chapter 1 introduction to federal taxation in canada

Review based on Canadian Tax Principles 2011-2012 Edition by Byrd & Chen

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Chapter 1 Introduction to Federal Taxation in Canada

The Canadian Tax System and Liability for Tax

Income Tax A tax on the income of taxable entities.

It is governed by the Federal Income Tax Act (ITA).

Federal Income Tax

ITA 2(1) Income tax is levied on all Canadian residents regardless of citizenship.

ITA 2(3) Income tax is levied on employment and business incomes earned by non-residents in

Canada as well as gains and losses incurred by the non-resident on disposition of a taxable

Canadian property.

International tax treaties override ITA when there is a conflict.

The Canadian Federal Income Tax System uses a progressive rate

Each province can ONLY levy tax on income earned in the province and income of persons

living in the province at the last day of the taxation year.

Taxable Entities Individuals (human beings)

Corporations

Trusts

All three types of taxable entities are referred to as “person”, and they are required to file income

tax returns.

Income tax returns for individuals, corporations, and trusts are called T1, T2, and T3 respectively.

Net Income for Tax Purposes

There are 4 types of income included in the Net Income for Tax Purposes

1. Employment Income (Loss) please refer to chapter 3 review

2. Business Income (Loss) please refer to chapter 6 review

3. Property Income (Loss) please refer to chapter 7 review

4. Taxable Capital Gain vs. Allowable Capital Loss please refer to chapter 8 review

Note: Taxable Capital Gains = ½ Capital Gains

Allowable Capital Losses = ½ Capital Losses

The calculation for the Net Income for Tax Purposes is as following


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Note: $0 is written as Nil.

Income Under ITA 3(a):

Employment Income $E

Business Income B

Income From Property P $XXX

Income Under ITA 3(b):

Taxable Capital Gains $G

Allowable Capital Losses (L) $YYY1

Balance From ITA 3(a) And (b) $ZZZ

Subdivision e Deductions (eee)

Balance Under ITA 3(c) $CCC3

Deduction Under ITA 3(d):

Employment Loss ($e)

Business Loss (b)

Property Loss (p) ($xxx)

Net Income for Tax Purpose (Division B Income) $BBB3

1where $YYY = $G - $L. If $YYY is negative, then it is treated as $0 for further calculations.

2where $CCC = $ZZZ - $eee

3If $BBB is negative, then treat it as $0, and write Nil.

Note: The negative amount of ITA 3(b) can be carried forward as allowable capital losses,

which are deductible against the taxable capital gains in any future taxation year.

The excess of $xxx over $CCC can be carried forward as ITA 3(d) deductions

against ITA 3(c) amount in any of the next 20 taxation years.

Please refer to Exercises One-6, One-7, One-8 on page 26 and Self Study Problems One-5,

One-6 on pages 31 and 32 for further reference.


Chapter 20 International Issues in Canada

Residency

A full year resident is an individual who lives in Canada for the year or has significant

residential ties with Canada.

The individual will be taxed on his worldwide income for the full year.

Factors Indicating Significant Residential Ties

1. The individual has a spouse or common-law partner who stays in Canada while the

individual is abroad and had been living with the individual prior to his or her

departure from Canada.

2. The individual has dependent(s) that remain(s) in Canada while he or she is abroad.

3. The individual has a home in Canada that isn’t rented out to an arm’s length party

while the individual is abroad.

A part year resident is an individual who becomes a Canadian resident or stops being a

Canadian resident during the taxation year.

For an individual who became a resident sometimes during the year, he or she will be

taxed on all sources of income earned starting on the date when they become a

Canadian resident.

For an individual who stops being a resident during the year, he or she will be taxed

on all sources of income earned prior to the latest of the following dates:

The date the individual depart from Canada,

The date the last of the individual’s spouse/common-law partner and other

dependants leave Canada, and

The date the individual becomes a resident of their new country.

A deemed resident is an individual who lacks significant residential ties with Canada, but is

taxed like a full year resident who does NOT reside in any particular Canadian province.

Please refer to paragraph 20-23 on page 944 for the list of deemed residents of Canada.

A non-resident is an individual who is neither a full year resident, nor a part year resident, nor a

deemed resident.

Non-residents are only taxed on employment and business income earned in Canada,

and gains and losses on the disposition of Taxable Canadian Property.


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Chapter 3 Income and Loss from an Office or

Employment

Definition of Employment Income

Employment Income

ITA 5(1) Employment income includes salary, wages, and non-monetary benefits, such as

gifts, received by the taxpayer in the year.

Employment Inclusions = Taxable Monetary Rewards + Taxable Benefits

Employment Income = Employment Inclusions – Employment Deductions

Employment incomes are reported on a cash basis, NOT on an accrual basis.

Employee vs. Self-employed

An individual doing work for an organization is either an employee or an independent

contractor.

Employees earn employment income while independent contractors earn business income.

Key Distinctions between Employees and Independent Contractors

Factors Employee Independent Contractor

Intent Contract of Service Contract for Service

Control The employer controls the method

in which a task is done.

The payer has little control over

the how a task is completed

Ownership of Tools

and Equipment

The employer supplies the tools and

equipments required for tasks.

The contractor supplies tools

and equipments required to tasks.

Ability to

Subcontract or Hire

Assistance

The payer has control over whether

or not an assistant may be hired and

the assistant’s qualifications.

The payer has no control over

the assistant hired by the

independent contractor.

Financial Risk The employer is responsible for the

financial risk associated with the

work done.

The contractor is responsible for

the financial risk associated with

the work done.

Responsibility for

Investment and

Management

Not involved in the management of

the employing business nor sharing

in the ownership of the business

responsible for the task.

Active in managing the business

that is responsible for the task.

Opportunity for

Profit

The employer receives all the

profits on the tasks performed.

A contractor receives all the

profits on the task performed.


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Employment Income Inclusions

Wages and salaries must be included in employment income.

ITA 6(1)(a) Any benefit given to an individual by his employer in relation to his

employment position, with the exception of certain items, must be included in income.

For the list of exceptions, please refer to paragraph 3-44 on page 78 of the textbook.

Inclusions - Tuition Fees

Situations under which educational costs are paid by the employer

1. Specific Employer-Related Training Courses related to the employer’s work.

2. General Employment-Related Training General business related courses.

3. Personal Interest Training Courses not related to the employer’s business.

Employer-paid personal interest training is a taxable benefit.

1. The amount paid by the employer is added to the employee’s employment income.

2. The employee can claim a related tuition fee tax credit.

Inclusions - Gifts

Non-arm’s Length Employees are employees who are relatives of the proprietor of their

employing business or a shareholder of their employing private corporation.

For a non-arm’s length employee and their related persons, value of all gifts are

added to employment income.

