Acco 643 Lecture Notes

Part IV

Other Sources of Income and

Deductions in Computing Income
DIVISION B - NET INCOME SECTION 3

3(a) Income from each office or employment +

Income from each business +
Income from each property +
Other sources of income (excluding taxable C/G) + +

3(b) Taxable capital gains +

Net taxable gain on LPP + +

Less:
Allowable capital losses –
1
Less: Allowable business investment losses (–) – +
+

3(c)Deductions under subdivision e (–)

+

3(d) Losses from an office or employment –

Losses from business –
Losses from property –
Allowable business investment losses – –
2
Net income for the year +

__________________________________
1 The amount at 3(b) cannot be negative; if the allowable capital losses are greater
that the taxable capital gains, the amount at 3(b) is nil but the difference is
known as "net capital losses".

2 The amount after 3(d) cannot be negative; if the amount after 3(c) is greater than
the total amounts after 3(d), the amount is the taxpayer's net income; if the
amount after 3(c) is less than the total amounts under 3(d), the net income is 0
and the difference is a notional "non-capital loss".

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OTHER SOURCES OF INCOME

 Other sources of income which are taxable (section 3(a))

1) Pension income (RRSP, RRIF, RPP,)

2) Old Age security
3) Benefits from CPP or QPP
4) Death benefits in excess of $10,000
5) Benefits from Employer’s DPSP
6) Retiring allowance received from an employer in recognition of long service or
court-awarded damages for loss of office
7) Benefits from employment insurance plan
8) Income from Registered education savings plan
9) Amounts received as scholarships, fellowships, bursaries, etc. in certain cases.
10) Research grants in excess of expenses
11) Payments received from a former spouse (including 3rd party payments) as

alimony or maintenance provided that:

 they are
received as periodic payments (no lump sum);
 pursuant to
court order or written agreement;
 to the extent
they are for the support of a former spouse (i.e. not for the support of a child,
which are not taxable);
 recipient has
discretionary use of the amounts;
 payments
are made to a spouse or former spouse who is living apart from the payer
because of the breakdown of their marriage.

Definition of Spouse

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• Person of the opposite sex who cohabits at that time with the taxpayer in a conjugal
relationship and

(i) so cohabits throughout the previous 12 months

(ii) is a parent of a child of whom the taxpayer is a parent
RRSP DEDUCTION

• Annual RRSP limit

• Rollover of retiring allowance
• Additional $2,000 contribution

Age Limit

• RRSP must be disposed of by the end of the year the annuitant turns age 71;
• The contributor can be over age 71 if the contribution is to a spousal plan
and the spouse has not turned age 71 in the year.

Annual RRSP Limit

• Unused deduction room carried forward

PLUS:

• lesser of:

(1) RRSP dollar limit

(2) 18% of prior year earned income

minus: Pension Adjustment (PA) of prior year.

Unused RRSP Deduction Room

• Started in 1991
• Indefinite carry-forward
• Annual limit minus actual contributions
• Can deduct balance in any year.

RRSP Dollar Limit

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2008 $20,000
2009 $ 21,000
2010 $22,000
2011 Indexed

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Earned Income is income from:

• Office or employment
• Business income (loss)
• Rental of real property – income (loss)
• Royalties in respect of a work or invention
• Alimony or maintenance received (paid)
• Supplementary unemployment insurance benefit plan
• Research grants
• CPP/QPP disability benefits for previous years.

$2,000 Over-contribution

• $2,000 at any time per individual

• can be carried forward indefinitely
• can claim as a deduction against annual limit at any time.

Penalties for Excess Contributions

• for over-contributions in excess of $2,000

• 1% per month on the excess plus tax on withdrawal
• avoid penalty and tax by withdrawal of excess in year of contribution or following
year.

Retiring Allowance

• defined in 248(1)
 on or after retirement from employment in recognition of
long service
 on loss of office even if damages awarded by the courts

• Rollover
$2,000 x pre ’96 years during which employed
plus $1,500 x pre ’89 years not vested.
i.e. for the years the
employee was a member of a
Direct Transfer Pension Plan but the
Employer contribution had
• From DPSP, RPP directly to RRSP not vested to the employee

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• Not reported in income.

