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Tax Update – What’s New?

Hugh Neilson FCPA FCA TEPKingston Ross Pasnak LLP

Video News Inc. October 22, 2017

Introduction

The past few years have seen a dizzying pace of change, even by tax standards, and more is clearly onthe way. Now, more than ever, our clients (whether in traditional public practice or those clients whoemploy ta advisors in industry) look to us for guidance on tax matters in the face of these significantchanges. The purpose of this session is to highlight some of the more significant changes impactingCCPCs and their owners, and hopefully identify those areas where each of us may need to look a littlecloser, reassess our historical practices and keep monitoring ongoing developments.

This session will not cover the July 19, 2017 Consultation Paper on CCPC Tax Planning Strategies, forwhich the Department of Finance consultation ended, and the Senate consultation began, on October 2,as Kim Moody will be addressing that topic tomorrow morning.

Tax Rates

In 2016, the significant changes implemented by both the Federal and Provincial governments were fullyphased in, so all we have there is a bit of indexation of the brackets. For 2017, only two relatively minorchanges occurred, both at the provincial level:

· As announced in the 2016 Provincial Budget, the small business deduction was enhanced by 1%effective January 1, 2017, reducing the Alberta rate from 3% to 2%, for a combined Federal andAlberta rate of 12.5%.

· To compensate for reduced corporate tax, the dividend tax credit on non-eligible dividends wasalso reduced, so the top personal tax rate on a non-eligible dividend in 2017 is 41.29%, up from40.24% in 2016. The Alberta dividend tax credit is now 54/359 of the grossup, or about 2.19% ofthe taxable dividend.

In the non-income tax world, of course, 2017 began the Carbon Levy, and it will increase by 50%effective in 2018. For our clients of more modest income levels, the Climate Leadership AdjustmentRebate will also rise by 50%. The full details are reproduced below, from the 2016 Alberta budget.




The State of Integration

With no material change to the rates, nothing really changes for integration. The higher personal taxrates have increased the incentive to retain income in a corporation and defer personal income tax, andthe deferral on small business income is even up a little. Let’s hope next year’s update stays this boring.

Income eligible for the small business deduction benefits from a substantial deferral if retained for acalendar 2017 corporate year. This income is slightly under-integrated in some provinces, and a bitover-integrated in others, but the variance is less than 1%. That’s been the state of integration fordecades – if you can leave small business income behind in the company, you do it for the huge deferral.There’s little or no benefit (or cost) if you pull it all out for personal spending.

High rate active business income benefits from a rising deferral, but carries a cost when ultimatelywithdrawn, which varies considerably between provinces. In most cases, we need a few years ofreinvestment to make paying high rate corporate tax today preferable to taking a bonus and lending thecash back to the company. Many business owners expect a substantial return on reinvested capital,and/or have a long time horizon before they anticipate needing the cash for personal spending.




Investment income generates limited or no deferral, with a 2.67% prepayment in Alberta. As well, whenthe funds are returned as dividends, there is an ultimate cost in every province, 5.03% in Alberta. As thesmall business deduction rate goes down, and the non-eligible dividend rate goes up, this cost continuesto rise.. Over the past several years, however, many private businesses have recognized that, if they canconsolidate their General Rate Income Pool (GRIP) and Refundable Dividend Tax on Hand (RDTOH) inone corporation, using eligible dividends to recover that RDTOH, the results can be quite advantageous.

There have been some commentators who suggested pulling all that investment capital out of thecompany to invest it personally, avoiding this under-integration. However, most recognize that sendingas much as 40+% of your investment capital out to the Tax Department will not be a win.

Still, it makes sense to consider options for transferring that investment income from corporate topersonal reporting. For business owners with large shareholder loans, a withdrawal is one possibility. Asecond would be structuring those shareholder loans to bear interest deductible against the corporateinvestment income.

Income eligible for foreign tax credits is much more under-integrated, with greater slippage for incomewith a 15% credit, like US source dividends. That’s still not enough to pay the cost of extracting all of thecapital, but it may merit consideration of portfolio rebalancing to shift foreign investment to personalaccounts, and “buy Canadian” in the corporation.

Dividends generate a small tax deferral in some provinces, and a prepayment in others. No ultimate taxcost, arises (outside of the potential issue of a rate change if the personal dividends are deferred). Formany investors, that may soften the blow of under-integration on other investment income. Here inAlberta, we get a slight deferral on non-eligible dividends but a significant prepayment on eligibledividends.

In Alberta, tax rates traditionally suggested always paying dividends to recover That’s still the case ifeligible dividends can be paid, and for ineligible dividends if the recipient has income under $202,800.Once that new tax Federal rate kicks in, it’s preferable to defer non-eligible dividends and let the RDTHride, unless funds are needed for personal spending.

What If We’re NOT in the Top Rate?

That question is a common challenge to integration tables assuming the top rate – and with a top ratethat does not apply until income tops $300,000, it seems more valid than ever. I’ve included some otherbrackets, but the reality is that integration depends on whether the dividend tax credit is adequate tocompensate for the corporate taxes paid to generate the cash paid out as a dividend.

Of course, lower personal tax rates mean lower deferrals from retaining corporate income, but theultimate cost or benefit does not vary much at lower income levels. So maybe those “top rate assumed”charts are still useful for lower income taxpayers.




2017 Federal Budget

The March 22, 2017 Federal budget was, from a tax perspective, considerably less exciting than manyrecent years. However, it did not fail to deliver some tax changes, major and minor.

What Was Not There?

There was considerable speculation leading up to Budget Day on matters which did not materialize. Apromised review of “tax expenditures” lead to considerable scrutiny and speculation when the annualreport on tax expenditures was released. However, the larger tax expenditures were untouched.

The persistent rumours of a change to the capital gains inclusion rate can be carried forward for anotheryear. A March 23, 2017 Globe and Mail article cited the Finance Minister being concerned with thespeculation in this regard, noting this has never been suggested as a matter the government isconsidering. The capital gains exemption and the small business deduction were untouched. Theprincipal residence exemption saw no changes beyond those announced in October, 2016 (discussedelsewhere in this presentation). Employer-paid private health services plan premiums remain a non-taxable benefit.

Many Changes Made

A variety of changes were proposed in the Budget. The PowerPoint slides identify those which wereincluded in the first Budget bill, Bill C44, which received Royal Assent on June 22, 2017.

A number of smaller tax expenditures were eliminated, including the following:

· Public transit credit (for transit passes after June, 2017)· Tax-free allowances for MLAs and municipal officers (after 2018)· Deduction for the benefit on the first $25,000 of a home relocation loan, a $250 deduction at

the present 1% prescribed rate (after 2017)· The investment tax credit for creation of new child care spaces (after Budget Day)· The first-time donors’ SuperCredit (which will simply be allowed to expire after 2017, with no

change to the current legislation).

The credits for infirm dependents, the caregiver credit and the family caregiver credit will beconsolidated, effective for 2017. Generally, the consolidated credit will equal or exceed the previouscredits. The most significant reduction will be a loss of any credit for non-infirm dependents. Thecaregiver credit was available for parents and grandparents over age 65 residing with the taxpayer.

The credit will be based on the same amount as the former infirm dependent credit ($6,883 for 2017)for an individual age eighteen or over who is dependent due a physical or mental infirmity. The creditwill be reduced by the dependent’s income in excess of $16,163 (the threshold of the former caregivercredit). Where the individual is a spouse or common law partner, either this credit or a married credit,enhanced by $2,150, may be claimed. A $2,150 amount may also be claimed for an infirm child underage 18.




Form T2201, certifying eligibility for the Dividend Tax Credit, may be signed by nurse-practitioners afterBudget day. The availability of a credit for medical expenses related to conceiving a child has beenexpanded, with retroactive effect allowing returns to be reassessed under the taxpayer relief program’s10 year period (which will allow adjustments back to 2007 to be filed up to December 31, 2017).

Tuition credits for occupational skills have been expanded to cover courses providing or improving skillsin an occupation, even where these are not at a post-secondary level. As with other tuition credits, thestudent must be at least 16 years of age.

Provisions restricting certain investments in RSPs, RRIFs and TFSAs will be extended to RESPs and RDSPs.These will have no impact on the portfolio investments held by most such plans.

A recent Federal Court of Appeal decision (McGillvray Restaurant Ltd.; A-571-14) held that the “de factocontrol” analysis should focus only on influence over the Board of Directors, and not with other factors,such as control of day to day operations. The Budget overrides this decision, providing that all factors,not only those relevant to control of the Board, are to be considered.

A specific anti-avoidance provision was introduced to address “straddle transactions”, basically theacquisition of derivative positions which offset one another, closing the “loser” shortly before year end(creating a loss) and the winner shortly after (creating a gain or income), pushing income one yearforward. Basically, the loss will be deferred until the gain position is also closed.

Draft legislation released on September 8, 2017 includes a number of the other Budget measures,including the following:

· Ecological gifts;· Clean energy and geothermal energy;· Oil & gas provisions;· De facto control· RESP and RDSP investment provisions;· Derivative straddles;· Further amendments related to nurse practitioners certifying various matters a medical

professional is required to certify.

Billed Basis Accounting – The WIP Deferral

Perhaps the most significant Budget proposal, certainly for the accounting profession, even if not formany of our clients, is the proposal to eliminate the election permitting certain professionals(accountants, chiropractors, dentists, lawyers, medical doctors, and veterinarians) to value their work inprogress (WIP) at nil. Of course, it is primarily lawyers and accountants who accumulate significant WIP.

The proposal would apply to the first fiscal period commencing after March 22, 2017 (so 2018 for acalendar fiscal year end). The Income Tax Act defines WIP is an inventory, valued at the lower of costand fair market value. The value of WIP is defined as the amount reasonably expected to becomereceivable in a later taxation year.




Many concerns have been raised in respect of this proposal. The Joint Committee on Taxation of theCanadian Bar Association and CPA Canada made a submission on May 31, 2017.

Concerns include the determination of the cost and fair market value of WIP. Little guidance existsunder Generally Accepted Accounting Principals, and it is unclear which costs would be required to becapitalized to WIP. Most legal and accounting firms, the professions most likely to have significant WIP,either carry WIP at nil or at expected future billings. The writer has seen none which attempt todetermine an “inventory cost” to account for WIP.

While it seems clear that the cost of professional time would be included, the treatment of benefits, theallocation of overheads and even the pro rating of salary costs is unclear. It is not clear whether partneror proprietor time would be included in valuing WIP, nor whether this could differ depending onwhether the partner or proprietor holds their interest in the business through a corporation.In the course of a similar proposal in 1981, it was suggested that variable overheads would be includedin the cost of WIP, but fixed overheads and partner/proprietor time would not be required to beincluded. Of course, professional corporations were not a consideration in 1981.

Determining the value of WIP will also be challenging in many instances. Contingency fees have beenraised as especially problematic. CRA has issues an FAQ document on their web site indicating that theproposal will not require any WIP be accrued in respect of contingency fee, however the legal basis forthis is unclear, and many commentators, including the Joint Committee, question whether this is legallycorrect.

