Taxation 1

Lecture 1

 Sources of Tax law

o Statute Law – Income Tax Act (Canada) (the “Act)
 Lengthy and complex
o Common Law – “Case Law”
 Primary source of definitions and interpretation
o International Tax Conventions
 Avoid incidence of double taxation
 Tax treaties take precedence over the Act
 ITA Section 3 – Income for taxation year
 Who develops Tax Law
o Department of Finance
 Develops income tax law
o Canada Revenue Agency
 Assess and collects tax
 Interpretation of tax law may conflict with intentions of drafters
 CRA’s interpretations are made public through Income Tax Folios (a technical
publication that has replaced Interpretation Bulletins)
 CRA’s interpretations are not law
 Determination of Income
o Framework
 Each entity subject to income tax determines its taxable income on the basis of a
taxation year
 Income for each entity is based on the world-wide income generated for five
categories
 Net Income for each of the five categories are aggregated
 The sum is referred to as “net income for tax purposes”
 Net income for tax purposes is reduced by a limited number of specific items
 Taxable income = Net income –specific deductions
 Taxation Year
o Defined differently for corporations and individuals [ITA 249]
o Corporations
 Any time period not exceeding 53 weeks (12 months) [ITA249.1]
 May be less than 12 months (e.g., when corporation is formed or ceases to exist)
 Exception for Professional corporations –December 31 taxation year-end
o Individuals
 December 31 of every year [ITA 249(1)
 Categories of Income
o An entity’s word income is derived from five basic sources [ITA 3]:
 Employment income
 Business income
 Property income
 Capital gains and losses
  Other specific sources
 Includes superannuation and pension receipts (including OAS and CPP
benefits), EI benefits, alimony payments, receipts from RRSPs and
deferred profit-sharing plans
 Net Income for Tax Purposes – The Aggregating Formula
o Must follow a basic accumulating formula [ITA 3]
o Same formula is used by individuals and corporations
o See Exhibit 3-4 in Buckwold/Kitunen text
 TAXABLE capital gains are 50% of capital gains (only divide when it says
capital)
 ALLOWABLE capital losses are 50% of capital losses
 Capital losses are only subtracted from gains not from total income
 It can be carried forward to the next fiscal year
 Taxable Income
o Net income for tax purposes is reduced by limited number of specified Division C
reductions to arrive at taxable income [ITA 110 to 116]
o Reductions applicable to individuals
 Unused losses of other years
 Employee stock option deduction
 Capital gains deduction on certain property
o Reductions applicable to corporations
 Donations
 Unused losses of other years
 Dividends from Canadian corporations
 Dividends from foreign affiliates
 Income from Employment
o Definition
 Not specifically defined in the Act
 When the relationship is not clear, the courts have considered four factors
 Control test (teachers opinion=most important to determine the outcome)
 Ownership of tools test
 Chance of profit or loss test
 Integration test
 Employment Income – Fundamental Rules
o ITA 5(1) - All formal compensation income, with exceptions, are taxable when received
o ITA 6(1)(a) -All benefits, with exceptions, are taxable when received
o ITA 6(1)(b) -All allowances, with exceptions, are taxable
o ITA 8(2) -All deductions are disallowed
 unless they are specifically allowed in the Act
 Cash Basis
o First fundamental rule -inclusion of formal compensation arrangements:
 Salary, wages and commissions [ITA 5(1)]
 Gratuities [ITA 5(1)]
 Bonuses [ITA 5(1)]
 Honoraria [ITA 6(1)]
 Director’s fees [ITA 6(1)(c)]
o Included on a cash basis
 When received, not necessarily when earned
 Taxable Benefits
o Common forms of taxable benefits [ITA 6(1)(a)]:
 Rent-free or low-rent housing
 Gifts in cash or in kind
 Non-cash gifts and non-cash awards with a total value < $500 can be
excluded from income annually
 Group term life insurance policies
 Holiday trips, prizes, and incentive awards in recognition of job performance
 Interest-free or low-interest loans
 Club dues when membership in the club provides little or no advantage to the
employer’s business
 Public transit is taxable
 Non- Taxable and Tax-deferred benefits
o Employer contributions to certain specific benefits are excluded on a deferred or