OTHER DEDUCTIONS IN COMPUTING NET INCOME

 Moving expenses

•moving expenses are deductible to the extent that the following conditions are
met:

they must not have been paid on a taxpayer's behalf in respect of (in the
course of or because of) the taxpayer's office or employment (para 62(1)(a));
they were not deductible under section 62 in the preceding taxation year (para
62(1)(b)) (expenses that could not be deducted in the year of the relocation may
be deducted in the following taxation year, subject to the income limitations in
paragraph 62(1)(c));
 the total amount claimed may
not exceed the taxpayer's employment (or business) income for the year at the
new work location; and
 • all related reimbursements and
allowances received by the taxpayer must be included in computing the
taxpayer's income (para 62(1)(d)).

• Individual moving within Canada to take up a new job;

• Or to study full-time for post-secondary education
• Can deduct eligible moving expenses incurred to move from
former residence;
• He/she must move at least 40Km closer to the new place of
work or study.
• Eligible moving expenses: moving expenses eligible for
deduction under subsection 62(1) include those described in subsection 62(3) as
follows:

travel costs for the taxpayer and members of the taxpayer's household (para
62(3)(a));

cost of moving (storing) household effects (para 62(3)(b));

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cost of meals and lodging near either residence, for up to 15 days, for the
family members (no S.67.1 limitation); (62(3)(c))

cost of cancelling the lease, if any, for the old residence (para 62(3)(d));

selling costs relevant to the old residence (para 62(3)(e);

if the old residence is sold, legal expenses in respect of the purchase of the
new residence, and taxes, fees or duties imposed on the transfer or registration
of title to the new residence (other than any GST or VAT) (para 62(3)(f));

interest, property taxes, insurance premiums and the cost of heating and
utilities, to a maximum of $5,000, for the old residence left vacant and not
rented out to any other person and incurred for a period during which
reasonable efforts are made to sell the old residence (para 62(3)(g));

the cost of revising legal documents to reflect the taxpayer's new address,
replacing drivers' licenses and non-commercial vehicle permits, and obtaining
utility connections and disconnections (para 62(3)(h)).

• Ss 62(3) state that moving expenses do not include costs (other than those
referred to in paragraph 62(3)(f)) incurred by the taxpayer in respect of the
acquisition of the new residence. Thus, for example, house-hunting expenses
would not be deductible as moving expenses.

• Also taxable: 50% of amounts received by an employee in excess of $15,000

for a loss on a sale or reduction in value of a former house or for higher mortgage
interest payments at the new location.

 Child care expenses

 Section 63 is intended to provide a measure of tax relief to taxpayers who, in order to

pursue a gainful occupation away from the home or undertake education or retraining,
must pay someone to look after their children while they are at work or school.

 Lower income spouse may claim the deduction with some exceptions;

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 Attendant care expenses

 Section 64 provides tax relief for an individual with a severe and prolonged mental or
physical impairment who must pay an attendant for care in order to be able to perform
the duties of an office or employment, carry on a business, or carry on research or
similar work for which a grant was received.

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Computation of Taxable Income and

Taxes Payable for Individuals
DIVISION C - TAXABLE INCOME

Net Income for Tax Purposes (Division B)

Minus: Division C deductions

Individuals Corporations
Employee stock option Donations
Home relocation loan Loss carry-over
Loss carry-over Dividends
Capital gain deduction
Northern allowance

= Taxable Income (if any)

DIVISION C DEDUCTIONS

Type of Apply against Carry over

Deduction type of income Back Forward

Dividends Any type 0 0

Donations Any type 0 5
Net Capital Losses Taxable capital gains 3 Indefinitely
Non Capital Losses Any type 3 7 (10 years for t/y
ending after March 22, 2004
20 years after
2005)
Restricted Farm Losses Farm income 3 10 / 20
Farm Losses Any type 3 10 / 20

Application of Division C Deductions

Consider: 1. Type of income the deduction can be applied against.

2. Number of years available in the carry-over period.

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3. The likelihood that the type of income needed will arise in

the carry-over period.
Generally apply most restrictive loss first.
NON-CAPITAL LOSSES

3(d) losses from an office, employment, business or property plus ABIL

Add: Net capital losses claimed under Division C

Add: Dividends deducted under Division C
Deduct: 3(c) income

Equals: Non-capital loss for the year

NET CAPITAL LOSSES

Allowable capital loss for the year

Less: Taxable capital gain for the year

Equals: Net capital loss for the year

Note: Net capital losses are stated using the inclusion rate
In the year they were incurred

Up to 1987: 50%
1988 & 1989: 66 2/3 %
1990 to Feb. 27, 2000: 75%
Feb. 28,2000 to October 17, 2000: 66 2/3%
October 18, 2000 and later: 50%

Adjust to today’s inclusion rate.

