Tax

Other income - Research grants

Research grants provided to an individual to allow that individual to carry out research are included in the taxpayer's income to the extent the grant exceeds expenses incurred in carrying out the research. The following expenses are not allowed: • personal or living expenses • expenses the taxpayer has been reimbursed for • expenses deductible in the year under other provisions of the ITA • expenses that are unreasonable in the circumstances • expenses paid by someone else on behalf of the taxpayer

Royalties

Royalties are payments based on the production of or use of property, including amounts received from the use of patents, copyrights, franchises, and licensing arrangements. Income from royalties may be either business income or property income. If the taxpayer is the author or inventor, the royalty payments received are classified as business income. If the taxpayer purchased or inherited the right to the royalties, the royalty payments received are classified as property income.

CH5 - Division C deductions -Loss carryovers - continued

1 Non-capital losses A non-capital loss arises in a year where current-year losses from non-capital sources exceed income from all sources. Non-capital losses may be carried back three years or forward 20 years and may be deducted against any source of income, including taxable capital gains. 3.2 Farm losses A farmer may be categorized as follows: • A full-time farmer is an individual for whom farming may reasonably be expected to provide the majority of income or is the centre of the individual's work routine. For a full-time farmer, a loss from a farming business is categorized as a non-capital loss that is fully deductible. • A hobby farmer is an individual who carries on farming activities as a hobby. For a hobby farmer, the losses are not deductible. • A part-time farmer is an individual who does not look to farming for his livelihood but carries on farming as a sideline. For a part-time farmer, losses are restricted and are deductible as follows: The total deduction cannot exceed $17,500. 1. Deduct the first $2,500 of the loss. PLUS 2. Deduct the lesser of: i. (The restricted farm loss less $2,500) / 2 ii. $15,000 The restricted farm loss carryover is the difference between the current period loss from farming and the amount determined above. A restricted farm loss may be carried back three years and forward 20 years but is only deductible against farming income earned in the carryover period. 3.3 Allowable business investment loss As discussed in the e-book chapter on capital gains and losses, a business investment loss results from a disposition of shares or debt of a small business corporation (SBC). An SBC is a CCPC where all or substantially all of the assets (90%) are used in an active business carried on primarily in Canada. A business investment loss (BIL) is the full amount of the loss, and an allowable business investment loss (ABIL) is one-half of the BIL. In the year that an ABIL is realized, it is deductible against any source of income. If it cannot be used in that year, it may be carried back three years and forward 10 years and deducted against any source of income in those years. If the taxpayer is unable to use the ABIL in the carryover period, it is added to the taxpayer's net capital loss carryover balance. 3.4 Net capital losses Net capital losses arise when allowable capital losses exceed taxable capital gains realized in a year. Net capital losses may be deducted in the carryover period against taxable capital gains realized in the year that were included in the taxpayer's net income for tax purposes. The term "net capital" means the loss carryover has been determined using the inclusion rate for the year in which the net capital loss was realized. Example A taxpayer has a net capital loss carryover of $9,375 that was realized in 1999 when the inclusion rate was 3/4. The taxpayer realized a taxable capital gain of $8,000 in the current year. The net capital loss that may be claimed in the current year is the lesser of: (i) Taxable capital gain included in net income for tax $8,000 (ii) Net capital loss carryover: $9,375 × 4/3 × ½ $6,250 3.5 Ordering of loss carryforwards Oldest losses are applied first. Other than this, loss carryovers may be applied in any order. Generally, it is best to apply the most restrictive types of losses first (that is, losses that can only be deducted against a specific source of income). However, it is important to consider losses with limited carryforward periods in making this determination. 4 Lifetime capital gains deduction The lifetime capital gains deduction is a Division C deduction. It is discussed in a separate e-book chapter. 5 Deductions for northern residents This Division C deduction is available to individuals residing in a prescribed northern zone or a prescribed intermediate zone. The individual must have resided in the zone for a period of at least six consecutive months commencing or ending in the year. The purpose of the deduction is to compensate individuals for the higher cost of living up north. The amount of the deduction for a resident living in a prescribed northern zone is: a) $22.00 per day ($16.50 for years prior to 2016) for a self-contained domestic establishment in the prescribed area b) $11.00 per day ($8.25 for years prior to 2016) where a self-contained domestic establishment is not maintained The deduction for residents of a prescribed intermediate zone is one-half of the deduction for residents of a prescribed northern zone. In order to determine whether a place is located in a prescribed northern zone or a prescribed intermediate zone, the Canada Revenue Agency (CRA) website has a list of prescribed zones by province / territory.

CH5 - Change in use - primary residence - test your knowledge

1.2.3 Test your knowledge Miguel owned a home in Halifax that he acquired in Year 1. In Year 4, he decided to move to Edmonton and rented out his Halifax home. In Edmonton, he initially stayed with his sister and her family before renting a home. In Year 13, after giving his Halifax tenants sufficient notice, he moved back into the Halifax home. He sold the Halifax home in Year 15. In any of the years that the property was rented, Miguel did not claim any capital cost allowance against his rental property. Additional information for the Halifax home: Year 1 — cost $235,000 Year 4 — fair market value 315,000 Year 13 — fair market value 420,000 Year 15 — selling price 450,000 Required Determine the amount and timing of the capital gains for Miguel under the following two assumptions: Assumption 1: Miguel does not make an election not to have a change in use in either of Year 4 or Year 13. Assumption 2: Miguel makes elections not to have a change in use in both Year 4 and Year 13. Additionally, at the time of the first change in use in Year 4, he elects to designate the home as his principal residence for an additional four years. Answer Assumption 1 Year 4 — first change in use Deemed proceeds $ 315,000 Adjusted cost base (235,000) Capital gain 80,000 PRE: [(3 + 1) / 4] × 80,000 (80,000) Capital gain $ nil The years owned to the time of the change in use are Year 1 to Year 4 for a total of four years. Miguel may designate the home as his principal residence for Year 1 to Year 3, resulting in fully exempting the gain on his home. Year 13 — second change in use Deemed proceeds $ 420,000 Adjusted cost base — fair value at the first change in use (315,000) Capital gain 105,000 PRE: [(2 + 1) / 10] × 105,000 (31,500) Capital gain $ 73,500 The number of years owned totals 10 years (Year 4 to Year 13). Miguel lived in the home at some time during Year 4 before he moved to Edmonton and again in Year 13 when he moved back to Halifax, so he can designate the home as his principal residence for two years. Year 15 — sale of home Proceeds on sale $ 450,000 Adjusted cost base — fair value at the second change in use (420,000) Capital gain 30,000 PRE: [(2 + 1) / 3] × 30,000 (30,000) Capital gain $ nil The number of years owned totals three years (Year 13 to Year 15 inclusive). Miguel designated the home as his principal residence for Year 13 at the time of the second change in use, so Year 13 is no longer available. He may designate the home as his principal residence for Year 14 and Year 15. Because of the "1 +" in the formula, the Year 15 gain on sale is completely exempt from tax. Assumption 2 As Miguel has made elections not to have a change in use in both Year 4 and Year 13, there are no tax consequences in either of those years. Year 15 — sale of home Proceeds of sale $ 450,000 Adjusted cost base (235,000) Capital gain 215,000 PRE: [(11 + 1) / 15] × 215,000 (172,000) Capital gain $ 43,000 The number of years owned totals 15 years (Year 1 to Year 15, inclusive). Miguel lived in the home from Year 1 to Year 4 and from Year 13 to Year 15, for a total of seven years. Because he made the election to designate the home as his principal residence for the additional four years, the total number of years designated is 11. He cannot take advantage of the election to designate the home as his principal residence for the four years prior to the Year 13 change in use, as the total of the two elections may not exceed four years.

Inclusion rate - capital gain

A capital gain is the full amount of the gain. The capital gain is multiplied by an inclusion rate to determine the amount to include in income. The amount included in income is referred to as the taxable capital gain. The inclusion rate has changed over time but is currently 50%. A capital loss is the full amount of the loss, and an allowable capital loss is the full amount of the loss multiplied by the inclusion rate. Allowable capital losses are only deductible to the extent of taxable capital gains included in the taxpayer's net income in the year. If current period allowable capital losses realized are in excess of taxable capital gains, the excess amount (referred to as a net capital loss) may be carried back three years and forward indefinitely; however, it may only be deducted against taxable capital gains realized in the carryover period. Net capital losses are quoted in terms of the inclusion rate for the year in which the capital loss was realized. When a net capital loss from a preceding year is claimed in the current year, it may be necessary to use the reciprocal of the inclusion rate for the year in which the loss was realized to determine the amount of a net capital loss that may be claimed in the current year.

Disposition of property - Capital Gains and Losses

A disposition of property includes any transaction or event that entitles the taxpayer to proceeds of disposition. Dispositions also include deemed dispositions that occur in the following situations: • change in use of property • death of a taxpayer • ceasing to be a resident of Canada • gifting of property to another person These deemed dispositions are discussed in separate eBook chapters

Identical properties - Capital gains and losses

A floating weighted average method is used to determine the cost of individual properties when a taxpayer acquires identical properties over a period of time. These rules generally apply to investments in financial instruments, such as shares, bonds, and mutual funds. Shares of one class are considered identical properties, while shares of two different classes of the same corporation are not considered identical properties. Similarly, bonds of the same series are considered identical properties. The weighted average cost per unit is determined as the total price paid for all identical properties held divided by the total number of identical properties owned at that point in time.

Sale to an affiliated person (superficial losses) - Capital Gains and losses

A superficial loss arises in a situation where a taxpayer sells a property to trigger a loss and repurchases the property almost immediately because of the long-term potential for future growth in the value of the property. A superficial loss is denied and added to the cost base of the property. If the following three conditions hold, the loss is considered a superficial loss and is not deductible in the period realized: • The taxpayer, the taxpayer's spouse, or a corporation controlled by either the taxpayer or his or her spouse sells a property. • Any of the above taxpayers acquire or reacquire the same property or an identical property in the 30-day period before or after the sale of the property. • Any of the taxpayers referred to above still own the property at the end of the 30-day period after the sale of the property. The taxpayer, the taxpayer's spouse, and a corporation controlled by either the taxpayer or his or her spouse are referred to as "affiliated persons." (See the eBook chapter on stakeholder relationships for additional information on affiliated persons.)

CH 5 - 1.2 Change in use - Income producing to personal

A taxpayer may acquire a property and initially rent it out for some period of time before occupying the home as a principal residence. If no election is made at the time of the change in use, there is a deemed disposition of the property at fair value at that time. If no capital cost allowance was claimed on the property during the time that it was an income-producing property, the taxpayer may elect to not have a deemed disposition at the time of the change in use. This election also allows the taxpayer to claim the PRE for up to four years prior to the year of the change in use. The combination of this election and the election above, where the change in use is from personal to income producing, may not exceed four years.

ACB - Capital Gains and Losses

ACB The initial cost of a property generally includes all costs directly associated with acquiring the property, such as the invoice cost, shipping, and brokerage fees. After determining the initial cost, it may be necessary to increase or decrease that cost to determine the ACB. The following are select items that impact the ACB: • Government grants and assistance relating to the acquisition of capital property are deducted from the ACB. • Non-deductible property taxes and interest on vacant land are added to the ACB. • The employee stock option benefit is added to the exercise price of the shares acquired under an option plan when determining the ACB of the shares. • The actual amount of capital gains, dividends, and interest earned on mutual funds, where the taxpayer is issued additional units of the mutual fund in lieu of a cash payment, is added to the ACB of the mutual funds. • Stock dividends from Canadian companies are subject to tax and thus are added to the cost base of the shares. • Superficial losses are added to the cost base of a property.

CH5 - Other deductions - Actual child care expenses incurred

Actual child care expenses incurred Expenses must be substantiated by receipts. If the payment is made to an individual, the receipt must include the social insurance number of the individual performing the service. The maximum amount that may be claimed for a child's attendance at a boarding school or overnight camp is: • $200 per week for each child under the age of seven at the end of the year • $275 per week for a child who has a severe or prolonged mental or physical impairment (and is eligible for a disability tax credit) • $125 per week for other eligible children 8.4 Maximum deduction for the lower-income earner The maximum deduction for the lower-income earner is the least of three amounts: i) The actual amount paid for child care services, other than for a boarding school or overnight camp, plus the limited amount for a boarding school or overnight camp as described above ii) The total of the annual limits (described above) iii) Two-thirds of the taxpayer's earned income Earned income includes: • employment income before deductions from employment income • training allowances and research grants included in net income • net business income (business losses are not considered) • a government disability pension 8.5 Maximum deduction for the higher-income earner The higher-income earner is allowed to deduct child care expenses for the period where the lower-income earner is any of the following: • in full-time or part-time attendance at a designated educational institution • infirm and incapable of caring for the children for at least two weeks (must be certified by a medical practitioner) • confined to prison for at least two weeks • living apart from the higher-income taxpayer throughout a period of at least 90 days commencing in the year due to marital breakdown The maximum deduction for the higher-income earner is the least of: i) The actual amount paid for child care services, other than for a boarding school or overnight camp, plus the limited amount for a boarding school or overnight camp described above ii) The sum of: • $200 times the number of children under seven years of age at the end of the taxation year • $275 times the number of children who have a severe and prolonged mental or physical impairment eligible for the disability tax credit • $125 times the number of other eligible children Multiplied by the number of weeks the lower-income earner was: • in full-time attendance at a designated educational institution • infirm and incapable of caring for the children • in prison • living apart from the taxpayer as a result of a marital breakdown iii) Two-thirds of the higher-income earner's earned income Where the higher-income earner is eligible for a deduction under the rules above, the deduction for the higher-income earner is determined first. Next, the maximum deduction for the lower-income earner is determined and is then reduced by the deduction allowed to the higher-income earner. ( there is an example at the bottom of this chapter not copied here )

Test your knowledge - Options property

Adam paid $1,000 for an option to purchase a tract of land at any time within three years at a price of $100,000. At the end of the option period, Adam exercised his option and acquired the land. Four years later, Adam sold the land for $250,000. What is Adam's taxable capital gain? Answer The taxable capital gain is $74,500. The capital gain is equal to the proceeds of $250,000 less the ACB of $101,000 ($100,000 for the land plus the $1,000 option price). The capital gain of $149,000 is then multiplied by 50% to determine the taxable capital gain. Expenses of disposition Expenses of disposition include: • the agent's or broker's commissions • the legal costs of drawing up sales documents • advertising costs • a bonus paid to discharge a mortgage on real property prior to maturity • any other expenses directly caused by the disposition

CH5 - Other deductions - Child care expenses - Additional restrictions

Additional restrictions An eligible child includes a child who was under 16 years of age in the year or dependent as a result of a physical or mental impairment and whose income in the year does not exceed the basis for the basic personal tax credit for the year. Child care payments cannot have been made to persons under 18 years of age who are related to the taxpayer or to his or her spouse by blood, marriage, or adoption (but can be paid to aunts, uncles, nieces, or nephews if under 18) or to a person claimed by the taxpayer as a dependent.

