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Introduction ................................................................................................................................................... 1
    Underlying Concepts ......................................................................................................................................................... 1
       Purpose ........................................................................................................................................................................... 1
       History ............................................................................................................................................................................ 2
       How proportional is Canadian Tax? ............................................................................................................................... 3
    Competing Ideologies ........................................................................................................................................................ 3
       Liberalism ....................................................................................................................................................................... 3
       Benefit Principle ............................................................................................................................................................. 4
       Marxist ............................................................................................................................................................................ 4
       Critical Tax Theory......................................................................................................................................................... 4
    Underlying Policy .............................................................................................................................................................. 4
       Equity.............................................................................................................................................................................. 4
       Simplicity........................................................................................................................................................................ 5
       Neutrality ........................................................................................................................................................................ 6
    Tax Expenditures............................................................................................................................................................... 7
    Tax Expenditure Analysis ................................................................................................................................................. 7
       Difficulties with TE Analysis ........................................................................................................................................... 8
    Tax Base Rationales: ......................................................................................................................................................... 8
       Inheritance, Bequeath or Inver-Vivos Gift: .................................................................................................................... 9
       Capital Gains .................................................................................................................................................................. 9
       Employment Income v. Investment Income ................................................................................................................... 9
    Deductions and Credits. .................................................................................................................................................... 9
       Refundable Credits ....................................................................................................................................................... 10
       Policy with Deductions and Credits .............................................................................................................................. 10
       Basic Personal Credits .................................................................................................................................................. 10
          S 118(1)(a): Spousal Deduction ............................................................................................................................... 10
          S 118(1)(c): Basic Personal Credit .......................................................................................................................... 11
    Infrastructure of the ITA ................................................................................................................................................ 11
       Constitutional Basis ...................................................................................................................................................... 11
       Tax Collection agreements: .......................................................................................................................................... 11
    Ontario Income Tax Act ................................................................................................................................................. 12
    Division of Labour in Tax ............................................................................................................................................... 12
       Disagreement with a Notice of Assessment: ................................................................................................................. 13
       Calculation of Taxes ..................................................................................................................................................... 13
       Deadlines ...................................................................................................................................................................... 13
       Payments of Taxes ........................................................................................................................................................ 13

Tax Unit ........................................................................................................................................................ 14
       Person ........................................................................................................................................................................... 14
       Justification for tax system based on the individual as the primary tax unit ................................................................. 14
       Implications .................................................................................................................................................................. 15
    Income Splitting ............................................................................................................................................................... 15
       Debate ........................................................................................................................................................................... 15
       Implementing Income Splitting .................................................................................................................................... 16
    Attribution Rules ............................................................................................................................................................. 16
          S 74.1(1) & (2): Income Attribution: for income, k gain or loss .............................................................................. 16
       Applicable Transferees ................................................................................................................................................. 18
       Consider When Does Attribution Stop?........................................................................................................................ 18
       Exceptions to Attribution .............................................................................................................................................. 18
          S 74.5(1): FMV Transfers ........................................................................................................................................ 18
          S 74.5(2): Loans for Value ....................................................................................................................................... 19
          S 74.5(3)(a): Spouses or Common-Law Partners Living Apart ............................................................................... 19
          S 74.5(12): Retirement Contributions ...................................................................................................................... 19
          S 74.5(13) & 120.4: Kiddie Tax ............................................................................................................................... 19
       Definitions .................................................................................................................................................................... 19
          S 251(1): Arm’s Length ............................................................................................................................................ 19
          251(2): Related Persons........................................................................................................................................... 20
          251(6): Blood relationship ....................................................................................................................................... 20

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    Residence of Tax Unit...................................................................................................................................................... 20
      Policy for using ―Residence‖ ........................................................................................................................................ 21
      Determining Residency - Individuals ........................................................................................................................... 21
         S 250: Deemed Residency ........................................................................................................................................ 22
         S 114: Part time residence ....................................................................................................................................... 23
         Thomson v. MNR (1946) .......................................................................................................................................... 23
         Nicholson v. The Queen (2003) ................................................................................................................................ 23
         Gaudreau v. The Queen (2005) ................................................................................................................................ 24
      Giving up Residence ..................................................................................................................................................... 24
         Canada-United States Tax Convention [2511] ........................................................................................................ 24
      Determining Residency – Corporations ........................................................................................................................ 25
         DeBeers Consolidated Mines Limited v. Howe (1906) ............................................................................................ 25
    Aboriginal Taxation ........................................................................................................................................................ 25
         Nowegijick v. The Queen (1983) .............................................................................................................................. 26
         Williams v. The Queen (1992) .................................................................................................................................. 26
         Schilling v. the Queen (2001) ................................................................................................................................... 26

Tax Base ....................................................................................................................................................... 28
       Defining Tax Base ........................................................................................................................................................ 28
    Inclusions .......................................................................................................................................................................... 28
          S 3: Determination of Income and Capital Gains .................................................................................................... 28
       Income .......................................................................................................................................................................... 28
          Schwartz v. the Queen (1996) .................................................................................................................................. 29
       Problems with the Source Concept of Income .............................................................................................................. 30
       Alternative Approaches to the Source Concept of Income ........................................................................................... 31
       Capital gains ................................................................................................................................................................. 31
       Capital Losses ............................................................................................................................................................... 32
       Allowable Business Investment Loss (s39(i)(c)) .......................................................................................................... 32
       Exceptions..................................................................................................................................................................... 32
       Net Capital Loss ........................................................................................................................................................... 32
    Exemptions ....................................................................................................................................................................... 33
    Division B: Computation of Income ............................................................................................................................... 33

Accounting Period ....................................................................................................................................... 36
    Taxation Year .................................................................................................................................................................. 36
         S 249(1): Definition of Taxation Year ...................................................................................................................... 36
    Timing Rules: ................................................................................................................................................................... 36
      Business vs. Employment Timing Rules ...................................................................................................................... 36
      Modify Accounting Period ........................................................................................................................................... 37

Rate Structure ............................................................................................................................................. 37
      Tax types ....................................................................................................................................................................... 37
    Federal Structure ............................................................................................................................................................. 37
      Federal Rates ................................................................................................................................................................ 37
         Guillemette v. R ........................................................................................................................................................ 37
      Federal Credits .............................................................................................................................................................. 37
    Provincial Structure – Ontario ....................................................................................................................................... 38
      Provincial Rates ............................................................................................................................................................ 38
      Provincial Credits ......................................................................................................................................................... 38
      Example ........................................................................................................................................................................ 38
    Corporate Tax Rates ....................................................................................................................................................... 39

Statutory Interpretation ............................................................................................................................. 40
    Tax Avoidance ................................................................................................................................................................. 40
       Tax Avoidance .............................................................................................................................................................. 40
       Tax Evasion .................................................................................................................................................................. 40
    Interpretive Considerations ............................................................................................................................................ 41
       Applying Interpretive Considerations ........................................................................................................................... 42
    Interpretive Doctrines ..................................................................................................................................................... 42
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        Strict Construction ........................................................................................................................................................ 43
           MNR v. MacInnes (1954) ......................................................................................................................................... 43
        Modern Approach ......................................................................................................................................................... 43
           Dominion Bridge ...................................................................................................................................................... 44
           Furniss v. Dawason (One of the Trilogy of UK Cases) ............................................................................................ 44
           Stubart v. The Queen ................................................................................................................................................ 44

Anti-Avoidance Rules.................................................................................................................................. 46
    Judicial Anti-Avoidance Rules ....................................................................................................................................... 46
      Sham Doctrine and General Approach ......................................................................................................................... 46
         Commissioners of Ireland Revenue v. Duke of Westminster .................................................................................... 46
      Ineffective Transaction Doctrine .................................................................................................................................. 47
         Atinco Paper Products Limited v. The Queen .......................................................................................................... 47
      Business Purpose Test .................................................................................................................................................. 48
         Gregory v. Helvering, Commissioner of Internal Revenue (1935)........................................................................... 48
         Stubart v. The Queen ................................................................................................................................................ 48
    Legislative Anti-Avoidance ............................................................................................................................................. 50
      GAAR ........................................................................................................................................................................... 50
         S. 245: GAAR ........................................................................................................................................................... 51
      Steps to applying GAAR: ............................................................................................................................................. 52
         Jabs Construction v. The Queen .............................................................................................................................. 52
         McNichol v. The Queen ............................................................................................................................................ 53
         Canada Trustco Mortgage Co. (2005 SCC)............................................................................................................. 54
         Mathew (2005 SCC) ................................................................................................................................................. 55

Professional Responsibility: ........................................................................................................................ 55
             McDonnell, “Professional Responsibility and Tax Practice” ................................................................................. 55
             McQuaig, “Behind Closed Doors: How the Rich won control of Canada’s Tax System” ...................................... 56
             Wilkins ..................................................................................................................................................................... 56

Employment Income ................................................................................................................................... 57
          S 248(1): Defining Employment ............................................................................................................................... 57
    Characterization: Employment v. Self Employment .................................................................................................... 58
       Factors in Distinguishing .............................................................................................................................................. 58
          Wiebe Door Services Ltd. v. MNR (1986): leading case .......................................................................................... 59
          Wolf (FCA 2002) ...................................................................................................................................................... 60
    Inclusions .......................................................................................................................................................................... 60
       Basic Inclusions ............................................................................................................................................................ 60
          S 5(1): Basic Inclusions in Income ........................................................................................................................... 60
       Specific Inclusions - Benefits ....................................................................................................................................... 61
          S 6(1): Specific Inclusions in Income ....................................................................................................................... 61
       Characterization as a benefit ......................................................................................................................................... 63
          Lowe v. The Queen (1996): travelling expenses ...................................................................................................... 63
          O’Brien .................................................................................................................................................................... 64
          Detchon .................................................................................................................................................................... 64
          Guay ......................................................................................................................................................................... 65
          Gernhart................................................................................................................................................................... 65
          McGoldrick: meals ................................................................................................................................................... 65
          Huffman: uniform clothing ....................................................................................................................................... 65
          Deitch: professional liability insurance paid by employer ...................................................................................... 66
          Faubert: Skills Training ........................................................................................................................................... 66
    Housing Relocation .......................................................................................................................................................... 66
       CRA Exclusion of Non-taxable Privileges ................................................................................................................... 67
       Valuation ...................................................................................................................................................................... 67
    Stock Options ................................................................................................................................................................... 68
          S 7: Taxation of Stock Options ................................................................................................................................. 69
          Taylor v. MNR .......................................................................................................................................................... 70
       Timing Exceptions ........................................................................................................................................................ 70
       Stock Option Deductions .............................................................................................................................................. 71
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Deductions from Employment Income ...................................................................................................... 72
         S 8(1): Employment Deductions............................................................................................................................... 73
   Section 8(1)(i) Deductions ............................................................................................................................................... 74
     Deductibility of Supplies .............................................................................................................................................. 74
         Martyn (1964) .......................................................................................................................................................... 74
         Fardeau (2002) ........................................................................................................................................................ 74
         Glenn ........................................................................................................................................................................ 75
         Strauss, “Teachers Getting More than an Apple” ................................................................................................... 75
     Deductibility of Office Rent ......................................................................................................................................... 76
         Prewer (1989) .......................................................................................................................................................... 76
         S 8(13): Work Space in the home ............................................................................................................................. 77
   Timing Issues ................................................................................................................................................................... 77

Income from a Business or a Property ...................................................................................................... 78
   Characterizations: ........................................................................................................................................................... 79
      Business or Property ..................................................................................................................................................... 79
      Capital Gains or Business Income. ............................................................................................................................... 79
         Taylor v. MNR (1956) .............................................................................................................................................. 80
         Regal Heights Case .................................................................................................................................................. 81
   Reasonable Expectation of Profit ................................................................................................................................... 82
         Stewart v. Canada (2002) ........................................................................................................................................ 82
      Proposed REOP Amendment ........................................................................................................................................ 84
   Inclusions in Business Income ........................................................................................................................................ 84
      General.......................................................................................................................................................................... 84
         S 9: General Inclusions for Business and Property Income..................................................................................... 84
      Interest .......................................................................................................................................................................... 85
      Payments of Interest and Capital Combined ................................................................................................................. 85
         Groulx (1967)........................................................................................................................................................... 86
         Vanwest Logging ...................................................................................................................................................... 86
      Dividends ...................................................................................................................................................................... 87

Deductions from Business or Property Income ........................................................................................ 88
   Fines and Penalties .......................................................................................................................................................... 89
         Imperial Oil .............................................................................................................................................................. 89
         65302 British Columbia Limited .............................................................................................................................. 89
         S 67.6: Amendment to Catch Fines .......................................................................................................................... 91
   Business v. Personal Expenses ........................................................................................................................................ 91
      Entertainment Expenses ................................................................................................................................................ 91
         Royal Trust (1957) ................................................................................................................................................... 91
         18(1)(l):Social club memberships ............................................................................................................................ 93
         67.1: Meals and Entertainment Deductions ............................................................................................................. 94
      Child Care Expenses ..................................................................................................................................................... 94
         Symes (1986) ............................................................................................................................................................ 95
         S 63(3): Deductibility of Child Care Expenses ........................................................................................................ 97
   Interest .............................................................................................................................................................................. 98
         S 20(1)(c): Deductibility of Interest ......................................................................................................................... 98
         Sinha ........................................................................................................................................................................ 99
      Meaning of Income Earning Use – Direct v. Indirect ................................................................................................... 99
         Trans Prairie Pipelines (1970): ............................................................................................................................. 100
         Sternthal (1974) ..................................................................................................................................................... 100
         Zwaig (1974) .......................................................................................................................................................... 100
         Bronfman Trust v. The Queen (1987)..................................................................................................................... 101
      New round of interest deductibility cases ................................................................................................................... 102
         Tenant (1996) ......................................................................................................................................................... 102
         Robitille (1997) (Post-Bronfman) .......................................................................................................................... 102
         Singleton (2002 SCC)............................................................................................................................................. 103
         Ludco (2002) SCC.................................................................................................................................................. 103
         Lipson..................................................................................................................................................................... 104
         Leslie ...................................................................................................................................................................... 104
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    Capital Expenses ............................................................................................................................................................ 104
      Characterization: Capital or Current Expense............................................................................................................. 105
         Johns-Manville Inc. v. The Queen (1985) .............................................................................................................. 105
      Repairs for a capital asset v. Replacement/Renovation .............................................................................................. 106
      Capital Cost Allowances ............................................................................................................................................. 107
         S 21(1)(a): Capital Cost Allowance ....................................................................................................................... 107
      Calculation .................................................................................................................................................................. 109
      Half-Year Rule............................................................................................................................................................ 111
      Terminal Loss ............................................................................................................................................................. 111
      Recapture .................................................................................................................................................................... 111
      Allocation of Purchase Price ....................................................................................................................................... 113
         Golden (1983) ........................................................................................................................................................ 113
      Steps in Applying CCA .............................................................................................................................................. 113