CAPITAL GAIN DEDUCTION - TERMINOLOGY

100 % 50%
Capital gain Taxable capital gain

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Capital loss Allowable capital loss

CG Exemption CG Deduction
Total $750,000 $375,000

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CAPITAL GAINS DEDUCTION OF $375,000 (50% x $750,000)

Qualified Farm Property (QFP)

 Gains on sale of QFP are eligible for the $750,000 C/G Exemption;

 QFP includes real property used by the taxpayer or members of the taxpayer's family in
the course of carrying on the business of farming in Canada.

 QFP also includes shares of a family farm corporation and interests in family farm
partnerships or trusts, and eligible capital property such as farm quotas.

 Property acquired after June 17, 1987 must have been owned throughout the 24 months
preceding its disposition and the gross revenue from the farming business must, in at
least 2 years during the period of ownership, have exceeded the individual's income
from all other sources.

 Where the farm is owned by a corporation or partnership, the gross revenue test is
inapplicable. However, the shareholder or partner must have been actively engaged in
the farming business on a regular and continuous basis during the 24-month period.

 Farm property acquired before June 18,1987 is exempt from the gross revenue test and
will qualify if it is used to "carry on the business of farming" in the year of disposition or
for at least 5 years during the period of ownership.

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Qualified Small Business Corporation Shares (QSBC shares)

 A capital gain realized on the disposition of QSBC shares may be eligible for the
$750,000 Capital Gains Exemption ($375,000 CGD) if certain conditions are met.

 Single corporation

1º Test: Small Business Corporation test (SBC) at the determination time (i.e. sale
or disposition)

 The shares must be shares of a SBC i.e. shares of a corporation which is a CCPC where
all or substantially all (90%) of the FMV of the assets are at that time:

a) used principally (>50%) in an active business carried on primarily (>50%) in Canada

by the corporation or a related corporation;
b) shares of the capital stock or indebtedness of one or more SBCs that were connected
with the particular corporation;
c) a combination of assets described in a) and b).

2º Test: Holding Period Test

 • Throughout the 24 months preceding the disposition, the shares must not be owned
by anyone other than the individual, or a person or partnership related to the individual.

3º Test: Basic Asset Test (50% test)

 Throughout the required 24-month period preceding the disposition, the shares were
shares of a CCPC for which more than 50% of the FMV of its assets were used
principally (50%) in an active business carried on primarily in Canada by the
corporation or related corporation.

EXAMPLE: basic asset test

A B C D
Active Business Assets (FMV) 85 50 51 40

Marketable Securities (FMV) 15 50 49 10

Shares of a connected SBC – – – 50

QSBC shares??? Y N Y ??

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 Two levels of corporations: HOLDCO and OPCO

 The 3º test (basic asset test) is modified whenever shares of OPCO are held through a
holding company (HOLDCO) that qualifies as SBC.

 If HOLDCO (corporation to be sold) can meet the 50% basic active business asset test
with its own active business assets, its shares will meet the asset test.

 Where the active business assets of HOLDCO are 50% or less, then the parent
corporation may still qualify by including shares and indebtedness of corporations
connected with it (i.e. of OPCO)

 If the particular corporation (HOLDCO) does not meet the 50% active asset test without
including shares or indebtedness of connected corporations, these connected
corporations are required to meet additional tests.

 Additional tests: 2 situations

1º If Holdco meets the 90% test throughout the 24 months ending at the determination
time with a combination of its own active business assets and shares and debts of a
connected corporation,

⇒ the connected corporation (OPCO) need only meet the 50% test on its assets.

⇒ the test is a 90%/50% for HOLDCO / OPCO

2º If the HOLDCO does not meet the 90% test for any period of time in the 24 months
ending at the determination time,

⇒ HOLDCO must meet the 50% test with a combination of its own active business
assets and shares and debts of a connected corporation,

⇒ the connected corporation (OPCO) must meet the 90% test.

⇒ the test is a 50%/90% for HOLDCO/OPCO.