Non-cash gifts and non-cash awards

An arm’s length employee

annual total gift value in excess of $500 is taxable

Non-cash long service/anniversary award

The employee must have performed at least 5 years of service for the employer.

For each employee, there must be a minimum interval of 5 years between two

consecutive long service awards.

The employee must be an arm’s length employee

Total award value in excess of $500 is taxable

The two amounts cannot be used to offset amounts in each other.

Items of immaterial or nominal values, such as coffee, tea, and T-shirts with employer logos, will

be treated as having a value of $0 for tax purposes.


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Cash and near-cash gifts (ex. gift certificates) are included in employment income.

Performance related rewards are included in employment income.

Please refer to Exercise Three-2 on page 80 as an example.

Taxable Benefit on Employer Provided Automobile

If an employer provides an employee with an automobile, it would lead to 2 taxable benefits.

ITA 6(1)(e) Standby Charge

Step 1: Full Standby Charge

Employer Owned Vehicle

Full Standby Charge = [(2%) (Cost of Car) (Months Available)]

Cost of Car is the amount paid (includes GST/HST/PST).

Months Available = (Number of days for which the employee has possession of the

car key ÷ 30)

Note: The number of months available is rounded to the nearest whole number,

with 0.5 rounding down.

Employer Leased Vehicle

Full Standby Charge = [(

) (Lease Payment for the Year) (

)]

Lease Payments for the Year equals the total lease payments for the year including

GST/HST/PST less the portion of the payment that goes to cover insurance.

Months Available = (Number of days for which the employee has possession of the

car key ÷ 30)



Months Leased = (Number of Days the employer’s lease payments covers ÷ 30)



Step 2: Percentage of Non- Employment Related Usage

Employment Usage =

Employment Kilometers = Total Kilometer this Year – Personal Kilometers this Year


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Step 3: Standby Charge

If Employment Usage ≤ 50%, then Standby Charge = Full Standby Charge.

If Employment Usage > 50% and the employee is required by the employer to use the

automobile in his employment duties, then:

Standby Charge = Full Standby Charge [(

]

Non-Employment Kilometers = Total Kilometers - Total Employment Kilometers

Note: The Non-Employment Kilometers can NOT exceed the denominator!

The Months Available is the same as the one used to calculate the full standby charge.

ITA 6(1)(k) Operating Cost Benefit

Step 4: Operating Cost Benefit

If the Employment Usage ≤ 50%, then:

Operating Cost Benefit = $0.24*(Personal Use Kilometers)

If the Employment Usage > 50%, then:

Operating Cost Benefit = (

)*(Standby Charge)

Step 5: Total Taxable Benefits

Total Taxable Benefit = Standby Charge + Operating Cost Benefit

Please refer to Exercise Three-7, Exercise Three-6, and Self Study Problem Three-3 on pages

90, 91, and 116 for further reference.

Stock Option Benefits

Stock options Options that allow, but do not require, the employee to purchase a specific

number of shares at a stated exercise price during a specified period.

Three key dates are involved in the stock option process:

Issue Date Exercise Date Disposition Date

Issue Date The date when the options are given to the employees.


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Exercise Date The date when the option is exercised by the employee to purchase the stocks

at the price stated on the option.

Disposition Date The date when some or all of the shares acquired at exercise price are sold.

Step 1: Public Corporation vs. Private Corporation

Determine if the company is a public corporation or a private corporation.

ITA7 (1)(a) Public Corporation


Market Price Market Value Market Value

Exercise Price Exercise Price Adjusted Cost Base

Step 2: On Issue Date

There is no tax consequence on issue date.

Step 3: On Exercise Date

The amount calculated below is included in the employment income in the year of exercise.

Fair Market Value of Shares Acquired [(number of shares)*(market price)] $XXX1

Cost of Shares [(number of shares)*(exercise price)] (XXX2)

ITA 7(1)(a) Employment Income Inclusion

= Increase in Net Income for Tax Purposes XXX3

ITA 110(1)(d) Deduction [(1/2)($XXX3)] (XXX4)

Increase In Taxable Income XXX5

$XXX1 is calculated using the market price on the exercise date.

$XXX4 is only available if the exercise price ≥ market price on the issue date.

Step 4: On Disposition Date

The amount calculated below is included in the employment income in the year of

disposition.

Proceeds of Disposition [(number of shares)*(disposition date market price)] $XXX6

Adjusted Cost Base [(number of shares)*(market price on exercise date)] (XXX1)

Capital Gain $XXX7

Inclusion Rate ½

Taxable Capital Gain $XXX8

Please refer to Exercise Three-14 on page 105 of the textbook for more details.

ITA7 (1)(a) Canadian Controlled Private Corporation (CCPC)


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Market Price Market Value Market Value

Exercise Price Exercise Price Adjusted Cost Base

Step 2: On Issue Date

There is no tax consequence on issue date.

Step 3: On Exercise Date

There is no tax consequence on the exercise date.

Step 4: On Disposition Date

The amount calculated below is included in the employment income in the year of

disposition.

Fair Market Value of Shares Acquired [(number of shares)*(market price)] $XXX1

Cost of Shares [(number of shares)*(exercise price)] (XXX2)

ITA 7(1)(a) Employment Income Inclusion

= Increase in Net Income for Tax Purposes XXX3

ITA 110(1)(d) Deduction [(1/2)($XXX3)] (XXX4)

Increase In Taxable Income XXX5

$XXX1 is calculated using the market price on the exercise date.

$XXX4 is only available if the exercise price ≥ market price on the issue date or the shares

are held for at least 2 years after their acquisition.

The amount calculated below is included in the taxable capital in the year of disposition.

Proceeds of Disposition [(number of shares)*(disposition date market price)] $XXX6

Adjusted Cost Base [(number of shares)*(market price on exercise date)] (XXX1)

Capital Gain $XXX7

Inclusion Rate ½

Taxable Capital Gain $XXX8

Please refer to Exercise Three-15 on page 106 of the textbook for more details.


Chapter 4 and 11 Tax Payable and Tax Credits for

Individuals

Calculation of Tax Payable

2011 Income brackets and their marginal rates

Taxable Income Exceeding: Marginal Federal Tax Rate

$0 15%

$41,544 22%

$83,088 26%

$128,800 29%

Example: For an individual with an income of $90,000, his total federal tax would be calculated

as following:

Taxable Income In Excess

Of

Marginal Federal Tax Rate

on the Bracket

Amount of Tax

$41,544 15% $6,231.60

$41,544 22% $9,139.68

$6,912 26% $1,791.12

Hence, the total federal tax payable on the $90,000 would be $17,162.4.

Surtax Additional tax charged on the regular tax payable.

Ontario charges surtax on the portion of Ontario Tax Payable in excess of $5,219.

Ontario charges 56% surtax and Prince Edward Island charges 10% surtax.

An individual has to pay provincial tax on all his income other than business income to the

province in which he resides on the last day of the taxation year.