permanent basis [ITA 6(1)(a)(i) to (v))]
 Employer contributions to a deferred profit-sharing program (“DPSP”), a group
sickness or accident insurance plan, a pooled registered pension plan (“PRPP”), a
private (not public) health services plan, a registered pension plan (“RPP”) or
supplementary unemployment plan
 Counselling services relating to the mental or physical health (including family
members) or to the re-employment or retirement of the employee
 When an employer provides scholarships, bursaries, and free tuition for post-
secondary education to family members of employees to assist them to further
their education.
 Tax Exempt Benefits
o Arbitrary non-taxable benefits include [CRA T4130 Guide]:
 Discounts on merchandise
 Subsidized meals
 Child care –if provided at workplace, managed by the employer, and provided to
all employees at minimal or no cost
 Uniforms and special clothing
 In house recreational facilities
 Club dues, where it is clearly to the employer’s advantage to be a member of the
club
 Internet at home –providing primary benefit is to the employer
 Cell phones and computers –primarily for business purpose
 Tuition/Training costs reimbursed –if course primarily benefits the employer
 Taxable Benefits – Automobiles
o To the extent automobile is for personal use, a taxable benefit arises
o There are two components:
 Standby charge [ITA 6(1)(e), 6(2)] AND
 Operating cost benefit [ITA 6(1)(k), 6(1)(l)]
o See Handout
 Employee Loans
o The benefit an employee’s receives from a low interest loan is a taxable benefit [ITA
6(9)]
o Taxable benefit is the difference between the prescribed rate of interest and the actual
interest paid [ITA 80.4]
o See Handout
 Relocation Expenses
o Generally reimbursement of moving expense are not taxable
o Reimbursement of two specific types of relocation expenses are taxable:
 ITA 6(1)(a) / 6(23) - Reimbursement of costs to finance a residence is taxable
 ITA 6(1)(a)/6(19)-(21) - Reimbursement of loss on sale of home:
 First $15,000 - not taxable, but
 one-half of any amount above $15,000 is taxable
 Allowances
o All allowances are taxable, subject to specific exceptions [ITA 6(1)(b)]
o Only three of the exceptions have broad application:
 ITA 6(1)(b)(v) - Employees selling property or negotiating contracts
 ITA 6(1)(b)(vii) - Employees other than salespeople
 CRA Employer Guide – Overtime meals and allowances
 Employees selling property or negotiating contracts
o Entitled to a non-taxable allowance for travel expenses include transportation, car, meals,
lodging, and other incidental costs.
o The allowance must be reasonable:
 if unreasonably high or low in relation to the actual costs incurred, the allowance
is taxable.
o Tax-free allowances are not always beneficial.
 Employees Other than Salespeople
o Also entitled to receive a tax-free allowance for travel expenses.
 Travel allowance that does not relate to the use of an automobile is considered
tax-free only if:
 The allowance is a reasonable amount; and,
 The employee travels outside the municipality or metropolitan area in
which the employer is located.
 Reasonable Travel Allowance
o Automobile allowances are considered tax-free if:
 The allowance is for the purpose of travelling in the performance of their duties
as employees; and,
 The allowance is reasonable and
 based solely on the number of kilometres used to conduct employment
duties.
 CRA’s new administrative policy is to consider a per kilometre allowance of
$0.59 for the first 5,000 kilometres and $0.53 for the remainder (2021) as a
guideline for reasonableness.
 Overtime Meals and Allowances
o Reasonable overtime meal allowances are not taxable if:
 Employee works two or more hours of overtime right after scheduled hours.
 The overtime is infrequent and occasional (less than three times a week).
 Up to $23 per meal will generally be considered reasonable
o Otherwise, the allowance is a taxable benefit.
 Stock Options
o Categories of Stock Options
 In-The-Money Options: Stock options of public companies with an option price
below FMV at the date the option is granted
 Not-In-The-Money Options: Stock options of public companies with an option
price equal to or greater than the FMV at the date the option is granted
  Stock options of a CCPC
o See Handout