Capital Gains ............................................................................................................................................. 113
          S 39: Capital Gains ................................................................................................................................................ 113
    Election for Canadian Securities .................................................................................................................................. 115
    Characterization ............................................................................................................................................................ 116
          Regal Heights (1960) ............................................................................................................................................. 116
          Manrell (2003) ....................................................................................................................................................... 117
          S 56.4: Non-Compete Payments are Taxable ......................................................................................................... 118
    Computation of Capital Gains ...................................................................................................................................... 118
       Valuation .................................................................................................................................................................... 118
       Dispositions ................................................................................................................................................................ 119
       Reserves ...................................................................................................................................................................... 119
       Deemed Disposition .................................................................................................................................................... 120
          S 70(5): Deemed Disposition on Death.................................................................................................................. 120
          S 69(1): Deemed Dispositions for Non-Arm’s Length Transactions ...................................................................... 120
       Rollover ...................................................................................................................................................................... 121
          S 70(6): Rollover to a Spouse on Death ................................................................................................................. 121
          S 73(1): Inter Vivos Transfers by Individuals ........................................................................................................ 122
       Capital Gains Attribution ............................................................................................................................................ 122
          S 74.2(1): Capital Gains Attribution ...................................................................................................................... 123
    Capital Gains Exemption for small Business Corporation Shares ............................................................................ 123

Adjustments to Find Taxable Income ...................................................................................................... 123
    Other Income and Deductions ...................................................................................................................................... 123
       Subdivision d of Division B of Part I: miscellaneous sources of income ................................................................... 123
    Income to Taxable Income: Div C ................................................................................................................................ 123
    Taxable Income to Tax Payable ................................................................................................................................... 124




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Introduction
Underlying Concepts
Purpose
  Taxes raise money so government can function. It is a contribution to government revenue
   compulsorily levied on individuals, property or businesses that can serve multiple policy
   objectives. Private markets will not automatically ensure the most efficient allocation of economic
   resources, so government plays an important role in addressing market failures.
  Government serves 3 purposes:
       o Allocation: acts to ensure an efficient and socially desirable level of investment in
           various economic and social activities that are not adequately addressed by the
           market alone.
             o Address market failures (free riders and external costs): Certain goods or services
                 (defence, R&D) provide benefits that cannot be easily restricted to those willing to
                 pay for the relevant good or service, private markets will undersupply the good
                 since free riders can benefit from the provision without contributing to its cost;
                 where a production of a good or service has a negative effect on third parties
                 (pollution) private markets will oversupply the good or service to the extent that
                 these external costs are not taken into account by the parties to the transaction.
             o Public sector can eliminate free-rider problems by providing goods and services
                 itself or subsidizing their provision by third parties and allocating the associated
                 costs through compulsory taxes.
             o Other market failures (pollution) can be dealt with by public regulation or corrective
                 taxes.
       o Distribution: acts to achieve a fair distribution of resources among individuals in a
           market economy.
                  Corrects the fact that market distribution depends to some extent on prior
                     endowments (avoids systemic disadvantages for these individuals)
                  Government's role in redistributing market returns is subject to political
                     judgments about what is fair
                  important role to play in moderating the distributive outcomes of the market
                     economy by redistributing economic resources from those favored by the
                     market economy to those who are less advantaged.
       o Stabilization: government is needed to monitor and moderate economic cycles,
           adjusting aggregate supply and demand to ensure relatively stable prices and incomes
           (Keynesian Fiscal Policy) (in other words, to forestall dramatic shifts from boom to bust
           in the economy); attempt for relative price stability, full employment, and economic
           growth; transfer and direct spending program. Taxes are also used as a direct form of
           implementing these programs.
                 o A progressive tax system has a stabilizing effect on the economy; restraining
                     expansions by moving taxpayers into higher tax brackets, and restraining
                     contractions by moving taxpayers into lower tax brackets. By the same token,
                     income tax revenues are subject to more severe fluctuations than revenues from
                     other taxes.
  How does the tax system fulfill these three functions?
  Indirect Role: Plays an indirect role in that it provides revenues to finance various forms of
    government action designed to advance these goals. Example - Government may impose a
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      regulatory scheme on particular industries, provide transfer payments to individuals, invest in
      public services such as health care and education, or provide subsidies to private firms to help
      them invest in new technologies
   Direct Role: plays a direct role in each of these functions, as one of the instruments through
      which government influences economic and social decision making
   The public finance objectives of allocation, distribution and stabilization are sometimes offered
      to explain certain aspects of tax system design
   E.g. Allocation – lower tax rates for manufacturing firms or small business corporations, or tax
      concessions for firms that purchase environmentally safe equipment - All attempt to increase
      overall level of investment in certain sectors or activities deemed desirable
   E.g. Distribution – progressive tax rates and heavier tax burden on those who are more fortunate;
      typically understood as a means of redistributing income to reduce inequalities produced by
      markets
   E.g. Stabilization – also progressive tax rates; a less well known justification for progressive
      rates, but widely accepted by public finance economists that progressive rates act as an
      "automatic stabilizer" for the economy (as incomes rise the tax rate increases, putting a
      damper on further price inflation by removing discretionary income from consumers' pockets;
      when incomes drop the tax rate automatically declines, leaving proportionately more after tax
      money in consumers' pockets to support aggregate levels of demand.
As an instrument for redistributing economic resources, personal income taxes are much more
effective than other forms of taxation such as sales and excise taxes, which impose a higher
proportionate burden on those with lower incomes for whom a larger percentage of income is
devoted to consumption, and cannot readily account for differences in each taxpayer‟s personal
circumstances.
   Through this lens, the design of the tax system at any one moment in history can be seen as a
      reflection of the current balance of class interests, or the current state of the tension
      between accumulation and legitimation

History
  Enacted in 1917 to help finance WWI
        o Income tax was a very small share of tax revenue
        o Originally enacted more to quell political protests about inequality in the tax burden
                  Sales Taxes were the main source of taxation and tended to fall
                     disproportionately on those with lower incomes.
  Since the beginning equity has been at the heart of the ITA
        o Underlying beliefs:
                  Market success depends on original endowments which depend on, to a great
                     extent, luck.
                  Market success is not simply a function of one‘s own merits but also benefits
                     from society (others helping you along the way).
        o So it has always been a progressive tax system
  As the need for revenue grew (Depression, WWII, the emergence of the Welfare State) so too did
   the ITA
        o Broader definition of the Tax Base
  1970‘s - tax became the largest source of Government revenue.
        o Remains the largest source of Government revenue.
  Current:
        o It is a tool of economic and social policy as well as a revenue raising tool.
        o ITA is progressive.
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How proportional is Canadian Tax?
  there are three basic types of rate structures: progressive: the rate of tax increases as income rises;
   proportional: the rate of tax is constant for all income levels (a ―flat tax‖); regressive: the rate of
   tax decreases as income rises. Fed personal income tax = progressive rate structure since its
   inception in 1917, though the degree of progressivity has varied significantly over time.
       o Personal Income tax is progressive
       o Retail taxes are very regressive
       o Corporate taxes are proportional (flat rate).
       o Progressive for federal taxes, less so for provincial and regressive for municipal.
       o Lower levels of government base their tax revenue less on IT and more on other taxes like
           property taxes which are regressive.
  Overall: It is progressive but it is nearly proportional.

Competing Ideologies
  Opinions about tax policy are grounded in fundamental beliefs about how our society is or should
   be ordered:
       o Ideas about the proper role of the state in the lives of citizens
       o Prioritization of basic values such as liberty and equality
       o Belief in markets as an efficient and morally acceptable mechanism for ordering our
           economic affairs.

Liberalism
  Louis Eisenstein, ―The Ideologies of Taxation‖
       o Taxes are ―coerced contributions to our general welfare‖ and ―a constitutional means of
           appropriating private property without just compensation.‖
  Defining feature of liberal democratic societies is the boundaries they construct between ―public‖
   and ―private‖ spheres
  Liberalism is highly protective of a private sphere
       o High value on the liberty of individuals to live according to their own economic and
           domestic choices, and to enjoy exclusive ownership of private property
  But recognizes that some kind of collective decision making body is needed to maintain the
   order that allows individuals to enjoy their liberty.
       o Rule of law: individual freedoms may need to be subordinated to collective needs, but
           only through the application of clear laws.
  Liberalism Debate:
       o Classical or Laissez Faire Liberal: seeks a minimalist state and tax system.
                   Emphasize the importance of negative liberty, or freedom from state
                     intervention.
                   Tend to prefer formal equality, in which everyone would be subject to
                     identical treatment by the state regardless of circumstances.
                          Progressive taxation is inequitable because they have justly earned it.
       o Social Democratic or Egalitarian Liberal: favours a more robust state that takes certain
           actions to promote the positive liberty of citizens.
                  o i.e. expanding the range of choices realistically available to individuals by
                     providing a minimum level of support in terms of food, shelter, education
                   Would define equality less in terms of identical treatment and more in terms of
                     in terms of equal opportunity or substantive equality.


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                    Individuals starting from different positions may need to be treated differently,
                     in order for equality to be achieved.
         o idea of redistributive taxation is generally more appealing to a social democratic liberal
           than to a classical liberal, as is the idea of using the tax system to encourage or assist
           particular groups or economic activities

Benefit Principle
  Tax payers should pay according to how much they benefit from the system
        o Based heavily on user fees
  Difficulty: Tracing services to individuals. Direct users may not be the only ones that benefit
   from the system. Considerable Free Rider Problems.

Marxist
  Neo-Marxist: The liberal state performs two principle (and conflicting) functions:
        o i) Accumulation: to facilitate the accumulation of capital by the small minority who own
           substantial private property, and
        o ii) Legitimation: to reduce the social conflict that arises from the vast economic
           inequalities entailed by capitalism.
                   This might require measures to reduce inequality to avoid political crisis and
                      maintain some degree of social cohesion.
  Taxes achieve both.
        o So we may find in the ITA both provisions that reinforce the unequal distribution of
           resources, and provisions that alleviate it.
  the design of the tax system at any one moment in history can be seen as a reflection of the current
   balance of class interests, or the current state of the tension between accumulation and
   legitimation


Critical Tax Theory
  It is not enough to look at the distributive effects of tax law among abstract income groups or
   classes
  these scholars scrutinize the tax system‘s intended and unintended effects on a diverse array of
   less privileged social groups
        o ITA is laced with provisions that reinforce (or sometimes redress) inequalities rooted in
            gender, race, culture, physical ability, and sexual identity, for example.
  Example, Gender: women are generally in the lower tax brackets than men.
        o So lower taxes for lower tax brackets mean lower taxes for women.

Underlying Policy
Equity
  Equity (or fairness) requires a fair sharing of the tax burden based on the ability to pay.
   This calls for graduated rates that rise as income rises. This is a progressive system.
  Vertical: people in different circumstances should pay appropriately different amounts.
  Horizontal: people in similar circumstances should pay the same amount of tax.
  Considerations:



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         o These sound very a-political BUT what counts in determining people‘s circumstances
            (ability to pay) can be a highly political decision. What do we take account of in
            determining ability to pay
                   Big city living vs. small town living
                   Medical expenses
                   Students
                   What is in the tax base?
         o Issue: what factors are relevant in determining if people are in the same or different
            circumstances - do we look just at their dollar incomes? Does it matter how they earned
            their incomes (for example through labour or investment)? The number of dependents
            they are supporting? Whether they have access to income of a spouse or other supporting
            person? Their age? The cost of living in their city or region?
         o What is an ―appropriately different amount‖
                   Progressive: rate of tax increases as income rises
                   Proportional: rate of tax is constant for all income (a ―flat tax‖)
                          Federal Corporate IT 29% on all income.
                          Alberta IT taxes are 10% on all income.
                                Though it is still somewhat regressive because of the high bpc.
                   Regressive: rate of tax decreases as income rises
                          Sales taxes have a regressive incidence.
                          Bermuda Corporate Taxes
 Importance of Tax Base: the incidence of the tax burden (its progressivity or otherwise) depends
   not only on the rate structure but also on how the tax base is defined (what is included in or
   excluded from income, what deductions are available to taxpayers in different income groups)
 Carter Commission criterion principles for ability to pay required:
          • That tax be levied at progressive rates
          • That tax be levied on a comprehensive tax base as opposed to the relatively narrow
              concept of income
          • That tax be levied on families as opposed to individuals
          • That tax concessions to particular industries or activities be avoided
          • That corporate and personal income tax on corporate profits be integrated to avoid
              double taxation.
 Equity (or fairness) should be the major subsidiary objective of the income tax system
   (Carter Commission)
 Not everyone would even agree that vertical equity is achieved by the "ability to pay"
   principle
Some would argue a "benefit principle" is more equitable, in which individuals pay tax on the basis of
how much benefit they derive from government services (such a system would favour user fees, for
example)

Simplicity
  Compliance by taxpayers and administration by government are both easier and less costly in a system that
    is simple and understandable.
  It is important that people know what to pay (keep compliance costs low).
  to facilitate compliance, make laws more certain and transparent, and facilitate collection
  If a tax is difficult to administer or if compliance burdens are excessive, no matter how perfect it
   may appear in theory or design, the tax will fail to serve its intended function as a reliable source
   of revenue

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  This policy objective often requires some sacrifice of equity and neutrality concerns.
       o Administrative: to actually collect
       o Predictability: to allow planning of finances.
                 Encouraging investment and economic growth.
                 Reduced simplicity means that some people are better able (those with
                    more resources, accountant, different types of assets to apply deductions
                    too) to avoid taxes.
       o Rule of Law: makes it more acceptable because people are able to access the law and
          question their leaders on it.

