Beausejour newspaper highlights the problem that a local trucking corporation (Lakeland Inc.) had with CCRA.  In a CCRA reassessment against Lakeland, CCRA took the position that any truck operator who leased equipment from Lakeland was an employee of Lakeland and, therefore, reassessed Lakeland for payroll deductions, plus interest and penalties for all leases entered into by Lakeland back to 1997.  Even though Lakeland plans to appeal the case to the Tax Court, CCRA seized their bank accounts and receivables of $380,000 which, “rendered Lakeland incapable of meeting their financial obligations”.

Also, a Tax Court case was heard in Calgary in September, 2001 where CCRA had assessed for unremitted CPP and EI on the basis that over one hundred sales and cable T.V. and internet installers for Shaw Communications Inc. were employees rather than independent contractors.  The decision is pending.

REASONABLE EXPECTATION OF PROFIT (REOP)

In a January 9, 2002 Tax Court case, the Court noted that the rental losses on a condominium at Whistler, British Columbia should be allowed because:

1.     There was no personal element.  Neither the taxpayer, their friends or family used the property.

2.     CCRA is simply second-guessing the appellant’s business judgment.

3.     CCRA did not allow a reasonable period of time to earn income.

In a September 5, 2001 Tax Court case, Mr. W commenced to carry on a lawn maintenance business in 1989 but suffered losses each year, including losses of $39,000, $40,000 and $41,000 in the years 1994, 1995 and 1996.  CCRA disallowed the 1994 to 1996 losses on the basis that there was no REOP.

Good News!

The Court noted that there were no expenditures that were even “blurry” as between business and personal - there were no entertainment expenses, no personal car usages, no convention and promotion expenses.  Every expense was directly applied to a “business” activity.  The fact that losses may not be recovered in the foreseeable future is not a bar to the claiming of such losses.  When there is a genuine business, losses can be sustained, depending on the circumstances, as long as the losses cannot be disallowed for other reasons such as personal or capital.

STRIP BONDS

In a February 27, 2002 Technical Interpretation, CCRA note that interest must be included in income over the period of ownership of the strip bond.

Generally, the interest income will be included in each taxation year on the strip bond’s anniversary day.

UNIVERSAL LIFE INSURANCE

A tax exempt universal life insurance policy (UL) provides a tax sheltered investment.  The portion of the premium which is used for investments accumulates tax free.  Upon death, the face value of the policy, plus the accumulated investments, may be paid out tax free to the beneficiaries.

ULs are often advertised on the basis that withdrawals of the accumulated investments may be made during lifetime or, loans could be made against the policy.  Upon death, the insurance proceeds would be used to pay off the debt.

This was discussed in the April 20, 2002 issue of the Financial Post.  Some points noted include:

1.     ULs have attracted $40 billion, or 30% of the $134 billion face amount of new insurance coverage purchased in 2001.

2.     Even though UL is a form of permanent insurance which provides a tax free death benefit and a tax deferred investment component, one potential problem is the high commissions and management expense ratios (MERs) on the underlying investments in the UL.

3.     ULs are sometimes sold with overly aggressive return assumptions.

4.     There usually are surrender charges when a policy is cancelled within the first ten years.  Cancellation may even trigger a tax liability.

2% LOANS

If a person makes a loan to a non-arm’s length person and charges the prescribed rate of interest on the loan, income earned on the money by the borrower is not attributable to the lender as long as the interest is paid within thirty days after the end of each year.

The prescribed interest rate for loans made in the second quarter of 2002 is 2%.  The prescribed interest rate has not been this low since introduced in 1984.

IN-TRUST ACCOUNTS

In-trust accounts are usually funded by the parents for a child or grandchild.  Most financial institutions require that the account be opened in the name of a parent with the account designated “in-trust”.  Even though the attribution rules apply on investment income, they do not apply on capital gains.

In many cases, the “in-trust account” is not a legal trust and, therefore, avoids trust tax filings and statutory requirements.  However, the child is now the owner of the asset.

The parent loses control of the amounts unless there is a full fledged “trust” established.  A trust could provide the parent with control as to beneficiaries, distributions and so on.  Therefore, for large amounts, it may be advisable to use a legally structured trust.