CH5 - Election for additional deferral of capital gains

An election for additional deferral is available for dispositions of business property (that is, land and building) when replacement property is acquired within the time periods specified above. This election applies to both voluntary and involuntary dispositions. The election allows the taxpayer to reallocate the proceeds of disposition between the land and building. This election may be beneficial in a situation where total cost of the replacement property (including land and building) is greater than total proceeds of disposal of the replaced property, but the cost of one part of the replacement property — either land or building — is less than the proceeds of the replaced land or building. ( example in Ch5 - Special Rules 2 )

CH5- Other deductions - Disability supports deduction

An individual may claim a disability supports deduction for amounts he or she personally paid to enable the individual to: • work as an employee or as an independent contractor • attend a designated educational institution or a secondary school • carry on research work for which the individual received a grant Expenses allowed are as follows: Types of taxpayers • Individuals with speech, hearing, or sight impairments, learning disabilities, or other physical or mental infirmities Expenses allowed • The cost of devices and other assistance that enable the individual to engage in one of the activities listed above (most devices or other assistance must be prescribed by a medical doctor, with very few exceptions) • Example: The cost of sign language interpretation services for an individual with a hearing impairment Types of taxpayers • Individuals with a mental or physical disability that qualifies the individual for the disability tax credit (see the eBook chapter on calculating tax payable for information on the disability tax credit) • Individuals who do not qualify for the disability tax credit but who, because of their mental or physical impairment, require a full-time attendant, as certified by a medical practitioner Expenses allowed • Amounts paid to an attendant who is not the individual's spouse or common-law partner, or to an unrelated attendant who is at least 18 years of age in the year The amount that can be deducted is limited to the lesser of: i) The amount of disability supports payments made (net of any reimbursement) ii) The total of the following: a) employment income (before deductions), business income, the taxable portion of scholarships (if any) and net research grants included in income b) where the individual attends a designated educational institution, the least of: • $15,000 • $375 times the number of weeks of school attendance • the amount by which the individual's net income is greater than the sum of income included in (a) above For example, an individual who has become disabled as a result of an accident and has received and invested a settlement may only have investment income. If that individual attends a designated educational institution, the provision in (b) above allows the individual to claim a disability supports deduction despite having no employment, business, or scholarship income. Most of the amounts noted above also qualify for the medical expense tax credit (see the eBook chapter on calculating tax payable for an individual). In most cases, the taxpayer would prefer to claim a disability supports deduction for the following reasons: • The basis for the medical expense credit is reduced by the lesser of 3% of the individual's net income and a specified amount (indexed annually to inflation). • If the individual is in any tax bracket other than the lowest tax bracket, the disability supports deduction has greater value than the medical expense tax credit. • A medical expense claim for a full-time attendant precludes the taxpayer from claiming the disability tax credit. A disability supports deduction claim does not preclude the taxpayer from claiming a disability tax credit.

CH5 - Other deductions - Attendant care costs

Attendant care costs Full-time attendant — cost is greater than $10,000 per year. Part-time attendant — cost is equal to or less than $10,000 per year. Attendant care costs are deductible as follows: ( check CH5 - Other deductions for more detail )

CH 5 - Other Deductions

Canada Pension Plan contributions on self-employed earnings The employer share of Canada Pension Plan (CPP) contributions on self-employed earnings are classified as other deductions. See the eBook chapter on calculating tax payable for an individual for additional information on determining the employer share of CPP payable on self-employed earnings. Overpayments Where a taxpayer is required to repay an amount that was previously included in the taxpayer's income and classified as "other" income (see the eBook chapter on other income), the taxpayer is allowed a deduction for the amount of the repayment. Examples of such repayments include pension benefits and employment insurance. 3 Legal and accounting fees incurred in an objection or appeal Legal and accounting fees incurred with respect to an objection or appeal under the Income Tax Act (ITA) or other legislation are deductible in the year incurred regardless of whether the objection or appeal is successful.

Basic calculation - Capital gain / losses

Capital gain / loss = Proceeds of disposition - Adjusted cost base - Expenses of disposition Proceeds of disposition are generally equal to the selling price of the property, although the amount may be adjusted in certain circumstances (as discussed below). The adjusted cost base (ACB) is generally equal to what was originally paid for the property, although this too is subject to certain adjustments, discussed below. Expenses of disposition include any costs incurred to allow the taxpayer to sell the property. These are deducted in determining the capital gain / loss. For instance, a commission of $1,000 paid to sell shares would be deducted in determining the capital gain / loss on the sale of the shares.

CH5 - Deferral of capital gains on disposition of small business investments

Capital gains realized by an individual on disposition of an investment in shares of an eligible small business corporation may be deferred to the extent that the proceeds of disposition of the shares are reinvested in replacement shares of other eligible small business corporations. An eligible small business corporation is: • A Canadian-controlled private corporation (CCPC) that used substantially all of the fair value of its assets principally in an active business carried on primarily in Canada. • A CCPC where the carrying value of the assets of the CCPC and related CCPCs are equal to or less than $50 million. The following conditions must be met: (i) The individual must have owned the common shares of the eligible small business corporation throughout the 185-day period immediately preceding the sale. (ii) Replacement shares in one or more other eligible small business corporations must have been acquired within 120 days of the end of the year in which the replaced shares were sold. The maximum deferral is as follows: Capital gain × Lesser of proceeds and cost of replacement shares Proceeds of disposal An individual may choose a deferral that is less than the maximum by making a designation on a fewer number of shares. An individual may wish to choose less than the maximum deferral when he or she has remaining capital gains exemption room. (See e-book chapter on the capital gains exemption.) The adjusted cost base of the replacement shares is reduced by the deferred gain.

CH5 - Other deductions - Child care expenses

Child care expenses are generally considered a personal or living expense and thus may not be deducted except as allowed under specific rules. Specifically, the child care expenses must have been incurred to allow a taxpayer to do one of the following: • be employed • carry on a business • carry on research for which a grant was received • attend a designated educational institution or secondary school The parent or supporting individual with the lower net income is allowed the deduction for child care expenses (see exceptions described below). A supporting person includes: • the child's parent • the spouse or common-law partner of the child's parent • an individual who may make a claim for an eligible dependant, infirm dependant over 17, or family caregiver amount for the child (this would include a grandparent if the child lives with the grandparent) Net income before the child care deduction and OAS and/or EI clawback is used to determine which taxpayer is the lower-income earner. In a single-parent family, the supporting person with the lower net income is the single parent because there is no other supporting person.

CH5 - Other deductions - Annual child care expense limits for the lower-income earner

Child's age in the year Attributes Amount Under 7 No disability $8,000 7 to under 16 No disability $5,000 15 or over The child is dependent on the taxpayer as a result of a mental or physical disability that does not qualify for the disability tax credit. $5,000 Any age The child is dependent on the taxpayer as a result of a mental or physical infirmity that qualifies the child for the disability tax credit. $11,000

CH 5 - Capital Gains and Losses Special Rules 2 - 1 - Replacement property rules

Deferral of tax on capital gains on acquisition of replacement property (replacement property rules) and deferral of tax on capital gains on rollover of small business investments are discussed in this chapter. 1 Replacement property rules In some situations where a property is sold and a replacement property is acquired, capital gains and/or recapture arising on disposition of the property may be deferred. The taxpayer includes any capital gain and/or recapture in income for tax purposes in the year in which the property is disposed of. Then, in the year in which a replacement property is acquired, the taxpayer makes an election to defer the capital gain and/or recapture on the property disposed of. When the replacement property is acquired in a taxation year after the year of disposition of the replaced property, the election is made by filing an amended tax return for the year of disposal of the replaced property. The two situations in which the replacement property rules apply are: • An involuntary disposition of property where the property is lost, stolen, destroyed or confiscated. • A voluntary disposition where the taxpayer sells real property used in a business.

CH5 - Deferred capital gains

Deferred capital gains Capital gains may be deferred to the extent the proceeds on the property disposed of are reinvested in a replacement property. The maximum gain that may be deferred is the lesser of the following: (i) Proceeds less original cost (OC) of property disposed of (that is, capital gain determined in the normal manner) (ii) Cost of replacement property less OC of the property disposed of If all of the proceeds received for the replaced property are reinvested in a replacement property, the full amount of the capital gain arising on disposition of the replaced property may be deferred. The cost of the replacement property is reduced by the deferred capital gain. The deferred gain will be taxed on future disposition of the replacement property.

CH5 - Deferred recapture

Deferred recapture is the lesser of the following: (i) (Lesser of proceeds and OC of replaced property) less undepreciated capital cost (UCC) of replaced property [Recapture determined in the normal manner] (ii) Cost of the replacement property If the cost of the replacement property is greater than recapture determined in the normal manner, the full amount of the recapture may be deferred. The capital cost of the replacement property (as determined above after the deferred gain, if any) is reduced by deferred recapture. Tax will be paid on the recapture in the future on disposition of the replacement property.

CH5 - Test your knowledge - Deferral of capital gains on disposition

During the current year, Carol sold shares of Arnco Inc. (Arnco) for $3,200,000. She had originally paid $1,500,000 for these shares. Before the end of the current year, Carol acquired shares of Caron Co. (Caron) at a cost of $1,300,000 and shares of Balwin Inc. (Balwin) at a cost of $1,500,000. All three corporations are eligible small business corporations and Carol owned the Arnco shares for three years before the sale in the current year. Assuming Carol wishes to defer the maximum possible capital gain, determine the deferred gain and the adjusted cost base of the replacement shares. Capital gain on sale of Arnco shares: Proceeds $ 3,200,000 ACB (1,500,000) Capital gain $ 1,700,000 Total deferred gain: $1,700,000 × [2,800,000 / 3,200,000] (1,487,500) Capital gain not deferred $ 212,500 The deferred gain is applied to reduce the adjusted cost base of the replacement shares as follows: Caron Cost of replacement shares $1,300,000 Deferred gains: $1,700,000 × [1,300,000 / 3,200,000] (690,625) ACB $ 609,375 Balwin Cost of replacement shares $1,500,000 $1,700,000 × [1,500,000 / 3,200,000] (796,875) ACB $ 703,125

Allocation of selling price between properties - Capital Gains and losses

If a single selling price is specified in an agreement for the sale of more than one property, and the sales agreement is silent on the allocation of the price, the selling price must be allocated to each property on the basis of the relative fair values of the individual properties. In real estate transactions, it will be necessary to allocate the selling price to the land and building on the basis of the relative fair values of the land and building. If the allocation results in a terminal loss on the building and a capital gain on the land, the ITA requires a reallocation of the proceeds between the land and building to minimize the amount of the terminal loss. (See the eBook chapter on capital cost allowance for the detailed rules of the reallocation mechanism.) The allocation of the selling price between assets must be "reasonable." If it is considered unreasonable, the Canada Revenue Agency (CRA) may reallocate the proceeds. It is important that the allocation be based on hard bargaining and competing interests. This ensures that the agreed-upon allocation cannot be challenged by the CRA.

CH 5 - 1.2 Change in use 1.2.1 Personal to income producing

If a taxpayer ceases to inhabit a home as a principal residence and commences to rent the property, there is a change in use of the property from personal to income producing. The taxpayer is permitted to designate the home as his or her principal residence for up to four years after the year of the change in use as long as no capital cost allowance is claimed against any income earned on the property. A separate election may also be made at the time that the property is rented out to not have changed its use. The consequence is that there is no deemed disposition at fair value at the time of the change in use.

CH 5 - Test your knowledge - personal residence

In Year 1, Max and his wife, Elyse, purchased a home in Kitchener, Ontario, for $460,000. In Year 7, they acquired a cottage on Wasaga Beach, Ontario, at a cost of $300,000. In Year 13, they sold both the home and the cottage. Proceeds on the sale of the house were $544,500, while proceeds on the sale of the cottage totalled $356,000. Both Max and Elyse have worked regularly over the years and have contributed equally to the purchase of the properties. Required Determine the lowest capital gain that Max and Elyse can report in their tax returns for Year 13. Answer Capital gain on Kitchener house ($544,500 - $460,000) $84,500 Capital gain on cottage ($356,000 - $300,000) $56,000 Years Kitchener house owned Year 1 to Year 13 13 years Years cottage owned Year 7 to Year 13 7 years Gain per year on Kitchener house: $84,500 / 13 years $6,500/year Gain per year on cottage: $56,000 / 7 years $8,000 / year Designate as follows: 1. Kitchener house as the principal residence for Year 1 to Year 7 — seven years. 2. Cottage as the principal residence for Year 8 to Year 13 — six years. House Cottage Gain $ 84,500 $ 56,000 Exemption (52,000) (56,000) Capital gain $ 32,500 $ 0 Exemptions: House: [(1 + 7) / 13] × 84,500 = 52,000 Cottage: [(1 + 6) / 7] × 56,000 = 56,000 The optimal solution is to designate the cottage (the property with the highest gain per year) as the principal residence for one year less the number of years owned. This results in the capital gain on the cottage being fully exempt from tax. This leaves an additional year for the Kitchener house, which maximizes the exempt part of the capital gain on the Kitchener house. Max and Elyse will each include a taxable capital gain of [($32,500 × ½) = $16,250 / 2 = $8,125] in their Year 13 net income.

CH 5 - Other Deductions

In general, "other" deductions are amounts that are not associated with earning a specific type of income, such as employment, business, or property income, but are allowed as deductions under the Income Tax Act.

Capital gains reserve

In some cases, on a disposition of a capital property, the vendor may agree to receive payment over a period of time. To align the taxation of the capital gain with the cash available to the vendor (and to ensure that the vendor has sufficient cash to pay the tax), a capital gains reserve may be claimed to defer the payment of tax. The reserve is calculated as the lesser of two amounts: 1. Capital gain × (Proceeds not due * / Total proceeds) 2. 20% of the capital gain × (4 - Number of preceding years ending after the disposition); this ensures the entire amount of the taxable capital gain is brought into income by the end of the fifth year * Due means an enforceable right to immediate payment. The amount included in income each year is calculated as follows: • In the year of the sale: [(Capital gain - Reserve) × Capital gains inclusion rate]. • In each year after the sale: [(Prior-year reserve - Current-year reserve) × Capital gains inclusion rate]. In years after the sale, the previous year's reserve is added back and a new reserve may be claimed if applicable.

CH5 - Listed personal property

Listed personal property (LPP) is a subset of PUP that includes collectibles that do not tend to depreciate in value. LPP includes the following: • prints, etchings, drawings, paintings, sculptures, and other similar works of art • jewelry • rare folios, rare manuscripts, or rare books • stamps • coins Tax consequences of the disposal of LPP: • One-half of gains on the disposal of LPP are taxable. • One-half of losses on disposal of LPP may be deducted against taxable capital gains on the disposal of LPP. • To the extent that an LPP loss may not be used in a year because it is in excess of LPP gains realized in the year, the loss may be carried back three years and forward seven years to be applied against LPP gains realized in the carryover period. • LPP loss carryovers are deducted in the determination of net income; they are not a Division C deduction (deduction from net income to determine taxable income). For the purposes of determining the gain on disposal of LPP: • Adjusted cost base of the property is deemed to be the greater of the original cost of the property and $1,000. • Proceeds of disposal of the property are deemed to be the greater of actual proceeds and $1,000.