Neutrality
  Neutrality, also known as “efficiency”, requires a tax system that does not affect people‟s
   behaviour. Business or personal opportunities, rather than tax planning, should drive
   business or personal decisions
  tax laws ideally should have the minimum possible effect on people‘s economic and personal
   choices
  Individuals should not be encouraged to choose one form of economic activity over another, or
   one domestic arrangement over another, for tax reasons rather than based on what is the best
   investment or what are their own true preferences ("market distortion")
        o But sometimes market distortions are required because of market failures.
                   Free-riders: everyone gets the benefit of certain good (i.e. defence) but not
                      everyone would necessarily pay for it.
                   External Costs: all of the costs are not included in the price (i.e. gas and
                      pollution) the costs need to be
        o Sometimes market distortions are favourable to acquire certain objectives.
                   Incentives for giving to charity
                   Incentives to buy fuel efficient cars.
        o The market requires the government to run!
                   Is government action a distortion or simply the foundation of the market?
                   Market is not a natural being. It requires law and structure to exist.
  Issues: the neutrality criterion assumes a strong faith in the efficiency and morality of market
   forces; what is a ―market distortion‖ to one person may be from another perspective simply a
   needed action by government to correct a market failure, or to rectify an unfair or socially
   undesirable inequality in market outcomes ; impossible to define normal market behaviour in a tax
   free world; the market is not a naturally occurring system upon which taxes and government are
   superimposed, - rather the market as we know it is created through laws of contract and property,
   as well as other regulatory schemes, all maintained by governments. If there were no taxes, there
   would be no revenue to fund a legal system that enforces property and contract rights, and no
   market as we know it; changing tax rules may well change behaviour, but cannot be said to
   distort “true” market behaviour
  In a system focused on the ability to pay, the provisions that violate neutrality, such as tax
   concessions, tend also to violate equity by abandoning the criterion of ability to pay in favour of
   other policy objectives; tax concessions cause differences in the liability to pay that are unrelated
   to the differences in the ability to pay.
  Government continues to use the tax system to pursue various social and economic policies, often
   using deductions from income or credits against tax as the means of providing the desired
   incentive.
  The Act may also indirectly create changes, such as individuals trying to claim income as business
   income so as to benefit from the greater amount of deductions.
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Summary
   These three criteria of equity, neutrality and simplicity are often in tension with each other
   In designing a particular provision, for example, the need for equity among different cases may
    require more complexity and a compromise to neutrality; or certain inequities between
    individual cases may be tolerated in order to create a more simple or neutral system


Tax Expenditures
Tax Expenditure Analysis
       first developed in 1960‘s by Stanley Surrey
       Surrey argued that the traditional criteria of equity, neutrality and simplicity were inadequate
        because the modern tax system is used not just as a revenue raising instrument, but increasingly
        as a means of delivering government spending programs
Each tax concession, whether in the form of a deduction or a credit or a rate-reduction or an omission from
income, has a cost to government, namely, the amount of revenue foregone by the concession.
     Its effect on government revenue is the same as if the government writes a cheque to the taxpayer
        (hence the term ―tax expenditure‖)
     the distributive effects of tax expenditures depend on how they are delivered, whether as deductions,
        credits, or so-called ―refundable credits‖; the ―upside down subsidy‖ problem that is created when tax
        expenditures are delivered in the form of deductions
     they are really indirect spending programs, so it is not sufficient to evaluate tax expenditures in
        terms of the traditional tax policy criteria; instead they should be evaluated on the same basis as
        direct spending programs, that is whether they achieve their policy objectives in a cost efficient
        and fair manner
     Surrey defined a tax expenditure as a deviation from the normal or benchmark income tax system
the benchmark system is defined by four basic elements:
                               what counts as income for the purpose of determining a taxpayer‘s ability to
                                  pay?
                               what is the accounting period for determining income?
                               what is the tax unit?
                               what is the rate structure?
                      once these four basic elements have been defined, any special concessions or tax breaks
                         that deviate from the benchmark system for particular taxpayers or activities are treated
                         as tax expenditures
     Reasons why they should be justified and evaluated as direct spending programs:
              problem that tax delivered subsidies are not as visible or transparent as a direct spending
                 program;
              they tend to be concealed from most members of the public within the technical details of
                 income tax law
              they are administered by finance and revenue authorities as part of the overall tax system,
                 instead of by a spending ministry with specialized responsibility for programs in a certain area;
              because of their relative lack of visibility, it may be tempting for governments to use tax
                 expenditures when they wish to get around their own promises of spending restraint to benefit
                 favoured groups;
              because they are often not designed or evaluated as carefully as direct spending programs, tax
                 expenditures may have inequitable or inefficient effects that go undetected;
                      RPP and RSP: people in lower income groups get very little benefit from the program.
                         People with the highest income get the most benefit. Seems a strange way to structure a
                         program meant to help people retire.
                      Child Care and Tuition: those with smaller incomes do not get most of the benefit from
                         the program.
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                       Refundable tax credit: Highly biased towards the lower income earners. Refundable
                        credit targets low income tax payers much better than deductions – which tend to be
                        biased to high income earners.
             once embedded in the tax code they can be difficult to remove due to the lack of systematic
                review or auditing of policy effectiveness;
             they also have no budgetary cap so their cost is open ended and depends on how many
                taxpayers claim the concession, which is difficult to estimate in advance - can have unpredicted
                expenses – R&D credit. No way to tell in advance how many people will utilize the tax
                expenditure. There is little ability to contain costs once the Tax Expenditures are enacted.
             erosion of public confidence in the fairness of the income tax when it is known that so many
                groups are allowed concessions
           Solution: Surrey recommended that governments should go through a budgeting exercise for tax
            expenditures similar to that for direct expenditures.
            o Identify all the tax expenditures in the system and for each one determine:
                o Policy effectiveness: does the measure have clear policy objectives, and are they being
                    achieved? could they be achieved better through a direct spending program?
                o Cost: how much government revenue is foregone as a result of the measure?
                o Distributive impact: who receives the benefits?

       Note: in 1979 the Canadian Department of Finance began publishing tax expenditure accounts which
        attempt to estimate the cost of a wide range of tax concessions; now discussed albeit in fairly superficial
        terms the policy objectives of these provisions; with rare exceptions there is no public evaluation of the
        performance of tax expenditures in achieving their objectives, and no analysis of how the benefits are
        distributed

Difficulties with TE Analysis
       Difficult to define the benchmark - Not all deductions or credits are TE; some are needed to
        measure the ability to pay accurately or the accounting definition of income i.e. business expenses
        (person gets 60,000 sales revenue, but spends 45G to acquire inventory and rent commercial space;
        inappropriate to tax them on full 60G as this does not accurately reflect their ability to pay; but if we
        then tax 15G profit at a special low rate because we wanted to encourage business in a new industry,
        then this is a tax expenditure)
     Difficult to identify them and distinguishing from deductions, credits or other provisions which really
        are preference to a particular kind of income from those which are necessary in order to define income
Note difference: H earned wages of $40,000 from employment; I received $40,000 of interest on savings and
investments; J realized a $40,000 capital gain (a profit on the sale of property); K received a cash inheritance of
$40,000 in 2002  yet they would not all pay the same amount of tax
     Measuring the cost – do it by looking at tax returns, recalculate returns without the reductions – doesn‘t
        look at changes in behaviours as a result of changes in law i.e. if no RRSP deductions may have saved
        less and sought ought other ways to protect their income from tax.
     Tax penalties, which seek to discourage an activity by taxing it more heavily, are departures from the
        benchmark tax structure and should be treated as negative tax expenditures.
     Difficult to estimate the amount of revenue foregone by the tax concessions, since people would alter
        their behaviour if the concessions were removed.
     Analysis assumes a benchmark tax structure that is equitable, neutral, and comprehensive, and
        which contains no tax preferences




Tax Base Rationales:
   ITA tax base is composed only of sources of income: some exceptions (Capital Gains) are
    explicitly included.

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  Canada used to tax wealth (Estate Tax: Tax on the increase in the Estate year over year). This is
   still done in European countries.

Inheritance, Bequeath or Inver-Vivos Gift:
  Inheritance, bequeath or inter-vivos gift: not a source of income for tax purposes. It is a
   transfer of an accumulated stock of wealth.
  Carter commission: should tax inheritance. This is an increase in economic capacity.
       o This was a very unpopular recommendation and was not included.

Capital Gains
  Capital Gains are not income from a source, they are income from the disposal of a source.
  Carter Commission: recommended Capital Gains should be fully included in the tax base. It is
   an increase in economic capacity.
        o This too was very unpopular.
  Compromise: ½ of Capital gains are included in the tax base.
        o The Estate Tax was repealed at the same time.
        o Inflationary affects: this is part of the reason for only ½ of the capital gain in included.
  Capital Gains are very disproportionately received by high income peoples.
        o Note: the progressivity of the ITA depends as much on how the base is defined as it
           does on the rates.
                  Partially exempting Capital gains makes the income tax system less progressive.

Employment Income v. Investment Income
  Debate: should employment income be taxed at a lower rate than investment income?
       o Employees need to save for contingencies – reduces their economic capacity.
       o Tax payers with investment income have already saved to account for contingencies.
  Partially Accounted For:
       o Employees can deduct from their income amount put into registered pension or savings
           plans.
       o Interest earners cannot do this.

Deductions and Credits.
  Deductions: removed from income before applying the marginal rates.
       o So the tax savings of the deduction are the amount of the deduction times the highest
           marginal rate.
                  Upside Down Subsidy: the deduction benefits the wealthy more than the poor
                    in a progressive tax system.
       o deduction reduces income subject to tax
  Credits: removed from the actual tax payable by the tax payer (IE after applying the rates)
       o The Tax savings are the full amount of the credit.
       o credits reduce tax payable directly
       o These are beneficial to lower income earners only if the taxpayer has tax payable that
           the credit can be applied against.
                  Most credits are not refundable – these benefit everyone equally.
                  a credit is a dollar for dollar reduction of the tax burden.
  Therefore, Gross Income - Deductions = Net Income X Apply Rates = Basic Tax payable -
   Credits = Tax liability
        o   Example - Deduction: $1000 Gross income X   rate = 50% = 500 tax liability

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         o   $100 deduction = 1000-100 = 900 then apply to tax rate X 50% = $450 of tax (since deduction is
             before the rate is applied). Value of deduction = 50 (which is the deduction x tax rate)
         o   Example - Credit: $100 credit - 1000 x 50% = 500 – 100 credit = 400 tax, therefore value = $100

Refundable Credits
  if these credits gives you a negative tax payable, they are refunded.
  4 Refundable credits:
        o Child Tax credit
        o GST credit (addresses the regressive effects of the GST)
        o Refundable medical expense credit
        o Child disability credit
  Problem: refundable credits require an active roll in the person getting the refund.

Policy with Deductions and Credits
    Deductions: goal of accurately measuring income; deduction for costs that must be incurred by a TP in
     order to obtain income of different kinds is necessary on grounds of equity and efficiency, since tax on
     gross receipts rather than net gains would exaggerate the economic resources available to those who must
     incur larger costs in order to obtain these receipts and discourage these activities by lowering their after-
     tax rate of return more than the reduction of lower cost enterprises
                o deduction for losses incurred in pursuit of income earning activity justified in order not to
                     discourage these risky enterprises
                o encourage specific activities—saving for retirement, contributions to charity
                o But, widely criticized as an inequitable way to encourage specific kinds of behaviour on
                     grounds that they benefit high income taxpayers subject to higher rates than low-income
                     taxpayers subject to lower marginal rates.  ie: controversy around child-care deductions—
                     inequitable b/c upside down subsidy. Justify on equity and efficiency grounds b/c it‘s a legit
                     cost of earning income and necessary to eliminate disincentive to participate in paid labour
                     force by "secondary earners" (i.e. women) resulting from non-taxation of self-performed
                     child care
                o govt has responded by converting many of these deductions into non-refundable credits -
                     disguised way of moving marginal rate upward?
    Exemptions: reduce amount of TP's taxable income, but are excluded at the outset from tax
        used to obtain accurate measurement of income
        same equity concerns as deductions—upside down subsidies
    Credits: non refundable credits share a basic defect in failing to provide any assistance to person whose
     incomes are too low to pay any tax at all—so want refundable credits
                o non-refundable credits in Division E are an inappropriate hybrid b/c they neither achieve the
                     goals of a deduction in providing an accurate measurement of each TP's ability to pay, nor
                     an equitable method of encouraging specific activities or subsidizing particular individuals
                o to the extent that these credits are intended to encourage qualifying activities or subsidize
                     eligible TPs, refundability is a more equitable way to provide this assistance

Basic Personal Credits
S 118(1)(a): Spousal Deduction
  Allows a credit for the spouse of a taxpayer equal to:
       o $7,505 + $6,055 – (C - $606)
       o C is the greater of $606 or the spouse‘s income for the year.
       o Where all numbers are indexed for CPI – See Table xxviii
       o for Ontario it is 7113 – tax rate applicable to credits is 6.05%


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        o note: can also claim this for TP who are singled, divorced or separated, but support
          a dependant in their home – can claim the wholly dependent person credit

S 118(1)(c): Basic Personal Credit
  Allows a deduction of $8839 x 15.25% = 1348 deduction, so then minus this from the amount
   of tax payable after you have applied the rates to net income
        o this is increased by up to 7505 for those supporting a cohabiting spouse or related
           dependant who earns no more than 629$.
        o Additional credit available for each disabled dependant over 17 and for TPs who share
           accommodation with aged or disabled relatives over 17
  in Ontario it is 8377 – tax rate applicable to credits is 6.05%


Infrastructure of the ITA
Constitutional Basis
  Feds and provinces have overlapping powers of taxation.
  Feds: 91(3)
       o To raise money by any mode or system (very broad)
  Provinces: 92(2)
       o Direct taxation within the province for provincial purposes.
                  Direct: a tax imposed on the very person intended to pay it. This has been
                    interpreted very broadly by the courts.
                         Indirect tax: a customs duty or tariff (these are expected to be passed on
                            to the end user at a higher price).
                         Direct tax: an income tax or sales tax.
  Discussion:
       o At confederation Indirect taxes were dominant. Direct taxes were highly unpopular and
           considered political suicide.
       o Because of the increased demands on the provinces for services (education and health
           care) the courts have construed indirect taxation very broadly to try to meet those
           needs.