The Joint Committee also suggested a two year phase in period is very short, and should be lengthenedconsiderably. The September 8, 2017 draft legislation reflects a five year phase in period, rather thantwo years, with no other substantive changes.

Sales and Excise Taxes

Ride sharing services such as Uber and Lyft have had an uncertain status for GST/HST purposes. Theusual small supplier rules permitting those with annual revenues under $30,000 to choose not toregister did not apply to taxi businesses. It was unclear whether ride sharing fell within that definition.The Budget amended the definition effective July 1, 2017 to include ride sharing services. The provisionsdo not apply to school transportation services for elementary or secondary schools, or to sightseeingservices. It remains an open question whether rise sharing fell within the prior definition.

Increases to tobacco and alcohol taxes were also included in the Budget. It was not indicated whetherthis specifically targeted accountants whose stress levels have increased from the rapid pace of taxchange, and may be overindulging.




Consultations

The Budget also announced two consultations.

The first related to the elimination of cash purchase tickets, used by grain farmers to defer revenues intothe subsequent taxation year. Initially scheduled to close on May 24, 2017, the consultation wasextended on May 23 to close on July 24, 2017. There has not yet been any announcement on theconclusions reached from the consultations.

The second, of course, was the consultation on CCPC tax planning strategies which ran from July 18 toOctober 2, which is being addressed in another session at this Forum, and which we are all doubtlessawaiting more news on.

Aggressive Tax Planning

Last year, we discussed both dividend sprinkling shares and strategies to realize capital gains instead ofdividends. That consultation paper I am not talking about today has definitely changed the landscape inthose areas! While the final legislation remains uncertain, we can be pretty confident that thesestrategies will not be available going forward.

A variety of other developments in the arena of aggressive tax planning occurred over the past year –hopefully, I will not be stepping on the toes of the Case Law Update presentation later in the Forum.

Repeat Appearance - Non-Arm’s Length Share Sales

Last year, we discussed the Poulin case (2013-2554(IT)G and 2013-2555(IT)G), which provided anexcellent example of the operation of Section 84.1 and, more broadly, the determination of whetherunrelated persons act at arm’s length. The case involved three individuals, P and T (founders of Opco),and H (an employee of Opco). They were unrelated.

P and T had fallen into disagreement, and one of them had to go. After much negotiation, T Co, whollyowned by T, purchased P’s shares. P reported the gains, and claimed the capital gains exemption. Tsold his shares to HCo, wholly owned by H. T also reported the gains, and claimed the capital gainsexemption. CRA challenged both claims, arguing that the purchaser corporations did not act at arm’slength to the vendors, so Section 84.1 applied to deem them to receive dividends, not capital gains.

Despite the similarity of the transactions, P won and T lost. Why?

There was a major conflict between P and T, the best interests of Opco required one leave, and theyreached agreement only after difficult negotiations. Specifically, structuring the sale to make the CGEavailable did not, by itself, indicate the parties did not act at arm’s length. They were, in fact, acting atarm’s length.

But the purchase of shares from T by HCo was undertaken solely as an accommodation to T. Thetransactions did not reflect commercial norms. There was no interest to T for payment over time, andno specific repayment terms. Rather, as HCo received cash from Opco, T was paid. They were notacting at arm’s length.




This year brought us the Turgeon case (A-320-16) from the Federal Court of Appeal. Mr. Turgeon wasthe “T” (Mr. Poulin won – why should he appeal?). The Court upheld the Tax Court’s decision, and CRAhas identified this case as a great resource for assessing whether unrelated people act at arm’s length.

Repeat Appearances – the Half Loaf

Back in 2002, Mr. Gervais undertook a tax strategy commonly known as the “half loaf” to transfer aportion of his shares to his spouse shortly before the corporation was sold to an unrelated third party.We will not review the details of this strategy, however it involved a series of steps designed to allowthe spouse to acquire a portion of the shares, and realize a capital gain on which she claimed the capitalgains deduction.

In March, 2014, the Tax Court held that the planning strategy was not effective for a technical reason.As such, the Court declined to comment on the applicability of the General Anti-avoidance Rule (GAAR).

In January, 2016, the Federal Court of Appeal ruled that the plan was technically effective, and that theGAAR therefore should have been considered. That was referred back to the Tax Court.

In September, 2016, the Tax Court ruled that the strategy abused the provisions which allow assets totransfer between spouses at income tax cost by using the identical property rules, which average theadjusted cost base of shares, to frustrate the intention that future gains on such assets attribute back tothe transferor spouse. CRA was therefore correct to attribute the capital gains back to Mr. Gervaisunder the GAAR.

This decision now awaits hearing by the Federal Court of Appeal.

Trusts – 21 Year Rule

At the 2016 Canadian Tax Foundation Conference, CRA responded to a question regarding a strategyunder which a Trust (“Old Trust”) approaching the 21st anniversary of its settlement would distribute itsassets to a corporate beneficiary (“Holdco”). Holdco’s shares would be held by a new Trust (“NewTrust”).

CRA noted that a transfer of assets from Old Trust to New Trust would have resulted in New Trusthaving the same 21-year anniversary date as Old Trust. However, as the assets would be transferred toHoldco, rather than to New Trust, there would be no deemed dispositions on the 21st anniversary of OldTrust.

CRA indicated that this strategy would frustrate the legislative intent that gains accruing within a Trustbe subject to taxation every 21 years. CRA indicated that they would consider applying the GeneralAnti-avoidance Rule to this type of planning, but that the GAAR committee had not yet rendered anopinion on such a strategy.




Reversionary Trusts

For several years, cases related to reversionary trusts have been under review by CRA. The SatomaFinancial Trust case (2014-3800(IT)G) case reviewed such a strategy, addressing dividends paid in 2005,2006 and 2007. Basically, these strategies are undertaken as follows:

1. A Trust is established with beneficiaries including individuals and at least one corporation(Holdco).

2. Holdco provides funds to Trust.3. Trust uses the funds to acquire shares of Opco.4. Opco pays a dividend to Trust – Subsection 75(2) deems the dividend to be income of Holdco.5. Holdco and Opco are connected, so Holdco pays no tax.6. The dividend becomes capital of the Trust, and can be paid out to individual beneficiaries with

no further tax.

In an earlier case (Brent Kern Family Trust, 2010-1860(IT)G), the planning failed because the Opco shareswere determined to have been acquired in a manner which did not cause Section 75(2) to apply.

In this case, the Tax Court concluded that the GAAR applied. As such, the dividend was taxable to theTrust, rather than to Holdco. The Court did not accept the argument that tax should be delayed untilthe Trust distributes the funds, and only tax the Trust if the dividend was not paid to Holdco. The Courtopined that there was no reason the Trustees would ever distribute these funds to a corporatebeneficiary under this structure.

Trusts - Capital Gains Allocations

We often see structures where Trusts own shares of operating companies and, on sale, proceeds aredivided between multiple beneficiaries, each of whom claims the capital gains deduction (CGD). TheLaplante case (2015-349(IT)G) provides an example of such planning gone awry.

The Trust made a total of $375,000 payable to each of seven beneficiaries, sufficient to fully utilize theirCGD limits, and paid the funds out to them. Note that only the taxable portion of a capital gain needs tobe distributed. The Trustee, also the principal of the corporation, arranged (and paid) for thepreparation of their 2008 personal tax returns. Each beneficiary (adult siblings, in-laws, nieces, nephewsand cousins of the principal) then gave the principal a gift equal to the Trust allocation, less anyalternative minimum tax (AMT) payable due to the large exempt capital gains.

CRA argued that the beneficiaries did not receive funds on their own account, but rather as agents forthe principal, and added the capital gains to his tax return. The Court agreed that the formal legaldocumentation was not reflective of the true arrangements between the parties, which was a “secretagreement” to allow the beneficiaries’ CGD room to be used to reduce the principal’s taxes, for whichthey were allowed to keep the future recovery of AMT paid in 2008. CRA’s reassessment, which wasmade after the usual three year limit, was upheld.




Creation of Paid-Up Capital

Another recent GAAR case dealt with a strategy by which an individual used his capital gains deductionto access corporate funds on a tax-free basis. CRA has won a number of cases where the CGD was usedto avoid tax on dividends, however this was a different approach. The facts were pretty complex, butcan basically be summarized as follows:

1. An individual (I) transferred shares of Opco to Holdco, taking back preferred shares havingnominal paid up capital (PUC). He realized a capital gain on the transfer, offset with his CGD.

2. Opco rolled business assets to Holdco, receiving preferred shares of the same class. Opco’spreferred shares had paid up capital equal to the undepreciated capital cost of the assetstransferred in.

3. The PUC of the Holdco preferred shares is averaged under Subsection 89(1), so the PUC of I’spreferred shares

4. Holdco redeemed its preferred shares issued to Opco, and Opco repurchased its shares held byHoldco, offsetting the resulting intercorporate balances.

5. They then repeated the process with a second Holdco.

The result was that I had started with Opco shares having an ACB and PUC of $110, and finished withHoldco shares having an ACB of $750,000 and PUC of $595,264. CRA argued that the PUC of I’spreferred shares should be reduced to $110.

The Tax Court agreed that the plan abused the PUC averaging provisions to defeat the purpose ofSection 84.1, to prevent extraction of corporate surplus free of tax using the CGD. As a result, CRA’sGAAR assessment was upheld. [1245989 Alberta Ltd., 2013-3907(IT)G & Perry Wild, 2013-3912(IT)G]

Valuation Issues

On first blush, this case (Mady, 2015-1539(IT)G) looks like a pretty typical estate freeze. Dr. M was thesole shareholder of a professional corporation (PC). He undertook a fairly standard estate freeze,converting his common shares to 2,071,497 preferred shares, redeemable for $1 each, and 100 Class B,100 Class C and 100 Class D common shares (valued at $0.01 each). He then sold 85 common shares toeach of his spouse and his two children, for one cent per share.

Subsequently, 800,000 preferred shares were redeemed as part of a transaction undertaken to purifythe PC for sale. The PC was then sold for a total of $4,500,000.

The valuation on which the freeze was based was effective July 1, 2011. The case decision indicates thefreeze was actually implemented on January 13, 2012, the same date the shares were sold for $4.5million in aggregate. R. M testified that the reorganization was supposed to be completed by October31, 2011.




The valuation used for the freeze was completed by a CBV. She was not advised of the sale negotiationswhich were in progress at the time the valuation was prepared.

The Court held that the actual sale proceeds were the best indicator of the FMV of the shares. On thatbasis, Dr. M was deemed to dispose of the 85% of the common shares transferred at fair market value,resulting in additional capital gains of over $2.2 million be reported by him, in accordance withparagraph 69(1)(b) of the Income Tax Act. That provision provides for a one-sided adjustment, meaningthe cost base to the spouse and children would remain the $0.01 per share purchase price, resulting inthat gain being taxed twice. The Court declined to address the suggestion the transfer should becharacterized as a gift, such that the tax cost to the recipients would be increased, as the spouse andchildren were not parties to the appeal.

However, Dr. M was not properly subject to gross negligence penalties. His reliance on professional taxadvisors and valuators in respect of these complex matters was reasonable.