A Canadian resident who is not a resident of a particular province will not have to pay any

provincial taxes, but is charged an additional surtax of 48% on federal tax payable.

Example: A Canadian official working at a Canadian embassy abroad.

Please refer to Exercise Four-2 on page 136 of the textbook for more details.


Personal Tax Credits

Tax Credit Base A calculated amount to which the minimum federal tax rate, unless

otherwise specified, is applied to determine a tax credit amount.

Example: A tax credit with a tax credit base of $10,527 will have an amount equal to 1579.05

[0.15*($10,527)].

The tax credits will directly reduce tax payable.

Please refer to page ix to xi of the textbook for a detailed list of the tax credits.


Chapter 5 Capital Cost Allowances and Cumulative

Eligible Capital

Key Terms

Capital Asset An asset that is capable of producing income and is held to generate income.

The same type of asset may be classified as inventory or capital asset

depending on the business.

Capital Cost Allowance (CCA) Equivalent to depreciation expense for tax purposes.

Only capital assets are given Capital Cost Allowance.

CCA calculation is done for each separate class of assets.

Undepreciated Capital Cost (UCC) The balance consists of the total of the original costs of

all the assets ever added to the class less all the CCA

ever deducted from income.

Capital Cost of Asset The acquisition cost of a capital asset.

The capital cost of a property purchased with foreign currency will

be converted to Canadian dollars using the exchange rate on the

date of acquisition.

Additions to Capital Cost

The following adjustments are done to the amount paid for a capital asset to arrive at the

capital cost:

1. ITA 21(1) A taxpayer can choose to add the interest on the funds borrowed to

acquire the depreciable property to the capital cost of the acquired property.

Note: the corresponding interest would NOT be deductible as expense.

2. ITA 13(7.1) Capital cost of an asset is reduced by amounts received or receivable

from the government.

3. ITA 248 (16) Capital cost of an asset is reduced by amount of refundable

GST/PST/HST.

Available for Use Rule A Property is only eligible for CCA deductions starting at the earliest

of the following times:

The year when the non-building property is first used by the taxpayer for earning

income.

The year when 90% or more of the building is used for its intended purpose.


The second taxation year after the year of acquisition.

The year in which accounting depreciation is first recorded on the property

(public companies only).

The year when the required certificate or license is obtained for the transport

equipment.

ITR 1102 Land is specifically excluded from depreciable properties.

When a real property is purchased, must proportionate the total cost between the building

component and the land component.

Depreciable assets are assigned to different classes, and CCA is calculated on a class basis.

CCA rate differs based on the class in which an asset belongs.

When a specific type of asset is reclassified into a different CCA class, the change will apply

only to the relevant assets acquired after the specified date.

Please refer to page 216 to 217 of the textbook for a detailed list of the various classes of assets.

Separate Classes

Assets that belong to the same CCA class are usually assigned to the same balance and

depreciated as a group. The following are a few exceptions:

1. Same type of assets owned by different unincorporated businesses cannot be grouped

together into a single class, even when the businesses are owned by the same individual.

2. Rental properties acquired after 1971 at a cost of $50,000 or more must each be given its

own separate CCA class.

3. Passenger vehicles acquired at a cost higher than $30,000 must each be given its own

separate CCA class.

4. Non-residential buildings and assets that quickly becomes technologically outdated are

each allowed to be given its own separate CCA class.

Calculation of Capital Cost Allowance

Declining Balance Class The CCA for the class is determined by applying a specified rate is

to the class’ end of the period UCC balance.

Straight-line Class The CCA for the class is determined by applying a specified rate to the

total capital cost of the assets in the class.

Rental Property Restrictions The total CCA claimed on rental properties cannot exceed the

amount of net rental income prior to CCA deductions.


Half-Year (First Year) Rule For applicable classes, every year, the CCA calculation is based

on the ending UCC balance after a deduction of ½ of any

excess of additions for acquisitions over deductions for

disposition.

Exception: Property transferred in non-arm’s length transactions where prior to transfer,

the property was owned for more than at least 1 year.

Certain CCA classes as shown in the Commonly Used CCA Class section.

Short Fiscal Period A taxation year with less than 365 days.

Short Fiscal Period Rule The CCA deduction, after applying the half year rule if applicable,

will be multiplied by the number of days the business is in

operation and divided by 365.

Exceptions are class 14 assets and CCA deductions against

property income.

Commonly Used CCA Classes

Class 1 – Buildings acquired after 1987

4% Declining Balance.

Rental building costs more than $50,000 must be allocated to a separate class 1.

Buildings acquired after March 18, 2007, allocated to its own separate class 1, and

is 90% or more used for manufacturing and processing 10%

declining balance

is 90% or more used for non-residential purposes but not 90% or

more manufacturing 6% declining balance

Class 3 – Buildings acquired before 1988


Rental building costs more than $50,000 must be allocated to a separate class 1.

Class 8 – Various Machinery, Equipment, and Furniture


Includes machines, equipments, structures, and furniture that are NOT specifically

included in another class.

Individual photocopiers, electronic communications equipments, and software that

belong in this class and have a capital cost of $1,000 or more can be allocated to a

separate Class 8.

Please refer to Exercise Five-12 on page 209 of the textbook for more details.


Class 10 – Vehicles


Includes most vehicles except for passenger vehicles with cost in excess of

$30,000.

Class 10.1 – Luxury Vehicles


Passenger vehicles with cost in excess of $30,000.

Each vehicle must be allocated to a separate 10.1 class.

The amount of addition is limited to $30,000.

In year of retirement, ½ of the normal CCA rate can be deducted.

No recapture or terminal losses can be recognized.

Class 12 – Computer Software and Small Assets


Class 12 medical or dental instruments and tools costing less than $500, uniforms,

and chinaware are NOT subjected to half-year rule.

Class 13 – Leasehold Improvements

Straight-line.

Maximum CCA =

Note: Lease Term = number of full 12 month periods from beginning of

the taxation year in which the improvement is made

until the termination of the lease. Limited to 40 years.

Class 14 – Limited Life Intangibles

Straight-line over legal life.

Includes all limited life intangibles except for patents.

For year of acquisition and the year of disposition,

Maximum CCA = CCA * (

)

Half year rule and short fiscal period NOT applicable.

Class 29 and 43 – Manufacturing and Processing Assets

Acquired before March 19, 2007 are included in Class 43 30% Declining

Balance.

Acquired on March 19, 2007 and after are included in Class 29 50% Straight-

line, half-year rule is applicable.

Class 44 – Patents

25% declining balance rate.

Can choose to put these assets in Class 14.


Class 45, 50, and 52 – Computer Hardware and System Software

Please refer to page 199 of the textbook for more information.

Class 52 is exempted from the half-year rule.