Tax Collection agreements:
  Taxes are imposed by all level of government.
       o Multiple taxation can impose burdens of compliance on individuals and without co-
           ordination between the governments there is the possibility of:
                  Over-taxation
                  Competing objectives that may cancel out both policy objectives
  Tax Agreement:
       o The feds collect income tax for the provinces and reimburse the taxes to the province
           (done for free or with small admin fee).
                  All provinces except Quebec have such deals.
       o In return the provinces agree to adopt the federal definition of Taxable Income – giving
           the country a common tax base (except Quebec).
       o Provinces sacrifice a major policy tool BUT avoid complexity, tax competition, and huge
           expense on the collection of taxes.
                  Quebec system tracks the Federal system closely but does have some differences
                    that mark Quebec‘s policies.
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  2000, Tax Collection Agreements Edited
       o Provinces given much more flexibility.
                Now able to set differing percentages of tax for different incomes and provide
                   varying credits.
                Used to have to collect only a percentage of the federal rate.
       o Provinces are tied to the Federal Tax Base but set their own:
                Rate Structure (Table xix)
                Tax Credits (xxii)
       o This means a higher compliance cost for tax payers
       o But more social policy powers for the provinces.

Ontario Income Tax Act
  S. 1(1): Tax base is the same as in the Federal Income Tax Act.
  S. 2: everyone who lives in Ontario or makes income in Ontario are subject to the Ontario ITA.
  S 4(2): Before 2000 very simple to calculate Ontario tax: multiply the federal tax payable by the
   applicable provincial percentage. (R x T)
  S 4(3): After 2000 calculate provincial tax payable with reference to the brackets in Table xix
   separate of the federal tax payable.
        o As well, Ontario has a surtax.

Division of Labour in Tax
  Minister of Finance:
      o Designs the tax system and develops tax policy. Sets the ITA.
      o Amendments:
                 Generally done as a part of the budget.
                 Some done in Technical Bills
                        Amendments not tied to the budget.
                        Generally technical in nature (Changes to the rules about taxing estates
                           or credits on them).
                 Press Release
                        Done to close major loopholes quickly.
                        When the bill is passed it will be effective as of the press release –
                           passed in either a budget or a Technical Bill.
      o The development of the budget is very secretive.
                 As the ITA has become a greater source of government spending (through tax
                   expenditures) the secrecy of the budget has come under increased criticism.
  Canada Revenue Agency (CRA)
      o Applies the system that the Ministry of Finance works out.
                 Assists tax payers in complying with the ITA
                 Process tax returns
                 Create tax forms
                 Detect tax evasion
                 Provide Technical Documentation on how the CRA will apply provisions or
                   sets of provisions.
                        Administrative Bulletins: These Bulletins are not law! They are not
                           legally binding on a court or the CRA.
                               They may find it useful to inform their decision but it will not bind
                                   them.

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                           Advance Income Tax Ruling (ATR): lawyers lay out the facts of
                            something that is proposed to happen in the future – it must be a
                            transaction that is actually going to happen.
                                The CRA considers themselves bound by these.
                                These are very expensive.
                                These are published but are only binding on the CRA for the
                                    transaction for which they are created.

Disagreement with a Notice of Assessment:
  Try to find an administrative solution before filing a formal objection.
  If that fails then you need to file a Notice of Objection. (S 165)
        o Need to file within 1 year. (S 165)
  Your file is re-assessed by CRA by a different group of auditors.
        o Vacate: no money owed.
        o Vary
        o Uphold: same amount is owed.
        o If you receive no response after 90 days you can have the claim vacated (S 169).
  If the claim is upheld and you decide to appeal then you go to the federal tax court (S 169) and
   they can make the same orders as the CRA (S 171).

Calculation of Taxes
  S 151: All tax payers file a self estimation of their tax payable.
  S 152: CRA checks the self estimates.
       o Look at some returns in great detail.
       o Loot at most returns in a very cursory manner.
  S 152(2): Government sends a notice of assessment if they change your estimate.

Deadlines
  S 156(4): Taxpayers have to pay by their balance due date the amount by which tax payable
   exceeds your source deductions, installments, and deductions.
       o Tax payable – ( deductions + Source deductions + Installments)
  S 248 “balance due date”: Definition of balance due April 30.
  S 161(1): If after the balance due day the tax payer owes money on Taxes then that money is
   subject to interest.
       o Regulation 4301: Sets the interest rate to be paid.
                  Rate of interest is tied to a market rate of interest plus 4% on any amount that
                     the taxpayer owes to the government.
  S 164(3): If the Taxpayer has not been given their refund within 30 days of their balance due
   date then you are to receive interest on that amount at the market rate plus 2% - See Reg. 4301.
  S 165: Need to file a notice of objection within 1 year.

Payments of Taxes
  Source Deductions:
       o Employees have taxes deducted from their income in advance of the Balance Due date.
  Installments:
       o People with income that is not source deducted (business income, investment income) pay
           installments on their expected tax payable.
       o Installments are based on your income from the previous 2 years.
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   Balance Due Day:
        o April 30 following the year in question.
        o Need to pay all your taxes by that date. (S 156(4))

Tax Unit
S 2(1): Charging provision - Definition of Tax Unit
Every person Resident in Canada at any time in the year shall pay income taxes.

Person
   All individuals and corporations.
         o S 248(1) “Person”: every individual and corporation
         o S 248 (1) “Individual”: person other than a corporation
   Person does not include Trusts or Partnerships.
   This is an individual tax system based on individual ability to pay
   Alternative: Family Unit
         o Carter Commission: should adopt a family unit.
         o US uses the family unit.

Justification for tax system based on the individual as the primary tax unit
   Person Tax System is based on the Control Principle: tax the economic power that they derive
    from their entitlement to and effective personal and legal control over income.
         o Favored Unit in developed world.
   Family Unit Tax System is based on the Benefit Principle: tax the economic benefits that people
    derive from income received by themselves or others, rather than legal entitlement to or effective
    control over the income. (Regards the family as the collective owners/shared beneficiaries of
    income received by individual members)
         o Arguments for familial unit: family is the basic consumption unit in society and the
             benefit of family income is usually shared. Thus, tax should be applied to the aggregate
             income of these units rather than the income of each individual. Where the tax is based on
             the benefits provided by the income, couples should be taxed more heavily than 2 single
             individuals with half the combined income of the couple – equal income couples and
             families should bear equal tax burdens.
         o Arguments for the Individual: This system cannot be applied fairly and efficiently
             because of diversity in economic and familial groupings (same sex, other familial units) –
             this system assumes that all families share income in the same way.
         o Violates Neutrality: as it encourages or discourages the existence of the relevant unit;
             discourages participation in the paid labor force by secondary earners by stacking their
             income on top of that already received by the primary earner.
               o Most feminists are opposed to the Family Unit Tax System for these reasons.
                   (Dulude, Lahey)
   Canadian System: we have a modified Control Principle system. We recognize the dangers of
    looking at the Individual Unit alone and so we take family relationships and dependency of
    family members into account. We do this by adding ―relieving provisions.‖
         o Canadian Relieving Provisions:
                    Credit for supporting a common-law partner. (S 118(1)(a))
                    Medical Expenses for spouse or dependent. (S 118.2)
                    Credit for supporting an adult child with a disability (118.3)

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                    s. 118.8: transfer of unused tax credits (age, pension, disability, tuition,
                     education tax credits to spouse) and s. 118.9 (transfer of tuition and education
                     credits to a parent or grandparent)
                  Caregiver credit (tax payer who lives with an elderly or infirm adult relative –
                     low Threshold to find a person is a relative).
                  RESPs (Registered Education Savings Plan): tax credit for saving money for a
                     family member below the age of 20. Possible to make RRSP contribution on
                     behalf of spouse in S. 147
                  Spousal Rollover: Spouses can transfer property without triggering capital
                     gains. Deferring otherwise applicable taxes on transfers of property between
                     spouses and on transfers of farm property from parent to child (inter vivos and
                     testamentary transfers; s. 73(1) and 70(6)). Exempt from recognition of capital
                     gains and recapture of capital cost allowance dispositions of property between
                     spouses and some dispositions between parents and children.
         o These are a recognition of legal/ethical support expenses.
         o Also, certain refundable credits are a direct recognition of the Family Unit: Refundable
           credits – GST: s. 122.5, Child Tax credit: s. 122.6-122.64, medical expense supplement:
           s. 122.51 – are available to target groups -- means or income tested credits. When taxing
           income, combine the income of both spouses, income added to determine if either is able
           to have the refundable credit – child, $32,000 or under it can get full credit but based on
           joint spousal income

Implications
  Different individuals face different tax burdens: Since progressive rates apply to the separate
   incomes of individual taxpayers rather than the combined income of the family, couples or
   families with the same total income can face different tax burdens depending on the share of this
   aggregate amount received by each individual in a progressive system. Result: aggregate tax on
   families in which each member receives a share of the total income is less than the tax on couples
   or families in which the same aggregate income is received by a single member  IE family with
   aggregate income of 140G received by 1 member, will pay over 5,900 more in basic federal tax
   than a family in which this aggregate income is shared between 2 members of the family.
  Strong incentive for taxpayers to split their incomes with an otherwise low-income spouse or
   child, given the effect of progressive rates and the individual tax unit
        o Hence the myriad of anti-avoidance and anti-attribution rules in the act.
  Splitting income reduces tax payable:
        o Family A: two individuals earning $30 K, pay considerably less than Family B: one
            individual earning $60 K and the other $0.
        o Justification: Imputed Income
                   Tax difference is in part explained by the imputed income for the otherwise
                      untaxed services provided by the stay at home family member in Family B –
                      more leisure time. Though the taxation is unrelated to the amount or even the
                      provision of these services.
        o The ITA does take account of some of this difference through credits.

Income Splitting
Debate
  Why prevent Income Splitting?


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       o It hurts the progressive nature of the tax system to the near exclusive benefit of high
          income families.
       o It erodes the tax base.
       o The income does not actually change control.
                 No change in de facto control (as this remains with the transferor of the income
                    or property) only de juri control.
                 It is really about achieving a tax break
  Why allow Income splitting?
       o Preventing it disrespects the integrity of the Spouse who is not an income earner.
                 Should not assume that they do not have de facto control.
       o encourages sharing of income between the spouses; promotes equitable distribution of
          wealth between the spouses
       o Income splitting encourages transfers of property to women and recognizes the autonomy
          of women for tax purposes.
       o It is a form of private compensation for care giving work.
                 It would be better to just give tax breaks to the unpaid caregivers.
                 Or better to support women in getting into the labour market.
  Strong consensus that income splitting with minors is inappropriate.

Implementing Income Splitting
  Hire family members and pay them salary if you run a business
       o This would be a deduction and it is not subject to Attribution.
       o But it is subject to the “reasonableness” rule.
  You can transfer income earning property to the family members
       o A share or bond that generates a stream of income
       o A piece of real property that pays rental income.
       o A gift or loan of $ that can be used to be invested.
       o But these Property transfers are caught by the attribution rules
  “Income splitting” in a dual income earning household with a modest salary.
       o The lower income earner invests all of his salary. That way all the investment money
           becomes the lower income earners‘.
       o The higher income should be used to pay for house hold expenses and should not be
           invested.
  Dividend Sprinkling
       o Dividends paid from a corporation‘s shares, that are bought for FMV, are not subject to
           Attribution (Neuman) – as the dividends are paid by the corporation. Spouse incorporates
           his business and pays dividends to lower income earner.