In a second issue, shares had been distributed of shares from a trust to Dr. M’s spouse, who thentransferred them to Dr. M as a gift. Dividends paid on these shares were reported by Mrs. M, based onthe attribution rules. CRA asserted that the dividends were properly taxed to Dr. M, on the basis thatthe transactions were designed to use the attribution rules to reduce taxes (Subsection 74.5(11)providesthat attribution does not apply in such cases). The Court “strongly recommend[ed] that the Ministerreassess Mrs. M” to refund the taxes she paid on the dividends, under the taxpayer relief provision, ifshe makes the appropriate application within the ten year window.

Toys for the Shareholders

We have all seen assets acquired by a corporation for the personal use of the owner(s). The Tax Courtaddressed this in the context of GST/HST and a $310,000 recreational vehicle (RV) (9124-0515 QuebecInc., 2014-84(GST)). Where the shareholder used the vehicle personally, a $2,000 per week charge, plusGST/HST, was debited to his shareholder loan, and cleared with dividends at year end.

Third party evidence showed that fair market value rent would be between $4,500 and $5,000 perweek. The Court concluded that nearly 70% of the use of the RV was for personal trips, “even assumingthe record” provided by the taxpayer “is authentic”. As a result, the RV was held to have been acquiredexclusively, or at least primarily, for the shareholder’s personal use, and not primarily for use incommercial activities. The shareholder did not pay fair market value for use of the RV. As such, no inputtax credit was permitted. There was no indication of any adjustment for GST/HST in respect of personaluse of the RV.

The taxpayer argued that the RV was used as a “mobile office”, claims that were rebutted by theassertion that his spouse and son accompanied him on alleged “business trips” between Quebec andWestern Canada, he could show evidence of only three business meetings conducted on those trips, andthe work eventually done in Western Canada was for clients located in the Quebec area where thebusiness was located. The taxpayer also argued his provision of the RV to a Nascar driver was a businesssponsorship, while CRA asserted this was a personal pastime. The fact that a personal RV theshareholder had owned for eight years was traded in demonstrated a history of personal RV use.




Prescribed Rate Loans

The Income Tax Act provides an exception to the attribution rules where loans are advanced bearing arate of interest no less than the prescribed rate at the time the loan is advanced (1% for the past severalyears), and that interest is paid each year, by January 30 of the following year.

In a technical interpretation (2016-0642811E5), CRA suggested they may apply provisions including theGAAR where one of the main purposes of such a loan is to reduce the family’s income tax liability.

To the writer, it seems bizarre to suggest that a specific exception to an anti-avoidance provision wouldbe subject to GAAR when used exactly as the legislation appears to envision. The writer can think of noreason other than tax planning where such loans are employed. CRA was asked to provide the basis forthis interpretation as one of the questions on the agenda of the 2017 CRA – CPA Alberta Round Table,however they declined to respond to that question.

Ongoing Developments

There have been an array of tax changes in recent years which have left considerable uncertainty amongpractitioners. How have some of these “old friends” developed over the past year?

Small Business Deduction Changes

The restrictions on the small business deduction (SBD) introduced in the 2016 Budget were a source ofgreat concern last year. Now that they are becoming effective, for fiscal years commencing after March22, 2016, we are forced to grapple with these.

Although a great many concerns were raised in the consultation period following the 2016 Budget, fewchanges were made to the legislation eventually passed.

One unwelcome addition provides that, where:(a) a partnership provides services to a private corporation;(b) “all or substantially all” of the partnership’s income is not derived from arm’s length parties

other than such entities; and(c) A partner, or a person with whom a partner does not act at arm’s length, owns an interest in the

private corporation

that partner, and all no-arms length persons, will not be eligible for any small business deduction inrespect of its income from the partnership. Unlike the other Specified Partnership Income/SpecifiedCorporate Income rules (“SCI/SPI”), this denies the SBD on all income from the partnership, not just theportion that traces back to the “tainted” revenues from the private corporation.

A more welcome reduction to red tape was added, however. Where income is received from anassociated corporation, the SPI/SCI rules will not apply to that income, unless the payer is deducting thepayment from its own income otherwise subject to these rules.




One of the issues raised in respect of the changes was the impact on farmers (and fishermen) who sell tocooperative corporations, in which they normally own a small interest. On May 5, 2017, Financeproposed another relieving amendment, exempting “specified cooperative income” from the SCI rules.Sales of farming products or fishing catches to arm’s length agricultural or fishing cooperatives qualifyfor this exception (which is not yet law). Unfortunately, the purchasing corporation must meet thedefinition of a cooperative corporation (Subsection 136(2)), which requires, among other restrictions,that all members have equal voting rights. One entity not meeting this criteria is the Canadian WheatBoard.

A great many questions remain. CRA declined to answer an extensive series of questions at the CPAAlberta – CRA Round Table. They did review a submission from the Joint Committee on Taxation of CPACanada and the Canadian Bar Association (JC). Unfortunately, they agreed with all of the issues raisedby the JC, advising that any fix would have to come from Finance. The JC reissued their examples toFinance, however there has been no response to date. Some of the issues raised include:

· The “all or substantially all” exception requires tracking of sales by customer, a significantadministrative burden. This is made more complex due to the use of “non-arm’s length”, ratherthan “related” requiring an ongoing factual determination.

· Multiple entities create added complexities (two examples were provided, one involving apartnership whose partners do business with each other and a second involving a chain of threecorporations involved at different stages of a process).

· There are no de minimis tests – a single share of millions issued still creates SCI issues.· It is unclear whether income (say, for the “all or substantially all” test) means gross income

(revenue) or net income (after allocating expenses). If it is net income, how are expensesallocated?

· A “direct or indirect” interest is a very broad term, attributing ownership through a chain ofintermediary entities. The term is not restricted to shares – could options, debts or evencontractual relationships be “an interest”? CRA confirmed this is as broad a term as could beimagined.

· The technical definitions under the Income Tax Act may even mean payments from Canadiansubsidiaries of foreign corporations are affected. The Joint Committee presented the exampleof a CCPC selling to Ford Canada, with a shareholder of the CCPC owning units of a mutual fundwhich holds shares of Ford U.S.

On the topic of expense allocations, can owner-manager compensation be paid from a specific source ofincome, such as paying salaries from “tainted” income, leaving the untainted income behind to claimSBD? CRA has not commented on this question, but a recent court case (AG Shield Canada Ltd., 2014-4749(IT)G) may indicate the answer is “yes”. That case dealt with SRED. The shareholders were paidsalaries for their work in SRED, and took any remaining distributions as dividends. CRA argued that thesalaries paid had to be allocated proportionately to the time they spent on various activities, but the TaxCourt said they could choose to take salaries for some work, and not for other work.

However, the bar was set pretty high – the Court reviewed their records of hours spent on SRED work,and the basis on which they determined appropriate hourly compensation was well documented basedon payments to unrelated third party service providers.




So what if we just decide it’s not worth the hassle, and claim no SBD? CRA points out (2016-0674221C6)that there is no requirement to claim the SBD. However, the general rate reduction applies on incometo which the SBD is not available, not to income on which the SBD is not claimed, so the income onwhich the taxpayer chooses to claim no SBD would be subject to a Federal tax rate of 28% (add inAlberta tax with no SBD, and that totals 40%).

Of course, if the reason we did not claim SBD was the assumption we did not qualify, it might beinteresting to see the response when we tell that auditor “OK – give us the SBD on the income instead!”

Principal Residence Exemption

With the rule changes announced October 3, 2016 (just in time for last year’s forum, you may recall), wewere faced with the new issue of disclosing principal residence disposals on 2016 personal income taxreturns. Luckily, CRA wanted to receive stacks of T2091 forms (which cannot be filed electronically)about as much as we wanted to file them, so they modified Schedule 3 to provide a check box.

Their intent was to avoid T2091’s for fully exempt dispositions. However, the check box indicated tocheck if the property was designated the taxpayer’s principal residence for all years owned. Thosefamiliar with the rules noted that we would never do that, due to the “1+” rule. As well, there is almostalways one year when we own both the old and new residence.

CRA updated their website in early March to indicate Box 1 would be interpreted as “all years, or all butone year” such that the gain is fully exempt from tax. They also took that opportunity to suggestmaintaining a written record of principal residence designations.

Some other PRE issues cropped up over the year. CRA was asked about a condo owner who also owneda parking space – on separate title. CRA indicated the parking space regarded as contributing to thepersonal use and enjoyment of the residence could qualify for the Principal Residence Exemption, butmust be owned by the same person who owns the condo unit. [2015-0590371E5]

What if the house is destroyed, for example by fire? As if that were not bad enough, CRA notes that,with no house on the land, it cannot be ordinarily inhabited, and if the property is not ordinarilyinhabited in the year, it cannot be designated a principal residence. However, CRA also noted that, ifthe land were sold in the same year as the house was destroyed, this should not be an issue as theproperty would be ordinarily inhabited for part of the year. Even a sale in the following calendar yearwould normally be OK, due to the “1+” rule, assuming all other years could be designated to theproperty. [2017-0702001E5]

CRA provided a less comforting response for a farm situation. The farmer wanted to transfer farm landto a corporation, but could not subdivide the portion his residence was on. He proposed to register theland in the corporate name, subject to a trust agreement where he retained beneficial ownership of theresidence. CRA opined that, since the individual no longer had the right to transfer ownership of theproperty (due to the corporation’s legal title), he would not own the property, so it could not bedesignated his principal residence. Other possible ownership structures, such as joint title, or theindividual holding legal title, with much of the land in trust for the corporation, were not discussed.




Many people use a portion of their residence to earn income. CRA generally considers the wholeproperty to remain personal use, and eligible for the PRE, provided:

· Income use is ancillary to the main use as a residence (no specific percentage – the main use isas a residence);

· No structural change is made to the property (for example, adding an entry, or a kitchen, oradding or removing walls) to facilitate income earning use;

· No capital cost allowance is claimed.

CRA notes that, where there is a partial change of use of a property to income generating use (such asconverting the basement to a rental suite with a structural change), there is no election to defer adeemed disposition. Subsections 45(2) and (3) can defer a deemed disposition on change of use of anentire property. [2016-06733231E5]

This issue was also the subject of a question at the CRA-CPA Alberta Round Table, to which CRA declinedto respond.

Section 55

Section 55 was already considered one of the most complex provisions in the Income Tax Act, evenbefore the changes flowing from the 2015 Federal Budget, which broadened its scope significantly.Advisors continue to struggle with how to address these issues, and advise clients. This is another areawhere questions submitted for the CRA – CPA Alberta Round Table received no responses.

CRA’s Rulings Division has, however, issued several Technical Interpretations over the past year, on avariety of issues.

Purpose Test

Prior to the amendments, Section 55 applied only where one of the purposes of a dividend was toreduce the capital gain which would otherwise have been realized on disposition of shares of thedividend payer. If that purpose test was not met, then the dividends were not exposed to Section 55.The broadened purpose test also includes the purpose of increasing the tax cost of property held by thedividend recipient, and the purpose of reducing the fair market value of any share of the dividend payer.