Example: In its first year of operations, a business purchased a $60,000 Class 8 asset 30 days

before the end of the taxation year. At the end of the taxation year, this is the only asset in the

Class 8 balance. If the business had operated for 50 days in this taxation year and there is no

other transaction involving Class 8, what is the maximum Capital Cost Allowance on Class 8?

Maximum CCA = [(1/2)(0.2)($60,000)]*(50/365) = $821.91

Half-Year Rule Short Fiscal Period Rule (using days of operation)

Please refer to Exercises Five-2, Five-3, Five-4, Five-5, and Five-6 on page 201 of the

textbook for more details.

If only partial CCA deduction can be claimed due to insufficient related income, the full CCA on

the class with the lowest rates should be taken before going towards the classes with higher CCA

rates.


Disposition of Depreciable Assets

Upon disposition of an asset, the amount to be deducted from the UCC balance is the lesser of:

The capital cost of the individual asset,

The proceeds of disposition for the asset.

Dispositions with Tax Consequences

1. At the end of the taxation year, the CCA class has a negative balance.

Note: For any asset required to be allocated into its own separate class, a negative

balance at any time during the taxation year will result in recapture.

Recapture of CCA = Absolute Value of the Negative Amount in the Balance

Recapture will be fully added to income, and the beginning balance for the related CCA

will be set to Nil for the next taxation year.

2. Proceeds of Disposition > Capital Cost of the Asset

Taxable Capital Gain = (

)*(Proceeds of Disposition – Capital Cost of the Asset)


Note: The deduction from the CCA balance is the capital cost.

A recapture could also occur alongside the capital gain.


3. At the end of the year, the CCA class has a positive balance but no asset in the class.

Terminal Loss = Amount of the Positive Balance

Note: For employee owned automobiles and aircrafts, terminal loss is $0.

Terminal loss will be fully deductible against any other income, and the CCA balance

will be set to Nil for the beginning of next year.

For CCA classes where the Half-year Rule and Short Fiscal Period Rule applies.

1. Without terminal loss or recapture

Beginning UCC Balance for Current Year $XXX1

Add: Acquisitions During the Year $XXX2

Deduct: Dispositions During the Year – Lesser of:

Capital Cost - $xxx

Proceeds of Disposition -$xxx (XXX3) XXX4

Deduct: ½ Net Additions (XXX5)

Base Amount for CCA Claim XXX6

Deduct: Current Year CCA (XXX7)

Add: ½ Net Additions XXX8

Beginning UCC Balance for Next Year XXX9

XXX4 = $XXX2

– $XXX3. Put Nil if the number is negative.

XXX3 = lesser of capital cost and proceeds of disposition

XXX5 =

XXX

XXX7 = CCA rate for the class * XXX6* (days of business operation this year/ 365).

2. With Recapture


Add: Acquisitions During the Year $XXX2


Capital Cost - $xxx

Proceeds of Disposition -$xxx (XXX3) XXX4

Deduct: ½ Net Additions N/A1

Negative Ending Balance (XXX8)

Recapture of CCA XXX8

Beginning UCC Balance for Next Year Nil


1There is no ½ net additions to be deducted because when there is a recapture, the net additions

in the year must be negative. The deduction is only done when the net addition is positive.

XXX8 = the amount of recapture of CCA added to income and the UCC balance.


3. With Terminal Loss


Add: Acquisitions During the Year Nil1


Capital Cost - $xxx

Proceeds of Disposition -$xxx (XXX3) (XXX3)

Positive Ending Balance XXX9

Terminal Loss (XXX9)

Beginning UCC Balance for Next Year Nil 1There cannot be additions to the class in the year or else there will still be at least one asset in

the class at the end of the year and a terminal loss cannot be recognized.

(XXX9) = the amount of terminal loss recognized and can be deducted from the balance.


Cumulative Eligible Capital (CEC)

Eligible Capital Expenditure An intangible capital property that doesn’t belong to a CCA

class but its cost is not deductible for tax purposes.

For the list of items to be included in CEC and the list of items to be excluded from CEC,

please refer to paragraph 5-79 and 5-80 on page 210 of the textbook.

Cumulative Eligible Capital A class for all the eligible capital expenditure of a business.

Every year, the CEC balance is increased by ¾ of all eligible

capital expenditures that year and reduced by ¾ of the proceeds

of disposition (i.e. the original cost doesn’t matter), to arrive at

the Base Amount for CEC amount.

CEC amount can only be deducted against business income.

ITA 20(1)(b) The maximum CEC amount for a taxation year is calculated by multiplying the

ending CEC balance by 7%.

The half-year rule does not apply, but the short fiscal period rule applies.


Scenario 1: Positive Balance with No Assets at the end of the Taxation Year

No terminal loss can be claimed for the CEC balance as the 7% CEC amount is applicable for as

long as there is a balance in the class, regardless of whether or not there are any actual assets in

the class.

Scenario 2: Negative Balance at the end of the Taxation Year

Recapture on CEC = total CEC deductions up to date

Capital Gain = Absolute value of the negative balance - Total CEC deductions

Taxable Capital Gain =

* Capital Gain

Please refer to Exercises Five-13 on page 213 of the textbook for further reference.

ITA 14(1.01) For eligible capital expenditures with a determinable cost, other that goodwill, a

choice can be made to deduct only

of the capital cost of the individual

disposition from the CEC balance, and treat the difference between the full

proceeds of disposition and the full capital cost as capital gain.

Please refer to Exercises Five-14 on page 214 of the textbook for further reference.


Chapter 6: Income or Loss from a Business

Overview and Classification of Business Income

ITA 248(1) Business is anything involving an adventure or concern in the nature of trade,

which is indicated by the factors listed below.

1. For frequently repeated activities, if the activities are capable of producing profit.

2. For single transactions, if any of the following conditions is met:

1. The taxpayer’s original intention was to sell the asset.

2. The taxpayer uses the asset for same way as a businessperson would

use the asset.

3. The asset can only produce income through sales.

ITA 12(1)(b) Business income is effectively calculated on an accrual basis.

Revenue Generated by Properties

The classification of the revenue generated by a property depends on how the property is used.

1. Used in business and not for sale (ex. a factory for a manufacturing company, a

bookshelf in a bookstore, and a computer in a bank).

While the property is held, business income/loss is generated.

Upon disposition:

The non-depreciable property leads to capital gain/loss.

The depreciable property leads to terminal loss (business loss),

recapture (business income), or a recapture (business income) and

capital gain.

2. Used as inventory for resale.

Upon disposition, business income/loss is generated.

3. A property that requires little effort on the part of the owner to produces income (ex.

stocks and Canada Savings Bonds).

While the property is held, property income/loss is generated.

Upon disposition:

The non-depreciable property leads to capital gain/loss.

The depreciable property leads to terminal loss (business loss),

recapture (business income), or a recapture (business income) and

capital gain.