Attribution Rules
S 74.1(1) & (2): Income Attribution: for income, k gain or loss
  Under 74.1(1) and (2) Designed to prevent income splitting by attributing any income or loss
   from property that is transferred or loaned to a spouse or CL partner or related minor to
   have been received by the taxpayer and not be the other person to whom the property is
   actually transferred.
  Under ss. 74.2 where a person has transferred (or loaned) property to or for the benefit of his or
   her spouse (or common law partner), any capital gain from the disposition of the property by
   the transferee is attributed to the transferor

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 Income, loss or k gain earned from transferred property by the transferee is attributed back to
  the transferor.
       o ITA does not undo the gift it just forces the transferor to report the earnings of the
           transferred property.
       o ONLY APPLIES TO INCOME FROM PROPERTY WHICH IS PASSIVELY
           RECEIVED
                           Where the transferee takes the loan and uses it to start her own business
                             and makes a profit from carrying out the business as a sole proprietor -
                             Business profit can only be generated (it is assumed) with some effort or
                             labour on the part of the business owner, so it is considered to be
                             genuinely earned by Tina and properly taxed in her hands.
 Also, 248(5) “Substituted Property”: property purchased with the assets from the disposition of
  the transferred property.
         o If the recipient sells the property and reinvests the proceeds of sale, the attribution rules
             continue to cling to the new investments
         o Income from the new investments (or capital gains from the disposition) will be
             attributed in the same way as if the investments were the original subjects of the transfer
             or loan.
          If money is transferred and they purchase income earning property with the money, that
             income is also attributed.
          Ex: A sells rental property to brother B; B sells the rental property and uses the 1mil in
             proceeds to purchase shares of a corporation – received dividends on the shares totaling
             40G in 2005 and 50G in 2006 (he would be 18 in 2006): 40G will be attributed to A as
             income from ―property substituted‖ for the rental property that she originally transferred
             to him. Though this is an increase in the amount of rental property, any increase in the
             property‘s value or in its income earning capacity is treated as part of the original
             property transferred. However 50G will be taxed to J – as he will turn 18 before the end
             of 2006. This is if they are dividends from shares of a public corporation – if they
             are shares of a private corp, kiddie tax prevention kicks in and the amount of the
             dividends above would not be attributed, but taxed in the hands of the minor at
             top marginal rate of 29%
 Property purchased with the income from the substituted property is not attributed back to
  the original transferor. ( where it is income on income - “Second Generation Income”)
     o However, if the recipient of property to which the attribution rules apply invests the income
         yielded by the transferred property, the income yielded by the investments representing the
         income is not attributed.
     o Ex: A transfers a condo that earns rental income to B. B invests rental income in bonds.
         Attribution applies to the rental income but Attribution does not apply to the bond income.
     o Ex: A gave rental property to her brother B, B then uses the 20G‘s income from the rent to
         purchase an investment certificate that bears interest at a rate of 4% per annum. CRA's
         administrative practice is not to attribute the interest to Anna on the basis that ―income on
         income‖ is not attributable within the wording of 74.1. While the $20,000 of annual net
         rents would continue to be attributed to Anna in 2004, therefore, the additional 4% interest
         derived from reinvesting last year's rent would not.


 S 74.5(6): Back to Back Loans
      o Any transfers to a 3rd party through an intermediary are deemed to have been transferred
          directly to the 3rd party.

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        o Any consideration received shall be deemed to have been received directly by the
          individual and not through the intermediary.
        o The attribution rules therefore also apply to indirect transfers through a trust or
          corporation. Here, it is the intervention of a third party individual that masks the transfer
          of the property to a spouse, common-law partner, or related minor. 74.5 (6) treats the
          transaction as if the property had been given directly.

Applicable Transferees
  S 74.1(1): A person who is or becomes the spouse or common-law partner of the transferor
  S 74.1(2): Related Minors (under the age of 18) and:
        o Does not deal at arm‟s length with the transferor, or
        o If the nephew or niece of the transferor. (who are normally not caught by ―Arm‘s
           Length‖ provision)
  S 248(1) “Common Law Partner”: co-habitation in a conjugal relationship, and:
        o Has co-habited with the taxpayer for a continuous period of at least 1 year.
        o Would be the parent of a child of whom the taxpayer is a parent. (Does not have the 1
           year time limitation for a couple raising their child.)
  Common law relationship ends when the couple has stopped living together for 90 days due to
   the break down of the relationship.

Consider When Does Attribution Stop?
  If the Transferor stops being a resident of Canada
  If the Transferee is no longer a spouse or common law partner
  The death of either transferor or transferee
  If (for a minor) the Transferee stops being a minor.
        o It stops for the ENTIRE YEAR in which the minor stops being a minor.
  Otherwise is continues forever.

Exceptions to Attribution
  consider CRA Policy (Not Case Law): only passive property income is attributed.
        o Something involving a combination of labour and property is considered active income
            and is not attributed. IE Money is lent to start a business, does not create attribution on
            that business income.
  Following exceptions ensure that artificial sale for inadequate consideration or for consideration
   in the form of an interest-free debt cannot be used as a device to divert property income from the
   vendor to the purchaser who is a spouse, common-law partner, or related minor.

S 74.5(1): FMV Transfers
  Where the property was transferred for FMV.
  Where there is a sale of property however at FMV, then attribution rules do not apply as the
   transferor has simply substituted another potentially income-producing asset for the one
   transferred; there is no income splitting
        o If indebtedness was included in the FMV of the transfer then the debt was charged
            interest as described in 74.5(2) – at a rate equal to or greater than the lesser of – (A)
            prescribed rate (commercial rate, see Reg 4301(c)) that was in effect at the time. or (B) a
            rate that would have been agreed on by parties dealing with each other at arm‘s length
        o amount of interest is to be paid no later than 30 days after the end of the year.


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S 74.5(2): Loans for Value
  Property purchased with a loan is not attributed if that loan charges interest greater than or
   equal to the lesser of:
       o The prescribed rate in Reg. 4301
       o The rate that would have been agreed upon by arm‘s length parties.
  And the interest was paid within 30 days of the end of the year.

S 74.5(3)(a): Spouses or Common-Law Partners Living Apart
  Attribution does not apply when they are living apart due to a break up of the relationship.
        o BUT only for the period they are living apart. If they resume living together, the
            attribution will be restarted.
        o Divorce: attribution of income ceases permanently, as they are no longer spouses.
        o CL partners (opposite or same sex) must be living separate and apart for a period of
            at least 90 days.

S 74.5(12): Retirement Contributions
  RRSP contributions for the spouse. The deduction is taken from the transferee‘s allowable
   deduction.
  Similar system for a pension plan contribution.

S 74.5(13) & 120.4: Kiddie Tax
  Attribution does not apply where the Kiddie Tax applies
  Kiddie Tax: a minor who receives passive income from dividends from private corporations is
   taxed at the top marginal rate (29%). (S 120.4)
        o imposes a special income-splitting tax on certain types of income received by individuals
            under the age of 18, such as dividends from private corporations as a proxy for the tax
            that the parents would have otherwise paid. Eliminates any advantages from these
            income-splitting techniques
  was introduced because of the ease with which tax planners were able to avoid the attribution
   rules following certain court decisions (especially Neuman v. The Queen, 1998 (SCC)). Very
   basically, a taxpayer could avoid attribution by having his or her spouse or children subscribe for
   shares in a private, family-owned corporation. The board of directors of the corporation (typically
   controlled by the taxpayer) could then declare dividends on the shares owned by spouse and
   children. In that case, the Court held that the dividends could not be attributed back to the
   taxpayer because the corporation was a separate legal person which made an independent decision
   to issue shares and pay dividends to the spouse and children. That is, the taxpayer personally
   could not be considered to have transferred or directed any amount to his spouse and children.
  Instead of amending the attribution rules to catch this form of planning, the government
   introduced s.120.4 which attempts to eliminate the benefits of splitting the dividend income, by
   taxing it at the highest marginal rate in the hands of minor children.
  Note: kiddie tax does not affect spouses, so that income splitting with spouses can be achieved by
   way of the "dividend sprinkling" arrangement approved by the Supreme Court in Neuman (IE:
   dividends paid by a corp are not subject to attribution if the shares of the corp are purchased at
   FMV)

Definitions
S 251(1): Arm’s Length

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  s. 251(1)(a) Related persons shall be deemed to not deal at arms length.
        o Narrow exception for trusts: (b) TP and a personal trust are deemed not to deal at arm‘s
            length if the TP is beneficially interested in the trust.
  If they are not found to be related, and deeming rule in s. 251(1)(a) does not apply, go to ss.
   (c) = In any other case it is a question of fact if they are dealing at arms length.
        o No rigid set criteria as to what would constitute de facto non-arms length dealing,
            but considerations according to the CRA:
                   Acting in concert, without separate and independent interests?
                   Is one person directing the bargaining for both parties to the transaction?
                   Did one person effectively control the other‘s decisions, through some
                       advantage, authority or influence over the other?
                   Arm‘s length - groups where the parties have independent interests and one
                       party is not controlled by the other.

251(2): Related Persons
  Individuals: Blood relationship, related by marriage or common-law partner or adoption.
  Corporations: related to
       o The person who controls the corporation – s. 251(2)(b)(i): Control means de jury
          control, meaning ownership o the shares that carry more than 50% of the votes to elect the
          corporations board of directors.
            o non-controlling shareholder deals with the corporation at arm‘s length, subject to
                a finding they are non-arm‘s length as a matter of fact.
       o Member of a related group that controls the corporation.
       o Or a related person to one of the above.
       o Note: An employment relationship does not by itself cause an individual to be related to a
          corporation. Even senior employees normally would be considered to deal at arm‘s
          length with their employer. This is of course subject to a finding of being non-arm‘s
          length in fact.

251(6): Blood relationship
  includes only „vertical‟ and „horizontal‟ blood relatives.
  Blood relationship if one is the child or other descendant or the Brother or Sister of the other.
       o Great Grand Parent, Grand Parent, Parent, Child, Child‘s Child
       o Brother or Sister.
       o This does not include Aunts, uncles, nieces or nephews – hence 74.1(2)
  Blood relationship if one is married to the other or the blood relations of the spouse.
       o Taxpayer‘s Sister‘s Husband/CLP is a blood relation, as well as:
                  Great Grand Parent, Grand Parent, Parent, Child, Child‘s Child
                  Brother or Sister
  Adoption: all the same people are related as to a natural child.
       o Great Grand Parent, Grand Parent, Parent, Child, Child‘s Child of the adopted child.
       o Brother or Sister of the adopted child.


Residence of Tax Unit
  Residence provides justification for taxation
  Section 2(1) Tax payable by persons resident in Canada provides that an income tax is payable
   on the taxable income of every person resident in Canada at any time of the year.

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  Residency is undefined in the ITA (avoiding ―bright line‖ tests prevents tax avoidance).
  Case law provides:
        o Residence requires a strong social and economic presence
        o But doesn‟t require that you remain in the country.
        o S 250 supplies specific incidents of residence.
  Residents are taxed on worldwide income.
        o Canadian residents are subject to tax on their worldwide income, though the Act permits a
           non-refundable credit for income taxes paid to foreign governments and income from
           foreign sources is exempt from Canadian income tax under bilateral tax treaties.
        o S. 126 – allows Canadian residents a credit against Canadian tax for tax paid to another
           country; double taxation addressed in tax treaties that Canada has entered into.
  Non-residents: For non-residents, not liable to pay Canadian income tax unless the person
   received certain kinds of income from Canadian sources. Only on income earned in Canada.
   Their tax is computed based on Division D. Taxation of Non-Residents applies to income from (S
   2(3)):
        o Employment in Canada
        o Running a business in Canada
        o Disposal of Taxable Canadian property.

Policy for using “Residence”
     The factor of residence produces the largest class of taxpayers with strong social and economic
      ties with the country; they are all people with moral obligation to finance the government; and
      they are all people against whom enforcement is practicable.

Determining Residency - Individuals
  Determining residency is a factual determination based on the taxpayer‘s ordinary mode of living.
  Courts have had a slightly more revenue friendly approach to residency than they have in other
   areas.
       o Normally a battle between the Individual and the state in Tax Law.
                  Courts are protective of the individual‘s rights.
       o But in residency it is really a battle between two states. So courts are more protective of
           the state‘s rights.
       o Though recent jurisprudence appears to be moving away from this and more
           towards protection of the individual.
  Guidelines:
       o Residency is primarily a question of Fact.
       o availability of a place where the taxpayer has the right to stay is usually the critical
           element in determining the country of residence, although the courts will look at other
           factors as well, such as frequency and duration of visits, and the presence of social and
           business connections.
       o Every person has residence somewhere.
                  Relative question: where are your ties closer?
       o A person can be resident in more than one country at any time.
       o Intentions are not determinative but are always dependent on surrounding facts.
                  Courts will look at the intentions, but self declared intentions will be looked at
                     critically.
                  “Residence is chiefly a matter of the degree to which a person in mind and fact
                     settles into or maintains or centralizes his ordinary mode of living with its

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                   accessories in social relationship, interests and conveniences at or in the place
                   in question” (Thomson v. MNR)
        o Residence generally involves either the taxpayer‟s physical presence, or ownership
          of a right to occupy a building in the jurisdiction. When not physically present,
          residence can turn on social and economic ties. Including:
                Most Significant Residential Ties:
                        Dwelling Place or Places
                        Spouse or common-law partner
                        Dependants
                Secondary Residential Ties:
                        Personal Property (furniture, clothes, automobiles)
                        Social Ties (Membership in clubs and religious orgs.)
                        Economic Ties (employment, active involvement in a Canadian business,
                           bank accounts, RSP, Credit Cards)
                        Landed immigrant status or work permits
                        Hospitalization and medical insurance coverage
                        Driver‘s license in a province
                        Registered vehicle
                        Canadian Passport
                        Membership in union or professional organization.
                Limited Importance:
                        Retention of Canadian Mailing address, P.O. box, or safety deposit box
                        Telephone Listing
                        Newspaper and Magazine subscription.

S 250: Deemed Residency
  S 250(1): People are deemed to be resident in Canada if they:
       o (a) If you have sojourned (visited) in Canada for 183 days or more, taxed as a
           resident
                 Sojourned: Sojourn means something less than residence—it means physically
                    present in Canada but on a more transient basis than a resident
                 sojourner lacks the settled home in Canada that would make them a resident.
                 temporary residence or residence for a temporary purpose.
       o (b) A member of the Canadian forces
       o (c) An ambassador or civil servant in another country.
       o (d) Worked on a Canadian international development assistance program
       o (f) A dependent of one of the above
       o (g) Subject to an international agreement which says you pay taxes in Canada.
                o S 250(2): For S 250(1)(b)-(g) they are only deemed to be resident for the part
                    of the year that these subsections apply.

  S 250(3): Extends the act to include people who are ―ordinarily resident,‖ examines the person‘s
   residency over an extended period of time and not just the year in question.
        o applicable to those who lived in Canada most of the time, or temporary absence
        o even absence lasting for the full taxation year in issue, does not necessarily involve a loss
           of Canadian residence.
        o If a family household remains in Canada, or even possibly if close personal and business
           ties are maintained in Canada, then the taxpayer may be held to be ordinarily resident.