As any dividend will result in a reduced fair market value of shares of the dividend payer, and willtransfer assets having a cost to the dividend recipient, many questions have arisen regarding whichdividends CRA will consider to meet the purpose test (or even whether there are any that do not). Someinterpretations by CRA follow.

CRA indicated one example where dividends would likely not offend the purpose test was dividends paidunder a well-established dividend policy (2015-0613821C6). This caused concerns for private business,in that such a policy would seldom, if ever, exist. CRA noted that this was one example of situation thatlikely fell outside the purpose test, but that the absence of a written dividend policy, dividends whoseamounts and timing are determined by the Directors with discretion, and dividends higher than thosethat might be received on shares of a similar corporation in the same industry would not, in and ofthemselves, mean the purpose test was offended. [2015-0613821C6]




Some further guidance by CRA included:

· The fact that funds borrowed to pay a dividend would be considered deductible would not, ofitself, demonstrate the purpose test was not offended.

· The purpose of a dividend passing through multiple corporations must be assessed at each stage(i.e. as each corporation pays a dividend).

· A lack of intention to reinvest the dividends in the dividend payer does not mean the purposetest is not offended.

The term “not, in and of itself, conclusive” recurs with great frequency, as does the need to examine allrelevant facts and circumstances to determine whether the purpose test has been offended.

In another CRA commentary, they were asked about a $100,000 dividend paid from Opco to Holdco.Opco had no safe income, and wants to enable Holdco to acquire real estate for their premises. CRAnoted that, to assess the purpose test, they would consider questions such as the following:

· What did the taxpayers intent to achieve by reducing the value of the shares?· How would the reduced share value benefit the taxpayers?· What actions were taken in respect of the value reduction?

CRA noted that, in the specific case, they would also assess other approaches the taxpayers could havetaken. In particular, they noted the desire to have the real estate acquired by Holdco seemed motivatedby creditor protection, which CRA has indicated they consider a “purpose” of reducing share value,attracting S 55.

CRA was also asked whether they could instead repurchase 99.999% of the common shares, fallingwithin the related party exception (Section 55(3)(a)). CRA indicated that the exception is intended tofacilitate legitimate corporate restructuring, and they would consider applying GAAR where shareredemptions or repurchases are used to avoid Section 55. [2017-0683511E5]

CRA has commented that they do not believe the purpose of purification to maintain eligibility for thecapital gains deduction attracts Section 55. [2016-0658841E5] They note, however, that a transactioncan have multiple purposes, and if any one attracts Section 55, it would apply.

CRA has, however, issued a recent ruling [2016-0675881R3] where the division of a corporation into twocorporations, one intended to be inherited by each of two children. As the parents, and founders,would retain control of both corporations, CRA ruled that Section 55 would not apply. Note that, forpurposes of Section 55, siblings are not related.

Part IV Tax

Prior to the amendments, if Part IV tax applied to a dividend, it was generally exempt from Section 55(absent specific strategies to offset the Part IV tax by dividends paid to other corporations). The revisedlegislation allows no exemption if the Part IV tax is recovered by payment of dividends “by” acorporation.




This creates questions regarding the timing of any deemed capital gain. CRA has indicated that thecapital gain does not arise until the Part IV tax is recovered. Using the example of a $1 million dividendreceived by Holdco, subject to Part IV Tax, followed by a $1 million dividend from Holdco to its individualshareholder(s), CRA indicated the following would result:

(a) Holdco is subject to Part IV Tax ($383,333).(b) Holdco recovers its Part IV tax as a dividend refund ($383,333), but only when it files its

corporate tax return.(c) As the dividend was otherwise subject to Section 55, and the Part IV tax was recovered, the

dividend is converted to a capital gain.(d) As there is no more dividend received, the Part IV tax is reversed, and all RDTOH created by the

$500,000 taxable capital gain is recovered due to the $1 million dividend.(e) Holdco cannot retroactively change a portion of its dividends paid to capital dividend, but could

pay a capital dividend after year end.

CRA did not comment on the timing of the capital gain if Part IV tax did not apply, nor on what wouldhappen if the Holdco dividend was paid in a later year, recovering the RDTOH. [2016-0671491C6]; [2016-653451E5] The legislation deems the corporation to have realized a capital gain during the year, but notat any specific time.

Discretionary Dividend Shares

A dividend is not subject to Section 55 if it is paid from “safe income”, which is an uncertain figure.Basically, however, it is the portion of any gain inherent in the shares on which the dividend is paidwhich is attributable to income realized by the corporation from 1972 onwards. As safe income is aportion of the gain on the share, CRA has noted there can be no safe income if there would be no capitalgain on the shares, disposed of for fair market value.

It has become common practice to issue shares with a fixed redemption price (typically their nominalexercise price), no voting rights and eligible for dividends at the discretion of the Board of Directors.These shares are believed by many to have a value no greater than their redemption price, such thatthere are no gains inherent in the shares.

While CRA has refused to comment on the valuation of such shares, they have noted that, assumingthey have no value appreciation, and therefore no gains, they also cannot have any safe income. As aconsequence, any dividends paid would be exposed to Section 55, assuming they fell within the purposetest and were not otherwise excepted from the application of Section 55. [2016-0655921C6; 2016-0652991C6]

CRA has announced a study of the subject of discretionary dividend shares in general, and indicated theywill provide no further views on the topic until that study is complete. [2016-066965C6]




Safe Income Issues

CRA has indicated that any dividend subject to Section 55 to the recipient would not reduce the safeincome of the dividend payor’s other shares. [2016-0652991C6]

CRA commented on a hypothetical estate freeze [2016-0653001C6]. Opco converted its common sharesto preferred shares redeemable for $1 million, at a time when its safe income was $700,000. Thoseshares were entitled to annual dividends of $80,000. CRA indicated the following:

· The $700,000 safe income would be attributed to the preferred shares.· If the value of the shares increased due to the annual dividends, this would also result in their

safe income increasing (CRA declined to comment on the valuation itself).· All dividends on the preferred shares would come first from their safe income, so they would

not be converted to capital gains until the safe income is exhausted.

CRA has issued some comments on the determination of safe income [2016-0673321C6], indicating that:

· They would expect to see a year by year computation starting with net income for tax purposesto accumulate the safe income figure.

· In the course of any audit, they would verify each step of the computation, and review the sharehistory in the Minute Book to ensure changes in shareholdings have been taken into account.

· CRA would not consider proxy amounts, such as retained earnings, to be strong evidence, andwould apply a “very stringent validation process” before accepting such a measure isreasonable.

· Subject to their own resource availability, they will attempt to provide documentation fromtheir files as requested.

· The onus is on the taxpayer to support their tax numbers.

CRA has also noted that they do not believe there is any means of “streaming” safe income to a specificshare class. However, they did indicate that shares entitled to receive a share of accounting income(with no further growth) would also receive that percentage share of safe income. [2016-0658841E5]

Stock Dividends

In conjunction with the changes to Section 55, stock dividends paid to corporations are now deemed tobe dividends equal to the fair market value (FMV) of the shares issued. That dividend comes first fromsafe income. Stock dividends paid to non-corporate shareholders continue to result in dividends equalto the paid-up capital (PUC) of the shares.




CRA was asked about a corporation which had $700,000 of safe income, and a value of $1 million, whichpaid a stock dividend of preferred shares with stated capital, and therefore PUC, of $1 and a FMV of$700,000. CRA confirmed this would be deemed to be a dividend of $700,000, entirely from safeincome. The shares would therefore have an ACB of $700,000, but still have only $1 of PUC. This meansthey have no safe income, as there is no gain on the shares. CRA noted that, on redemption, Section 55would apply to the resulting $699,999 deemed dividend, but this would result in the shares beingdisposed of for $700,000, their ACB, so no capital gain would result. If Section 55 did not apply to thedividend, the same dividend would result, and there would be no capital loss on the shares (Subsection112(3)). [2016-0668341E5]

Where a stock dividend is received by a person other than a corporation, CRA believes the safe incomemust be apportioned between the new shares issued and the old shares on which the stock dividendwas paid, based on their relative FMV. CRA analyzes a stock dividend paid to a corporate and individualshareholder in some detail in Technical Interpretation 2016-0658351E5.

It’s Not Fair!

While I don’t disagree, tax is not fair. The Tax Court confirmed that in a court case (101139810Saskatchewan Ltd., 2014-2389(IT)G) in which Section 55 applied to convert deemed dividends on a pre-sale restructuring into corporate capital gains. The taxpayer argued this was an unfair result, as thegains were taxed twice, once to the corporation and again to the individual selling the shares.

The Tax Court held that any unfairness was clearly Parliament’s legislative intention, presumably todeter tax avoidance through tax planning techniques offending Section 55, so the double taxation wasupheld.

Corporate Matters

De Facto Control

Before the Budget proposals to put the de facto control rules back to where we originally thought theywere, the Tax Court got to apply the interpretation set down by the Federal Court of Appeal, in a casewhere CRA argued that a 46% shareholder who lived in the United States held de facto control(Aeronautic Development Corporation, 2014-4207(IT)G). A Canadian held 44%, and two others ownedthe remaining 10%.

The Court noted that the 46% shareholder also represented the corporation’s sole client and source offinancing. Share capital was nominal. The development agreement also favoured the U.S. principal, andit owned most of the assets used by the corporation. Non-arm’s length transactions and unilateraldecisions by the U.S. shareholder were also noted.

The financial statements disclosed economic dependence, except for the statements after the auditbegan, which the Court suggested might have influenced those statements. The Court concluded that,due the this economic dependence, the other shareholders would vote their shares however the U.S.shareholder dictated, and therefore the U.S. shareholder controlled the Board of Directors.




While this case dealt with CCPC status, the issue is equally relevant in determining association. Giventhis decision, it seems like the Budget proposal to restore the determination of de facto control toconsider factors that go beyond control of the Directors may not have been essential.

Three Year Rule

Another issue which seems like it will never go away is the loss of eligibility for dividend refunds, andactual tax refunds, if the initial tax return is not filed within three years of the year end. An Ontariocourt ruled on a lawsuit against the accountant who had failed to file the returns within the three yeartime limit (Presidential MSH Corp vs Marr Foster & Co. LLP and Larry Himmelfarb, CV-12-460302),resulting in denied dividend refunds. The Court concluded that the claim had not been filed within thelimit of two years after discovering the damages leading to the lawsuit.

The Court measured that date from the initial CRA assessment denying the dividend refund. However,on appeal (C62490), the Ontario Court of Appeal ruled that the case was commenced within the twoyear time limit. That limit began only when the CRA Appeals process was exhausted, a process withwhich the accountant was assisting. Whether the same results would occur under Alberta law remainsopen to question.

In a Federal Court of Appeal case, (Duplessis, A-171-15), the dividend refund would have offsetcorporate taxes otherwise payable, but for the three year limit. The taxpayer told CRA the corporationhad no assets, so it could not pay the tax bill. CRA applied Section 160, which transfers tax liabilitywhere assets are transferred to a non-arm’s length person while the transferor owes tax (whether ornot that tax has been assessed). A dividend paid from a non-arm’s length corporation can permit CRA toapply Section 160, so the Director who received the dividend which should have resulted in a dividendrefund was liable for the additional taxes. The fact that this resulted in double taxation, contrary to theprincipal of integration, did not protect the shareholder from liability.