CH5 - Division C deductions -Loss carryovers

Loss carryovers Income and/or losses are determined for a specific taxation year (calendar year for individuals). An individual may have income in one year followed by losses in another year. The loss carryover provisions allow an individual to carry losses back or forward to offset taxable income in profitable years. Type of loss Non-capital losses, including farm losses for a full-time farmer Deduction period Three years back and 20 years forward Deductible against Any type of income Type of loss Restricted farm losses Deduction period Three years back and 20 years forward Deductible against Only against income from a farming business Type of loss Allowable business investment losses (unrestricted) Deduction period Three years back and 10 years forward Deductible against Any type of income Type of loss Net capital losses Deduction period Three years back and forward indefinitely Deductible against Only against taxable capital gains realized in the year

CH 5 - Other Deductions

Moving expenses 6.1 Categories of taxpayers Moving expenses are deductible under the following two scenarios: 1. Moving to a new business or employment location in Canada In this situation, moving expenses are deductible to the extent of employment or business income earned in the new work location. There is no requirement for the employee to have a new employer; it is only necessary to have a new work location. 2. Moving to attend a qualifying post-secondary educational institution on a full-time basis In this situation, moving expenses are deductible to the extent of scholarships, fellowships, or research grants included in income, as well as income from a part-time job used to finance the education. It is important to note that scholarships and fellowships are generally not included in income. 6.2 Conditions for deduction • The move must result in the new residence being at least 40 kilometres closer to the new work location / school than the old residence. The 40-kilometre distance is measured by the nearest land route. • Moving expenses that exceed income from the new work location / school in the year of the move may be carried forward and deducted from income earned at the new work location /school in subsequent years. • The moving expenses must have been paid. The taxpayer must not have been reimbursed for the moving expenses. 6.3 Eligible moving expenses Moving expenses eligible for deduction include: • travelling costs (including meals and lodging) from the former residence to the new residence (see discussion below for optional measurement of meals and automobile costs) • transportation and storage costs incurred in moving household effects • the cost of meals and accommodation near the old residence or an acquired new residence for a period not exceeding 15 days o Days to travel from the former residence to the new residence do not count toward the 15-day maximum. o If the taxpayer takes a house-hunting trip to the new location, only the meals and accommodation for the days after the lease is signed or the new house is purchased may be included here. Days prior to signing a new lease / buying the new property do not qualify. Travel costs (such as flights) are not deductible for house-hunting trips. • lease cancellation costs on the old residence • selling costs of the old residence, including advertising costs, legal fees, real estate commissions, and penalties for early termination of a mortgage • if the old residence has been sold, the cost of legal fees and title transfer taxes on the new residence (excluding GST) • the cost of maintaining a vacant former residence (including mortgage interest, property taxes, and insurance premiums) to the extent of the least of: i) the actual amount of maintenance expenses ii) $5,000 • the cost of changing the address on legal documents, replacing automobile and driving licences, and utility hookups and disconnects A taxpayer may opt to use a simplified method of calculating meal and motor vehicle costs near the old or new residence for the 15-day maximum. The simplified method does not require receipts and allows the taxpayer to claim: • a flat rate of $17 per meal, to a daily maximum of $51 • a per-kilometre rate, found on the Canada Revenue Agency website, that varies by province; the rate for the originating province or territory is used in this calculation

CH 5 - Other Deductions

Old Age Security clawback Higher-income earners may have to repay all or part of Old Age Security (OAS) payments received in a year. For 2018, the repayable amount is the lesser of: i) OAS benefits received in the year $XXXX ii) Net income before the clawback $XXXX Less (1) (75,910) Excess, if any $XXXX • 15% of the excess, if any $XXXX Net income used to determine the OAS clawback is net income after incorporating all other income inclusions and deductions except the OAS clawback. The required repayment is deducted in determining net income and added to the individual's tax payable for the year.

CH5 - Personal-use property

Personal-use property (PUP) is property used primarily for the taxpayer's personal use and enjoyment. In other words, PUP is property owned by the taxpayer that is not used for producing income. PUP tends to depreciate over time. Examples of PUP include an individual's personal items, such as the following: • vehicles • boats • furniture • clothing • all other personal and household items Tax consequences of disposal of PUP: • One-half of gains on disposal of PUP are taxed. • Losses are denied. For the purposes of determining the gain on the disposal of PUP: • Adjusted cost base of the property is deemed to be the greater of the original cost of the property and $1,000. • Proceeds of disposal of the property are deemed to be the greater of actual proceeds and $1,000. This rule results in no gain being realized on the disposal of a PUP that is bought and sold for less than $1,000. Property owned by a corporation for the personal use of related individuals is considered PUP.

CH5 - Test your knowledge - Deferred Capital Gains

Test your knowledge Bob operates a sole proprietorship. As part of his plans for expansion of the business, Bob sold the property originally used in his operations. When Bob had purchased this property, he had made an election to include the cost of the building in a separate Class 1 for capital cost allowance (CCA) purposes. Details of the property sold are as follows: Land Building Selling price $489,000 $503,000 Original cost 325,000 456,000 UCC 328,000 In the same year, Bob acquired a replacement property in a new industrial area, with a substantially larger building: Land Building Cost $434,000 $487,000 Determine the maximum capital gains and/or recapture Bob may defer and determine the capital cost and UCC of the replacement property. Answer Deferred capital gains are the lesser of: Land Building (i) Capital gain: proceeds less OC • $489,000 - $325,000 $164,000 • $503,000 - $456,000 $47,000 (ii) Cost of replacement property less OC of property disposed of: • $434,000 - $325,000 $109,000 * • $487,000 - $456,000 $31,000 * All of the proceeds of disposal of the replaced property have not been reinvested in the new property; therefore, the full amount of capital gains may not be deferred. Deferred recapture is the lesser of: (i) Normal recapture: $456,000 - $328,000 $128,000 * (ii) Cost of replacement property $487,000 ACB / Capital cost and UCC of replacement property: Land Building Cost of replacement property $ 434,000 $ 487,000 Deferred gain (109,000) (31,000) ACB / Capital cost $ 325,000 $ 456,000 Deferred recapture (128,000) UCC of replacement building $ 328,000 Deferred gains and deferred recapture will be taxed on future disposition of the replacement property.

CH5 - Other deductions - moving expenses

Test your knowledge During the current year, Juana was transferred by her employer from the Toronto office to the Calgary office. She has estimated her moving expenses as follows: Cost of trip to Calgary prior to move to find new home $ 925 Three-day drive to Calgary to move to new home: • gas 280 • meals 95 • accommodation 150 Moving van rental 6,500 Selling cost of Toronto home 15,800 Legal and title transfer fees on new home 1,650 Total $25,400 The CRA per-kilometre amounts are as follows: Alberta $0.435 Ontario 0.540 The driving distance from Toronto to Calgary is 3,500 kilometres. Juana's employer has offered to reimburse her for actual expenses incurred but is open to negotiation. Assume the estimated expenses above are very close to actual expenses incurred. Required Advise Juana on whether she should accept the reimbursement or negotiate different terms. If you think Juana should negotiate different terms, explain what those terms should be. Answer If Juana accepts a reimbursement of her moving expenses, the amount of the reimbursement is not included in her employment income (is not a taxable benefit), and as a result, Juana may not deduct moving expenses. Juana should renegotiate the terms for her move as follows: She should ask to be reimbursed for the cost of the house-hunting trip to Calgary. The cost of the house-hunting trip is not an eligible moving expense and the reimbursement for the cost of the trip is not a taxable employment benefit. She should request an allowance of approximately $24,200 for the remainder of the moving expenses ($25,100 - $925 = $24,175). The allowance is a taxable employment benefit, so it is included in Juana's employment income; however, she may deduct the following moving expenses: Three-day trip from Toronto to Calgary • mileage: 3,500 kilometres × $0.555 (1) $1,943 • meals: $51 × 3 days (2) 153 • accommodation 150 Cost of moving household effects 6,500 Selling cost of old house (3) 15,800 Legal and title transfer fees for new house (4) 1,650 Total deduction $26,196 Juana's employer should be indifferent between the two alternatives, as the total cost is the same, and in both cases the amount is fully deductible to the employer.

CH 5 - Principal residence formula

The formula for calculating the exempt portion of the gain is as follows: Total gain × (1 + years designated) Years the property was owned If a taxpayer buys or sells a property partway through a year, for the purposes of determining the number of years that a property was owned (the denominator above), each part-year counts as a full year. If a taxpayer sells a home and purchases another home in the same year, the taxpayer will have owned two homes in the same year but can only designate one as a principal residence for that year. The "1 +" in the formula above ensures that any gain arising in the year in which the first property is sold and another property is purchased may be exempt from tax. Where a family unit owns more than one residence in a year, the family unit may only designate one of the residences as a principal residence for that particular year. In order to maximize the PRE, a taxpayer should designate the property with the highest gain per year as the principal residence for the years in which more than one residence is owned. When determining the "years designated" in the formula above, the exemption may be maximized by designating the residence with the higher gain per year as the principal residence for one year less than the number of years that the property was owned. This leaves one year to be used for the other residence.

CH 5 - Special Rules 2 - Summary

The criteria for deferral are as follows: Voluntary dispositions: Method of disposal Taxpayer sells property Type of property rules are applicable to Real property (land or land and a building) Use of property Property must have been used in a business Type of property acquired as a replacement property Property must have been acquired for the same or similar use as the property disposed of Timing of acquisition of replacement property Within 12 months following the end of the taxation year in which the former property was sold Involuntary dispositions: Method of disposal Property is lost, stolen, expropriated or destroyed (because of a fire or natural disaster, for example) Type of property rules are applicable to Generally any kind of capital property except vacant land Use of property Property does not have to have been used in a business or to earn income Type of property acquired as a replacement property Property must have been acquired for the same or similar use as the property disposed of Timing of acquisition of replacement property Within 24 months following the end of the taxation year in which the former property was disposed of For voluntary dispositions, the date of disposition is the date the purchaser of the replaced property takes legal title to the property. For involuntary dispositions, the date of disposition is considered the earliest of the following: • The day the taxpayer has agreed to the full amount of compensation. • The day the compensation is determined by a court or tribunal.

CH5 - Personal Division C deduction

The following Division C deductions are addressed in this document: Net income for tax purposes (Division B income) $XXXX Less Division C deductions: Section 110 deductions Employee stock options (XXXX) Deduction for payments: Guaranteed Income Supplement (XXXX) Social assistance payments (XXXX) Workers' compensation payments (XXXX) Amounts exempt from tax under a tax treaty (XXXX) Section 111 deductions Loss carryovers (XXXX) Section 110.6 deductions Lifetime capital gains deduction (XXXX) Section 110.7 deductions Deductions for northern residents (XXXX) Taxable income $ XXXX 1 Employee stock options The determination of the employee stock option benefit is addressed in the e-book chapter on employment income. The stock option benefit included in employment income is based on the difference between the fair value of the shares on the date that the option is exercised and the exercise price. If an individual is eligible for a Division C deduction related to this employment benefit, the deduction is one-half of the employment income inclusion. The result is that for each option exercised, one-half of the difference between the fair value of the share on the exercise date and the exercise price is included in taxable income, similar to a capital gain. The availability and timing of the Division C deduction is different for employees of public companies and employees of Canadian-controlled private corporations (CCPCs). In both cases, the shares acquired must be common shares, and an arm's length relationship must exist between the company and the individual acquiring the shares both before and after the option is exercised. Rules Employee of a public company Employee of a CCPC Conditions Fair market value of the share on the grant date is equal to or less than the exercise price (option is not in the money on the grant date). Fair market value of the share on the grant date is equal to or less than the exercise price (option is not in the money on the grant date). OR Fair market value of the share on grant date is greater than the exercise price (option is in the money on the grant date), but the shares acquired under the option plan are held for at least two years after the option is exercised. 1 Timing of deduction Year the option is exercised (same year as the employment income inclusion). Year the shares are sold (same year as the employment income inclusion). 2 Deduction for payments This deduction is for certain amounts that are included in net income for tax purposes (Division B). The following amounts are deductible under Division C: • Guaranteed Income Supplement • social assistance payments • workers' compensation • amounts that are exempt from tax in Canada by virtue of a tax treaty with another country A variety of tax credits (both refundable and non-refundable) are reduced by some version of an individual's Division B income (net income). All of the amounts noted above are included in net income for tax purposes (Division B income); therefore, they affect the individual's eligibility for certain tax credits. As it is not the government's intention to tax these amounts, they are deducted under Division C to offset the inclusion of the payments in net income for tax purposes.

Business investment losses

The lifetime capital gains exemption provides a tax incentive for investing in a successful small Canadian business (see the eBook chapter on the lifetime capital gains exemption). The business investment loss rules provide tax relief for investing in shares or debt of a failed small Canadian business. A business investment loss results from the actual or deemed disposition of certain capital properties. This may arise on the disposition of shares or debt of a small business corporation (SBC). An SBC is a Canadian-controlled private corporation where all or substantially all of its assets (90%) are used in an active business carried on primarily in Canada. A business investment loss (BIL) is the full amount of the loss, and an allowable business investment loss (ABIL) is one-half of the BIL. In the year that an ABIL is realized, it is deductible against any source of income. If it cannot be used in that year, it may be carried back three years and forward 10 years and deducted against any source of income in those years. If the taxpayer is unable to use up the ABIL in the carryover period, it is added to the taxpayer's net capital loss carryover balance. If a taxpayer has made a claim for a capital gains exemption in a preceding year or in the current year, some amount of the BIL will be restricted. The restricted amount of the BIL becomes an ordinary capital loss. The restricted portion of the BIL is determined as being the lesser of: • the BIL for the year (before deducting the restricted portion) • the cumulative capital gains deduction claimed in preceding years × a factor for that year Factors: • 2/1 for years before 1988 • 3/2 for 1988 and 1989 • 4/3 for 1990 to February 27, 2000 • 3/2 for February 28, 2000, to October 17, 2000 • 2/1 for October 18, 2000, and subsequent years

CH 5 - Capital Gains and Losses - Principal residence exemption

The principal residence exemption (PRE) allows Canadian taxpayers to be exempt from paying tax on all or a part of a capital gain arising on the disposal of the taxpayer's principal residence to the extent that the taxpayer has designated the residence as his or her personal residence for one or more years. A principal residence: • includes any housing unit (house, condo, cottage, mobile home, and so forth) • must have been ordinarily inhabited at some time during the year by the taxpayer or the taxpayer's spouse, common-law partner, former spouse, former common-law partner, or child Exemption is limited to the building and half a hectare of land, unless the taxpayer can prove that the excess land is necessary for the taxpayer's use and enjoyment of the property. The excess land must clearly be necessary for the housing unit to fulfil its function as a residence and not simply be desired. Only one residence may be designated as a principal residence for a family unit for a given year. A family unit includes the taxpayer's spouse or common-law partner and their single children under 18 years of age at the end of

Proceeds of disposition

The proceeds of disposition of a property are generally equal to the agreed-upon selling price. In a sale of property between unrelated parties, the buyer and seller will normally negotiate a purchase price / selling price equal to the fair market value of the property. In a non-arm's length transaction, the agreed-upon selling price may not equal the fair value of the property. (See the eBook chapter on non-arm's length transactions for tax consequences of a non-arm's length transaction where the selling price does not equal fair value). Proceeds of disposition include the following: • cash • notes receivable • other property • assumption of debt

Options - Capital Gains and Losses

There are two types of options: 1. Call option — The grantee pays an amount to the grantor for the right to purchase a property from the grantor. 2. Put option — The grantee pays an amount to the grantor for the right to sell a property to the grantor. In the year the option expires, the grantee is considered to have realized a capital loss equal to the option price. In the year the option is granted, the grantor is considered to have realized a capital gain equal to the option price. If the option is exercised in a year subsequent to the year in which the option is granted, the grantor files an amended tax return to remove the taxable capital gain previously included in income. This table describes the treatment of the option price when different types of options are exercised: Type of option Call option Put option Grantee The option price is added to the purchase price of the property. Grantor The option price is added to the selling price of the property. Grantee The option price is deducted from the proceeds of sale. Grantor The option price is deducted from the ACB of the property. If the option is sold prior to being exercised (that is, prior to purchasing the property), a gain or loss will result from the disposition of the option to the extent that the selling price is different from the original price of the option.