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          o Recent decisions have relied on this provision to conclude that taxpayers who neither
            lived in Canada nor maintained a Canadian dwelling during one or more years were
            nonetheless ‗ordinarily resident‘ in Canada over a longer period of time.

   S 250(4): Deemed to be resident in Canada throughout the entire year if incorporated in Canada
    after April 2, 1965.
         o Displaces the common law “central management and control” test.
         o Corporation incorporated before April 2, 1965 still look to common law.
                    Common law: Look for central management and control to determine
                      residency.
   S 250(5): not a resident if an international treaty says so.

S 114: Part time residence
   For immigration or emigration to or from Canada, S. 114 provides for a part-time resident (relief
    from tax on worldwide income when not resident), so as to apportion the period that you were in
    fact a resident during the taxation year and exempt income earned for part of the year where
    wasn‘t resident
   So, a part-time resident is not taxed as a resident for the part of the year when he was not resident.
   This section apportions the year between resident and non-resident.
         o Taxes flow accordingly.
   Part time residence and sojourning rule are mutually exclusive.
         o The sojourning rule only applies if you do not meet the common law definition of
             residence.
   Dixon (recent case): Canadian Lawyer goes to Texas to practice law. He severs his residency
    with Canada. He returns to Alberta to practice law and live in Canada.
         o Held: He was deemed to fall under the Part time residence rule and not the sojourning
             rule (though he qualified for that rule)

Thomson v. MNR (1946)
It is chiefly a matter of degree to determine residency. Give “Resident” its ordinary usage.
It is impossible to define residency precisely, it is a highly flexible term.
   Facts: Man born in Canada became very wealthy in Canada. He declared that he was leaving
    Canada because of high income taxes and he left. He eventually came back for the summers and
    retained ties with his family.
   Held: his having a summer home in Canada and spending time here as well as keeping close ties
    to Canada meant that he was still a resident.

Nicholson v. The Queen (2003)
Courts need to recognize that people move around for work. Residency may not depend on family.
Key Factor: he thought that it was a permanent move – going to Chicago when done.
   Facts: N had 2 bank accounts, and 2 kids in Canada. He held an interest in the matrimonial home.
    Paid CPP to maintain health benefits for the children. Most of the salary went to his Canadian
    bank account (trying to avoid paying tax in UK). Wanted to pay in Canada. Until he left for the
    UK he lived in Canada. He married in Canada. Short stay in UK (less than 2 years). Explicitly
    temporary. But he was supposed to go the Chicago.
   Held: Not resident for the period.
        o He had severed his Canadian residence.
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                      Key factor was the assumption this was a long term move. He did not think he
                       was coming back.
          o It is not unusual that people move around for work we should recognize that mobility.
          o Visiting Canada once does not give him residence.

Gaudreau v. The Queen (2005)
His intention (stated in his employment contract) to return was an important factor in determining residency.
The actions of his nuclear family (his wife) are important in determining the residency of the Taxpayer.
Look at the ties to either country to determine where he has stronger claim of residency.
   Facts: Away from Canada for 4 years in Egypt as the site manager for a power plant. Spouse went
    home for several weeks each summer. No social life in Egypt – worked 7 days a week – all spare
    time with his wife (No strong connections to Egypt). There were lots of ties to Canada:
                   Real Property: he had a house and didn‘t rent it.
                   He kept all of his possessions.
                   Held 2 bank accounts
                   Paid bills
                   Retained RRSPs
        o Planned to return to Canada. He was receiving CPP. He had real property and family
            members in Canada.
   Held: He was resident in Canada. There was a clear intention to return.
        o Distinguishes Nichols on this point (the intention to stay away or leave forever)
                   He always intended to return after 4 years.
        o He really had no ties to Egypt but many to Canada
        o It is important what his wife does because she is a member of his nuclear family.
                   Her frequent visits to Canada are important to deciding his residency.
   This case is being appealed to the FCA this year.

Giving up Residence
       CCRA: Canadian resident who leaves the country for less than two years will be presumed to
        have continued as a Canadian resident throughout the time abroad unless the taxpayer can
        clearly establish that he severed all residential ties on leaving Canada.
       S. 128.1(4) – Departure Tax: policy is to prevent resident from leaving the country without
        paying tax on capital gains which had accrued but not been realized while they were residents
        in Canada. So taxpayer deemed disposed of all of his property at FMV immediately before
        ceasing to be a resident; ensure that any accrued capital gains or losses are recognized for
        purposes of Canadian tax, and are recognized as falling into income during the period of
        Canadian residence.
       When the taxpayer has a long history of residency in Canada clear and virtually
        irreversible measures are required to terminate his residency.
                    In these cases evidence of social and economic connections may play an
                       important role.
                    The recent jurisprudence does not require ―clear and virtually irreversible‖
                       measures to sever residency.

Canada-United States Tax Convention [2511]
   Article IV 1 of the ITA.
        o A resident of a Contracting state (use the domestic law of the contracting country) –
             where are you determined to be taxed.
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   Article IV 2 of the ITA: if taxed in both countries.
         o Resident in both states then look to the tie-breakers.
                    Permanent home.
                    State with which your personal and economic situation is closer.
                    Habitual abode.
                    Country where you have citizenship.
                    Competent authorities will settle the problem by mutual agreement.
   Dagenais: A Canadian won a US lottery. US taxes lottery winnings. Dagenais tries to claim a
    foreign tax credit on his payments. Foreign tax credits are only available against Canadian tax
    payable on the same income. There is no Canadian tax payable on lottery winnings, so there is
    nothing to set the tax credit against.

Determining Residency – Corporations
   S 250(4): Deemed to be resident in Canada throughout the entire year if incorporated in Canada
    after April 2, 1965.
         o Displaces the common law “central management and control” test.
         o Corporation incorporated before April 2, 1965 look to common law test from
            DeBeers.

DeBeers Consolidated Mines Limited v. Howe (1906)
A company resides for the purposes of income tax where its real business is carried on.
Real Business is carried on where central management and control actually abides.
   English Courts: Employ a de facto control test. Look through de jure control.
   Canadian Courts: Central management and control abides in the jurisdiction in which a majority
    of the board of directors resides and meets.
         o S 250(4) displaces this test in Canada.
   Trusts follow the same rules. (Thibodeau Family Trust v. The Queen)

Aboriginal Taxation
   Aboriginals are taxed unless they fall within a narrow exemption in S 87 of the Indian Act
        o Narrow because of how the Courts have construed it.
   Royal Commission reported on Aboriginals in 1996: All aboriginal pay some tax to some
    governing body and the overwhelming majority cannot take advantage of the exemption.
   Exemption S 87 Indian Act: The following property is exempt from taxation:
        o Interest of an Indian or band in reserve or surrendered lands; and
                  Doesn‘t include corporations, metis, innuit.
        o The personal property of an Indian situated on a reserve.
                  Courts: Interpreted to mean a strong nexus to the reserve.
                          So unavailable to those living in urban areas.
                                 70% of aboriginals live off the reserve.
                          If you do work off the reserve you may not be able to claim the
                             exemption.
    Corporation owned by Indian cannot get the tax exemption since corporation cannot be Indian
    Exception applies only to income or transactions that have strong nexus to a reserve
    For the most part, the exemption is unavailable to those living off-reserve, or even those living
      on reserve if income derived from off-reserve employment


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       Personal property situated on the reserve is exempt from tax, income is personal property for
        this section—the problem is figuring out if it's "situated on the reserve".

Nowegijick v. The Queen (1983)
It was only important to consider where the money came from. Money is personal property.
The Indian Act should be construed largely and liberally to serve remedial purposes.
   Facts: Nowegijick lived on the reserve and was employed by a company that ran a logging
    business (partly operated off the reserve). All of the owners and employees of the company were
    on the reserve. Nowegijick worked off the reserve but was paid by head office.
   Held: Nowegijick was exempt.
         o Personal Property applies to Income.
         o Only mattered where the income came from.

Williams v. The Queen (1992)
Look for a connection to the reserve for the money. Source of the money is not determinative.
Consideration for determining a connection:
   The purpose of the exemption
   The character of the property
   The incidence of taxation upon the property.
Purpose of the exemption: To respect the fiduciary position of the crown and protect Indians from any efforts
by non-natives to dispossess Indians of the property which they hold qua Indians.
Facts: logging company performs the services on the reserves; when W loses his job and collects UI,
cheques are now coming from HRC off reserve.
   Held: The EI was not taxable. UI cheques were income on the reserve.
         o The revenue must be connected to the reserve because the work done to qualify for UI
             was done on reserve.
         o Consideration for determining a connection:
                   The purpose of the exemption
                   The character of the property
                   The incidence of taxation upon the property.
         o Purpose of the exemption
                   To respect the fiduciary position of the crown and protect Indians from any
                     efforts by non-natives to dispossess Indians of the property which they hold qua
                     Indians.
                   Not to ameliorate a historic disadvantage. So income from the economic
                     mainstream is not protected.
                   Not for the Political reason of recognizing Indians as a sovereign people. There
                     was a promise made that there would not be taxation. (Should be read broadly.)

Schilling v. the Queen (2001)
Factors to be weighed:
   Location of the employer. Work integral to the life of the reserve. Where the recipient of the
    income lives. The nature, location and surrounding circumstances of the work. Nature of any
    benefit that accrued to the reserve from the work. Is it earned in the commercial mainstream (it is
    not intended to ameliorate the disadvantage just the reserve economic base)
Particular attention should be given to the nature of the work performed and the location of employment.
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 Facts: Schilling gets paid by a Native Leasing Services Corporation (NLS) while working in
  Toronto. The company she works for paid NLS and NLS paid her – this was done to take
  advantage of the S 87 exemption. Schilling had a long history of connection to the Rama Band.
  Takes up work in Toronto. Starts to live there after a year. But still regards reserve as her home.
  Moves away partly because her son has fallen in with a bad crowd. She is paid from a company
  on a different reserve (6 Nations). She is paid to a bank on a different reserve (where she goes for
  ceremonial sweats).
 Decision: Not Tax exempt; Income not situated on reserve; not entitled to exemption since the
  place where available work was done was not on reserve. Only factor connecting to reserve, was
  that income paid from a reserve, but no other connection. Therefore income made in commercial
  mainstream and therefore subject to tax. Moreover, court states that this was for tax purposes, and
  therefore the individual is entitled to arrange affairs for tax exemption; had the choice of planning
  how she will live to get exemption. But are they upholding her right to engage in formal tax
  planning?
                  Consider factors to be weighed. Particular attention should be given to the
                    nature of the work performed and the location of employment.
       o Where you live is just a factor but not a major factor.
                  But it is now a factor which it was not under Nowegijick.
       o In this case the only factor connecting the pay to the reserve is the residency of the
           employer NLS.
                  Location of the employer will be of little weight regardless of if the transaction
                    was entered only for tax planning purposes.
       o She has chosen to enter the commercial mainstream and so she should be taxed like
           everyone else.
                  Employment off reserve is an indication that the Indian is acquiring income
                    in the commercial mainstream.
 Discussion
       o Court is drawing on Horizontal Equity to reach a reasonable result.
                  Comparing to other tax payers it seems fair.
                  But compare her to a commercial laborer (pumping gas, logging) on the reserve
                    and it doesn‘t seem as fair.
       o Neutrality?
                  Seems to encourage people to remain on the reserve to avoid tax liability.
                  S 87 exemption is one of the few benefits that Native firms have.
       o Feds keen on getting rid of the S 87 exemption (some organizations agree).
                  Vertically inequitable: Some Natives have high incomes and it is inequitable
                    that they should be tax exempt
                  It is not neutral or efficient: Even if you draw the exemption more broadly
                    people will try fit the exemption so it is not neutral.
                  Stigmatizing
                  Admin and compliance costs of the exemption (given the fluctuation in its
                    meaning)




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Tax Base
Defining Tax Base
  S 2(1): residents of Canada are subject to tax on their taxable income
  S 2(2): taxable income is the taxpayer‘s income plus the additions and minus the deductions
   permitted by Division C.
       o Division C ( S.110 to 114.2) deductions:
                  Corporate charitable deductions
                  Capital gains exemption (from Division B only ½ of capital gains count
                     anyways)
                  Business Expenses.

Inclusions
S 3: Determination of Income and Capital Gains
  Enumerated Sources of income: S 3(a): Include all income from a source (without excluding
   the generality of the forgoing: identifies 4 traditional sources of income: office, employment,
   business or property).
        o Subdivision a of Division B (S 5-8): income from office or employment
        o Subdivision b of Division B (S 9-37): income from business of property
        o Subdivision d of Division B (S 56-59.1): miscellaneous inclusions.
  These four sources are not exhaustively defined in the Act, leaving much room for judicial
   interpretation
  In determining whether a receipt has a source, the courts tend to fit the receipt into one of the
   enumerated sources before deciding that the receipt is a non-taxable gift or a windfall

  S 3(b): Include all allowable capital gains (1/2 of capital gains (S 38)) less allowable capital
   losses (1/2 of capital losses (S 38)) not including any allowable business investment losses
   (ABILs).
        o Subdivision c of Division B (S 38-55): capital gains and losses

Income
  The meaning of income under 3(a) is limited for tax purposes to income from a "source"—not
   defined in the Act.
  ITA does not define Income.
        o Curran v. MNR: Income is to be given its ordinary meaning.
  Act reflects source concept of income – 2 principles: 1) no income can arise unless it has an
   identifiable source; 2) the sale of the source itself does not give rise to income
  there is a distinction between capital and income that permeates throughout the ITA.

  Source of Income: more than knowing where it came from. It is something that produces a
   stream of income.
        o Income is generally periodical receipts recurring at regular intervals.
        o Unusual/unexpected/one-time and non-recurring payments are not a source (ex.
           Gifts, Receipts and lottery and gambling winnings).
                  Considered a windfall.
                  Sale of a source of property is considered not to be a source.