Limited Review of Corporate Tax Returns

Small Business Deduction

A couple of years ago, CRA sent out correspondence asking many taxpayers to provide details of theirbusiness operations, specifically focusing on entitlement to the small business deduction. They laterindicated these reviews had a 40% reassessment rate, typically identifying specified investment businessincome being reported as active business income.

CRA was asked whether the project was extended, or a new project could be expected, given thoseresults, for the CPA Alberta – CRA Round Table. CRA indicated that there was no further project, butthat the issue continued in the more general review processes for corporate tax filings.

A good example of the issue appeared before the Tax Court (Skartaris Holdings Ltd., 2016-2477(IT)I) inthe form of a corporation reporting rent from as many as 11 residential properties as income eligible forthe SBD. The taxpayer argued that the business plan was to acquire a “critical mass” of properties,renovate them and resell them at a profit. That would require (at least) twelve properties. In themeantime, they were rented to defray ongoing costs.




The years under appeal were 2010 and 2011, but the history reviewed spanned the period from 2006 to2016. Properties had been acquired as far back as 2006. Some had been renovated and later listed forsale (or sold), but the properties were rented for many years between renovation and listing for sale.

The Court noted that CCA had been claimed on the properties, and that gains on properties sold hadbeen reported as capital gains, not ordinary income (although the owner later wrote the Court to saythat his testimony in that regard had been mistaken). Its income was entirely from rent. It was held tobe carrying on a Specified Investment Business, ineligible for the SBD.

Professional Fees

About a year ago, CRA undertook a project reviewing corporate professional fees. CRA discussed thisproject at the 2016 Banff Forum. At the CPA Alberta – CRA Round Table, CRA advised that about 30% ofreturns reviewed were reassessed. The reasons included fees that were not business-related, werecapital in nature, were personal in nature, lacked documentation and/or were claimed both as capitaland income deductions.

Given that adjustment rate, CRA indicated there was a good possibility of further activity in this regard,and one participant at the Round Table indicated their firm had received some recent requests forprofessional fee support.

Travel Expenses

CRA also confirmed a more recent project on travel expenses. The results are not yet known, althoughone Round Table participant reported many clients reviewed, and no adjustments or reassessments.

CRA noted these projects are sporadic, staffed with short-term transferred and temporary staff, so theycannot typically offer lengthy extensions of time for documentation to be gathered. They alsoconfirmed they expect to similarly examine a wide variety of expenses in future projects.

Business Income

Independent Contractor vs Employee

A Tax Court case (Monjazeb, 2016-488(EI)) addressed a worker who was offered employment, butwould only accept a position as an independent contractor. He invoiced twice a month, charged GST,and received vacation pay, fixed monthly remuneration and sales commissions, as well as expensereimbursements.

When the work ended, he applied for EI. CRA issued a ruling that he was an employee, and assessed theemployer. They objected. CRA reviewed their submission, and concluded he was not an employee,reversing the EI assessment and benefits. The Tax Court reviewed the usual tests, and concluded he wasan employee. The Court expressed sympathy for the employer, but the facts showed an employeerelationship.

The employee had also received a determination from the BC provincial labour authority that he was anemployee, so the costs did not likely end at EI premiums!




Reasonableness of Salaries

Does this sound familiar? The taxpayer paid his wife $76,190 in 2009 and $93,235 in 2010 for her workin his business. Her role included preparing corporate gifts for clients and prospects, arranging hisschedule and organizing meetings. Rather than issue paycheques, the taxpayer simply allowed herunlimited use of his credit card.

The Court was less than impressed – there was no contract, no clear definition of the work, no evidenceas to when work was done, no evidence of payment of fees, and no link between the invoices issued andactual payments. The credit card charges involved a wide range of investments.

The Court concluded that the work done was provided as a generous spouse, not an employeeperforming services for remuneration. The taxpayer was a financial planner, so the Court suggested hemust have known about the expense deductibility requirements for tax purposes. This justified grossnegligence penalties on the disallowed deductions.

End result: income stays on the wife’s return; no deduction for husband; 50% penalty for husband.

The Court also noted the parties were now divorced. Finally, costs were awarded against the taxpayer.

Legal Fees – Costs of Appeal

On the positive side, CRA has confirmed that costs awarded against a taxpayer who loses in court aredeductible as costs incurred in respect of an appeal (Subsection 60(o)). [2015-0578131I7]

Electric Vehicles

The tax system often struggles to keep up with new developments in technology. CRA has made anumber of comments in this regard, including the following:

· CRA has no specific policies regarding the determination of electricity costs, which cannot bedetermined with precision. They indicated average per km energy costs from manufacturers’data, and consideration of the availability of free or pay charging stations, may be usefulevidence.

· A charging station is a separate asset from the vehicle itself, and may (from the 2016 FederalBudget) fall within Classes 43.1 and 43.2, failing which they would be included in Class 8.

· Government assistance towards the acquisition of electric vehicles would reduce the capital costof the vehicle (which could impact its classification between Class 10 and Class 10.1), but not thecapital cost for standby charge purposes.

· For a leased vehicle, the assistance would be considered a deposit, to be added to monthly leasepayments for standby charge purposes, but would not impact the lease costs, including thededuction limits.




Workspace in the Home

Folio S4-F2-C2, Business Use of Home Expenses, released by CRA on January 31, 2017, providesconsiderable discussion on these common costs. The document reiterates the requirement that thework space either be the principal place of business, or be used exclusively for business purposes, andfor meetings on a regular and continuous basis. CRA interprets these terms as follows:

· The principal place of business is the main place where business is carried on.· Exclusive business use requires one or more rooms be segregated, and used for no purpose

other than the business use.· Meetings must be in person (the Courts have allowed telephone meetings, however CRA does

not accept this interpretation).· Two meeting a week would not be “regular and continuous”, while five meetings a day, five

days a week, would be.· A workspace used to earn property income would not be subject to these restrictions.

Private Health Services Plans (PHSP)

This common workplace benefit can be challenging when applied to owner-managers. Some recent CRAcommentary [2016-0635351E5] is as follows:

· A plan must meet the definition of a PHSP – coverage such as that offered by Blue Cross isgenerally accepted to meet this definition.

· The non-taxable status of this benefit depends on receipt in an employment capacity, and notdue to shareholdings, and CRA generally presumes owner-managers receive benefits asshareholders. Some facts which may rebut that presumption include:

o All employees, including non-shareholders, have the same benefits available.o The benefits are comparable to those offered by similar corporations to their non-

shareholder employees (useful where all employees own shares, or are related toshareholders).

Reasonableness

A common basis for challenge of business expenses by CRA is that they are “not reasonable”. Whatdoes that actually mean? The Tax Court summarized a number of parameters relevant to that analysisin a recent decision (Peach, 2013-4435(IT), as follows:

· Poor business judgement does not, in and of itself, mean an expense was unreasonable.· The test is whether an expense was incurred for the purpose of earning revenue, so they cannot

be assessed against the actual revenues earned.· The correct test is that no reasonable businessperson in similar circumstances would pay such

an expense.

Of note, the test applies to each element of each expense – it is not sufficient to decide that, inaggregate, an expense is unreasonable. The reasonable portion must then be determined.




CPP on Partnership Income Post-Retirement

Many partnerships continue to allocate a portion of income to former partners for a period of time afterretirement. While conceptually similar to a pension, these payments are actually structured as ongoingallocations of partnership income (Subsection 96(1.1)). The Tax Court recently concluded (Freitas, 2016-905(IT)I) that these payments remain income earned from the partnership business. They are neitherpension inc0me nor retiring allowances, but business income. As such, they are subject to self-employment CPP premiums where the earnings are otherwise pensionable (e.g. for a retired partnerunder age 65).

Farm Partnerships – T5013?

On January 31, 2017, CRA updated its website to extend its policy that a farm partnership whosepartners are all individuals (not trusts or corporations) will not be required to file partnershipinformation returns. The update notes it applies to the 2016 tax year, and a decision for 2017 will bemade after stakeholder consultations and analysis of data collected.

Travel Allowances

Many employers pay reasonable allowances for travel to their employees, which are generally non-taxable benefits for income tax purposes. But what if the worker is not an employee of the payer of thetravel allowance? CRA addressed this question [2014-0547931I7], making the following comments:

· A self-employed individual would be required to include the entire payment (whether the travelis business or personal in nature) in their income. The individual can, of course, deduct travelexpenses as usual.

· A payment received by virtue of employment would be a taxable employment benefit – thesedo not have to be received directly from the employer. These benefits would follow all of theusual rules for employee payments. Note, however, that the exception for reasonable travelallowances requires payment from the employer, so a third party payment would not besimilarly exempt.

· The payer should issue a T4A slip in respect of these payments, reporting the travel payments inBox 154 (which the slip describes as “cash award or prize from payer”.

Those businesses engaging workers as independent contractors should be especially aware of CRA’sviews in this regard. Many provisions related to benefits apply differently in employment situations.




Personal Tax

Employment Benefits

Since releasing Folio S2-F3-C2, Benefits and Allowances Received from Employment, CRA typically citesthe following indicators which would suggest that a benefit is primarily for the benefit of the employer,and therefore is not taxable to the employee:

· The employer provides the benefit for a business purpose (i.e. not as an employee perk).· The benefit is necessary to facilitate effective performance of employment duties.· The benefit is required to fulfill a condition of employment.· The employer has either a contractual or a moral obligation to provide the benefit in order to

protect the employee from undue harm, or risk of harm, in carrying out their duties ofemployment.

CRA has suggested this might be the case where an employee moves for the benefit of their employer,who pays their moving costs, even if they would not have been deductible expenses to the employee(for example, because they moved less than 40 kilometers). [2016-0629351E5]. Similarly, areimbursement for the costs of maintaining two residences during a period of transition might bereimbursed with no taxable benefit [2016-0639401E5], although CRA noted that extending thesepayments due to an employee choice to delay the move (for example, to a more convenient time, or inthe hopes the value of the former residence might rise) would be taxable.

Generally, the costs of preparing a tax return is a personal expense, so a payment by the employer fortax services would be a taxable benefit. But what if the employee required tax services due to theiremployment? CRA indicated that, where employees were reimbursed for costs related to dealing withan employer payroll error, these reimbursements would not be taxable benefits. [2017-0699741I7] Thespecific enquiry dealt with issues related to the Phoenix Payroll System, which processes payroll for theFederal Government.

Payroll Advances

Loans to employees can give rise to taxable interest benefits. Where an employer provides payrolladvances, does this create an interest benefit? CRA says No [2015-0623571I7] – rather, advances foremployment income expected to be earned in the future are ordinary employment income taxable onreceipt. Note that this also means CRA considers source deductions and T4 reporting to be undertakenon the basis these advances are income at the time of advance.

CRA further notes that, if a portion of the advance must later be repaid to the employer, a deductionwould generally be available in the year of repayment, but could not exceed the amount of the advanceincluded in income.