4. A property acquired by an individual for personal use (ex. personal cell phone)

Upon disposition capital gain is produced (with a few exceptions).

5. A real property that is not used to produce income.

Upon disposition capital gain is produced (with a few exceptions).

Business Income vs. Capital Gain Classification

Income Classification Advantages Disadvantages

Business Income Business losses are fully

deductible against all forms

of income.

Business incomes are fully

taxable.

Can only be carried forward

for next 20 years.

Capital Gain Capital gains are only 50%

taxable.

Allowable capital Losses can

be carried forward forever.

Capital losses are only 50%

deductible.

Allowable capital losses can

only be applied against

taxable capital gains.

Business Related Reserves

Reserves A group of specific items deductible from the income of a particular tax year, but

must be added back to the subsequent year’s income.

ITA 20(1)(l) Reserve for Doubtful Debts

Reserve for doubtful debts is to take into account the portion of revenue that may be

uncollectible in the future (i.e. bad debt expense).

1. ITA 20(1)(l) A reserve amounting to the anticipated bad debt expense can be

applied as a deduction against the current year’s business income.

2. ITA 20(1)(p) The actual write-offs incurred in the current year may be deducted

from current income.

3. ITA 20(1)(d) The previous year’s reserve for doubtful debt must be added to

current year’s business income.

Add: Previous Year Reserve for Tax Purposes $XXX

Deduct:

Current Year Actual Write-Offs ($XXX)

Current Year Reserve for Tax Purposes (XXX) (XXX)

Current Year Net Deduction For Tax Purposes (XXX)


Please refer to Exercise Six-3 on page 238 for more details.

ITA 20(1)(m) Reserve for Undelivered Goods and Services

1. Prepayments for future goods or service to be delivered are included in the current year’s

business income.

2. A reserve for undelivered goods and services is given as deduction against the current

year’s business income for the portion of the goods and services that have not yet been

delivered in the current year.

3. Previous year’s reserve for undelivered goods and services must be added back to the

current year’s business income.

Example: During the taxation year 2011, Cheerful Renovations has received $100,000 in cash,

out of which, $30,000 are for services to be delivered in 2012. What is the amount of

the ITA 20(1)(m) reserve deductible in 2011?

A $30,000 reserve can be deducted against her 2011 business income, but must be

added to her 2012 business income.


ITA 20(1)(n) Reserve for Unpaid Amounts

Reserve for unpaid amount is used to delay the recognition of revenues that are already earned

but are to be received over a long time.

Conditions

With the exception of real property, at least some part of the proceeds will NOT

be received until 2 years or more after the date of sale.

The purchaser is neither a corporation controlled by the seller nor a partnership

in which the seller has a majority interest.

Constrain

No reserve can be deducted in the current year for sales that took place more

than 36 months (i.e. 3 years) before the end of the current year.

Example: On October 5, 2010, PD Corporation sold a porcelain artifact to Allen for $500,000.

The buyer will pay the full $500,000 of proceeds in five $100,000 annual installments starting on

November 30, 2010.The cost of the vase to PD Corporation was $300,000.

The gross profit from the sale will be $200,000.


The profit is distributed in the same proportion as the the revenue.

As some of the proceeds will be received after October 2012 (two years from the

sales date), the reserve is allowed.

The reserve for the each year equals the percentage of the profit that has not been

received by the end of the year.

2010 Reserve = (0.80)*($200,000) = $160,000

2011 Reserve = (0.60)*($200,000) = $120,000

2012 Reserve = (0.40)*($200,000) = $80,000

2013 Reserve = Nil because the end of 2013 is after October 5, 2013, which is

exactly 36 months after the date of sale.





Income from 2010 sale for 2011 can be calculated as shown below.

Add: 2010 Reserve for Tax Purposes $160,000

Deduct:

2011 Reserve for Unpaid Amount (120,000)

Current Year Income From Sale 40,000


Add: 2012 Reserve for Tax Purposes $80,000

Deduct:

2013 Reserve for Unpaid Amount Nil

Current Year Income From Sale 80,000


Add: 2013 Reserve for Tax Purposes Nil

Deduct:

2014 Reserve for Unpaid Amount Nil

Current Year Income From Sale Nil



Chapter 7 Income from Property

Definition of Income from Property

Property Income A return that is earned by simply owning a property, and requires little or

no effort on the part of the owner in the earning process.

ITA 9(3) Capital gains are NOT included in property income.

A deduction equal to the amount of foreign taxes on property income in excess of 15% is

available to individuals.

Interest Deductions

ITA 20(1)(c) Only interests related to the generation of property or business income are

deductible against the relevant income.

Direct Use Rule The deductibility of interest depends on the direct use of the related capital.

Example: A businessperson takes $100,000 cash out of his business to purchase a

personal residence. Then, he immediately fills in the cash shortfall in his business by

borrowing $100,000 from the bank at 5% per year.

The economic reality of the loan is to help purchase the businessperson’s personal

residence. However, since the interest is legally attributed to the bank loan that is

directly used to invest in the business, the 5% interest is fully deductible against

business income.

Exceptions to Direct Use Rule (please refer to paragraph 7-23 on page 292)

1. Filling the Hole

2. Interest-Free Loans

Current Use Rule The interest on a loan is deductible for as long as the loan is for property

or business income producing purposes.

Exceptions to Current Use Rule:

1. Disappearing Source Rule If the loan is invested in a business or

property income producing property that is sold for less than the debt,

then the interest on the debt will continue to be deductible.

ITA 20(1)(c) The amount of imputed interest included in an individual’s employment income as

a result of an employer-provided loan is deductible against the business or property income

generated by the usage of the loan.


Interest Income

ITA 12(4) For individuals, interest is accrued on each anniversary date of an investment

contract (debt securities).

The anniversary date is based on the calendar date that is immediately before the date of issue,

and repeats every year starting in the year immediately after the year of issue and ending on the

year of maturity.

Example: For a 3 year debt issued on January 31, 2011, the anniversary dates will be January 30,

2012, January 30, 2013, and January 30, 2014.

1. At each anniversary date, the individual recognizes interest income equal to:

Total interest accrued since issuance – Total interest previously included in income

2. At each payment date, the individual recognizes interest income equal to:

Total interest received to date – Total interest accrued up to most recent anniversary date

3. For each taxation year, interest income to be included equal to:

Amount recognized on anniversary date + amount recognized on payment date

Please refer to Exercise Seven-3 on page 298 as an example.

Rental Income

Rental revenues are included in income on an accrual basis.

Expenses related to the earning of the rents are all deductible against the rental revenues.

Example: Utilities, maintenance, agent fees, property taxes, and related insurances.

Capital Cost Allowance on rental property can also be deducted on the building component of

the real property.