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SUMMARY:

Mrs. A CASE #1 CASE #2

Holdco must meet: Holdco must meet:

• 90% test or more on the
Holdco disposition and
• 90% test throughout the 24-
month period
Opco must meet:
• more than 50% throughout
Opco the 24-month period and
• 90% test on the disposition
• more than 50% throughout
the 24-month period and
• 90% test on the disposition
Opco must meet:
• 90% test or more on the
disposition and
• 90% test throughout the 24-
month period

 Purification

 Assume Mr. X owns all the shares of OPCO. The following has been the situation for
OPCO for the last 24 months:

FMV of investment assets = 99 (49.5%)

FMV of active assets = 101 (50.5%)
Total FMV = $200

o Mr. X wants to sell his shares of OPCO.

o Does the shares qualify as QSBC shares? ⇒No, since at the determination time,
the corporation must meet the 90% test (i.e. must be SBC).

 Purification technique

⇒Use investment/liquid assets to repay liabilities;

⇒Pay a dividend to Mr. X;
⇒Pay a bonus, and/or retiring allowance to Mr. X;
⇒ Pay a dividend from CDA;
⇒ Reduce PUC and make payment to Mr. X;
⇒ Redemption of shares ⇒ deemed dividends

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Cumulative net investment losses (CNIL)

 A CNIL is defined as:

a. the total of the individual's investment expense for the year or a preceding taxation
year ending after 1987

less

b. the total of the individual's investment income for the year or a preceding taxation
ending after 1987.

 Investment income and investment expense: see B & L page 772-773.

 A CNIL will in fact reduce the availability of the C/G deduction; therefore planning
should be undertaken to minimize the CNIL.

CAPITAL GAINS DEFERRAL

 Section 44.1 provides rollover relief on a disposition of common shares of certain

small business corporations, to the extent that the proceeds are reinvested in shares of
another such corporation or corporations.

 Only capital gains realized by individuals are eligible for rollover relief.

 To improve access to capital for small businesses with high growth potential, section
44.1 permits individuals to defer limited amounts of capital gains on eligible small
business investments to the extent that the proceeds are reinvested in another eligible
small business investment.

 The rollover is available on the first $2,000,000 invested in an eligible small business,
which can have no more than $50 million immediately after the investment. The
investment must be in newly issued treasury shares.

 The eligible business is required to be primarily carried on in Canada for 24 months

while the investor holds the shares

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ALTERNATIVE MINIMUM TAX (AMT)

• Compare minimum tax with regular tax

• Pay higher of the two taxes

• If minimum tax is higher, then can recover over the next seven years

• 15% x (Adjusted taxable income - $40,000 basic exemption)

minus: non-refundable minimum tax credit

= Minimum tax

Adjusted Taxable Income

 When AMT is calculated, net income and taxable income is revised to exclude certain
tax preference items (you add these items back) to the extent they exceed a base
amount of $40,000.

 The entire revised taxable income is then subject to a federal tax rate of 15%.

 There is no dividend tax credit as there is no dividend gross-up.

 If revised federal tax is greater than the normal federal tax, the former applies.

 Some of the preference items which affect net income:

CONSIDER 100% of the dividend instead of 125% or 145%

CONSIDER 80% of the excess capital gains over capital losses for the year
instead of 50%

CONSIDER 80% of ABIL instead of 50%

NOT losses from CCA or carrying charges on residential

ALLOWED properties or Canadian films; losses on resource properties from
CEE, CDE

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 Some of the preference items which impact taxable income:

CONSIDER 2/5 of the employee stock options deductions (i.e. 2/5 x 50% = 20%,
net=80%, just like the capital gain inclusion)

ADD home relocation loan deduction

CONSIDER a basic exemption of $40,000

 The resulting adjusted taxable income is then multiplied by 16%.