Employment Expenses

The Income Tax Act restricts the availability of deductions from employment income significantly, soquestions often arise.

Can an employee claim costs related to professional discipline? The Courts have denied claims relatedto charges from the Securities Commission and to defending a professional accounting designation inthe past. More recently, a pharmacist was denied costs incurred in respect of a professional disciplinehearing [Ross, 2016-531(IT)I], including legal representation and courses required to be taken under theterms of a settlement reached. The Court noted that only direct costs of legal representation would bea “legal expense”. Further, only legal expenses incurred to collect unpaid salary or wages can bededucted by an employee.

Similarly, a police officer could not deduct legal fees incurred to defend against criminal charges, despitethe fact he would lose his employment if convicted. [Geick, 2014-3740(IT)G] The fact that he wouldalso lose pension entitlement was also of no assistance. Neither was the argument that the bank wouldcall loans used for investment if he lost his job.

What about cell phone and data expenses? CRA has indicated that these could be “supplies consumeddirectly” in providing employment services. An employer-signed T2200 would, of course, be required.CRA felt the costs of a cell phone and data plan used exclusively for employment would be fullydeductible. However, this would require no personal use whatsoever. [2016-0639401E5]

Where use is mixed, documentation of the use of minutes and data would be required to allocate thecosts. While most service providers provide a detailed breakdown of minutes used, the same is not thecase for data, meaning no deduction would generally be available for employment data usage.

Where a reasonable allowance is received for travel expenses, the allowance is not taxable, but therelated expenses are not deductible. How does one determine whether the allowance is reasonable?An allowance computed on criteria with little or no relationship to the travel costs would likely beunreasonable. As well, an allowance which is either too high or too low to be reasonably expected tocover the related expenses would be unreasonable.

CRA indicated that an allowance for meals and accommodation based on distance travelled would likelybe unreasonable (especially for a truck driver who sleeps in the cab of the truck). While it is oftendifficult to judge the context, it appears that the specific interpretation would permit at least some ofthe affected employees to report their allowance, and deduct actual expenses which exceeded thatallowance. [2015-0577201I7]

Similarly, CRA has opined that a per kilometer automobile allowance might be unreasonable where notall kilometers driven for employment purposes are eligible for an allowance. [2016-0674811C6 and2016-0674801C6] Examples provided included the following:

· After a maximum number of kilometers, no further allowance is paid.· Only the portion of kilometers in excess of minimum distance per trip qualify for the allowance.· The allowance is based on the lesser of actual distance travelled and the distance to and from

the regular place of business.




CRA also noted that, while the expect employers to complete T2200 forms where appropriate, there isno legal requirement they do so (at least under the Income Tax Act).

Marital Breakdown

As if the emotional and financial issues of a failed relationship are not sufficiently devastating, the taxsystem imposes a further layer of issues to the end of a marriage.

A huge number of Tax Court cases in recent years have addressed the ability to claim an “eligibledependent” credit for a child in a shared custody arrangement. The issue revolves around theprohibition against any claim for a child in respect of whom the individual is required to pay a supportamount.

There is an exception where, due to that provision, no one would be able to claim the individual as adependent. This has resulted in a substantial number of court cases, largely dealing with shared custodyarrangements.

The Canada Child Support Guidelines provide for support in such cases to be determined based on theamounts each parent would pay, if the other had sole custody, and netting the two. However, the usualresult is an order that one parent make payments to the other. The Courts have held that the payer isthe sole person required to pay a support amount in such cases (e.g. Harder, 2014-3977(IT)I).

Some cases involve orders or agreements where each spouse is required to make a payment to theother, with a set-off and one spouse making a net payment. In one case (Leinweber, 2015-787(IT)I), theCourt noted the definition of a support amount requires the recipient of the payment have discretion asto how it will be spent. As a set-off of the entire amount removes that discretion, this arrangement washeld to be ineffective.

However, another case (Ruel, 2016-5499(IT)I) held that this arrangement did allow either parent toclaim the child. The parties, unfortunately, could not agree which of them would make the claim, soneither received the credit.

In a third case (Lawson, 2015-3474(IT)I), a similar arrangement was held to be effective, and the creditwas available. That case noted the agreement was very clear in establishing a specific obligation of eachparent.

What happens when the relationship ends, but the parties continue residing at the same address, oftenfor economic reasons? It is possible they are “separated”, but expect CRA to be skeptical. They notethat relevant factors to consider include not only sharing a roof, but also personal and sexual relations,services provided between them (e.g. cooking and laundry), social activities, financial support and evenhow society perceives them. [2016-0674821C6]




CRA has indicated the following might be useful support of a claim to live separate, under the same roof(and that multiple documents may be required):

· A written document (Court Order or agreement) detailing living arrangements, custody andsupport;

· A divorce document;· Mortgage documents showing assumption of the entire mortgage by one party, and timing of

same;· Proof of individual vehicle loans and insurance, including date of change;· Proof of individual medical insurance, including date of change;· Individual credit card statements , including date of change;· Letters from independent third parties corroborating the claim of separation, that they live

separate lives and no longer appear as a couple since a specific date.

Investment Management Fees

Segregated funds, a product offered by many insurance issuers, look a lot like mutual funds. However,in tax, as in most legal matters, form rules over substance – often a painful issue for we accountants toconfront.

As a segregated fund is a contract of insurance, and not a share or security, CRA has indicated that feespaid for advice on purchase or sale of such investments, or for their administration or management,would not fit with Subsection 20(1)(bb), which provides that such costs are generally deductible whererelated to securities.

For many years now, fees related to funds held within registered accounts like RRSPs and TFSAs havebeen non-deductible. It remains commonplace, however, for the annuitant of these plans to pay relatedfees personally to avoid erosion of the tax-advantaged investment capital.

CRA has now determined, however, that the “advantage tax”, aimed at abusive strategies involvingregistered accounts, technically applies to such fees. The advantage tax is assessed at a rate of 100%, sothis is a significant issue. Recognizing that this is a serious change in their policies, CRA announced thatthis change in policy would be effective only for fees related to periods after 2017. [2016-0670801C6]

Subsequently, CRA determined the issue merited more time, and announced the new policy will applyno sooner than January 1, 2019, to provide time to consider submissions by stakeholders.




Estates and Trusts

For most practitioners, Estate and Trust filings are an infrequent aspect of their practice. However,especially as one’s client base ages, they are also an unavoidable part of practice. After some significantchanges to estate taxation a few years back, it seems like new issues arise regularly in this area.

Connected Status

It has become fairly common to have an operating company owned by a Trust, with a holding companybeing a beneficiary of the Trust. All individuals involved are typically related, so that Holdco isconnected to Opco. Dividends are paid to remove excess cash from Opco, and the Trust pays them toHoldco, over time.

What happens when Opco is sold to a third party, and pays out a dividend prior to sale, which is thenpaid out to Holdco? CRA recently reviewed an example of this situation [2016-0647621E5], and notedthat, on the sale of Opco by the Trust, Opco ceased to be connected to Holdco.

it was still connected when the dividends were paid, but the Trust has a December 31 tax year end.Income which a Trust pays, or makes payable, to a beneficiary is income of the beneficiary on the lastday of the Trust’s tax year. At that time, Holdco and Opco are not connected. This would mean Part IVtax applies to that pre-sale dividend.

Phantom Income

Income of a Trust which is paid or payable to a beneficiary becomes the beneficiary’s income. But whatabout income that arises on a deemed basis for income tax purposes, rather than arising from an actualtransaction? This “phantom income” (PI) may be problematic.

CRA notes that the first question to ask is how that PI is treated for Trust law purposes. Theirunderstanding is that it is a “nothing” – neither income nor capital. The terms of the trust would needto permit the PI (or an amount equal to it, and representing the PI) to be paid or made payable tobeneficiaries. This might be possible if the Trustees have been given the power to pay out amountswhich are defined as income for income tax purposes. [2016-0634921C6; 2015-0604971E5]

If the Trust is discretionary, the Trustees must exercise their discretion before the end of the tax year.To be payable, the beneficiary must have the right to enforce payment. CRA believes this requires anirrevocable designation with no conditions, evidenced by written resolutions of the Trustees. They alsobelieve the beneficiaries must be notified of their entitlement in writing prior to the Trust year end.

If payment is to be made in kind, the Trust Deed would have to permit this, and the resolutionauthorizing the distribution should be clear that it is payment of the PI, not a capital distribution.

Both CRA documents dealt with capital gains realized electively under Section 48.1, immediately beforea corporation went public. However, this would also be relevant to gains arising on other deemeddispositions, such as those occurring on the 21st anniversary of the Trust. With the July 19, 2017Consultation Paper I am not talking about proposing elections to realize gains in 2018, a review of theTrust terms with a Trust lawyer may be in order.




Beneficiary Rights

Rights to Trust income and assets are governed by the Trust Deed. CRA recently reviewed a situationinvolving a Trust whose terms included a prohibition that no minor beneficiary could receive orotherwise obtain the use of any of the income or capital of the Trust while being a designated person (asdefined in Subsection 74.5(5) of the Income Tax Act) in respect of their father. Such restrictions arefairly common to avoid exposure to deemed income under Section 74.4.

Despite this, the Trustees made payments to such beneficiaries, which they deducted from the incomeof the Trust, and which the beneficiaries reported.

CRA opined that, notwithstanding the funds had been paid, they could not have “become payable” tothose beneficiaries, as the Trust terms prohibited this. As a result, it was their view these amounts couldnot be deducted by the Trust (so the Trust would be taxable, at the highest personal tax rate).

This would also mean that the usual provisions under which beneficiaries are taxable on Trust incomewould not apply. However, CRA noted that Subsection 105(1) applies to the value of all benefitsreceived under a trust, unless they are included in income under some other provision (some otherexceptions apply). [2016-0663971I7]

Based on CRA’s analysis, the income would be taxed both to the beneficiaries and to the Trust. Inpreparing Trust tax returns, it is critically important to review and understand the terms of the Trustitself.

Taxing Income in the Trust

In some situations, it is desirable to have income taxed to a Trust or Estate, and not to the beneficiaries.Prior to 2016, the Trustees could elect to tax income in the Trust at their discretion. However,commencing in 2016, this election is invalid if the Trust is left with taxable income. As such, if theincome is paid or payable, it must be reported by the beneficiaries.

This has raised the question of whether income of an Estate is paid or payable to its beneficiaries, underthe standard terms of a will. CRA has provided limited guidance, noting that the income cannot be paidor payable if it is to be taxable in the Estate. During the “executor’s year”, the common law does notpermit beneficiaries to enforce their rights to payments from the Estate. CRA has indicated that, if thisis the only reason the income is not payable, they would still consider the income payable to thebeneficiary, and therefore taxable to the beneficiary, rather than the estate. [2016-0630781E5]

One reason for taxing income within the Estate would be to use up losses of other periods. If a loss wascarried forward, income sufficient to offset the loss could be designated to be taxed in the Estate, asthere would be no taxable income after claiming the loss. But what if the loss occurs in a later year?CRA has indicated they would generally accept a late designation to return income to the Estate in anamount sufficient to be offset by losses carried back. However, as always, the devil is in the details.