CH5 - Taxes Payable — Personal

This chapter reviews the calculation of taxes payable for an individual. The first part of this chapter deals with a comprehensive approach to the determination of income taxes payable for an individual. It mirrors the detailed federal calculations found on a T1 General personal tax return. Taxable income is the starting point in determining personal income tax payable. Taxable income is net income (Division B income) less Division C deductions. The determination of net and taxable income is addressed in other eBook chapters. 1 Calculating taxes payable There are a number of components in the calculation of taxes payable for an individual. It is important to carefully consider the individual's circumstances in order to determine which components of the calculation are applicable. The following chart provides a summary of the components required to calculate individual taxes payable. Calculation of taxes payable for an individual Gross federal tax on taxable income $XXX Subtract: Non-refundable federal tax credits (XXX) Federal dividend tax credit (XXX) (XXX) Basic federal tax XXX Subtract: Federal foreign tax credits (XXX) Federal tax XXX Subtract: Federal political contributions tax credit (XXX) Other federal tax credits (XXX) (XXX) Federal tax before clawbacks or repayments XXX Add: Old Age Security (OAS) clawback XXX Employment insurance (EI) repayment XXX Canada Pension Plan (CPP) payable on self-employed earnings XXX XXX Net federal tax XXX Add: Provincial tax (XXX) Provincial surtax (if any) (XXX) Total federal and provincial tax payable XXX Less: Income tax deducted at source (XXX) Overpayments of CPP or EI (XXX) Federal refundable tax credits, if any (XXX) Tax paid by instalments (XXX) Provincial refundable tax credits, if any (XXX) (XXX) Balance of tax payable or (refund) $XXX ===== 2 Calculate gross federal tax on taxable income The first step is to determine gross federal tax before deducting tax credits. Gross federal tax is determined by applying federal tax rates to taxable income. The rates vary from 15% in the lowest tax bracket to 33% in the highest tax bracket. The brackets are indexed to inflation, so the dollar limits for the brackets change each year. A progressive tax system is used. The federal tax brackets for 2018 are as follows: 2.1 Marginal tax rate A taxpayer's marginal tax rate is the tax rate that is payable on an additional dollar of income. The marginal tax rate for an individual increases as income rises. 2.1.1 Test your knowledge Calculate gross federal tax payable for individuals with the following taxable incomes: 1. $40,000 2. $100,000 3. $240,000 In addition, what is the marginal tax rate for each individual? Answer Federal taxes payable: 1. $40,000 = $6,000 ($40,000 × 15%) 2. $100,000 = $18,311 [$16,545 base tax + 26% × ($100,000 - $93,208)] 3. $240,000 = $58,942 [$47,670 base tax + 33% × ($240,000 - $205,842)] Marginal tax rates: 1. 15% 2. 26% 3. 33% 3 Calculate non-refundable federal tax credits The second step is to calculate non-refundable federal tax credits. Non-refundable credits that cannot be used in the current year, due to federal tax before considering tax credits being too low, do not form the basis for a refund. These credits may not be carried forward. Thus, if these credits cannot be utilized in the year, they are lost. Federal non-refundable tax credits are a direct reduction in tax payable; they are not deducted in determining either net or taxable income. First, the basis for all credits is accumulated and totalled, and then the total is multiplied by 15% to determine the reduction in income tax payable. The rate applied to the non-refundable tax credits is the rate for the lowest federal tax bracket (15%). The following table describes most of the non-refundable tax credits available to individuals. The basis for many of the tax credits is indexed annually to inflation.

CH 5 - Summary The differences between the rules for regular property, PUP, and LPP are summarized

Type: Capital property other than PUP and LPP Gains: Taxable (at an inclusion rate of 50%) Losses: May be utilized against any form of capital gain. Unused losses may be carried back three years and forward indefinitely but may only be deducted against taxable capital gains realized in the carryover period. Net capital loss carryovers are deducted under Division C (deduction from net income to determine taxable income). Type: PUP Gains: Taxable (at an inclusion rate of 50%) Proceeds are deemed to be the greater of actual proceeds and $1,000. Cost is deemed to be the greater of actual cost and $1,000. Losses: Denied Type: LPP - Listed personal property Gains: Taxable (at an inclusion rate of 50%) Proceeds are deemed to be the greater of actual proceeds and $1,000. Cost is deemed to be the greater of actual cost and $1,000. Losses: LPP losses may be deducted against LPP gains realized in the year. Unused LPP losses may be carried back three years and forward seven years and may be deducted against LPP gains realized in those years. LPP net capital loss carryovers are deducted against LPP gains included in Division B income (that is, deducted in determining net income).

CH5 - Deferred Income Plans (RRSP, TFSA, RESP) - no test of knowledge

Whole chapter This document will discuss the following deferred income plans: • Registered Retirement Savings Plan (RRSP) • Tax-Free Savings Account (TFSA) • Registered Education Savings Plan (RESP) 1 Registered Retirement Savings Plan 1.1 Introduction Prudent financial planning for any individual generally involves adequate saving for retirement. A cornerstone of this planning usually involves taking advantage of Registered Retirement Savings Plan (RRSP) deductions. An individual may contribute to an RRSP up to their RRSP deduction limit which is discussed below. The amount contributed to an RRSP, up to an individual's RRSP deduction limit, can then be deducted for tax purposes, which reduces the taxes otherwise payable in the year. The amount contributed to an RRSP grows within the plan on a tax-deferred basis. The proceeds from an RRSP are taxed when they are withdrawn. Anyone with RRSP contribution room can contribute to an RRSP, up to and including in the year that the contributor turns 71 years of age. 1.2 Contributions The deadline for making a deductible contribution in a particular calendar year is 60 days after the end of that year. For example, a contribution may be made before 20X1, during 20X1 or on or before March 1, 20X2, to be deductible against 20X1 income. Contributions may be deducted against all types of income. This results in the deferral of tax until the RRSP amount is withdrawn. As a matter of practice, the earlier an RRSP contribution is made, the better, as there is a longer time during which the income is compounding without tax. Deductions of contributions are limited to an individual's RRSP deduction limit, which is calculated each year (see next section). A penalty is imposed on over-contributions equal to 1% per month. A $2,000 over-contribution is allowed without penalty. See the e-book chapter on other income for a discussion on retirement allowances that may be transferred to RRSPs. 1.2.1 Contributions to individual's or spouse's RRSP If an individual has available RRSP contribution room for themselves, the individual may contribute funds to their own RRSP or to the RRSP owned by their spouse (which includes a common-law partner). If the individual contributes to the spouse's RRSP, the contributor will receive the deduction against their income (not the spouse). This contribution has no impact on the spouse's RRSP contribution room. If a contribution is made to a spouse's plan, and the spouse subsequently withdraws the funds in the year of contribution or the two years following, the amount withdrawn will be included in the contributor's income. An exception to this rule exists if the spouses or common-law partners were living separate and apart at the time of the withdrawal by reason of a breakdown of their marriage. 1.3 RRSP deduction limit The RRSP deduction limit outlines the maximum RRSP contributions that can be deducted for a given year. 1.3.1 Deduction limit formula The formula for calculating a taxpayer's RRSP deduction limit for a taxation year is determined as follows: A + B + R - C Where A is the unused RRSP deduction room from the prior year. B is the amount, if any, by which a) the lesser of: i. the RRSP dollar limit for the year, and ii. 18% of the taxpayer's earned income for the preceding taxation year exceeds the total of all amounts, each of which is b) the tax payer's pension adjustment for the preceding taxation year in respect of an employer, or c) a prescribed amount in respect of the taxpayer for the taxation year. * R is the taxpayer's total pension adjustment reversal for the year. C is the taxpayer's net past service pension adjustment for the prior year. 1.3.2 Unused RRSP deduction room The basic intent of the unused RRSP deduction room is to allow an individual who does not contribute the maximum for any given year to make up the difference later in any future year. The unused RRSP deduction room at the end of the preceding year represents the cumulative total of all RRSP deduction limits from previous years, less any amount deducted in those years. 1.3.3 RRSP dollar limit The RRSP dollar limit is indexed for inflation each year. The limits for 2016 to 2018 are as follows: 2016 $25,370 2017 $26,010 2018 $26,230 1.3.4 Earned income for RRSP purposes The unused deduction room is limited by 18% of the prior year's earned income. For example, in calculating the 20X2 RRSP deduction, the relevant earned income will be that of 20X1. "Earned income" for RRSP purposes consists of: • income from office or employment including all taxable benefits, less all employment-related deductions, without any deduction for registered pension plan (RPP) contributions made by the employee, employee contributions to a retirement compensation arrangement or a clergyman's residence • income from a business (carried on by the taxpayer, either alone or as a partner actively engaged in the business) • income from the rental of real property • royalty income from authorship or invention • support (alimony / maintenance) income • research grants received • disability pension benefits received after 1990 by an individual under the Canada Pension Plan or the Quebec Pension Plan Earned income is decreased by the following more common items: • loss from business • loss from the rental of real property • support (alimony / maintenance) deducted Passive income sources such as interest, dividends and income from a limited partnership are not included in "earned income." In summary, earned income does not include pension benefits (other than a disability pension, as outlined above), retiring allowances, EI benefits, death benefits, investment income, taxable capital gains, amounts received from RRSPs and so on. 1.3.5 Pension adjustment The pension adjustment (PA) is intended to measure the value of the RPP or deferred profit-sharing plan (DPSP) benefits that accrue to an individual during a particular calendar year. Recall that individuals receive a deduction from income for their RPP or DPSP (refer to the Other Deductions e-book chapter). Therefore, the PA reduces the RRSP deduction limit. The PA must be calculated by the employer and reported on the employee's T4 each year. The PA for the various plans is calculated as follows: • PA for a DPSP = employer contributions • PA for a defined contribution RPP = employer contributions + employee contributions • PA for a defined benefit RPP = (9 × amount of benefits earned in the RPP) - $600 Note that the PA for the preceding year is used to calculate the RRSP deduction limit for the current year. For example, the 20X1 PA is used to calculate the 20X2 RRSP deduction limit. 1.3.6 Pension adjustment reversal A pension adjustment reversal (PAR) arises when an employee who has previously been granted credit for service loses entitlement to the credit for service. It is used to restore an individual's RRSP room when an individual terminates their membership in a DPSP or in a benefit provision of an RPP. For example, an employer has an RPP where the benefits vest after five years. An employee decides to leave after two years. The employer was required to report PAs for the employee for the first two years. When the employee leaves, the employer will calculate the PAR so the employee does not lose their RRSP deduction limit because they will not be entitled to the employer's portion of the contributions because they did not vest. The PAR is calculated as the difference between the PAs and past service pension adjustments (PSPAs) reported and what the employee receives from the plan, which will be less. Note that employees are entitled to their own contributions to the pension plan by law, so the calculation will only apply to employer contributions. 1.3.7 Past service pension adjustments If there has been an increase in benefits for an individual's defined benefit RPP relating to prior years, the PSPA will reduce the RRSP deduction limit in the year that credit is granted for past service. The PSPA is calculated as the difference between new PA amounts for the years impacted less the PAs that have already been applied in those years. For instance, an individual has been a member of a defined benefit plan since 2016 with a retirement benefit of 1% of pensionable earnings for each year of service. In 2018, the benefit formula increased to 1.5% and was applied retroactively. If the individual has $40,000 in pensionable earnings each year starting in 2016, the PSPA for 2018 would need to be calculated for 2016 and 2017. The PSPA would be $40,000 × 9 × 2 years × (1.5% - 1%) = $3,600. The 2019 RRSP deduction limit is based on the 2018 PA, the 2018 PA will reflect the new rate, so 2018 is not included in the calculation. 1.4 Withdrawals Review the e-book chapter on Other Income for a refresher on how amounts withdrawn from deferred income plans are taxed. If an amount is withdrawn from an RRSP, it must be included in income unless received under the Home Buyers' Plan or Lifelong Learning Plan (discussed further below). A certain percentage will be withheld as a partial payment toward the tax that will be assessed on the withdrawal. These withdrawals are treated as ordinary income regardless of whether they were earned as dividends or as capital gains within the plan. 1.4.1 Withdrawal of RRSPs on marriage breakdown Where there is a property settlement between spouses as a consequence of a marriage breakdown, there may be an agreement to split the RRSPs. The general rule is that a withdrawal from an RRSP is taxable to the beneficiary of the RRSP. However, where there is a transfer of an RRSP or part of an RRSP to a spouse or former spouse in settlement of a written agreement on breakdown of marriage, there is no income inclusion and corresponding deduction to either party. 1.4.2 Home Buyers' Plan Using the Home Buyers' Plan (HBP), a person can effectively "borrow" from their own RRSP to fund the purchase of a home. In very general terms, the following apply: • The withdrawal must be for a home that will be the residence of the taxpayer. • The taxpayer cannot have owned a home in the prior four full calendar years. • The maximum withdrawal available is $25,000. A taxpayer and their spouse or common-law partner can each use $25,000. Repayment of the amount must be made in equal annual instalments over a 15-year period commencing in the second taxation year following the calendar year in which the withdrawal is made. To the extent that the repayments are not made, the amounts will be included in income for tax purposes. No deduction will be permitted for RRSP contributions made less than 90 days before its withdrawal under the plan. 1.4.3 Lifelong Learning Plan The Lifelong Learning Plan (LLP) allows an individual to withdraw funds from their RRSPs to finance their education and the education of their spouse or common-law partner, without including the withdrawal in computing income. The withdrawal period is limited to four calendar years, with a maximum withdrawal of $10,000 per year and an overall total limit of $20,000. In general, the individual must be enrolled at a designated education institution in full-time training or higher education requiring not less than 10 hours per week for at least three consecutive months in the year. 1.5 Termination RRSPs must be terminated in the year that an individual turns 71. However, a taxpayer can still deduct contributions made to a spouse or common-law partner's RRSP after turning this age (assuming that the spouse is younger than 71). RRSP funds are commonly transferred on a tax-free basis to registered retirement income funds (RRIFs). RRIFs are similar to RRSPs; however, deductible contributions cannot be made to an RRIF. Further discussion on this topic is beyond the scope of PEP. 2 Tax-Free Savings Account Starting in 2009, an individual who is resident in Canada and is over 17 years old can establish a Tax-Free Savings Account (TFSA). A TFSA is different from an RRSP in that contributions are not deductible. The benefit of a TFSA is that no withdrawals are taxable. 2.1 Contributions In 2018, a contribution of $5,500 can be made to a TFSA. The amount is indexed for inflation if the Canada Revenue Agency (CRA) indexation factor results in a $500 increment. The CRA indexation adjustment amount for 2018 was 1.5%. $5,500 × 1.5% = $68.75, which is less than $500. Any portion of the contribution limit not used in one year will carry forward to the next year, similar to an RRSP. The contributions to the plan are not tax-deductible; however, the income earned in the plan is not taxable. Excess contributions are subject to a penalty tax of 1% per month for each month that the excess remains in the plan. Similar to RRSPs, if a taxpayer borrows money to invest in the plan, the interest will not be deductible. The TFSA can be invested in the same types of investments as an RRSP. 2.2 Withdrawals There is no income inclusion when funds are removed from the plan. Funds removed from the plan can be added back to the plan starting in the following calendar year. In other words, the contribution limit is increased in the following year for any withdrawals that are made. 2.3 Other rules Attribution rules will not apply where one spouse gives the other spouse the funds to establish the plan. In other words, the TFSA can be used for income splitting. On divorce, the TFSA may be transferred without any tax consequences. On death, if the plan is transferred to the spouse, it will remain a TFSA and income will continue to accumulate tax-free. If, on death, the plan is transferred to someone other than a spouse, the income earned in the plan after death will be taxable. 3 Registered Education Savings Plan A Registered Education Savings Plan (RESP) is a valuable tool in assisting individuals to save for their children's education. The benefit of an RESP is that it can result in significant tax deferral and savings as well as government grants. A contribution to an RESP is not tax-deductible when it is made, and the eventual withdrawal of the "capital" portion by the original contributor is not taxable. This is different from a contribution to or withdrawal from an RRSP. The tax benefits from RESPs arise because the tax on investment income earned in an RESP is: • deferred until some future year (discussed below) • taxed in the beneficiary's hands in a future year when post-secondary education is pursued In other words, while the "capital" is in the RESP, no tax is paid on the accumulating income. The beneficiary is taxed upon withdrawal from the RESP. However, the beneficiary is usually at a lower tax rate than the contributor and generally has tuition tax credits. 3.1 Contributions There is no annual maximum that may be contributed to an RESP, but there is a lifetime maximum of $50,000 per beneficiary (exclusive of the Canada Education Savings Grant). In the case of a single beneficiary RESP (non-family plan), contributions can be made up to and including the 31st year of the plan's existence (35 years if the beneficiary is disabled). 3.2 Canada Education Savings Grant RESPs are eligible for the Canada Education Savings Grant (CESG). Each beneficiary of an RESP who is a resident of Canada and under 18 years of age accumulates CESG contribution room of $2,500 per year for a maximum annual grant of 20% × $2,500 = $500. The maximum aggregate lifetime CESG is $7,200. For low-income families, there is an additional 10% or 20% of the first $500. For 2018, the calculation for the CESG for an annual contribution of $2,500 is as follows. Net family income for 2018 Below $46,606 $45,606 to $93,208 Above $93,208 CESG on first $500 $500 × 40% = $200 $500 × 30% = $150 $500 × 20% = $100 CESG on remaining $2,000 $2,000 × 20% = $400 $2,000 × 20% = $400 $2,000 × 20% = $400 Maximum annual CESG $600 $550 $500 Lifetime CESG $7,200 $7,200 $7,200 3.3 Canada Learning Bonds Canada Learning Bonds (CLBs) are government contributions to an RESP, similar to CESGs, but they are not based on the amount of contributions. Children must be born after 2003 and have an RESP established in their name in order to qualify. Their family must also qualify for the National Child Benefit supplement each year in order to receive CLB contributions. CLBs are $500 in the first year of eligibility and $100 each subsequent year that the child is eligible until the year the child turns 15. In the first year, there is also a one-time additional amount of $25 for the cost of setting up the RESP. 3.4 Withdrawals A withdrawal from an RESP to fund a beneficiary's post-secondary education is called an education assistance payment (EAP). In general terms, when EAPs are made out of the RESP, a specified portion is deemed to be from the CESG and CLB. This portion of the payment is taxable income to the student. Also, any portion of the payment that represents accumulated income earned in the plan is taxable income to the student. The "capital" portion is not taxed because the capital funds contributed to the plan were paid out of after-tax income. An RESP can exist for 35 years before it must be closed. If a beneficiary does not wish to pursue post-secondary education immediately, it is recommended that the subscriber wait a few years until the beneficiary is certain. If the beneficiary does not pursue post-secondary education, the income and capital can be paid to the subscriber. The CESG and CLB contributions must be repaid to the government. The accumulated income earned in the plan is taxable to the subscriber, but this can be avoided if the subscriber has RRSP contribution room available, in which case the RESP funds can be transferred into the RRSP. The "capital" portion is not taxed. 4 Comparison of RRSPs, TFSAs and RESPs In a number of circumstances, an individual may make contributions to certain deferred income plans over and above the "normal" contributions. RRSP TFSA RESP Contributions to the plan are deductible in the calculation of net income for tax Yes No No Earnings in the plan are taxed No, but they are taxed when withdrawn No No, but they are taxed when withdrawn. Withdrawals are taxed Yes, unless withdrawn under HBP or LLP No Yes, but only earnings on contributions are subject to tax. However, the individual receiving the RESP (a student) is likely to be at a lower tax bracket than the person who made the contributions. Eligible for CESG No No Yes Eligible for CLB program No No Yes