Special Rules regarding CCA on rental properties

1. No pro rata adjustments required for a short fiscal period for individuals.

2. Each rental property acquired after 1971 at a cost of $50,000 or higher must be put

in its own separate CCA class.

3. The total amount of CCA plus terminal loss claimed on all rental properties each year

cannot exceed the total rental income (including recapture) from all the rental

properties before CCA deductions.


Note: When claiming less than the maximum allowable CCA, the classes

with the lowest rates should be deducted first.

The Rental Income can be calculated with the following method:

Gross Rents $xxx

Recapture of CCA on Rental Properties xxx

Terminal Loss of CCA on Rental Properties (xxx)

Rental Expenses other than CCA (xxx)

Rental Income before CCA $xxx

CCA (xxx)

Net Rental Income $xxx

Please refer to paragraph 7-66 and 7-67 for the various CCA classes relevant to rental income.


Dividend Income

Dividend incomes received by individuals are paid out of the after-tax income of corporations.

Eligible Dividends Dividends from corporations that are taxed at a combined tax rate

between 27 and 33 percent.

Dividends from publicly traded companies often qualify.

Non-eligible Dividends Dividends received that aren’t eligible dividends.

Tax Treatment of Dividends

1. Both eligible and non-eligible dividends must be “grossed up” by a specified percentage

to reflect the amount of pre-tax corporate income required to produce the after-tax

dividends paid.

2. The “grossed up” amount of dividends will be added to the recipient’s property income.

3. Both a federal dividend tax credit (non-refundable) and a provincial dividend tax credit

will be provided for the recipient to reduce his or her tax payable.

Calculation for Total Tax Payable on Dividends Received

The Variables

X is the amount of dividends received.

Y is the combined federal and provincial tax rate in %.

Z is the % of the Gross UP given as provincial dividend tax credit.

T is the increase in total tax payable due to the dividends received.


Non-Eligible Dividends Received $X

Add: Gross UP At 25% 0.25*X

Taxable Dividends 1.25*X

Combined Federal/Provincial Tax Rate Y%

Tax Before Dividend Tax Credit 0.0Y*1.25*X

Less: Federal Dividend Tax Credit 2/3*Gross UP

Provincial Dividend Tax Credit 0.0Z*Gross UP

Total Tax Payable $T


Eligible Dividends Received $X

Add: Gross UP At 41% 0.41*X

Taxable Dividends 1.41*X

Combined Federal/Provincial Tax Rate Y%

Tax Before Dividend Tax Credit 0.0Y*1.41*X

Less: Federal Dividend Tax Credit 13/23*Gross UP

Provincial Dividend Tax Credit 0.0Z *Gross UP

Total Tax Payable $T



Chapter 8 Capital Gains and Capital Losses

Key Definitions

Capital Asset An asset used to generate income and not is intended for sale.

Capital Gains/Losses Gains or losses resulting from the disposition of capital assets.

ITA 39(4) A taxpayer can choose to have all its Canadian securities treated as capital asset.

Once chosen, all future gains or losses on the dispositions of Canadian

securities by the taxpayer will be treated as capital gain or loss.

Not available to non-residents and taxable entities that engages in the business

of money lending and securities trading.

ITA 54 and ITA 13(21) Proceeds of Disposition

The price at which a property is sold.

Compensation (ex. proceeds from insurances) for property damage or loss.

ITA 69 For non-arm’s length transfers, the proceeds of disposition for tax purposes is the

higher of the actual proceeds and the fair market value of the relevant assets.

Determining the Adjusted Cost Base

ITA 54 The adjusted cost base (ACB) of an asset is:

The capital cost of the asset, if the asset is a depreciable property of the

taxpayer.

The cost, with a few adjustments specified in ITA 53, of the property to

the taxpayer, if the asset is not a depreciable property.

ITA 53 Adjustments to the cost required to arrive at ACB

1. Government Grants and Assistance provided must be deducted from the cost.

2. Superficial Losses

30 days before 30 days after

Date of Disposition


If a taxpayer or his spouse/common-law partner obtains a property within 30

days before or after the disposition date of an identical property by one of the

two taxpayers, any loss on the disposition date will not be deductible, and will

be added to the cost the newly obtained identical property.

3. Property taxes paid for vacant land and any interest related to the vacant land

are added to the cost.

4. Refundable GST/HST/PST amounts are deducted from the cost.

ITA 42 The full amount of the proceeds of disposition must be recognized regardless of whether

or not the proceeds include payment for a warranty on the asset sold. However, subsequent costs

associated with the warranty obligation are treated as capital losses in the year when they occur.

Please refer to Exercises Eight-1, Eight-2, and Eight-4 on pages 339 and 342 of the textbook

for more details.

ITA 40(3) At any point in a taxation year, if the adjusted cost base of an asset becomes negative,

then the amount of the negative balance will be treated as a capital gain for the taxation year and

the adjusted cost base immediately will be adjusted to Nil.

Exception: partnership interests where the taxpayer is NOT a limited partner or

inactive partner.

Calculating the Capital Cain or Loss

Capital Gain/Loss = Proceeds of Disposition – Adjusted Cost Base – Expenses of Disposition

Taxable capital gain = Inclusion rate * Capital Gain

Allowable capital loss = Inclusion rate * Capital Loss

Note: Allowable capital loss can only be deducted again Taxable Capital Gain.

The inclusion rate used depends on the period when the capital gain/loss occurred.

Period Inclusion Rate

1972 through 1987 1/2

1988 and 1989 2/3

1990 through February 27, 2000 3/4

February 28, 2000 through October 17, 2000 2/3

October 18, 2000 to Present 1/2

The chart is taken from page 336 of Byrd and Chen’s Canadian Tax Principles.


Proceeds of Disposition $XXX1

Less – The Aggregate of:

Adjusted Cost Base ($XXX2)

Expense of Disposition (XXX3) (XXX4)

Capital Gain (Loss) $XXX5

Inclusion Rate1 1/2

(Allowable) Taxable Capital Gain (Loss) $XXX6

If $XXX5 is negative, then $XXX6 will be negative too, leading to an allowable capital

loss, which can only be deducted against taxable capital gain. 1

For dates before October 18, 2000, refer to the inclusion rate list for the appropriate rate.

Identical Properties

ITA 47 For a group of identical properties owned by the same taxpayer, the adjusted cost base

for the assets being disposed of is the average cost of the entire group at the date of sale

Example: The following is a list of the transactions carried out by a taxpayer involving his

common shares of Evergreen Incorporated, a Canadian public company.