CRA noted that the following filings would be required: [2016-0634901C6]

· Form T3A related to the loss year, to request the loss be carried back;· Form T3ADJ for the prior year to amend the return for the late designation;· Amended T3 slips for the prior year, which must also be issued to all of the beneficiaries;· Form T1ADJ for each beneficiary to reduce their income from the Estate.

CRA suggested the T3A and T3ADJ need to be filed together, as they will need to be processed together.As well, they noted that the returns cannot be statute barred or they cannot be adjusted. The writerwill suggest that the administrative cost of such filings will often deter this approach being undertaken.

Intestacy

Where an individual dies without a will, in theory an application is made to the Courts to appoint anadministrator. In practice, especially for simple estates, a relative informally administers the Estate. Butthis technically leaves no one empowered to file tax returns. I have never seen CRA fail to cash taxcheques and assess the return, but they cannot process requests for representative access.

On June 4, 2017, however, CRA released a series of forms to be used for intestacy situations, accessibleat https://www.canada.ca/en/revenue-agency/services/tax/individuals/life-events/what-when-someone-died/affidavit-form-intestate-situations.html. These ask CRA recognize persons managing thetax affairs of the deceased. CRA lists a “priority order”, and requires a signed consent from anyonehigher in that list, which is generally as follows:

1. Spouse or common-law partner2. Adult child(ren)3. Parents4. Siblings5. Grandparents

21 Year Rule

On every 21st anniversary, most Trusts are deemed to dispose of and reacquire their assets at fairmarket value, becoming taxable on any gains. Often, proper planning can mitigate any tax issues. The21 year anniversary was overlooked, resulting in a recent court case (Ozerdinc Family Trust vs. GowlingLafleur Henderson LLP, 13-57421 A1) against the Trust’s legal counsel for failure to advise the Trusteesof this impending tax issue.

The law firm acknowledged they did not meet the appropriate standard of care, but that any damageswere the fault of the accountants, who were the ones responsible for tracking the 21-year deemeddisposition date, and advising on tax planning strategies. The Court held that the lawyers werenegligent, and that any action against the accounting firm would appropriately be argued and triedindependent of the case against the law firm.




Nonresident Beneficiaries

The Estate was not already complex enough – discovery that one or more beneficiaries reside outsideCanada adds a further layer of complex issues. With an increasingly mobile population, this seems morefrequent every year.

A capital distribution is, due to various provisions of the Act, an acquisition of an interest in the Estatefrom a beneficiary. Where the Estate derives its value primarily from Canadian real estate at thedistribution date, or at any time in the preceding 60 months, CRA Form T2062 must be filed for thedistribution. Technically, a 25% tax withholding is required, however the writer’s experience is that, ifthe disclosures are filed, they can disclose the lack of any tax liability, and Certificates of Compliance areissued. However, the filings are subject to penalty if they are late or overlooked, at the usual $25/day,minimum $100, maximum $2,500. As well, if the beneficiary owes Canadian taxes for other reasons,CRA may well not waive the 25% withholding, using it to collect other taxes in arrears.

CRA addresses an Estate’s status as “taxable Canadian property” in technical interpretation, 2014-0542551E5. How often is this an issue? How often is the residence of the deceased of sufficient valueto make up more than half of the value of the Estate?

Income distributions are often subject to withholding taxes under Part XIII of the Income Tax Act. Theseare payable when the income itself is paid out. Form NR4 is used to report the income and thewithholdings. However, CRA has recently noted that all distributions from an Estate to a non-residentare technically subject to NR4 reporting, even if no withholding tax is payable – even capitaldistributions that were already reported on T2062 forms. [2015-0608201E5; 2017-0691141C6]

CRA has indicated the slip should use code “S” to indicate no withholdings are required. That code is ageneric “other reason no withholding is required” code which seems destined to attract CRA enquiries.

Part XII.2 Tax

An Estate or Trust with non-resident beneficiaries can also be subject to Part XII.2 tax. This tax appliesto a Canadian resident trust meeting the following criteria:

· It earns designated income, generally income from real estate in Canada (including capital gainson sale of such property, rental income or royalties) or from business carried on in Canada;

· It has a designated beneficiary (generally a non-resident person); and· It deducts amounts payable to a beneficiary.

With the 2016 changes, this has become more widely applicable, for two reasons. First, it is not possibleto designate the income to be taxed in the Trust, which would have avoided the deduction of amountspayable to a beneficiary. Second, previously all testamentary Trusts were exempt, but now onlyGraduated Rate Estates are exempt.




The tax is computed as 40% of the lesser of the following amounts:

· The Trust’s designated income (prior to amounts payable to beneficiaries being deducted);· 100/60 of the deductions for amounts payable to beneficiaries.

So, in theory, the Trust might earn $100,000 of designated income, pay $60,000 to the beneficiaries, andpay $40,000 of Part XII.2 tax.

The non-resident beneficiaries remain subject to withholding tax, if applicable, on the actual paymentsto them (so the 60% portion). Assuming the standard 25% rate applies (not reduced for a Treaty), thiswill add another 15% of the income, so Canada collects 55%. For a U.S. resident, the Treaty reduces thewithholding to 15%, so the tax is effectively 9% of the income, for a total cost of 49%.

The tax is paid on all Trust income, so Canadian beneficiaries effectively also pay 40%. This is considered“paid or payable” to the Canadian beneficiaries, and so it will be included in their income. However, it isalso treated like a source deduction, so they can claim it back when they file their personal tax return,and recover any excess over their actual taxes payable.

Registered Accounts

TFSA – Survivor Benefits

CRA has indicated that a TFSA can transfer to a surviving spouse even where the survivor is not thedesignated beneficiary of the deceased’s TFSA. The payment must be received as a consequence of thedeceased spouse’s former TFSA directly or indirectly to the spouse’s TFSA. The transfer must occur bythe end of the calendar year following the year of death (so for an individual who passed away in 2017,the funds must reach the surviving spouse’s TFSA by December 31, 2018).

CRA acknowledged that the funds could be transferred by the Executor in accordance with the terms ofthe will. [2016-0679751E5] The funds could flow through the Estate without losing the ability totransfer them to the surviving spouse’s TFSA. Similarly, a debt related to division of family propertycould transfer to the surviving (ex-)spouse’s TFSA. [2015-0617331E5]

RRSP Transfer

By contrast, CRA indicated that a transfer of RRSP funds from a deceased individual to their formerspouse or common-law partner cannot be undertaken on a rollover basis. The transferor spouse mustbe alive at the time the transfer is made. [2016-0651721C6]

T1 OVP – Statute Barred?

A recent court case (Hall, 2016-815(IT)I) addressed a taxpayer assessed almost $5,000 in Part X.1 tax,interest and penalties for RRSP contributions in excess of his deduction limit. The assessment reflecteda six year period of overcontribution. The taxpayer argued first that CRA was beyond the usual threeyear reassessment deadline. However, this tax is reported on Form T1-OVP, not the personal incometax return. Until a T1-OVP is filed, the statute barred period does not begin, so CRA has unlimited timeto assess.




CRA has discretion to waive the tax when the excess contributions arise due to reasonable error, andreasonable steps are taken to eliminate the excess. The Court could not provide this relief, althoughgiven the taxpayer’s circumstances, including a period of mental illness, it did recommend CRA exercisediscretion in this regard, on application by the taxpayer.

Capital Gains and Losses

Income Earning Purpose

A capital loss cannot arise on a loan which was not advanced for the purpose of earning income. CRAreviewed a situation where two non-shareholders advanced funds on a no-interest basis to acorporation (Opco) owned by their mother. All three jointly owned real estate which Opco rented for itsoperations.

CRA noted that, although the sons had no direct income-earning purpose (such as interest on the loan),an indirect income earning purpose would be sufficient to allow a loss claim. The sons argued that theloans protected their rental income on the building. However, CRA considered the rental income toosmall to support the view that loans as large as those in question would reasonably be advanced inorder to protect the rental income. [2015-0597971I7]

Securities Trades – Income or Capital?

A couple of recent court cases highlight the possibility that some securities trades generate ordinaryincome, not capital gains or losses. In one, a designated CFA who was the co-head of institutionaltrading at a brokerage firm, was held to have undertaken securities trading on business account. Hemade 38 purchases and 50 sales over a ten month period, involving values in the range of $2.5 million,and gains of over half a million.

The Court noted factors such as the trading behaviour (including taking some short positions), spendingconsiderable time each day monitoring the markets (about 45 minutes per day, over and above hisemployment activity), his experience and knowledge, the regularity of purchases and sales, and his shortholding periods.

Foreign Exchange

A CRA technical interpretation (2016-0676961E5) indicating their administrative position that T5008forms need not be filed for trades of money market funds does not extend to funds denominated inforeign currency serves as a reminder that foreign exchange gains or losses are subject to taxation. Theproceeds and ACB are required to be translated at the time of each transaction (in practice, the writerfinds CRA will often accept annual averages). The gain cannot be calculated in foreign currency and thentranslated – each of the proceeds and cost must be translated at the rates in effect at the time ofpurchase and sale, respectively.




Historically, the Bank of Canada was the common source for foreign exchange rates. However, it sharplyreduced the currencies it publishes effective May 1, 2017. CRA has indicated they will generally acceptspot rates from other reputable sources (e.g Bloomberg LP, Thomson Reuters corporation and OANDACorporation). [2017-0684831I7]

CRA indicated any rate used should meet the following criteria:

· published by an independent party on an ongoing basis;· recognized by the market;· used in accordance with well-accepted business principals;· used consistently from year to year;· where applicable, used in the taxpayer’s financial statements.

Capital Gains Deduction (CGD)

To be eligible for the CGD, a corporation must meet asset tests for a 24 month holding period, and atthe date of sale. This sometimes raises questions on how certain assets should be treated.

CRA has indicated that an asset under a capital lease is not owned by the corporation (even if GAAPrecords it as though it were). The actual asset is the right to lease the asset, and that lease right ispotentially an asset for the purpose of determining SBC and QSBC status. [2016-0652941C6]

When asked whether AgriInvest or Agri-Quebec accounts held in a farm corporation were “good assets”(i.e. used in active business) or “bad assets”, CRA had the surprising response that they are not assets atall. The value of a net income stabilization account is deemed to be nil for this purpose, and CRAconsiders these program accounts to fall within that definition. [2015-0583561E5]

Do It Online!

CRA continues its efforts to enhance online services.

Personal Tax Programs

For 2016, CRA added a few new electronic services. Pre-authorized debits were added to the T183, witha new version of the form released in early 2017 to remove bank account information. However, bankaccount information was still required to be entered in the tax software file. Many tax advisors haveexpressed concern over having this very confidential information retained in their files.

The Express Notice of Assessment program allowed the tax preparer to receive the Notice ofAssessment electronically. However, this meant no paper Notice will be sent to the taxpayer, althoughif they use My Account and Online Mail, they would receive a notification email. How popular was this?Well, CRA announced on May 11, 2017 that over 7.3 million taxpayers used Autofill My return, and over9 million received refunds by direct deposit (about 70%). Express NoA was used by 41,565 individualsand representatives. I suspect many practitioners do not want to be the sole recipient of these Notices.