If a full fledged trust is not used, it is important to have proper documentation - which is usually provided by the financial institution.

Also, the child’s social insurance number (S.I.N.) should be used for the account as problems with CCRA may arise if the parent’s S.I.N. is used because of CCRA’s computer matching program.

In a January 18, 2002 Tax Court case, a furniture retail company was in financial difficulty from September 1, 1994 to June 30, 1995 when it did not remit its monthly GST returns.  On July 18, 1995 it made a proposal to its creditors under the Bankruptcy Act.

Mr. V, the director, was held personally liable by CCRA and the Tax Court for the unremitted GST of $73,869 on the basis that he was aware of the financial difficulties and the unreported GST.  He appeared to have made a deliberate attempt to keep the company alive by using the remittances to satisfy creditors.  Even though he attempted to put the blame on the accountant, the Court noted it was clear that he was an inside director, experienced, knowledgeable and active in the company’s business, and should have been, and in the Court’s view was aware, that the company was not, for an extended period, making its GST remittances.

In another January, 2002 Tax Court case, CCRA assessed Mr. E as a director for unremitted payroll source deductions of $735,736 even though he did not own any stock and served only as an outside director.

Good News!

Mr. E was not liable on the basis that he acted as a reasonably prudent person.  Nothing in the financial statements gave Mr. E any idea that the remittances of source deductions were not being made.  There was nothing he could have done to prevent the failure.

An outside director is only required to use reasonable care to prevent defalcation.

RRSP BENEFICIARY

If the beneficiary of an RRSP is a child or a grandchild of the deceased who is financially dependent on the deceased at the time of death as a result of a mental or physical infirmity, the RRSP may be transferred to an RRSP, RRIF or annuity for that child.

Where the child is a minor who is financially dependent, but not mentally or physically infirm, the child may use the funds to acquire an annuity up to age 18.

CCRA normally takes the position that a child is not financially dependent if his/her income for the year prior to death was greater than the “basic personal amount” - $7,634 for 2002, unless the taxpayer can prove otherwise.

INDIVIDUAL PENSION PLANS (IPP)

An IPP is a defined benefit pension plan for an owner-manager of a corporation.  However, contributions to an IPP reduce RRSP contribution levels.

The IPP contribution is made on a tax-deductible basis by the corporation for the owner.  It usually provides higher contributions than RRSPs, based on actuarial evaluations.  It also provides creditor protection under Provincial Pension Acts.

At retirement, the owner-manager may transfer the accumulated money to a Locked In Retirement Fund (LIRF) or acquire an annuity and take income as needed within certain boundaries.  To implement an IPP, an actuary will be required.  The fees could be in the $1,000 per year range with initial setup and wind-down fees in the $2,000 to $3,000 range and, three year tri-annual valuation reports in the $1,000 range.  Also, an asset manager or pension consultant may be involved in the investment of the funds and required paperwork.

IPPs are complicated and require ongoing consultation with advisors, such as actuaries.

Actuarial calculations show that IPPs make the most sense for individuals aged fifty plus having annual personal earnings of $100,000 or more.

U.S. ESTATE TAXES AND GIFT TAXES - PENALTIES

The U.S. Internal Revenue Code includes penalties for unreported taxes based on valuations which were not entered into in “good faith”.  The Estate and Gift Tax penalties are 20% if the value claimed on the tax return is 25% to 49% of the actual value; and 40% if the value on the return is less than 25% of the actual value.

For example, in a July 6, 2001 case the penalties were $30 million U.S. on a tax deficiency of $76 million.

CANADIAN RESIDENTS

CCRA recently introduced IT-221R3 which explains their position concerning an individual’s residence status for income tax purposes.  The IT looks at factual residence upon entering or leaving Canada such as residential ties, regularity and length of visits to Canada, and residential ties elsewhere.

The above information is general in nature. Please ensure that you contact Canham Rogers, Chartered Accountants to discuss any specific transactions prior to implementation. We would be pleased to assist you in these and other area’s of your business.