Date Number of Shares

Purchased (Sold)

Cost (Proceeds) Per

Share

Total Cost

(Proceeds)

Jan. 1995 2000 $8 $16,000

Feb. 1998 4000 16 64,000

May 2000 (1000) (10) (10,000)

Nov. 2002 6000 10 60,000

Apr. 2011 (2000) (15) (30,000)

For the May 2000 Disposition:

Per unit adjusted cost base =

Proceeds of Disposition [(1,000)*($10)] $10,000

Adjusted Cost Base [(1,000)*($13.33)] (13,330)

Capital Loss (3,330)

May 2000 Inclusion Rate 2/3

Allowable Capital Loss ($2220)

For the April 2011 Disposition:

Per unit ACB =

–

Proceeds of Disposition [(2,000)*($15)] $30,000

Adjusted Cost Base [(2,000)*($11.52)] (23,040)

Capital Gain 6,960

Current Inclusion Rate 1/2

Taxable Capital Gain $3,480


The disposition of a part of a property would require a proportionate allocation of the adjusted

cost base of the whole property as the adjusted cost base for the partial disposition.

Please refer to Exercises Eight-1 and Eight-2 on page 339 of the textbook for more details.

Capital Gain Reserve

When a portion of the proceeds from the sale of a capital asset is not receivable in the current

year, a reserve can be deducted from the total gain.

ITA 40(1)(a)(iii) Reserve (i.e. Capital Gains Reserve)

The current year’s capital gain reserve will be deducted from the current year’s total

capital gain (not taxable capital gain), and added to subsequent year’s total capital gain.

Note that any interests charged by the seller on the unpaid portion of the proceeds are NOT

included in the reserve calculations.

Capital Gain Reserve = Lesser of A and B

A = [Total Gain]*[

B = [20% of Total Gain]*[

Where X = number of taxation year ends since disposition excluding the

current taxation year end.

Example: Mr. Smith sold a property with an adjusted cost base of $260,000 for total proceeds of

$1,000,000 in 2011. The total proceeds are paid in 6 separate installments of

$300,000 in 2011, $100,000 in 2012, $400,000 in 2013, $100,000 in 2014, $50,000

in 2015, and $50,000 in 2016. Determine the Taxable Capital Gain to be included in

income for each of the 6 years because of the 2011 sale.

Step 1: The total capital gain = $1,000,000 - $260,000 = $740,000

Step 2: Taxable Capital Gain for each of the 6 years.

Total Capital Gain $740,000

Deduct: Capital Gain Reserve for 2011 –

Lesser of

[$740,000*(700,000/1,000,000)] ($518,000)

[$740,000*(0.2)*(4-0)] (592,000) (518,000)

Amount to be Included in 2011 Capital Gain 222,000

Inclusion Rate 1/2

Taxable Capital Gain to be included for 2011 $111,000


Add: Capital Gain Reserve for 2011 518,000


Lesser of

[$740,000*(600,000/1,000,000)] ($444,000)

[(0.2)*($740,000)*(4-1)] (444,000) (444,000)

Amount to be included in 2012 Capital Gain $74,000

Inclusion Rate ½

Taxable Capital Gain to be included in 2012 $37,000



Lesser of

[$740,000*(200,000/1,000,000)] ($148,000)

[(0.2)*($740,000)*(4-2)] (296,000) (148,000)


Inclusion Rate ½




Lesser of

[$740,000*(100,000/1,000,000)] ($74,000)

[(0.2)*($740,000)*(4-3)] (148,000) (74,000)


Inclusion Rate ½




Lesser of

[$740,000*($50,000/1,000,000)] ($37,000)

[(0.2)*($740,000)*(4-4)] (0) (0)


Inclusion Rate ½


Add: Capital Gain Reserve for 2014 $0


Lesser of

[$740,000*(0/1,000,000)] ($0)


[0] (0) ($0)

Amount to be included in 2015 Capital Gain $0

Inclusion Rate ½

Taxable Capital Gain to be included in 2015 $0

Please refer to Exercises Eight-1 and Eight-2 on page 339 of the textbook for more details.

Bad Debts on Sales of Capital Property

If an amount receivable resulting from the disposition of a capital property turns out to be

uncollectible, the amount uncollectible can be recognized as a capital loss in the year when it

becomes uncollectible.

If subsequently, some of the bad debt is recovered, the recovered amount would be considered a

capital gain in the year of recovery.

Note: allowable capital loss arising from bad debt can only be deducted against any taxable

capital gain in the year when the bad debt is recognized.

Example: Mr. Elgin sold a capital property with an adjusted cost base of $125,000 for $300,000

in 2010. The proceeds consist of $160,000 of cash and a note payable for $140,000 due in 2012.

In 2012, the purchaser defaulted on the note payable. In 2013, Mr. Elgin recovered $40,000 of

the note payable. What is the affect on the taxable income of 2010, 2011, and 2012 respectively?

In 2010, Taxable Capital Gain =

*($300,000-$125,000) = $87,500.

In 2011, there is no tax consequence.

In 2012, Allowable Capital Loss =

*($140,000) = $70,000.

In 2013, Taxable Capital Gain =

*($40,000) = $20,000.

Please refer to Exercise Eight-6 on page 345 of the textbook for more details.

Special Rule for Sales of Real Property

The special rule applies when the proceeds of disposition for a building sold as a part of a real

property is less than the UCC for the building’s class, given that the building is the last asset in

its class.

Only applies to the seller, not the purchaser.


ITA 13(21.1)(a) Special Rule

Step 1: Calculate the Two Amounts

The Fair Market Value of the land and building $XXX1

The lesser of:

The Adjusted Cost Base of the Land $XXX2

The Fair Market Value of the Land XXX3 ($XXX4)

Amount ($XXX5)

The Greater of:

The Fair Market Value of the Building $YYY1

The lesser of:

The Cost of the Building $YYY2

The UCC of the Building YYY3 $YYY4

Amount ($YYY5)

$XXX4 is the lesser of $XXX2 and $XXX3.

$XXX5 = $XXX1 - $XXX4.

$YYY4 is the lesser of $YYY2 and $YYY3.

$YYY5 is the greater of $YYY1 and $YYY4.

Step 2 Allocate the Total Proceeds

The proceeds for the building would be the lower of $YYY5 and $XXX5.

The remainder of the proceeds will be allocated to the land portion of the real estate.

Please refer to Exercise Eight-7 on page 346 of the textbook for more details.


Chapter 9 Capital Gains and Capital Losses

Key Definitions

Subdivision d Inclusions that do not belong to any of the four income categories.

Subdivision e Deductions that do not belong to any of the four income categories

Many, but not all, of the items in the two subdivisions are related

Other Income – Subdivision d Inclusions

Examples: Pension amount received from Registered Pension Plans (RPP), Canada Pension Plan

(CPP), the Old Age Security ACT (OAS), and similar provincial pension plans.

Retiring Allowances

ITA 56(1)(a)(ii) Retiring allowances are amounts received by the taxpayer, including potential

damages awarded by court, upon or after the retirement from a employment.

1. Regarding the loss of an office or employment of a taxpayer, including the

amount of damages awarded by the judgement of a competent tribunal.