ReFIle is a new program that lets an amended tax return be filed electronically, like the EFILE of theinitial return. A T183 reflecting the new balances is required to be signed by the taxpayer, a step manypractitioners prefer to avoid. Those with Level 2 representative authorization can use the Change MyReturn feature on Represent a Client to submit adjustments. Electronic adjustments are certainlydesirable, as the processing of paper adjustments seems to take longer and longer. However, if anelectronic adjustment requires review, it appears to go into the same queue.

Account Alerts

Taxpayers can now register for Account Alerts to receive email notification if changes are made to theirhome or mailing address or direct deposit information. A notification will also be sent if mail isreturned. This requires use of either My Account or a CRA mobile app, but not use of online mail.

Service Canada Access

The My Account and My Service Canada accounts are now linked. However, representatives cannotaccess the latter.

Payment at Canada Post

You can now pay your taxes at Canada Post offices now. Only two things to consider. First, there is a$3.95 service charge for each payment. Second, payments cannot exceed $1,000. Still, it’s one moreoption, at least for relatively small amounts.

T Slips

The speed of processing at CRA has become a matter of great interest with the advent of AutoFill myReturn. CRA notes that most slips filed electronically (about 95% of slips) are processed within 48 hours,unless an error (e.g. an invalid social insurance number or duplicate slip) delays them. Paper filed slips,however, have a general standard of 90 days.

Amended T3 or T5 slips filed electronically are normally also processed within 48 hours, but the servicestandard for amended T4 slips is 60 days.

As noted on the CPA Canada blog where these turnaround statistics were highlighted, while AutoFill myReturn is a valuable tool, it cannot replace professional judgement.

Budget 2017 announced employers will be allowed to deliver T4 slips electronically, although the rulesare pretty strict. The employer must make the slips available through a secure electronic portal, providea secure site to print the slip, and provide printed copies on employee request. Employees on sick leave,or who have ceased employment, or who simply cannot be expected to have access to obtain anelectronic slip must be issued paper slips.

Other slips must still be issued on paper. Email issuance of T4 slips is not permitted due to securityconcerns.




Represent a Client

Accessing CRA data online for corporate, payroll and GST/HST accounts is no longer possible using FormRC59. CRA’s online process through Represent a Client has been required since May of 2017. However,CRA has indicated they continue working on allowing the filing to be undertaken through tax software,much like T1013s, although no rollout date has been formally announced.

Perhaps they are saving that announcement for some important event like forums in Alberta?

Telephone Service

The Canadian Federation of Independent Business awarded CRA a grade of C- in their latest test,released January 26, 2017. A more detailed report card follows:

· A+ in accountability – agents consistently provide names and ID numbers.· D- in accuracy of answers, with 69% of responses considered complete and correct, 23%

incomplete and 8% incorrect.· F in connecting to an agent, with nearly 30% of calls not getting through (ironically, that’s the

grade where a student is required to repeat).· B+ for wait times of 2 minutes or less once in the queue.· D for agent professionalism, despite best efforts to answer questions, many simply read from

the web page (or send callers there), and do not ensure callers understand the answer.

CRA has begun their dedicated telephone service pilot project, providing tax preparers with access tomore experienced staff to assist with technical questions. The pilot is restricted to small (3 or lesspartners) CPA firms in Ontario and Quebec (recently expanded to Manitoba and New Brunswick).

Appeals

A new protocol between CRA’s Appeals and Audit divisions will see additional information provided toAppeals referred back to Audit much more regularly. Documents requested, but not provided, at auditmust be returned to Audit (with an exception for the GST/HST Refund Integrity Program).

From a July 28, 2016 CPA Canada blog: Current CRA policy says Appeals officers don’t need newinformation or evidence to review and decide on an assessment’s correctness. In fact, the CRA says thepractice of withholding information until the Appeals stage undermines the value of audit proposals andreassessments. And it results in costly and time-consuming appeals.




Voluntary Disclosure

On June 9, 2017, CRA issued draft documents for the voluntary disclosure program (VDP) suggestingchanges may be effective in 2018. Since the end of a 60 day consultation, this issue has been quiet.Some highlights of the possible changes:

ELIGIBILITY:

· A new “limited program” would apply to “major non-compliance”, including active efforts toavoid detection, large amounts, multiple years, sophisticated taxpayers, disclosures occurringafter announcements of related CRA projects and other situations of high taxpayer culpability.Relief will be limited to waiver of gross negligence penalties, and no criminal charges beingconsidered.

· Under the general program, all penalties will continue to be waived, and 50% of interest forperiods beyond the most recent three years will typically be waived.

· VDP will not be permitted for income from proceeds of crime, disclosures from largecorporations (revenue in 2 of the last 5 years exceeding $250 million), or transfer pricing andcertain other international matters.

CONDITIONS:

· A letter from CRA inviting the taxpayer to come forward would not result in the disclosure failingthe “voluntary” test, but could be considered in determining whether the VDP goes into thelimited program.

· Completeness means all relevant years and any non-arm’s length circumstances must bedisclosed.

· Legitimate inability to locate all documents is acknowledged as possible, in which casereasonable estimates will be required.

· Payment of the taxes due (or, in extraordinary circumstances, a payment arrangement) will berequired.

· Objection rights must be waived (calculation issues and characterization disputes will still beeligible for objection).

NO NAMES DISCLOSURE

· Pre-disclosure discussions will be possible on a no-names basis, but the present no-namesdisclosure will be removed.

These proposals have faced considerable criticism, and it remains to be seen how CRA will respond.

Registration of Tax Preparers Program

At the Society for Trusts and Estate Planners 2017 conference, June 13, 2017, CRA announced that theprogram as envisioned was too costly. They indicated they will consult on their future plans. However,CRA declined to comment on this program at the CPA Alberta – CRA Round Table in September, 2017.




GST Letters

CRA has been sending letters asking registrants to review a previously filed GST/HST return and considerwhether there are errors needing correction. 250 letters were sent in each of December, 2016 andFebruary, 2017 with a further 2,500 planned for each of May and August, based on a CRA release inDecember of 2016.

Rental Loss Project

Several individuals have received extensive questionnaires regarding their reported rental losses. Theextent of any such project is unclear, but given the work that must have gone into developing thequestionnaire, it is presumably a significant project.

Sharing Economy

On March 17, 2017, CRA issued a Tax Tip regarding the sharing economy, identifying five key sectors(ride sharing, accommodation sharing, music and video streaming, online staffing andpeer/crowdfunding. Any guesses where CRA audit activity will be focused?

CRA Information Gathering

On March 30, 2017, Square Canada Inc. advised users that they would be providing information to CRApursuant to a Federal Court Order. The company provides a device which enables credit card paymentsto be taken using a mobile device. Information regarding sellers with more than $20,000 processed inany of 2012 – 2015 or the first four months of 2016 was to be provided.

The Federal Court of Appeal upheld a Court Order against Rona (A-419-16) requiring they provideinformation on contractors. CRA agents obtained Rona contractor account applications which they usedto guide their information request process.

I will admit I am impressed by CRA’s creativity in some of these cases.

CRA Audit Feedback

A May 25, 2017 CPA Canada blog discussed a new small and medium enterprise audit feedback survey,which taxpayers and their advisors may be invited to fill out after completion of the audit. Theanonymous survey will gather information such as whether the auditor treated the taxpayer courteouslyand professionally, answered questions about proposed adjustments before any reassessment wasissued, and provided at least 30 days for responses, with requested extensions of time granted whereapplicable. CPA Canada provided assistance in the design of the survey, estimated to require about 5minutes to complete.

Fraud

We continue to hear about various scam artists posing as CRA. In one recent scam, taxpayers victimizedpreviously are contacted with promises to repay funds previously lost, however a 5% administration feemust be paid up front. I guess everyone likes repeat business!




First Nations

Metis and non-status Indians

With the Supreme Court ruling that Metis and non-status Indians are “Indians” under Federal law, CRAhas noted that this does not allow them access to the tax exemptions available to status Indians, asthese are available only under the definitions in the Indian Act. [2016-0656851E5]

Bands Tax-Exempt

CRA has concluded that all Indian bands created under the Indian Act are municipal or public bodiesperforming a function of government, and are therefore tax-exempt. Previously, CRA had made thisdetermination by evaluating specific Bands. CRA notes, however, that this does not extend tax-exemptstatus to individuals, or even to Band-owned entities. [2016-0645031I7]

International Issues

T 1135

The T1135 issues seem to be trailing off, but new issues surface on occasion. CRA has indicatedproperty should be reported on the legal owner’s T1135, regardless of whether attribution applies.[2016-0639481E5,2016-0669081E5] This seems likely to generate questions – some practitionersindicate they include details of the attribution status of assets on the T1135 filing.

For part-year residents, CRA indicates only the period of Canadian residency should be considered todetermine whether a T1135 is required. However, if they are required to file, the assets held at anytime in the taxation year (not just the portion in which the taxpayer was resident) should be reported.[2015-0611141E5] Note that an individual is not required to file a T1135 for the year in which he or shefirst becomes resident in Canada (but this does not alleviate the filing requirement for a former residentreturning to Canada).

Purchases of Real Estate from Non-residents

The T2062 was mentioned in the context of estates and trusts earlier. A recent court case (Mao vs Liu,S160498) addressed a situation where CRA assessed the purchasers of real estate $695,000 on apurchase from a non-resident without filing the required forms and obtaining a Certificate ofCompliance. The notary who was engaged in connection with the purchase was held to be liable.




U.S. Persons

A recent U.S. case (Dewees, case #16-cv-01579 CVC) shows the severity of U.S. tax issues for citizens inCanada. In this case, the taxpayer failed to file disclosure forms (Form 5471) for twelve years. In 2009,he applied under the Offshore Voluntary Disclosure Program (OVDP). He was initially assessedsignificant tax and penalties, including some IRS errors, which were reduced to “only” $186,000 US.

He withdrew form the OVDP, and was assessed penalties of $120,000 US. He did not pay. In May, 2015,the IRS had enlisted CRA’s assistance under the Treaty, and his substantial Canadian refund waswithheld and paid to the IRS. His case was unsuccessful in having the penalties reduced.

U.S. Business

The IRS has indicated they plan to look at campaigns focusing below the “big fish”, including thefollowing:

· Related party transactions, focused on whether mid-market corporations are following transferpricing requirements.

· Inbound distributor campaign, assessing whether appropriate profits are being generated byU.S. subsidiaries of foreign corporations.

· Form 1120-F non-filer campaign, looking for foreign corporations with US permanentestablishments or business activity who have not filed US corporate tax returns.

Conclusion

The reader may be surprised that the writer grappled with numerous other possible inclusions from thepast year or so. Or perhaps not, as this has been the case for many years now. The pace of change hascertainly not slowed in recent years, and staying current is a challenge for all of us. Hopefully, the abovehighlights will be useful to participants in keeping their knowledge current!