Individual Filing Tax Return

1. tax is payable; 2. the individual has a taxable capital gain or disposes of taxable Canadian property in the year; 3. the Minister of National Revenue has issued a "demand to file"; 4. the individual has a positive Home Buyers' Plan or Lifelong Learning Plan balance at year end; or 5. a non-resident individual has a taxable capital gain

Other Income - Annuities

An annuity is defined as an amount payable on a periodic basis. If an annuity is acquired within a tax-deferred plan as noted above, the full amount of the payment received is taxed when amounts are received. Annuities may also be acquired outside a deferred income plan. For example, a taxpayer may use accumulated savings to acquire an annuity plan from an insurance company that pays a fixed amount per year for some period of time. The full amount of the annuity payment received in the year is included in the taxpayer's income, and a deduction is allowed for the capital element. The deduction is determined as follows: (Amount paid to acquire the annuity / Total payments to be received) × (Annuity payment)

Capital dividends

Capital dividends are paid out of the capital dividend account of a CCPC and are received on a tax-free basis. (See the eBook chapter on capital gains for additional information.)

2018 gross-up and federal dividend tax credit rates

Dividend gross-up Eligibledividends 38% Non-eligible dividends (1) 16% Dividend tax credit as a fraction of the gross-up 6/11 ( Eligible ) Dividend tax credit as a fraction of the gross-up 8/11 ( Non- Eligible ) Dividend tax credit as percentage of the actual dividend 20.727% ( Eligible ) 11.636% ( Non-Eligible )

Other income - OAS

OAS payments are made by the government of Canada to any individual 65 years of age or older who has been resident in Canada for a minimum of 10 years. OAS payments are included in income. Higher-income earners may be required to pay back some or all of their OAS

Misrepresentations in tax planning arrangements

Penalty is the greater of: • $1,000 • 100% of gross revenue derived by person from activity

Selling price less than original cost

Test your knowledge In 20X1, Susanne acquired a rental property for $950,000, of which $400,000 was attributable to the land and $550,000 was attributable to the building. In 20X4, at a time when there was a downturn in the real estate market, she sold the rental property to her daughter Jovette for $850,000, with $400,000 of the selling price attributable to the land and $450,000 of the selling price attributable to the building. The UCC of the building was $475,000 at the time of the sale. During 20X6, Jovette sold the property for $1,080,000, with $500,000 of the selling price attributable to the land and $580,000 of the selling price attributable to the building. During the time Jovette owned the property, she did not claim any CCA. Required What are the tax consequences for Susanne and Jovette? Answer 20X4: Tax consequences to Susanne: Taxable capital gain on sale of land: ($400,000 - 400,000) × ½ $ nil Terminal loss on sale of building: $475,000 - $450,000 25,000 UCC to Jovette Original cost to Susanne $ 550,000 CCA deemed taken: $550,000 - 450,000 (100,000) UCC for CCA $ 450,000 The capital cost for Jovette is deemed to be Susanne's original cost. The difference between the price paid by Jovette of $450,000 and Susanne's original cost is deemed CCA taken. This results in a UCC for Jovette equal to the price she paid to acquire the asset. 20X6: UCC $ 450,000 Lesser of $550,000 and $580,000 (550,000) Recapture $ 100,000 Capital gains Land Building Selling price $ 500,000 $ 580,000 Cost (400,000) (550,000) Capital gain 100,000 30,000 Inclusion rate × ½ × ½ Taxable capital gains $ 50,000 $ 15,000 In the absence of these rules, Jovette would have realized a taxable capital gain of $65,000 [($580,000 - $450,000) × ½ = $65,000]. Instead, she will be taxed on recapture of $100,000 and realize a taxable capital gain of $15,000. These, combined with the tax consequences on the sale of the property to Jovette, are the same tax consequences that would have occurred for Susanne if she had kept the property and sold it herself to the arm's length third party.

Capital gains and losses

Capital gains and losses arise when an asset used to produce property or business income is disposed of for proceeds greater or less than the original cost of the property. Generally, only one-half (50%) of capital gains are taxed. The taxable portion is referred to as a taxable capital gain. One-half (50%) of capital losses (referred to as allowable capital losses) are deductible, but only against taxable capital gains. Capital gains and capital losses can be realized by individuals, corporations, partnerships, or trusts.

5 Straight-line classes - Class 13 — leasehold improvements

Class 13 is one of the three most common straight-line classes. Leasehold improvements include costs for alterations made to rental premises to customize them for the specific needs of the tenant. These are generally items that cannot be removed at the end of the lease term, such as painting, flooring, and partitions. CCA must be determined separately for each leasehold improvement. For example, CCA on leasehold improvements made in the first year of a lease is determined separately from CCA on leasehold improvements made in the fourth year of a lease. The half-year rule applies. For the cost of leasehold improvements incurred in a given year, CCA is the lesser of: i) 1/5 × cost ii) [1 / (number of 12-month periods from the beginning of the taxation year in which the costs were incurred to the end of the lease term (maximum of 40 years) *)] × cost

Class 14 — limited-life intangibles

Class 14 includes intangibles assets such as trademarks or licences with limited legal lives. A separate CCA calculation is required for each limited-life intangible asset included in Class 14: • CCA claim in the year of acquisition: (Cost of asset / Legal life) × (Days remaining in the taxation year from acquisition date / Total days in the taxation year) • CCA claim in years after acquisition: Cost of asset / Legal life of the asset • The half-year and short taxation year rules are not applicable to this class. Short taxation year rules will be discussed in the EBook chapter on special rules for CCA. For a disposition of a Class 14 asset, the normal recapture and terminal loss procedures apply. The costs of patents and the right to use patented information, both limited and unlimited life, are included in Class 44 if acquired after April 26, 1993. However, a taxpayer may elect to include the cost of a patent with a limited legal life in Class 14 instead of Class 44 but likely would only do so if the patent had a short remaining legal life.

Short taxation year

Common situations in which a fiscal period of a business is less than 12 months include: • the year a taxpayer starts up a business • the year a taxpayer ceases to operate a business • on acquisition of control of a corporation partway through a fiscal period (see the e-book chapter on acquisition of control) For example, a business may be incorporated on June 1, and the owners may choose a December 31 year end. This situation results in a first fiscal period of the business of 214 days. If the fiscal period of a business is less than 12 months, the CCA claim for all classes except Class 14 is restricted to the CCA otherwise available multiplied by the number of days in the fiscal period divided by 365. Where there are additions to a class in a short taxation year, first apply the half-year rule to determine the CCA otherwise available and then pro-rate for the short fiscal period. Note that the short taxation year rule does not apply to a property acquired by an individual to earn rental income, as the fiscal period for an individual is generally the calendar year.

Deemed residents

Deemed residents of Canada are taxed in Canada for the full calendar year on their worldwide income. The following taxpayers are the most common types of deemed residents of Canada: • an individual who sojourns in Canada for a total of 183 days or more in the year (for the purposes of this rule, part days are considered full days) • a member of the Canadian armed forces • an ambassador, minister, high commissioner, officer or servant of Canada or a province, if the individual was resident in Canada prior to his or her appointment

Tax planning, tax avoidance, and tax evasion

Effective tax planning is defined by the Canada Revenue Agency (CRA) as an arrangement or arrangements where tax reduction achieved is consistent with the intent of tax law. Making Registered Retirement Savings Plan contributions as early in the year as possible to maximize tax-deferred savings is an example of effective tax planning. In general, tax avoidance is considered to be the use of tax law to minimize taxes through planning techniques that are in compliance with tax law (that is, legal). In contrast, the CRA views tax avoidance as tax-planning resulting in a reduction of tax that is inconsistent with the overall spirit and intent of the law — in other words, unacceptable and abusive tax planning. Tax evasion involves deliberately ignoring a specific provision of the law to achieve a reduction in taxes. Tax evasion is clearly illegal and can be attacked by the CRA through the courts and other means.

Eligible dividends

Eligible dividends are paid by: • Canadian public companies out of after-tax income taxed at the general corporate tax rate • CCPCs out of after-tax active business income not eligible for the small business deduction • CCPCs out of eligible dividends received Eligible dividends are paid out of the general rate income pool (GRIP).

Employment income

Employment income includes all of the salary, wages, and other remuneration, including tips and gratuities, received by a taxpayer. The details of various inclusions in and deductions from employment income will be reviewed in a related eBook chapter. In general, employment income includes: • salary, wages, and gratuities received • bonuses, tips, honoraria, and commissions • other employment income inclusions arising from employment • stock option benefits • deductions allowed against employment income

Dividend Income - Individuals

Individuals must include the actual dividend plus a gross-up in income. The grossed-up dividend is referred to as the taxable dividend. Dividends received by individuals will have been designated as either eligible or non-eligible by the corporation paying the dividend. A dividend tax credit (credit against the individual's income tax payable) is available to offset personal tax payable on the dividend. The gross-up and dividend tax credit rates depend on whether the dividends have been designated as an eligible dividend or non-eligible dividend.

Corporation Filing Tax Return

1. tax is payable (or would be, in the absence of a treaty); 2. at any time in the year, the corporation: i) is resident in Canada; ii) is carrying on business in Canada; iii) has realized a taxable capital gain; or iv) disposes of a taxable Canadian property

Employment Income - General inclusion

The taxation year for an individual is the calendar year. Employment income is taxed, on a cash basis, in the year that the salary or wages are received. If an individual received only salary and/or wages, employment income would simply be the cash amount received in the year

6 Deductions from property income

6.1 Carrying charges on vacant land Carrying charges include interest on loans used to acquire land and property taxes on the land. As a general rule, property taxes and interest on vacant land are only deductible to the extent of any income earned on the land. Property taxes and interest that are not deductible because they are in excess of income earned on the land are added to the cost base of the land. 6.2 Soft costs Soft costs are generally considered to include interest, legal, and accounting fees, insurance, and property taxes on the building or related land. These soft costs are not deductible during the period of construction, renovation, or alteration of the building. Because they are not deductible, they are added to the cost base of the building (that is, capitalized). Soft costs may be deducted to the extent of the taxpayer's income from any rental of the building during the period of construction, renovation, or alteration. The construction, renovation, or alteration of a building is completed at the earlier of: • the day on which the construction, renovation, or alteration is completed • the day on which all or substantially all (90%) of the building is used for the purposes for which it was constructed, renovated, or altered 6.3 Interest In general, reasonable interest paid or payable in a year is deductible if the borrowings are used to produce income or to acquire property to produce such income. The taxpayer must be able to tie the use of the borrowed funds directly to the acquisition of an income-producing asset. Interest on money borrowed: To make a low-interest or no-interest loan to an employee Is deductible: If the money was used to earn income and the amount was reasonable in the circumstances Interest on money borrowed: To make a low-interest or no-interest loan to a shareholder Is deductible: To the extent of interest paid by the shareholder plus any interest benefit included in the shareholder's personal income in the year Interest on money borrowed: By a shareholder or partner in order to make a low-interest or no-interest loan to his or her corporation or partnership Interest on money borrowed: Is deductible: If both of the following criteria apply: • The funds were used by a corporation or partnership to earn Canadian source income that is not exempt from tax. • The corporation or partnership was not in a position to borrow funds on its own on terms comparable with those obtained by the shareholder or partner.

Tax Balance due date

Individual: April 30 Corporation: i) two months after year end ii) three months after year end for certain Canadian-controlled private corporations (CCPCs)

Business income / loss

A business includes a profession, a calling, a trade, or the manufacturing of any kind of product and an adventure or concern in the nature of trade. Business income may be earned by individuals, corporations, partnerships, or trusts. In the context of personal tax, business income is income earned by an individual, such as a proprietor of an unincorporated business. A business includes a profession, a calling, a trade, or the manufacturing of any kind of product and an adventure or concern in the nature of trade. Business income may be earned by individuals, corporations, partnerships, or trusts. In the context of personal tax, business income is income earned by an individual, such as a proprietor of an unincorporated business. The calculation of business income for an individual earning income as an independent contractor or proprietor is generally the same as the determination of business income for a corporation.

Capital gains versus business income

A capital gain arises from the disposition, or deemed disposition, of capital property. Under the current rules, the inclusion rate is one-half, so only one-half of capital gains (referred to as taxable capital gains) are taxed. Business income arises from the disposition of inventory. Everything else being equal, a taxpayer selling property at a profit would prefer to report the gain as a capital gain instead of fully taxable business income. Therefore, one must determine whether the property sold is a capital property or inventory. Generally, capital property is acquired with the intention of holding it to earn income through its use, and not with the intention of reselling it at a profit. If an asset is not considered a capital property, it is inventory. In some cases, the distinction is obvious. Many less-obvious cases have been taken to court, and over time, the courts have developed criteria to assess whether the property sold is capital property or considered to be inventory. Courts have used the analogy of a fruit tree to explain the difference between capital property and inventory. A fruit tree produces fruit that can be resold at a profit. The fruit is inventory, so the profit from selling the fruit is business income. The tree itself is capital property, as it can be used over time to earn income from the sale of the fruit. Therefore, if the tree were to be sold, the gain would be classified as a capital gain. The courts have looked at the following in assessing whether an item is considered capital property or inventory: • Primary intention:Did the taxpayer intend to use the asset as an item of inventory or as a capital asset? • Secondary intention:If the primary intention to use the asset as a capital asset was frustrated, did the taxpayer have, at the time of purchase, a motivating intention to sell the property at a profit? Intention is a state of mind and is not observable. Courts have assessed the taxpayer's intention by examining the taxpayer's behaviour. Factors considered include: • The relationship of the transaction to the taxpayer's business — If the transaction is similar to other transactions entered into during the normal course of the taxpayer's business operations, this factor supports a conclusion that the profit from the sale is business income. • Nature of the asset — If the asset can be used over time to produce income, the asset can be considered a capital asset. • Number and frequency of transactions — A large number of similar transactions over a period of time imply that the asset is inventory. • Length of period of ownership of asset — A longer period of time implies that the asset is a capital asset, while a shorter holding period implies that the asset is inventory. The courts look at all of the above and reach a conclusion based on the balance of the evidence.