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       o BUT On occasion these unusual/unexpected/one-time and non-recurring payments
            are considered income.
                  Curran: a one time signing bonus was considered income and was captured in
                       S. 3 because it was close enough to the employment contract.
                  Consolidated Textiles: the profit or gain does not necessarily need to be
                       recurring in nature.
       o Characterization of as a lottery winning prevents the income from being from a source,
            even if it is something that produces a stream of income.
                  Rumack: Rumack won the ―Cash for Life‖ lottery.
                            Revenue Canada can tax annuity payments.
                            However, the prize winner is a lottery winner which is not taxable.
                            Only the Charity disbursing the annuity can be taxed.
  Ideally, income should reflect taxpayer‘s ability to pay; concept of fundamental importance since
   the Act is used as a policy instrument in the redistribution of income, definition of income
   inherently linked to tax equality.

  Two ways that an item can be included as income:
      o Income under S 3(a) – income from a source.
                This is a very broad concept. Dividends are an example of income from a
                   source.
                S 3(a) Names certain traditional sources of income (Office, business,
                   employment and property).
      o Subdivision d of Division B a list of items the government explicitly references that are
         to be included in income.
                Examples:
                        56(1)(n): a prize for achievement
                        56(1)(a)(ii): retiring allowances

Schwartz v. the Queen (1996)
S 3(a) has a wide scope and can include non-enumerated sources of income. However, it is not a “catch all”
provision.
  Facts: D resigned from the partnership to work in-house at ―Dyna Care.‖ Dyna Care cancels his
   position at the last minute. He is paid $300 K as ―severance‖ for his leaving, though he never
   worked there. He ends up working elsewhere.
  Held: Not taxed on the payment.
        o 3(a) contemplates income from other sources than those enumerated.
                  S 3(a) is general. It is an omnibus with a very wide scope. However, the
                     income must still be from a source – S 3(a) is not a “catch all” provision. If it
                     was there would be no need for Subdivision d of Division B.
                          Strike pay is not a income from a source
                          Retirement allowances are not income from a source.
        o Retiring allowances do not fall under 3(a). They are caught by 56(1)(a)(ii) – detailed set
           of rules to deal with pay from a loss of income.
                  Historical perspective of amendments to the act must be kept in mind when
                     interpreting the ITA.
                  Specific rules govern over general rules.
        o it is not clear that this was a retiring allowance.


                                                                                                       29
                                                                                                       30
                  He had entered the contract but the period for the provision of services had
                   not yet begun. In S 56(1)(a)(ii) employment only refers to current employment.
                               Since it was a payment from intended employment it is not caught.
      o Surrogatum Principle:
                Treat damages received in lieu of income from a source as income from that
                   source for tax purposes.
                        Fails here because there is no evidence of the damages being for
                          retirement.
  Minority Decision: S 3(a) should not be extended to include un-enumerated sources.
                Carter commission was rejected by the Federal Government. So courts should
                   not adopt a definition of income that includes all accretions of wealth.

Problems with the Source Concept of Income
  Uncertainty Regarding un-enumerated sources: how to treat items that do not easily fit into
   traditional sources – how do you treat receipts that don‘t fit within employment, business or
   property?
        o S 3(a): All sources of income are included. Some are named but the generality is not
            limited.
        o though unexpected, nonrecurrent payment, one-shot payment, is said to be not income
            from a source, some courts have held that such types of payments can be
        o Moreover, subdivision D of Division B, Part I = Parliament has provided that this section
            will catch receipts that don't fall into main categories.
        o Source of income is a broad concept.
                    However, it still requires there be a source of income before it can apply.
                    This does mean that if you are trading in capital or LLP as a business it will be a
                        source of income.
                    Issue though is that tax law should be construed narrowly so that taxpayers are
                        not being arbitrarily subjected to tax, should be imposed by explicit language –
                        reflects concern with property rights of individuals that shouldn‘t be lightly
                        interfered with and requires explicit legal authority which is one meaning given
                        to the rule of law, policy against that freedom from government arbitrary
                        involvement be protected.
                    Judges have been quite reluctant to recognize un-enumerated sources even
                        though the issue of generality; thus treated as non-taxable windfall if doesn‘t
                        look as amount from source, i.e. lottery winnings, gamblings, gifts, inheritances,
                        strike pay
  Distinguishing income from capital:
        o There is a lot of controversy, as some say that it is a source of income, while others state
            it is not. Is profit from a sale of land not a source of income?
        o argument is that any accretions in a person's economic power/ability to pay should be
            taken into account
        o neutrality—define tax base so as not to interfere w/ people's financial choices - kg's
            exception—creates huge incentive to engage in avoidance planning so as to receive kg's
            over income from a source - simplicity—generates legal uncertainty and litigation
                    Wilder: sold business for a life annuity. Not income, repayments of capital.
                    Shaw: collections on a life insurance policy were payments on account of
                        capital.



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                                                                                                     31
                  compromise between English position (kg's not income) and Carter Commission
                   (kg's like any form of income)—one-half of kg would brought into the tax base,
                   and other half is tax-free
  Courts in favour of a narrow reading of S. 3
      o This is why inheritance and gifts are not included in income.
      o The same is true of lottery winnings/gambling winnings.
                 Note: this is true for occasional gambling winnings. A bookie may be hard
                   pressed to show that his organization is not producing income. (There is an
                   organized effort to gain the money so it is likely to be characterized as
                   income.)
      o Strike pay.
      o Someone selling their business and getting a non-competition payment.
  Court‟s approach: Interpret tax law restrictively and construe things in favour of taxpayers.
      o Negative liberty: Private property is an important part of liberty.
                 Government should not be able to take private property away unless it is clearly
                   allowed by the law.
      o Competing with negative liberty is the Positive liberty provided by the state. The state
          needs resources to provide positive liberties.
      o Courts are interested in ensuring clarity in the law.

Alternative Approaches to the Source Concept of Income
  Haig-Simons: Need to tax the sum of market rights used in consumption with the change in value
   of the store of property rights. Economic definition of income, the money value of the net
   accretion to one‘s economic power between two points of time – any accretion to economic power
   in the course of a taxation year, regardless of its source, would count as income for the year.
        o Income equals consumption plus gain in net worth over a taxation year.
        o This would include all gifts, winnings and capital gains (not only realized when property
            is sold, but accrued kg on property that has increased in value over the year)
  Carter Commission: Tax the increase in economic power no matter how achieved. Income
   should include every accretion to wealth, regardless of its source, because every accretion to
   wealth increases the recipient‘s ability to pay. Adoption of a more comprehensive definition of
   income along the lines proposed by Haig and Simons; necessary both to the equity and the
   efficiency of the tax system. Idea that the traditional source based concept of income was not a
   satisfactory measure of the annual increase in a taxpayer‘s ability to pay tax, because it excluded
   from income so many accretions in wealth
        o It was inequitable to tax gains only when realized in that those who retained investments
            which have appreciated in value are allowed a tax-free investment of the accumulate
            gains that are built up free of tax while other, who turn over their investments, are denied
            this privilege
        o This would tax all gifts, winnings and capital gains.
        o “A buck, is a buck, is a buck.”
                   Provides certainty, consistency and equity.
        o Capital gains are disproportionately received by the wealthy and should be taxed.

Capital gains
  Capital gains - proceeds of sale of the land minus the original cost of the property; tax on just
   the appreciation of value of property while the tax payer held it



                                                                                                     31
                                                                                                   32
  However, capital gains are not considered to be income from a source, and thus are calculated
   under subdiv c as their own source of income to be included. They are income from the
   disposition of source.
  S. 9(3) also makes it clear that income from property does not include capital gains.
  Distinguish from LLP: S. 3(b)(i)(A): only allowable kl and kg of property, other than LPP
  Currently ½ of all capital gains and losses are included in income as allowable capital gains
   and losses (S 38(a) – half are therefore exempt from tax)
  Implications:
        o This means that it is more favourable to receive income from capital gains than from a
            source.
        o And more favourable to receive losses from a source than from a capital gain.

Capital Losses
  When computing capital losses do not include any ABILs or LLP losses.
  Listed Personal Property (S 54): tax payer‘s personal use property that is all or any portion of or
   any interest in or right to (complete list):
                   Print, etching, drawing, painting, sculpture, or similar work of art
                   Jewellery
                   Rare folio, rare manuscript, or rare books
                   Stamp
                   Coin.
        o Taxable Net gain from LLP (S 41): ½ of the amount if any by which your gains on LPP
           exceeds your LPP losses.
                   If LLP losses exceed LLP gains you can carry the LLP losses forward 7 years
                      or back 3 years to claim against LLP gains.
        o This is in recognition of the partial investment status of these items.

Allowable Business Investment Loss (s39(i)(c))
     a loss incurred on the disposition of shares in a small business corporation (ABILs are a
      subset of capital Loss that are treated more favourably than capital losses). – allowable means
      ½.
        o S 248(1) “Small Business Corporation”: An SBC must be Canadian Controlled
            (ownership must be more than 50% held by Canadian residents) and 90% of its assets
            (all or substantially all) need to be used in an active business in Canada.
                    An SBC does not necessarily have to be small.
        o S 3(d): ABILs can be deducted against ANY SOURCE OF INCOME whereas most
            capital losses can only be used against capital gains.

Exceptions
  Depreciable Capital Property: this is treated differently to take account of the depreciated
   capital cost allowed in previous tax years.
  Personal Use Property: used primarily for personal use and enjoyment by the tax payer. (Non
   Listed Personal Property)
        o Losses on personal use property are not permitted to be deducted because these represent
            personal consumption.

Net Capital Loss
  A net capital loss cannot be deducted in the year that they are incurred.

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                                                                                                              33
             o Capital losses cannot be deducted against sources of income.
             o Capital losses can carry forward indefinitely (until the year of your death) or back 3
                years (file amended return) and be used to offset capital gains or losses in other years.
       In the year of your death, and the preceding year (file an amendment) you can claim the capital
        loss against any source of income.


Exemptions
       Exemptions take certain amounts out of income to prevent it from being taxed.
            o Capital Gains: ½ of Capital gains are exempt from taxation. (S 38 (a))
            o Capital Gains on Principle Residence (S 40(2)(b))
            o Any amount declared exempt by another act of Parliament – Indian Act (S 81(1)(a))
       Some exemptions take the form of credits and some of deductions.
            o Move towards credits because of the disproportionate impact of deductions on the
                wealthy
       Policy: Tax exemptions are a method of achieving policy objectives through tax
        expenditures.
            o Provides relief to some tax payers
                      Take account of elevated costs of living (disability)
            o Encourage certain types of behaviour
            o Recognize fiduciary duty (Indian Act)

Division B: Computation of Income

Summary: Steps for Computing “Income”

3(a)    add net income from all sources inside or outside Canada, including office, employment, business or
property (but not including capital gains) [note: positive amounts only]

--------------------------------------------------------------------------------------------

3(b)       determine amount if any by which (i) exceeds (ii)

(i)        TKG (on property other than LPP) + taxable net gains on LPP

minus

(ii)       AKL (on property other than LPP) – ABIL’s

[positive amount only]

--------------------------------------------------------------------------------------------

3(c)       [3(a) + 3(b)] - any subdivision e deductions

--------------------------------------------------------------------------------------------

3(d)       result from 3(c)

minus

           losses from any office, employment, business or property

           allowable business investment losses (ABIL’s)

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---------------------------------------------------------------------------------------- ----

3(e)      amount determined under 3(d) is taxpayer’s “income” for the year

--------------------------------------------------------------------------------------------

3(f)      if a negative amount is determined under 3(d) income is deemed to be nil for the year

   S 3(a): Income from source: office/employment; business/property
        o Income is computed on a source by source basis
                    Compute net income from each source separately.
                    Expenses/losses from a source of revenues can only be deducted against the
                      source producing the revenue and no other source.
        o Only positive amounts of net income from a source are included
   S 3(b): Capital gains
        o The amount, if any, by which 3(b)(i) exceeds 3(b)(ii) (1 exceeds 2) (only include positive
             capital gains)
           1) 2 parts are summed together
                           A) All of your capital gains from property, other than listed capital
                              property.
                           B) Net gain for the year from listed personal property (Calculated in S
                              41)
           2) The amount by which the tax payer‘s allowable capital losses from the disposition
               of property other than LLPs exceed the taxpayer‘s ABILs.
                    Capital Loss: the amount by which the original purchase price exceeds the sale
                      price.
                    after determining ½ of the gain and loss – if the loss exceeds the gain, then
                      NOTHING is included under 3(b)
                    if you have a net capital loss, which cannot be recognized in that year, can
                      be carried back up to 3 years or forward to any future year indefinitely and
                      deducted from taxable income (s. 111); generally a net capital loss can be
                      deducted only to the extent a TP has taxable kgs in the carryover year.
                      (note: in year of death and proceding year, net capital loss can be deducted
                      against any income from any source)
                    LPP: If something is LPP within the meaning of s. 54 and its use by the TP
                      suggests that it was used primarily for personal use or enjoyment in accordance
                      with the definition of ―personal use property‖, and not primarily for business or
                      other income earning purposes – then capital loss on the item can be deducted
                      only against capital gains on other LPP – if they do not have any gains on
                      any other LLP, then add zero to taxable kg and cannot claim! The net loss
                      on LLP can be carried back 3 yrs and forward 7 and factored into the
                      computation of any “taxable net gain” on LPP in those years (s. 41)
        o Always Consider S 111: Carry over rules
                     o     Non-Capital Losses: can be carried forward 7 years and back 3 years.
                     o     Net Capital Loss: can be carried forward indefinitely and back 3 years.
                            ABILs convert to a net capital loss after 7 years.
                     o     Capital Gains Reserve Rule: if you sell property and realize a capital gain, but you receive the
                           proceeds of sale over a number of years.
                            Entitlement arises at that moment but no cash yet.
                            Can bring it in as a capital gain over a maximum 5 year period. Only available if you receive
                               the proceeds from the sale over an elongated period. If you receive the proceeds over 3 years
                                                                                                                         34
                                                                                                                    35
                         you can only claim the capital gains over 3 years. If you receive the proceeds over 10 years
                         you can only claim the capital gains over 5 years.
   3(c): Subdivision e Deductions.
         o Add income together under (a) to net capital gains (b) then claim subdivision e
            deductions. These are miscellaneous expenses.
         o Some (e) expenses:
                   Moving expenses (S 62)
                   RRSP
                   Child care (S 63 – to a maximum of $7000, if the child is under 7)
                   Spousal support.
                   Stock Options benefits under S 7 (53(1)(j))
   3(d): Account for Past Losses, Losses from a Source and ABILs
         o Take total from above and subtract any losses from a source for the year from an
            office, employment, business, property.
         o Subtract ABILs if any
               EX: if A has income from employment in the amount of 55G this is incld under
                  3(a). If the person had 28G in kg, this would be included under s. 3(b)(i) and would
                  be 14G. s.3(b)(ii) would be 0 as ABIL are ignored in 3(b) and deducted instead
                  under 3(d). So take 55G + 14000 and this is added under 3(c) to = 69000, as there
                  are no subdiv e deductions. Under 3(d) it would be 69000 minus (1/2 x 100G
                  business investment loss) = 19000 And this would be their income under s. 3
   3(e): Determination of Taxable Income
         o The amount on income in 3(d) is the taxpayer‘s income.
   3(f): No Negative Income
         o If the value in 3(d) is not positive then it is deemed to be zero.
   Division C: Computation of Capital Income
         o This is where taxable income is computed.
         o Non Capital Loss: when the amount from 3(c) does not exceed the amount of deductions
            permitted in 3(d) – i.e. there is negative income in 3(d).
                   Non Capital Losses can be carried forward 7 years or back 3 years. (S 111)
                            Can only deduct these to the extent that there is income available to
                               deduct them from.