The total amount of the retiring allowance must be included in income.

The amount of retiring allowance that is awarded for to pre-1996 services and is transferred to a

RPP or a Registered Retirement Savings Plan (RRSP) within 60 days of the year end of the

reception is deductible against the total retiring allowance inclusion.

Deferred Income Plans

Deferred Income Plans Plans that require the taxpayer to contribute in the current period and

receive certain benefits in the future.

Examples: Registered Retirement Income Funds (RRIFs) and RRSPs.

Payments from these deferred income plans are all subdivision d incomes that do not fall into

any of the other income categories.

The following amount must be included in subdivision d income.

1. Actual amounts removed from a RRSP

2. A specified amount when a scheduled RRSP repayment is missed.

3. Actual amounts removed from a DPSP.


4. The minimum withdrawal amount from RRIFs must be included in income

regardless of whether the withdrawal actually took place.

5. The amount of withdrawal from RRIFs beyond the minimum withdrawal amount.

Scholarships, bursaries, grants, and prizes are 100% exempt from income inclusion given that

they are received in relation to an elementary, secondary or post-secondary education that

qualifies for the education tax credit.

Research Grant to be Included = Grant amount – Unreimbursed Research Related Expenses

Universal Child Care Benefits (UCCB)

A family receives $100 per month for each child under the age of 6.

The amount received under UCCB are not ignored for the purpose of calculating income tested

benefits, Old Age Security amount, Employment Insurance amounts, and child care expense.

Two Parents Family

For couples, one of the two taxpayers must meet all the conditions listed below.

1. The individual lives with the child.

2. The individual is the primary caretaker of the child.

3. The individual is a Canadian resident.

The spouse with the lower Income for Tax Purposes must add the amount received to income.

Single Parent Family

For single parent, the taxpayer must meet all the conditions listed above.

The amount received can be included in the income of any one of the individual listed below.

1. The single parent.

2. A dependant for whom the parent could claim the eligible dependant tax credit.

3. The child for whom the amount is received.

Other Deductions – Subdivision e Deductions

Moving Expense

ITA 62(1) Moving expenses related to an “eligible relocation” can be deducted by the taxpayer.

Relocation is considered eligible when all of the following conditions are met.

1. The new location must be:

Around the taxpayer’s new workplace,


Around where the employee will be carrying out business, or

Around where the taxpayer will be attending a post-secondary institution.

2. The old location must be:

Around where the taxpayer used to work,

Where the employee lived while unemployed, or

Around where the individual was attending a post-secondary institution.

3. Both the old and new location of the residence must be in Canada.

4. The new residence must be at least 40 kilometers closer to the new work location

than the old residence.

Note: The distance is measured using the routes that would normally be

traveled by an individual rather than the shortest distance between two

routes.

The actual moving expenses are deductible against income received in the new work location in

any year after the move.

Reimbursements paid by the employer to fully or partially cover the expense of the move will

reduce the deductible moving expense.

Allowances paid by employer to cover the move will NOT affect the deductible moving expense,

but must be included in the income of the employee.

ITA 62(3) Deductible moving expenses for eligible relocations include all the costs listed on

paragraph 9-41 of page 407 of the textbook.

If an employer reimburses an employee for a loss on the sale of the old residence, the resultant

taxable benefit will only be ½ * (reimbursement - $15,000).

Income Attribution

ITA 74.1(1) and (2) Income Attribution Rule

Income earned by properties that have been transferred (through a sale or as a gift) or

loaned may be added back to the income of the transferrer of the property, provided that

the transferee is a spouse, a common-law partner, a non-arm’s length individual who is

under the age of 18, or nieces and nephews that are under the age of 18.

Applicability of Attribution Rule by Type of Income

Business Income No amount is taxable to transferrer.


Property Income Relevant amounts earned by spouse and related minors are taxable

to the transferrer.

Capital Gains Relevant amounts earned by spouse (with exceptions) are taxable to the

transferrer.

Income Subject to Tax on Split Income No amount is taxable to transferrer.

Exceptions to the Attribution Rule

1. Transfer through sale

The spouse paid the fair market value for the property and any resulting gain or

loss is included in income at the time of transfer.

The minor gave consideration equal to the fair market of the value of the assets

transferred.

2. Transfer through loan

The spouse paid interest that is equal to at least the prescribed interest rate.


Chapter 10 Retirement Savings and Other Special

Income Arrangements

Registered Retirement Savings Plans (RRSP)

ITA 146 An RRSP is a trust with an individual as the beneficiary and a financial institution (see

the list below) acting as the administrator.

Up to a limited amount of contributions to the plan is deductible.

The income earned by the plan is not taxable, but withdrawals from the plan are fully included as

income in the year of withdrawal.

Types of Registered Retirement Savings Plans

1. Managed RRSP Investment decisions made by administering financial institution.

2. Self-Administered RRSP Investment decisions made by the taxpayer.

An individual can own multiple separate RRSPs.

Interest paid on funds borrowed to finance RRSP contributions is not deductible.

Registered Retirement Savings Plans Deduction Limit

RRSP Deduction Limit The maximum deductible RRSP contribution in a given year.

Note: The RRSP Deduction Limit does NOT limit the amount of yearly contribution.

Unused RRSP Deduction Room The sum of the RRSP Deduction Limits from all the years

prior to the current year less the sum of all the RRSP

deductions ever claimed prior to this year.

RRSP Dollar Amount Changes every year, and is $22,450 for the year 2011.

Earned Income Please refer to page 463 of the textbook for the list of inclusions and

deductions used to determine earned income as specified by ITA 146(1).

Pension Adjustments RPP benefits earned by the employee and RPP and DPSP contributions

made by or on the employee’s behalf.


Past Service Pension Adjustments The total amount of additional pension adjustment that

would have been included had the change in the defined

benefit plan been in effect since the start.

Please refer to paragraph 10-66 on page 467 of the

textbook.

Pension Adjustment Reversals (PARS) The amount of previously recognized PAs that

corresponds to pension plan benefits lost due to

leaving the job before the benefits are vested.

ITA 146(1) Calculating the RRSP Deduction Limit

RRSP Deduction Limit = A + B + R – C

A is the unused RRSP deduction room at the end of the previous taxation year.

B = G – E, where

B cannot be zero,

G = lesser of:

0.18 * earned income for the previous taxation year

RRSP dollar limit for the current year,

E = Previous taxation year’s PAs for the + Current year’s prescribed amount

C is the taxpayer’s current year’s net past service pension adjustment.

R is the taxpayer’s current year’s pension adjustment reversal.

Please refer to Exercise Ten-7 on page 469 of the textbook for more details.

Reference

Byrd, C., and I. Chen. Byrd & Chen’s Canadian Tax Principles. Toronto: Pearson Prentice Hall

Publishing.

chapter 1 introduction to federal taxation in canada

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