 Only the following basic tax credits are allowed to the individual:

1. Personal and dependants

2. Age credit
3. Charitable tax credit
4. Medical expense credit
5. Mental and physical impairment credit
6. Tuition credit, and education credit
7. Employment insurance and CPP (QPP) tax credits

 Credits not allowed for AMT purposes:

• Pension income credit

• Credits transferred from spouse
• Disability credit transferred from dependant
• Tuition fees and education credit transferred from dependant

 AMT does not apply unless the federal tax calculation is greater than the normal
federal tax;

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MISCELLANEOUS CONCEPTS
DISPOSAL OF PROPERTY TO A MINOR

Transferor Transferee minor

PROCEEDS COST
Gift 69(1) =FMV =FMV

Sale 69(1) =Greater of: =Lesser of:

• Proceeds • Proceeds
• FMV • FMV
Income Attribution:

Non-arm’s length Business Property Capital

or niece or nephew Income Income/loss Gain/Loss

< 18 years N/A 74.1(2) N/A

> 17 years N/A N/A N/A

DISPOSAL OF PROPERTY TO A SPOUSE*

Transferor Transferee
PROCEEDS COST
Gift 73(1) =Transferor’s =Transferor’s
Automatic rollover ACB/UCC ACB/UCC

Elect out =FMV =FMV

Of 73(1)

Sale 73(1) =Transferor’s =Transferor’s

Automatic rollover ACB/UCC ACB/UCC

Elect out =Greater of: =Lesser of:

Of 73(1) • Proceeds • Proceeds
• FMV • FMV

* includes common law spouse as defined in 252(4).

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ATTRIBUTION OF INCOME ON TRANSFER BETWEEN SPOUSES

Business Property Capital

Income Income Gain/Loss

On loans or transfers N/A 74.1(1) 74.2

+ substituted property (not second
generation
income)

Exception 74.5(1)

(a) received FMV consideration

(b) if debt received:

• interest rate at least equal to prescribed or

commercial rate
• interest is paid not later than 30 days after the end
of the year
and

(c) elect out of 73(1) rollover

LOANS - SPOUSE

• attribution of: income/loss from property

capital gains/losses

• but not if interest rate is at least equal to prescribed or

commercial rate and the interest is paid not later than 30 days after the end of
the year.

LOANS – MINOR

Minor < 18 (non-arm’s length or niece or nephew)

• attribution of income from property but not capital gains

• but not if interest rate is at least equal to prescribed or commercial rate
and the interest is paid not later than 30 days after the end of the year.

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Individual > 17 (non-arm’s length)

• attribution of income from property if one of the main purposes of the

loan is to split income
• but not if interest rate is at least equal to prescribed or commercial rate
and the interest is paid not later than 30 days after the end of the year.

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DEATH OF A TAXPAYER

• Income tax on accrued income & gains to date of death

• Deemed Disposition 70(5)

 Capital property at FMV

 Depreciable property at FMV

• Rollover to Spouse or Spousal Trust 70(6)

 Automatic rollover at ACB or UCC

 Can elect out of rollover in which case proceeds equal to FMV 70(6.2)

SEPARATE TAX RETURNS

1. Final Return 150(1)

• Income accrued to date of death 70(1), IT-210R

• Gains on deemed dispositions
• Personal credits

 Capital losses

 Ss 111(2) modifies the calculation of the individual’s taxable income for the
year of death and the immediately preceding year for purposes of applying net
capital losses.

 All unused net capital losses (net of amount of net capital losses used to offset
current year’s taxable capital gains) arising in years up to and including the year
of death may be used to the extent needed to offset any taxable income for the
year of death and the immediately preceding year.

 Donations

 The legal representative of the deceased may claim the tax credit for charitable
donations up to 100% of net income of the deceased.

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2. Rights & Things (Income from) 70(2)

• Definition: amounts which are receivable at the date of death but have not been
received. examples:
 Matured, uncashed coupons;
 Declared but unpaid dividends;
Unpaid salary, commissions if pertaining to pay periods completed before date of
death.

• Personal credits can be claimed

3. Alternative method return

Where the business of the deceased taxpayer has an off-calendar fiscal period,
(i.e. the alternative method was used) and the death occurred in the year after
the fiscal year of the business;

The income from the end of the fiscal period to date of death can be reported
on a separate return, if the legal representatives so elect.

 Personal tax credits can be claimed

4. Trust/Estate Return 104(23)(d)

• Must file return and include income earned since date of death;
• Testamentary trusts are taxed at gradual rates;
• Fiscal period ends within 12 months from death;
• Tax and tax return due 90 days after year end.

Personal Credits under S 118, except pension credit, can be claimed on all returns
except on the Trust return;

 Pension credit must be claimed on return on which the related income is reported;

 Personal credits:

• Basic personal credit •Age credit

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• Infirm dependant credit

•Married or equivalent to married

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