Deemed resident of Canada

A corporation is deemed resident of Canada if either of the following conditions are met: • The corporation was incorporated in Canada after April 26, 1965. • The corporation was incorporated in Canada before April 27, 1965, and it either carried on business in Canada or was resident under common law at any time after April 26, 1965.

Recapture and terminal losses

A key concept is that a taxpayer should be allowed a deduction for the full out-of-pocket cost of a depreciable asset. Recapture and terminal losses are tax adjustments to ensure that over time, the taxpayer deducts no more or less than the taxpayer's net out-of-pocket cost for the asset. Recapture arises if, after adding the cost of all additions and deducting all disposals, the UCC balance is negative. A negative UCC balance means the taxpayer has previously claimed too much CCA. The negative balance is added back to UCC to arrive at a nil balance in UCC and is also added to the taxpayer's net income for tax purposes. A terminal loss arises if, after adding the cost of all additions and deducting all disposals, a positive balance remains in the class and the taxpayer owns no other assets in that CCA class (that is, the taxpayer has sold the last asset in the class). The positive balance is deducted from UCC to arrive at a nil balance in UCC and is also deducted from the taxpayer's net income for tax purposes.

Personal-services business

A personal-services business (PSB) is: • a business of providing services where: o an individual who performs services on behalf of the corporation ("incorporated employee"), or any person related to the incorporated employee: • is a specified shareholder of the corporation — a specified shareholder is an individual who owns, directly or indirectly, not less than a 10% interest in the company under consideration AND • the incorporated employee would reasonably be regarded as an employee of the person to whom the services were provided; but for the existence of the corporation UNLESS • the corporation employs in the business throughout the year more than five full-time employees OR • the services are provided to an associated corporation (see the e-book chapter on stakeholder relationships for a discussion on associated corporations).

Other Income - Retiring allowances

A retiring allowance excludes pension income and death benefits but includes payments received on or after retirement: • from an office or employment in recognition of long service, or • for loss of employment, including court-awarded damages A retiring allowance does not include amounts received from: • an employee benefit plan • a retirement compensation arrangement • a salary deferral arrangement Retiring allowances may be transferred on a tax-free basis, within certain dollar and time limits, to an RRSP or an RPP. The amount that may be transferred on a tax-free basis is the lesser of: (i) $2,000 for each year or part year during which the individual was employed by the employer or related employer with respect to service before 1996, plus an additional $1,500 for each year or part year, the taxpayer was employed by the employer prior to 1989 for which the employer's contributions to an RPP or DPSP had not vested by the time the retiring allowance was paid. (ii) The amount of the retiring allowance received in the year. The amount must be transferred to an RPP or an RRSP in the year or within 60 days after the year in which the retiring allowance is received. The full amount of the retiring allowance is included in income, and a deduction is allowed for the amount transferred within the dollar and time limits noted above.

Sojourners versus part-year residents

A sojourner is an individual who travels in and out of Canada in a year and, because of those travels, is in Canada for a total of at least 183 days in the year. Sojourners are taxed in Canada on their worldwide income for the year. A part-year resident is an individual who becomes or ceases to be a resident of Canada at some point in the year. Part-year residents are taxed in Canada on their worldwide income for the period they are resident in Canada.

Stock dividends

A stock dividend is a dividend payment made in the form of additional shares rather than in cash. Stock dividends are taxed in the same way as cash dividends (that is, grossed up and included in income) and are eligible for a dividend tax credit. Since stock dividends are taxed but no cash is received, the actual amount of the dividend is added to the adjusted cost base of the shares. The addition to the adjusted cost base of the shares will result in a reduction in any future gains.

Canadian securities - Capital Gains and Losses

A taxpayer is permitted to make an election to treat the disposition of Canadian securities as a capital transaction regardless of the taxpayer's intention with respect to these securities. The election is made by treating the gain or loss on disposal of a Canadian security as a capital gain or loss in the taxpayer's tax return in the year that the asset is sold. Once this election is made, it cannot be undone, and all subsequent dispositions of Canadian securities for that taxpayer are afforded capital treatment. This election is not available to the following: • a trader or dealer in securities • a financial institution • a corporation whose principal business is the lending of money, the purchasing of debt obligations, or a combination thereof • a non-resident A Canadian security is defined as a security (other than a prescribed security) that is a share of the capital stock of a corporation resident in Canada, a unit of a mutual fund trust, or a bond, debenture, bill, note, mortgage, or similar obligation issued by a person resident in Canada.

Other income - Pension income splitting

A taxpayer may make a joint election to allocate up to 50% of his or her eligible pension income to his or her spouse. The full amount of pension income received by the taxpayer (transferor spouse) is included in his or her income. The amount allocated to the transferee spouse is deducted from the transferor spouse's net income and added to the transferee spouse's net income. The definition of eligible pension income depends on the age of the recipient of the pension benefits as follows: Taxpayer age Eligible pension income 65 or older Lifetime annuity payments from an RPP, DPSP, RRSP or RRIF Under 65 Lifetime annuity payments from an RPP

Notice of objection and appeal process

A taxpayer who disagrees with an assessment or reassessment is entitled to file a notice of objection. The deadline to file this objection is as follows: • for an individual or a testamentary trust, the later of: o one year after the filing due date o 90 days after the date of mailing of the notice of assessment (or reassessment) • for any other taxpayer (for example, a corporation), 90 days after the date of mailing of the notice of assessment (or reassessment) The objection, stating the reasons the taxpayer disagrees with the (re)assessment, may be filed using form T400A, online using the My Account, My Business Account, or Represent a Client login services, or by simply sending a letter. The CRA is required to reconsider the assessment and notify the taxpayer in writing of the results. If the taxpayer is still dissatisfied after the objection process, the taxpayer may appeal to the Tax Court of Canada. This appeal must be made within 90 days of the mailing date of the CRA's reply to the objection or, if the CRA has not responded, 90 days after the notice of objection was filed. Either party may appeal the Tax Court's decision to the Federal Court of Appeal. This appeal must be made within 30 days of the date on which the decision is made by the Tax Court.

Other Income - Amounts from deferred income plans

Amounts contributed to deferred income plans such as registered pension plans (RPPs), deferred profit sharing plans (DPSPs) and registered retirement savings plans (RRSPs) are deductible in determining net income; therefore, they are contributed on a tax-free basis. As a consequence, amounts subsequently withdrawn from any of these plans are fully taxable as follows: Type of plan Amount taxed RPP • periodic payments • lump-sum settlement not directly transferred to another deferred income plan DPSP • periodic payments • lump-sum settlement not directly transferred to another deferred income plan RRSP • lump-sum withdrawal prior to maturity • amount of required repayment not made under the Home Buyers' Plan or the Lifelong Learning Plan Registered retirement income fund (RRIF) • annual amount withdrawn

Capitalization of interest - property income

An election is available pursuant to Section 21 that allows certain borrowing costs and interest to be treated as non-deductible expenses and added to the cost of depreciable property in respect of which the expenses were incurred. A taxpayer would usually only want to make this election if there was a chance that losses arising from the deduction of the interest could not be used within the available carryback or carryforward periods for the deductibility of the losses.

Date of becoming a non-resident

An individual who has become a non-resident of Canada at some point in the year is considered a part-year resident and is taxed in Canada on his or her worldwide income for the period from January 1 to the date on which the taxpayer became a non-resident. The date the individual is considered to have become a non-resident is considered by the CRA to be the later of: • the date the individual leaves Canada • the date the individual's spouse and/or dependants leave Canada • the date the individual becomes a resident of the new country he or she has emigrated to

Corporations

As indicated above, the ITA states "an income tax shall be paid as required by this Act on taxable income for each taxation year of every person resident in Canada" [ITA 2(1)]. A corporation is considered a person; therefore, all corporations resident in Canada are required to pay tax on worldwide income for each taxation year of the corporation. The taxation year of a corporation need not be a calendar year, and in the year a corporation becomes a resident of Canada or ceases to be a resident of Canada, the taxation year will generally be less than 12 months.

Tax consequences on ceasing to be a resident of Canada

At the time an individual becomes a non-resident of Canada, he or she is deemed to have disposed of most assets owned at the fair value of those assets on the date the taxpayer ceases to be a resident of Canada. The most common exceptions to the deemed disposition rules are: • Canadian real or immovable property and Canadian resource property • business property, including inventory of a business carried on through a permanent establishment in Canada • registered pension plans, including personal and employer-sponsored plans, deferred profit-sharing plans and tax-free savings plans The first two categories above are referred to as taxable Canadian property. The taxpayer may elect to have a deemed disposition of taxable Canadian property at the time he or she becomes a non-resident of Canada. A taxpayer would normally only wish to make this election if the taxpayer had capital or other losses he or she would not otherwise be able to use at the time of becoming a non-resident of Canada. If the election results in an allowable capital loss (that is, there is an accrued capital loss on the property the election is made on), the allowable capital loss may only be deducted against taxable capital gains that arise as a result of a deemed disposition. They may not be deducted against taxable capital gains arising from actual dispositions.

CCA calculations

The majority of CCA classes use a declining-balance method with a single CCA rate (for example, Class 10, 30%). Straight-line methods are used for a few classes, including Classes 13 and 14.

Employment Income - Bonuses

Bonuses are normally declared at a point in time and paid to an employee at a later date. There are a number of reasons for paying bonuses in this manner, including employee retention (as the employee would likely stay with the employer in anticipation of the bonus payout). Recall that employment income is taxable on a cash basis. However, business income is taxed on an accrual basis. As a result, a bonus may be included in an employee's income in a different period than it is deducted for the employer (in business income). The Canada Revenue Agency (CRA) has special rules for when a business can deduct bonuses (see the eBook chapter on business income). However, for employees, the cash basis rules apply for most bonuses (that is, the bonus is included in the employee's income when it is received, not necessarily when it is declared). The only exception is when a bonus is paid more than three years after the year end in which it is declared. As this is considered a salary deferral arrangement, the employee includes the bonus in income in the year that it is declared (not when it is paid).

Business Income

Business income concepts apply to the calculation of net income for tax for individuals and corporations. Business income may by earned either by an individual (referred to as a sole proprietor) or by a corporation. Business income earned by an individual is included in the individual's personal tax return (T1), while business income earned by a corporation is included in the corporate tax return (T2). An individual operating as a proprietorship may either include the details of his or her business income on Form T2125 (Statement of Business or Professional Activities) or prepare a reconciliation of accounting net income to business income and attach that to his or her personal tax return.

Items to deduct - Business Income

CCA Terminal losses Financing expenses Bond premium amortization Accounting gains on disposal of capital assets Allowable capital losses Scientific research expenditures deductible for tax purposes Pension contributions to the trustee of the pension plan assets Cash paid for warranties expenditures Allowable business investment losses Landscaping costs that have not been deducted in determining accounting net income Equity income on investments accounted for using the equity method of accounting

Key Concept -re CCA

CCA is a discretionary deduction. A taxpayer may claim, in any year, any amount from $0 to the maximum allowable CCA. For example, a taxpayer who has accumulated losses may choose not to claim CCA in order to minimize the accumulated losses, or to create income during a year in order to utilize a loss. CCA may not be claimed on an asset until it is available for use. The general rule is that an asset is considered to be available for use at the earlier of the time it is first used by the taxpayer and the second taxation year following the year of acquisition. (For a detailed discussion on "available for use" rules, see the EBook chapter on the special rules for CCA.) The CCA system operates on a "pool" basis where individual assets are not separately depreciated. The cost of similar assets is included in a specific UCC class. There are two exceptions to this general rule: • In some situations, individual assets are required to be included in a separate class (such as Class 10.1, automobiles costing more than $30,000 before GST). • For certain assets, a taxpayer may make an election to include the cost of a specific property in a separate class.

Capital cost allowance

CCA may be claimed on depreciable capital assets. A capital asset is an asset that is used by a taxpayer over a period of time to produce income. In the reconciliation of accounting net income to net income for tax purposes for a business, accounting depreciation and accounting losses on disposal of depreciable capital assets are added back, and accounting gains on disposal of depreciable capital assets are deducted. Adjustments are then made for CCA claims and recapture and terminal losses on disposal of depreciable capital assets. (Review the EBook chapter on business income for further discussion of these adjustments.) The CCA system is the means through which an annual deduction for the cost of depreciable capital assets used to earn income is allowed for tax purposes. The tax system recognizes a need to ensure taxpayers use a consistent and uniform approach to determine how much of the cost of a capital asset may be deducted each year.

Other income - Canada Pension Plan

Canada Pension Plan (CPP) payments are included in the income of the individual receiving the payment. Spouses and common-law partners may elect to split their CPP income equally. The amount that can be shared is 50% of the combined CPP benefits received but pro-rated by the length of time the individuals have been living together in relation to the period over which they have been contributors. A non-contributing spouse must be at least 60 years of age at the time of this election. The spouses must make an application to Service Canada to split their CPP income. If the application is approved, the split amount is paid separately to each spouse and is included in that spouse's income.

Other Income - Death benefits

Death benefits are payments made to the spouse or other beneficiary of a deceased employee upon the death of the employee in recognition of the employee's service of employment. These are included in the income of the surviving recipient(s), with a one-time maximum exemption of $10,000 per deceased employee. Where death benefits are paid to multiple beneficiaries, the following rules apply to the $10,000 exemption: • A beneficiary who is the surviving spouse is allocated the exemption up to a maximum of $10,000. • If any amount of the $10,000 remains after the allocation to the surviving spouse, the remaining amount is allocated on a pro rata basis to beneficiaries other than the spouse.

Other Income - Child Support

For agreements entered into after April 30, 1997, amounts paid for the support or maintenance of a child are not deductible to the person making the payment and are not taxable to the recipient. Child support payments are defined as any amount not identified in the agreement or order under which it is made as being solely for the support of the recipient spouse or former spouse or the parent of the taxpayer's child. If the full amount of the required support payments is not made in the year, only payments in excess of the required child support payments are included in the recipient's income and deductible to the person making the payment.

Notice of assessment

For individuals, the CRA can reassess up to three years after the date on the original notice of assessment. For corporations, the CRA can reassess up to four years after the date on the original notice of assessment. For CCPCs, however, the reassessment period is three years. A reassessment can be made at any time if the taxpayer has done either of the following: • made any misrepresentation that may be attributed to neglect, carelessness, or wilful default, or committed any fraud in filing the return or in supplying any information under the ITA • filed a waiver that extends the usual reassessment period with respect to the year for any reason Note that the reassessment period is expanded a further three years where transactions involve a taxpayer and a non-resident person with whom the taxpayer was not dealing at arm's length. Under a number of circumstances, a reassessment can be done up to three years after the expiration of the normal reassessment period. These circumstances include requesting a loss carryback. For individuals only, the CRA will reassess for up to 10 years after the end of a taxation year if the taxpayer requests to apply deductions or credits.

Refunds owed to the taxpayer from the Canada Revenue Agency (CRA)

For individuals: • Interest paid to an individual = refund amount × (prescribed rate + 2%). • Interest is calculated starting on the latest of the following dates and ends on the day that the refund is paid: i) 30 days after the balance due date for the relevant tax return ii) 30 days after the return is actually filed iii) the day on which the overpayment arose For individuals: • Interest paid to an individual = refund amount × (prescribed rate + 2%). • Interest is calculated starting on the latest of the following dates and ends on the day that the refund is paid: i) 30 days after the balance due date for the relevant tax return ii) 30 days after the return is actually filed iii) the day on which the overpayment arose For corporations: • Interest paid to a corporation = refund amount × prescribed rate. • Interest is calculated starting on the latest of the following dates and ends on the day that the refund is paid: i) 120 days after the end of the relevant taxation year ii) 30 days after the return is actually filed iii) the day on which the overpayment arose

Foreign dividends

For individuals: Foreign dividends are not grossed up, and there is no dividend tax credit on them. The actual amount of the dividend (before withholding tax) is included in the individual's property income. The result is that the dividends are taxed in the same way as interest income. For corporations: If the foreign dividend is from a foreign affiliate, there is a Division C deduction for that dividend under Section 113 of the ITA (same as dividends from a taxable Canadian corporation [Section 112 of the ITA]). There is no Division C deduction if the foreign dividend is not from a foreign affiliate. Remember that Division C deductions are not part of net income for tax but rather part of determining taxable income.

Determination of business income

For tax purposes, income from a business is its profit for the year. Profit is not defined in the Income Tax Act (ITA). In determining income from a business, the starting point is profit determined under generally accepted accounting principles (GAAP). If a specific provision with respect to an item of revenue or expense is not included in the ITA, and that item of revenue or expense has been included in or deducted from net income under GAAP, it is also included in or deducted from income for tax purposes. Specific provisions of the ITA override GAAP. The result is that GAAP net income must be reconciled with net income for tax purposes.

Selling price greater than original cost - CCA rules

For the purpose of the CCA rules, the addition to undepreciated capital cost (UCC) is limited in a situation where a depreciable property is acquired from a non-arm's length party at an amount greater than the capital cost to the non-arm's length vendor. The addition to UCC is the original cost of the depreciable property to the non-arm's length vendor plus the taxable capital gain realized by the non-arm's length vendor. These rules restrict the amount added to the purchaser's UCC and provide a limit for future recapture. The capital cost to the purchaser for the purposes of determining a future capital gain or loss on disposition of the asset will equal the price actually paid. This rule is designed to ensure that the purchaser cannot claim CCA on the portion of the purchase price that was not taxed in the non-arm's length vendor's hands (that is, on the non-taxable half of the capital gain).

Foreign-source property income

Foreign-source property income (including dividends, interest, royalties, and so forth) must be included in income. Foreign-source property income includes cash received plus any tax withheld by the foreign government. The property income must be translated into Canadian dollars using the exchange rate in effect on the date that the amount is received. Foreign tax withheld is used to calculate a foreign tax credit that can be deducted against Canadian taxes payable.

Non-arm's length transactions and additions to undepreciated capital cost 3.2.1 Selling price greater than original cost

In 20X1, Raj purchased a depreciable property to use in his business for $100,000. Early in 20X3, he sold the property to his son David for $125,000. The UCC of the property was $70,000 at that time. David used the property for the remainder of 20X3 and part of 20X4, at which time he sold the property for $115,000. David claimed CCA of $14,000 on the property in 20X3. Required What are the tax consequences for David as a result of the 20X4 sale of the property? Answer David's UCC Initial: $100,000 + [(125,000 - 100,000) × ½] $ 112,500 CCA claimed (14,000) UCC at time of sale $ 98,500 Credit to pool: Lesser of $112,500 and $115,000 (112,500) Recapture $(14,000) The credit to the pool is the lesser of the amount added to UCC of $112,500 and the selling price of $115,000. The original cost of $125,000 is not used, so recapture is limited to the amount originally added to UCC. There is no capital gain because David did not sell the asset for more than the $125,000 he originally paid.

Other income - Spousal and child support

In general, amounts that are tax deductible to the payer are included in the income of the recipient. 14.1 Spousal support Amounts paid for spousal support are deductible to the payer and taxable to the recipient if the following five tests are met: • The payments are made on a periodic basis. • The payments are considered an allowance for the maintenance of the recipient. • The payments are made during a time that the spouses or former spouses were living apart as a result of marital breakdown. • The recipient has discretionary use of the amount (he or she can use the amount in any way). • The payments are made as a result of a decree, order or judgment of a competent tribunal or a written agreement.

Personal loan planning and interest deductibility

In order to deduct interest, there must be a reasonable expectation of earning income. However, it is not necessary to earn income in a given year for interest to be deductible in that year. The deductibility of the interest is determined by the use of the borrowed funds. As a result, interest on funds borrowed for personal expenditures is not deductible. A connection must be maintained between the borrowed funds and the use of the borrowed funds.

Items to add back - in determining business income

Income tax — current and deferred / future taxes Interest and penalties on late payment of income taxes Accounting amortization on tangible and intangible capital assets Recapture of CCA Accounting losses on disposal of capital assets Taxable capital gains Charitable donations Political donations Scientific research expenditures deducted for accounting purposes Reserves and contingent liabilities Warranties Pensions Meals and entertainment expenses Club dues and recreation fees Bond discount amortization Automobile mileage allowances, unless the allowances are a taxable benefit to the employee, in which case no adjustment is required Lease costs on a passenger vehicle in excess of the permitted amount Equity losses on investments accounted for using the equity method of accounting Dividends received on investments accounted for using the equity method Asset write-downs (including impairments) Illegal payments, fines, and penalties Foreign advertising Personal or living expenses Life insurance where the corporation is the beneficiary (If the employee is the beneficiary of the life insurance policy, the cost of the life insurance is a taxable benefit to the employee; therefore, it is deductible to the corporation.) Convention expenses Foreign taxes paid Unpaid amounts in a non-arm's length transaction Carrying charges on vacant land (including interest and property taxes) Soft costs on construction or renovation of a building Reserves: Bad debts Reserves: Undelivered goods or services Reserves for an amount not due under an instalment sales contract Unpaid remuneration

Other Income - Indirect payments

Indirect payments are payments or transfers of property that normally would have been taxed in the hands of the taxpayer if he or she had received the payment or property transferred. The decision to pay or transfer property must have been made by or with the concurrence of the taxpayer. The following conditions must hold: • The taxpayer must have benefited from the transfer. • The payment or value of the transferred property would have been included in the taxpayer's income if the transfer had not been made. If these conditions apply, the payment or value of the transferred property is included in the income of the transferor. For example, consider an employee who asks his employer to pay part of his salary to his adult son who is attending university and has no other sources of income. The indirect payment rules would apply because the decision to transfer property was made by the taxpayer; the taxpayer benefited from the transfer because little, if any, tax would be paid on the amount of salary transferred, since the son has no other source of income; and if the taxpayer had not requested the salary be paid to the taxpayer's son, the salary would have been taxed in his hands.

Tax Filing Deadlines

Individual: i) April 30 ii) June 15, if taxpayer or spouse carried on a business iii) later of six months after the date of death and normal filing deadline, if the taxpayer passed away during the year. Corporation: six months after year end

Other Income - Third-party payments

Instead of making a payment directly to the former spouse, a taxpayer may make payments to third parties. Common examples of this include mortgage payments and tuition payments. These are deductible to the person making the payment and taxable in the hands of the former spouse who benefits from the payment if the following criteria are met: • The payments are made in the current year or the preceding year as a result of an order of a competent tribunal or a written agreement. • The expense was incurred for the maintenance of a former spouse or common-law partner. • The court order or written agreement specifically refers to ITA 56.1(2) (income inclusion to the recipient) and ITA 60.1(2) (deduction to the payer).

Interest income

Interest income is the return, consideration, or compensation for the use or retention by one person of a sum of money belonging to or owed to another. Debt obligations on which interest is earned include bank accounts, term deposits, guaranteed investment certificates (GICs), Canada Savings Bonds, mortgages, corporate bonds, and loans.

Interest and penalties -Late or deficient installments

Interest is charged on late or deficient instalments at a rate equal to the prescribed interest rate + 4%. Interest applies from the date the instalment was due or deficient to the earlier of: • the date the instalment is paid • the balance due date for the taxpayer's taxation year Penalty is 50% of the amount by which the interest on the late or deficient instalments exceeds the greater of: • $1,000 • 25% of the interest that would have been payable if no instalments had been made

Interest and penalties - Arrears interest — missed payment deadline

Interest is charged on taxes owing at a rate equal to the prescribed interest rate + 4% * until the amount is paid in full. Interest is compounded daily until the amount is paid in full; if the amount was owing on April 30, interest would be charged beginning May 1 until the amount is paid.

Other income - Spousal and child support- lump sum payments

Lump-sum payments do not qualify under the rules above — that is, they are neither tax deductible to the payer nor are they an income inclusion to the recipient. If a lump-sum payment is required to be paid by instalment, it is still considered a lump-sum payment and is not deductible to the payer. To establish the payments are periodic, the taxpayer should ensure the court order or agreement requires: • amounts be payable at regular intervals • amounts be fixed and predetermined A taxpayer may also agree to make payments for medical expenses or education of the former spouse. These amounts are not normally fixed or predetermined so should be set out separately in the court order or written agreement.

Net Income

Net Income Consists off: - Employment Income - Business Income / Loss - Property Income / Loss - Other Income Add: 1/2 Capital gains net of capital losses Deduct: Other deductions IF > 0, then = net income IF <0, then net income 0

Non-eligible dividends

Non-eligible dividends are paid by Canadian-controlled private corporations (CCPCs) out of after-tax active business income eligible for the small business deduction or from after-tax aggregate investment income. Since both of these types of income are taxed at preferential rates, the gross-up and dividend tax credit rates on non-eligible dividends are lower than the gross-up and dividend tax credit rates on eligible dividends. In some cases, a non-CCPC may earn or receive an amount that is taxed at a preferential rate. These amounts would be included in the low rate income pool (LRIP). To the extent that a non-CCPC has a positive balance in its LRIP, it must pay out that total amount as non-eligible dividends prior to declaring an eligible dividend.

Other sources of income and deductions

Other sources of income include miscellaneous types of income not included in any of the categories discussed above, while other deductions include items that are permitted by law but not attributed to a particular source of income. Additional sources of income include, but are not limited to: • pension income • retiring allowances • death benefits • annuity payments • spousal support • amounts received from deferred income plans (such as RRSPs) • social assistance payments • workers' compensation Additional deductions from income include, but are not limited to: • spousal support • moving expenses • RRSP contributions • Old Age Security clawbacks • child-care expenses • fees related to objections and appeals Other sources of income and deductions apply primarily to individuals.

Other Income - Employment Insurance benefits

Payments received under an Employment Insurance (EI) plan are included in income.

Failure to file return by due date

Penalty for first occurrence: Penalty is the total of: • 5% × unpaid tax • 1% × unpaid tax × number of months return is outstanding (not more than 12) If CRA sends a demand to file for the first late return before the second late return is filed, the penalty for subsequent late occurrences is as follows: Penalty is the total of: • 10% × unpaid tax • 2% × unpaid tax × number of months return is outstanding (not more than 20)

Participating in a misrepresentation

Penalty is the greater of: • $1,000 • 50% of tax sought to be avoided (to a maximum of $100,000 plus the fee charged)

False statements or omissions, knowing or gross negligence

Penalty is the greater of: • $100 • 50% of the understated tax (Penalty may be waived if the taxpayer voluntarily tells the CRA about the amount that was not reported.)

Repeated failure to report income equal to or greater than $500 (more than once in any three-year period)

Penalty is the lesser of: • 10% × amount of unreported income • an amount equal to 50% of the difference between the understatement of tax (or the overstatement of credits) and the amount of tax paid in relation to the unreported amount

Primary Residential Ties

Primary residential ties Factors indicating primary residential ties have not been severed Dwelling place in Canada maintained for the taxpayer's use The dwelling is still owned or leased by the taxpayer and is vacant. OR The dwelling is not vacant and is leased to a third party while the taxpayer is abroad, and the terms and conditions of the lease are not at arm's length. Spouse or common-law partner of taxpayer The spouse or common-law partner of the taxpayer remains in Canada. Dependants of taxpayer The dependants of the taxpayer remain in Canada.

Property Income

Property income is an amount earned in the year by the taxpayer that was dependent on the use of or production from property. In determining whether the income earned from the use of the property is business income or property income, you must analyze what the owner does or intends to do with the property. In general, property income is a return on invested capital, but only if the owner does not commit a significant amount of time or labour to the income-generating process. If the owner commits a significant amount of effort to the income-generation process, the income is classified as business income. (See the eBook chapter on the determination of business income.) Common types of property income include: • interest • dividends • other dividends • rental income • foreign-source property income • royalties Property income does not include capital gains and losses arising from the disposition of property.

Property income / loss

Property income is generally considered to be a return on invested capital where the investor does not commit a significant amount of time or labour to the income-generating process. Property income generally includes: • interest income from savings, deposits, loans, bonds, and debentures • dividend income • rental income • royalty income Property income can be earned by individuals, corporations, partnerships, or trusts.

Business Income - taxes payable for a corporation CCPC

Recall that a Canadian-controlled private corporation can earn the following types of income: • active business income • specified investment business income • personal-services business income • aggregated investment income • dividend income

Basic tax

Recall the basic tax formula: Net Income For Tax Purposes ( division B) - Division C Deductions = Taxable Income x Tax Rates = Federal Tax Before Tax Credits - Tax Credits = Basic federal tax

Other income - other registered plans

Registered education savings plans (RESPs) and registered disability savings plans (RDSPs) are other types of deferred income plans. They differ from the deferred income plans noted above in that the amounts contributed to the plan are not deductible. As a result, there is no tax deferral on amounts contributed to the plan, and the contributions are not taxed when withdrawn from the plan. However, the accumulated income of the plan is taxed when withdrawn either in the hands of the beneficiary or in the hands of the contributor if payments are not made to a qualified beneficiary. See the e-book chapter on deferred income plans for detailed rules.

Rental income

Rental income is income from renting a property that the taxpayer owns or has the use of. The property may include but is not limited to houses, apartments, rooms, and office space or other real or movable property. Revenue from rents is determined on an accrual basis as outlined in the Canada Revenue Agency guide T4036 Rental Income. It is calculated by including rental revenue in income in the year in which it is due, whether or not it is received in that year, and deducting expenses in the year they are incurred, regardless of when they are paid. In general, expenses include but are not limited to: • utilities • repairs • maintenance • interest • insurance • property taxes • advertising • management fees • capital cost allowance (CCA)

Other Income - Scholarships, bursaries and fellowships

Scholarships and bursaries are defined as amounts paid or benefits provided to students to allow them to continue their education. The scholarship or bursary may apply to any type of studies, including academic studies, professional programs or trades. Fellowships are the same as scholarships or bursaries (as long as they are not for research purposes) except they are normally awarded to graduate students. A fellowship provided for research purposes is considered a research grant. Any amount received by a student in a year as a scholarship, fellowship or bursary is exempt from tax if the student was in full-time attendance at a post-secondary educational institution or a secondary or elementary school.

Dividend income

The tax treatment of dividends depends on the taxpayer receiving the dividends and the type of dividend received. Corporations Dividends received by corporations from taxable Canadian corporations are included in net income for tax and are subsequently deducted under Division C of the Income Tax Act (ITA) in determining taxable income. The result is that the dividends received by a corporation from a taxable Canadian corporation are not subject to Part I tax. (See the eBook chapter on the computation of taxes payable for a corporation.) There is no gross-up or dividend tax credit on dividends received by a corporation.

Separate class rules - CCA

Separate class for luxury passenger vehicles Passenger vehicles costing in excess of $30,000 excluding PST and GST, or HST, are placed in a separate Class 10.1. This rule applies to all taxpayers, whether employed or self-employed and whether incorporated or unincorporated. Each passenger vehicle costing more than $30,000 before tax is included in a separate Class 10.1. The rules relating to recapture and terminal losses do not apply on disposition of a passenger vehicle included in Class 10.1. In the year of disposition one-half of the CCA that would otherwise have been allowed in respect of the passenger vehicle, had it not been disposed of, may be claimed. 6.2 Separate class election for electronic office equipment This election may be made on properties normally included in Class 8 costing $1,000 or more, including: • photocopiers normally included in Class 8 • electronic communication equipment, such as fax machines or telephone equipment, also normally included in Class 8 If the election is made, the property is included in a separate Class 8. This type of equipment tends to become technologically obsolete quickly. The advantage of the separate class election is the availability of a terminal loss when the asset is sold for less than the UCC of the separate class. 6.3 Separate class rules for rental properties Each rental property costing $50,000 or more must be included in a separate CCA class. The consequence of the rule is that when a rental property is sold for more than the UCC of the property, the taxpayer cannot avoid recapture on the disposal because the cost of the rental properties is not pooled.

Personal-services business

Test your knowledge Joanne is a senior executive at a publicly traded company, Girvan Inc. She earns an annual salary of $200,000. She incorporates a company, J Ltd., and resigns from her position with Girvan Inc. Girvan Inc. then hires J Ltd. to provide the senior executive services. Required Under what circumstances would J Ltd. be considered a PSB? Answer The following circumstances would result in J Ltd. being considered a PSB: • Girvan hires J Ltd. to provide consulting services to do the work Joanne did in her former position. • Girvan continues to provide Joanne with an office and all the equipment she needs to do the job. • Joanne is the only employee of J Ltd.

Test your knowledge - Annuities

Test your knowledge On January 1, Year 1, Bryan paid $135,900 to acquire a 20-year fixed-term annuity. Annual payments of $10,000 are to be received on December 31 of each year. Required Determine the annual impact on Bryan's income Answer Annual payment received $10,000 Capital element: [$135,900 / ($10,000 × 20)] × $10,000 (6,795) Impact on Bryan's income $ 3,205

Death Benefits - test your knowledge

Test your knowledge Tony died in the year, and his employer paid a $14,000 death benefit as follows: Spouse $6,000 Daughter 5,000 Granddaughter 3,000 Required Determine the exemption each taxpayer may claim. Answer Spouse $6,000 Daughter: $5,000 / $8,000 × $4,000 2,500 Granddaughter: $3,000 / $8,000 × $4,000 1,500 The spouse of the deceased taxpayer may claim an exemption of the lesser of the amount received of $6,000 and the maximum of $10,000. The remaining $4,000 exemption is allocated to the daughter and the granddaughter on a pro rata basis. Therefore, Tony's family will include the following in their income: Spouse: $6,000 - $6,000 $0 Daughter: $5,000 - $2,500 2,500 Granddaughter: $3,000 - $1,500 1,500

Common CCA classes

The CCA classes can be found in Schedule II of the Income Tax Regulations: 1 4% declining balance Buildings acquired after 1987 1 (4% + 2%) = 6% declining balance Non-residential buildings acquired after March 18, 2007, and not used by any person prior to March 19, 2007; must be included in a separate class to get the 2% bump-up 1 (4% + 6%) = 10% declining balance Manufacturing buildings used at least 90% (measured by square footage) for manufacturing and processing use, acquired after March 18, 2007, and not used by any person prior to March 19, 2007; must be included in a separate class to get the 6% bump-up 3 5% declining balance Buildings acquired prior to 1988 8 20% declining balance Furniture and fixtures; office equipment, including fax machines, copiers, and any equipment not included in another CCA class 10 30% declining balance Automotive equipment, including passenger vehicles costing up to $30,000 before taxes and also other automotive equipment such as delivery vans 10.1 (a) 30% declining balance Passenger vehicles costing more than $30,000 before tax 12 (b) 100% Library books; tableware; kitchen utensils costing less than $500; dies, patterns, and moulds; medical and dental instruments; tools costing less than $500; linens; feature films; computer software that is not systems software 13 Straight-line based on minimum of five years Leasehold improvements — details below 14 (c) Straight-line based on the legal life of the asset Patents, franchises, concessions or licences that have a limited legal life (patents with a limited legal life may be included in either Class 14 or Class 44) 14.1 5% declining balance Intangible capital assets acquired after January 1, 2017 that are not included in Class 14 or Class 44. (examples: goodwill, customer lists, trademarks, and licences with an unlimited life) Incorporation costs are considered an intangible asset for tax purposes. The first $3,000 of incorporation costs incurred are deductible as a current expense; any amount in excess of $3,000 is added to Class 14.1. The transition rules for adding existing Cumulative eligible capital (CEC) balances to Class 14.1 are beyond the scope of this document. 14.1 5% declining balance Intangible capital assets acquired after January 1, 2017 that are not included in Class 14 or Class 44. (examples: goodwill, customer lists, trademarks, and licences with an unlimited life) Incorporation costs are considered an intangible asset for tax purposes. The first $3,000 of incorporation costs incurred are deductible as a current expense; any amount in excess of $3,000 is added to Class 14.1. The transition rules for adding existing Cumulative eligible capital (CEC) balances to Class 14.1 are beyond the scope of this document. 17 8% declining balance Roads, sidewalks, airplane runways, parking areas 44 25% declining balance Patents acquired after April 26, 1993 50 55% declining balance Computer hardware and systems software acquired after March 18, 2007, and before January 28, 2009; and after January 31, 2011 53 50% declining balance Manufacturing and processing equipment acquired after 2015 (a) Automobiles having a capital cost in excess of $30,000 excluding PST and GST are placed in a separate Class 10.1. See detailed rules below under Separate Class Rules. (b) For Class 12, the half-year rule does not apply to the following assets: • books that are part of a lending library • chinaware, cutlery, and other tableware • kitchen utensils, medical, and dental instruments and other tools costing less than $500 • linens and uniforms • rental apparel or costumes and accessories (c) The half-year rule does not apply. In the year of acquisition, the CCA claim is pro-rated for the number of days owned in the year.

Integration - Dividends

The taxation of dividends is intended to prevent double taxation of income earned in a corporation and flowed through to shareholders by way of dividends. The idea is that the taxpayer should pay the same amount of tax regardless of whether income is earned in a corporation and first taxed in the corporation and then flowed out to the shareholder by way of dividends, or earned directly by the individual.

The General Anti-Avoidance Rule

The General Anti-Avoidance Rule (GAAR) was added to the Income Tax Act (ITA) in 1988 to give the CRA the ability to target and challenge what the CRA views as abusive tax-avoidance arrangements. The GAAR was put in place to challenge a transaction or series of transactions resulting in a tax benefit, where the transactions or series of transactions are not primarily for bona fide purposes other than to obtain the tax benefit. In the Canada Trustco case [Canada Trustco Mortgage Co. v Canada (2005)], the Supreme Court of Canada set out conditions to be used by the lower courts in determining whether GAAR applies to a specific tax plan: 1. A tax benefit must arise as a result of the transaction or series of transactions. This requirement alone will not make a tax-planning arrangement an avoidance transaction, as most tax-planning arrangements result in a tax benefit or benefits. 2. The transaction or series of transactions is an avoidance transaction. If the transaction or series of transactions have been arranged mainly for bona fide purposes other than to obtain a tax benefit, the arrangement is generally not considered to be an avoidance transaction. If there are both tax and non-tax purposes, the courts consider whether the non-tax purpose is the primary purpose of the transaction. Bona fide non-tax purposes include business, family or investment purposes. 3. The transaction or series of transactions is an abusive tax-avoidance arrangement. A tax-avoidance arrangement is considered abusive if it cannot be reasonably concluded that allowing a tax benefit would be consistent with the object, spirit or purpose of the provisions relied upon by the taxpayer. For GAAR to be invoked, all three conditions must be met for the courts to rule against a taxpayer. The taxpayer is responsible to show that conditions 1 and 2 have not been met — that is, either there is no tax benefit or the tax-planning arrangement is not an abusive transaction or series of transactions. The CRA is responsible to show that there is abusive tax avoidance. As indicated above, tax planning generally results in a tax benefit. If a taxpayer can show that there is no avoidance transaction, the courts need not look at the third requirement, as all three conditions must be met.

Taxation of PSB income

The PSB rules are intended to discourage an employed individual from incorporating a company through which they would provide their services to a business that would normally be considered to be their employer. The primary motivation for incorporation in such a situation would be the possibility of paying tax on the income at the lower corporate rates rather than having the salary income taxed personally at higher marginal rates, thus realizing a significant deferral of tax. To discourage this type of tax planning, the following rules apply to income from a PSB: PSB income is not eligible for the small business deduction. • PSB income is not eligible for the general rate reduction. Additionally, no outlay or expenses are deductible related to earning PSB income, except the following: • salary paid in the year to the incorporated employee • the cost to the corporation of any benefits / allowances provided to the incorporated employee • any amounts expended by the corporation to the extent that such expenses would have been deductible by an individual employee from the individual's employment income • legal expenses incurred in collecting fees for services rendered The effective federal tax rate that applies to PSB income is 33%. The combined federal and provincial corporate tax rate is significantly higher than the corporate rate that results in better integration. Thus, there is a significant tax cost to earning PSB income. Review the e-book chapter on the computation of taxes payable for a corporation for more information

Other income - Amounts included in net income and deducted under Division C

The following amounts are included in net income and deducted under Division C: • social assistance benefits (welfare) • Workers' Compensation • Guaranteed Income Supplement These amounts are included in net income. Thus, they will impact various amounts that depend on net income, such as the spousal, age and medical expense tax credits. It is not the government's intention to tax these amounts, so they are deducted under Division C in the determination of taxable income. See the e-book chapter on Division C deductions for more information.

Other income - Pension income splitting - considerations

The following should be considered when deciding on the amount of pension income to allocate to the spouse: • Marginal tax rates of both the transferor and the transferee spouse — if the transferee spouse is in a lower tax bracket, pension income splitting will generally be beneficial. • Availability of the pension tax credit to the transferee spouse — If the transferee spouse does not have any pension income, allocation of $2,000 of pension income from the transferor spouse to the transferee spouse will make the pension credit available to both spouses. • Impact of allocation on the Old Age Security (OAS) clawback — allocation of pension income from the higher-income spouse to the lower-income spouse will reduce the higher-income spouse's net income and possibly reduce or eliminate an OAS clawback. • Impact of the allocation on tax credits where net income is relevant, including the spousal, age and medical expense tax credits.

Available for use - CCA special rules

The general rule is that a taxpayer may not claim capital cost allowance (CCA) on a depreciable capital property until the earlier of the time the depreciable capital asset is put in use or the second taxation year following the year of acquisition. Additional clarification for specific situations: • When a building is acquired, it is considered to be available for use when all or substantially all (90% or more) of the building is used for the purpose for which it was acquired. • When a building is constructed or renovated, the building is available for use at the earlier of the time the construction or renovation is complete or the building is used substantially all for the purpose for which it was constructed or renovated. • For public companies, property (other than a building) is deemed to be available for use in the year depreciation is first recorded for that property under generally accepted accounting principles. 1 • Moving vehicles, including motor vehicles, trailers, trolley buses, aircrafts and vessels, are considered available for use at the time at which required permits, licences or certificates required to operate these vehicles have been obtained. 2

Losses transfers between affiliated persons

The general rule is that losses on sales to affiliated persons are denied until such time as the asset is sold to a third party.

Non-arm's length transactions and the half-year rule - CCA

The half-year rule does not apply to depreciable capital property acquired in a non-arm's length transaction if, before the transfer, the property was depreciable property that was owned for not less than one year, and during the period of ownership, the depreciable asset was used to earn business or property income. In addition, the property remains in the same CCA class it was in before the transfer

Individuals

The taxation year for an individual is the calendar year. Individuals are taxed as follows in Canada: • Factual full-time residents: Taxed on worldwide income for the year. • Factual part-year residents: Taxed on worldwide income for the part of the year they are resident in Canada. • Deemed full-time residents: Taxed on worldwide income for the year. Worldwide income includes all income no matter where it is earned. Therefore, all income — whether earned in Canada or abroad — must be included in a Canadian resident's personal income tax return. If foreign tax has been paid on foreign income, the taxpayer will generally be eligible for a foreign tax credit to compensate for foreign tax paid.

CCA - Buildings

There are two special rules that must be considered for CCA on a rental property building: 1. Each rental building costing $50,000 or more must be included in a separate CCA class. Buildings acquired after 1987 are included in Class 1, where they are eligible for CCA calculated on a declining balance basis at an annual rate of 4%. 2. A taxpayer may not create or increase a net rental loss by claiming CCA on a property or group of properties.

Taxation of non-residents

To the extent that a non-resident: • was employed in Canada (physically held a job in Canada), • carried on business in Canada at a permanent location in Canada, or • disposed of taxable Canadian property at any time in the year, or a previous year, the non-resident person is liable to pay Canadian income tax on Canadian-source income. A non-resident individual receiving Canadian-source pensions, annuities, management fees, interest, rents or royalties will have Part XIII tax withheld from the gross amount payable. The withholding rate under the ITA is 25%; however, the rate may be lower or there may be an exemption under a tax treaty. Part XIII tax is applied to the gross amount of the payment specified above. This may result in adverse tax consequences to the non-resident with respect to rental income, because the tax withheld is 25% of the gross rents. A non-resident taxpayer, earning rental income on a real property located in Canada, may elect under ITA section 216 to pay Part I tax on the rental income. When this election is made, the non-resident taxpayer files a separate return including the gross rental revenue and deducting the relevant rental expenses. No other deductions are available and personal tax credits may not be claimed.

UCC

UCC balance, beginning of year + Additions in the year (1) - Disposals in the year (2) - Half-year rule (3) = Base amount for CCA - CCA claimed in the year + Half-year rule (per above) = UCC balance, end of year (1) The cost of additions includes the amount paid for the asset and other fees incurred to acquire the property (such as shipping and installation). (2) The lesser of the proceeds of disposal and the original cost of the asset sold is deducted from UCC. If proceeds are in excess of original cost, a capital gain will also be realized as a result of the disposal of the asset. Proceeds of disposal are generally the selling price of the asset less selling costs. (3) If the cost of additions in a year is greater than disposals, one-half of the excess is deducted prior to determining the CCA claim for the year. This is referred to as the half-year rule. The amount is added back to determine ending UCC.(1) The cost of additions includes the amount paid for the asset and other fees incurred to acquire the property (such as shipping and installation). (2) The lesser of the proceeds of disposal and the original cost of the asset sold is deducted from UCC. If proceeds are in excess of original cost, a capital gain will also be realized as a result of the disposal of the asset. Proceeds of disposal are generally the selling price of the asset less selling costs. (3) If the cost of additions in a year is greater than disposals, one-half of the excess is deducted prior to determining the CCA claim for the year. This is referred to as the half-year rule. The amount is added back to determine ending UCC. Ending UCC may also be determined as follows: UCC at the beginning of the year, plus additions, less disposals, less the CCA claim for the year. 3.1.1 Recapture and terminal losses

Sale of land and building - CCA

When real property is sold, the proceeds are allocated to the land and building based on the relative fair values of each of the land and building. When this allocation results in a terminal loss on the building and a capital gain on the land, tax rules require that proceeds be reallocated with the following results: • Terminal loss > capital gain: Reduce the terminal loss by the amount of the capital gain and deduct the remaining terminal loss from net income for tax purposes. • Capital gain > terminal loss: Reduce the capital gain by the amount of the terminal loss and include one-half of the remaining capital gain in net income for tax purposes.

Terminal losses realized by affiliated persons (individuals, corporations, trusts and partnerships)

Where a person or partnership (the transferor) disposes of a depreciable property with an accrued terminal loss to an affiliated person: • The transferor's terminal loss is denied and the transferor is deemed to own a property with a capital cost equal to the denied terminal loss and may continue to claim CCA on that amount until the asset is sold to a non-affiliated person. • The transferee is deemed to have acquired the property at the capital cost to the transferor, and the difference between the capital cost to the transferor and the selling price is deemed CCA taken. This results in UCC equal to the transfer price.