Ex. In 2004 R was employed part-time at a hardware store, where she earned a total of $10,000. She also carried on
business as a freelance carpenter and handyperson. Her total revenues from the carpentry business were $25,000, and her
cost of materials and other overhead expenses was $18,000. In 2004 Rona also started up a new business of making do-it-
yourself home repair videos. She incurred costs of $5,000 to produce and advertise her first video, and received sales
revenues of 1,000. Rona received an inheritance of $20,000 in 2004. She paid child care fees of $7,000. What will be
Rona‘s income for 2004 for income tax purposes?
s.3(a) 10,000 (employment income) + 7,000 (net income from carpentry business)
(b)      0
(c)      17,000 – 7,000 (deductible child care expense, assuming child is under 7)
(d)      10,000 – 4,000 (net loss from video business)
income = $6,000




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Accounting Period
Taxation Year
  Taxation year is the artificial cut-off period for tax purposes.
       o There are incentives to postpone items of revenue to a later tax period and to put items of
           expense to an earlier period.
  We are permitted to take into account other taxation periods in determining our income.

S 249(1): Definition of Taxation Year
  Corporation Tax Year: Corporations are permitted to declare a fiscal period.
       o The fiscal period is the period for which the accounts of the business are made up.
       o Stub Year: a short year for the first/last year of the corporation that runs from
           incorporation to the end of the fiscal period/the start of the fiscal period to termination of
           the corporation.
       o S 249(1): the corporation‘s taxation year is called by the year in which it ends.
       o Forced to pay taxes in monthly installments so there is little advantage to the added
           flexibility of declaring their own fiscal period.
  Individual Tax Year: the Calendar year (Jan 1 – Dec 31).
       o Fiscal period must be 12 months and can end no later Dec 31.
  The Fiscal Period (S 249.1(1))
       o For a corporation: no fiscal period shall exceed 53 weeks.
                   Corporations have more flexibility.
       o For an Individual: the fiscal period shall be 12 months: Forces individuals to match
           their fiscal period to the calendar year.
  S 249.1(7): Permission from the Minister of Revenue is required to change your fiscal period
   once you have chosen one.
       o Need a good business reason to do this. (Merger of company, simplicity of business …
           but tax avoidance is not a good reason.

  S 11: an individual‘s income from a business for the year is the income from the fiscal period
   that ends in that year.
       o Prior to 1995 this allowed for deferral of taxes by declaring an off calendar year fiscal
           period.
       o Now: individuals and their businesses must end their fiscal period with the Calendar
           year. (S 249(1)(b))

Timing Rules:
  Specify the tax year to which item of income or expense must be allocated.

Business vs. Employment Timing Rules
  Employment uses a cash based timing system (included in the year it is received)
  Business uses an accrual based timing system (included in the year in which it is receivable –
   once it has been earned/legally entitled to receive it)
       o Even if you don‘t actually receive the revenue in that tax year.
       o Same goes for expenses. Once they are owed. It doesn‘t matter if the money hasn‘t been
           paid.


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                                                                                                  37
Modify Accounting Period
  Some provisions allow taxpayers to defer their income to later tax periods.
       o Farming and Fishing businesses can average their income over 5 years.
       o RRSP deductions
  These are special purpose deviations from the general rule.
       o Take account of family obligations, …
       o Make a better estimate of ability to pay.
  S 111: Carry over rules might be considered one of these (see above)


Rate Structure
Tax types
  Marginal: Everyone earning a certain amount will pay the same rate on that dollar no matter
   what they earn over that amount. (Rate paid on the last dollar of income.)
        o There is no clear impact on economic behaviour by raising marginal rates.
        o Debate: Higher rates make people work less – less economic incentive vs. Higher rates
           make people work more – maintain standard of living.
  Average: overall rate on your total income after applying the marginal rates on each ―chunk‖ of
   income. Average rates are always lower than marginal rates in a progressive system. As income
   increases, average rates approach marginal rates.

Federal Structure
Federal Rates
  S 117(2): Sets the Federal progressive rate structure
       o 15.25% first $36,378
       o 22% $36,379 - $72,756
       o 26% $72,757- $118,285
       o 29% $118,286+
  S 117(3): updates the income thresholds for the CPI. (See Table xxiii)
       o ―Bracket Creep‖ is avoided by indexing the dollar thresholds each year.
                  Without indexing, due to inflation, the ITA would tax lower real income earners
                     at higher percentages over time.

Guillemette v. R: progressive taxes are not unconstitutional

Federal Credits
  S 118: basic personal credit (S 118(1)(c)) or spousal credit (S 118(1)(a)) are given at the lowest
   marginal rate (S 118.1 and S 248.1). This is also indexed to CPI.
       o BPC: $8,839 x 15.25% = 1347.95
  Increasing the bpc is a very popular way to cut taxes.
       o This is because it appears to target low income earners.
       o BUT people who are not benefited are those who are already below the threshold (25% of
           taxable males and 39% of females).
  Multiply by the lowest marginal rate to avoid an ―upside-down‖ subsidy.
       o Defect of credits for policy objectives is that they only help if you have to pay tax. For
           those with income too low to pay tax they are of little assistance.
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                     Refundable credits are preferable to implement policy.
                     Non-refundable credits are preferable when trying to achieve an accurate
                      measure to the taxpayer‟s income.

Provincial Structure – Ontario
Provincial Rates
  Ontario ITA S 4(3): sets the provincial Progressive rate structure
       o 6.05% first $34,758
       o 9.15% $34,759 - $69,516
       o 11.16% $69,517+
  These are indexed to CPI
  Ontario ITA S 3 (surtax): Ontario charges a Tax on any tax exceeding a certain threshold after
   the bpc has been applied.
       o So take the tax payable, minus the below amounts (both if the tax is over both) x each
           rate. Add the amounts together and this is the surtax. Then add the surtax to the basic tax
           = total tax payable for ONT.
       o 20% on tax exceeding $4,016
       o 36% on tax exceeding $5,066
                  Because of the surtax in the top bracket the rate in Ontario is really 17.41%!
  Note:
       o Alberta has a proportionate tax of 10% on all income.
                  Because of the BPC this is not a rejection of progressively but a different kind of
                     it.
                  Places the tax burden disproportionately on middle income earners.
       o Ontario is the only province with a Sur Tax.

Provincial Credits
  Ontario ITA S 4.0.1(4): basic personal credit and spousal credit are given at the lowest marginal
   rate. This is also indexed to CPI.
        o BPC: $8,377 * 6.05% = $506.81

Example
  Federal and Provincial (Ontario) tax rates to an individual taxpayer with $80,000 of taxable
   income in 2006. The basic personal credit (―bpc‖) is also factored in.

Step 1: Federal marginal rates applied to taxable income, to determine federal tax before credits:
                   $36,378 x .1525= 5548
(72,756 – 36,378) = $36,378 x .22 = 8003
(80,000 – 72,756) = $7,244 x .26 = 1883
                                      $15,434 federal tax before credits
- OR here, take 13551 + (.26% of the amount by which the amount taxable exceeds 72,757)
For income up to 36,378 is X .1525%
For income between 36,379 – 72, 756  take 5548 + (.22% of the amount by which the amount
taxable exceeds 36,379)
For income between 72,757 – 118,285  take 13551 + (.26% of the amount by which the amount
taxable exceeds 72,757)
For income at 118,286 and over  take 25388 + (.29% of the amount by which the amount taxable
exceeds 118,285)
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Step 2: subtract the federal bpc to determine federal tax payable

2006 federal bpc = $8839 x .1525 = $1348
$15,434 (from Step 1) – 1348 = $14,086 federal tax payable

Step 3: apply the basic provincial marginal rates to taxable income, to determine basic Ontario
tax before credits

                    $34,758 x .0605 = 2103
(69,516 – 34,758) = $34,758 x .0915 = 3180
(80,000 – 69,516) = $10,484 x .1116 = 1170
                                     $6453 basic Ontario tax before credits

Step 4: subtract the Ontario bpc to determine basic Ontario tax

2006 Ontario bpc = $8377 x .0605 = $507
$6453 (from Step 3) – 507 = $5946 basic Ontario tax

Step 5: apply the Ontario surtax rates to the amount of basic Ontario tax that exceeds the surtax
thresholds

(5946 (from Step 4) – 4016) x .20 = 386
(5946 (from Step 4) – 5066) x .36 = 317
                                    $703 Ontario surtax

Step 6: add basic Ontario tax plus Ontario surtax to determine total Ontario tax payable

$5946 (from Step 4) + $703 (from Step 5) = $6649 total Ontario tax payable

Step 7: add federal tax payable plus total Ontario tax payable, to determine the individual‟s
combined tax payable

$14,086 (from Step 2) + $6649 (from Step 6) = $20,735 combined tax payable

Note that the taxpayer‟s combined average tax rate for 2006 is 20,735/80,000: 25.9%
This can be compared to the taxpayer‘s combined marginal tax rate computed as follows:
26% (fed) + (11.16 + [.56 x 11.16]) (ont.) = 43.4%

Corporate Tax Rates
  See Table xxxvii – most companies are taxed at 34.1% (Manufacturing and Production) 36.1%
   for General business activities and Investment Income.
  See table xl CCPC – 18.6% - combined federal and provincial tax rate.




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Statutory Interpretation
Tax Avoidance
  Tax Avoidance: Taking advantage of gaps between the letter and the spirit of the law. Arranging
   your affairs so as to reduce the amount of tax you pay.
       o Tax Avoidance Cases set the limits of tax avoidance planning and provide the courts
           with the opportunity to make their important statements about the law.

Tax Avoidance
  Tax Avoidance: perfectly legitimate method of avoiding tax liability. Entirely legal, does not
   involve fraud, concealment or any other illegal measures.
       o Try to comply with the ITA in such a way that limits tax liability.
                  Order affairs to minimize tax burden.
                  Relies on reasonable differences of opinion in the meaning of the statute and
                      exploiting ambiguities under the provision, or drafting mistake which leaves a
                      loop hole.
  Most controversial type:
       o Transaction is done only to avoid tax and the outcome appears to violate the spirit or
           intent of the statute.
       o Schilling: It appears that she contracted with Native leasing services for the sole reason
           of getting the tax exemption.
  Though the courts have often upheld tax avoidance provisions forcing statutory changes.
       o Needs to adhere to a valid reading of the law and be done in the open.
  Sanctions for Avoidance: not criminal. Perfectly legal
       o CRA would re-assess your filing.
       o May have to challenge in court – should have reasonable, good-faith for doing this
                  Can be costly to litigate these matters
                           May have to pay the crown‘s costs.
       o CRA may agree with you.
  Carter Commission: Costs of tax avoidance
       o There are concerns about allowing too much tax avoidance.
                  Under funded government cannot provide the services it needs to.
       o Waste of intellectual resources in avoiding taxes.
                  Brightest minds and lots of money spent on avoiding taxes.
       o Injustice and inequality for those unable or unwilling to avoid it.
                  Really only available to the wealthy. Not to the rest of the population.
                      Unavailable to those who income is derived from wages or salary and from
                      whom tax is deducted at source; only those with substantial investments or
                      business income are usually able to profit from tax avoidance.
       o Deterioration of Tax morality
                  Letting some get away with tax avoidance encourages tax evasion.
       o Shifts the burden of taxation.
                  Hurts the redistributive effect and progressive nature of taxation. Thus,
                      presumably shifts the burden onto other taxpayers through the need to maintain
                      tax rates at higher levels than would otherwise be needed.

Tax Evasion
  Tax Evasion: illegal methods of avoiding tax.
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      o Intentionally non-compliant with the ITA: failing to file a return, failing to report all
          taxable income, deducting non-existent expenses.
                 Usually involves an element of fraud, falsification of information,
                    concealment.
  Sanctions for Evasion: potentially criminal.
      o S 239(2): Up to 5 years in prison and financial penalties of up to 200% of the evasion.
                        Crown needs to meet the criminal burden of proof.
                              MR and AR beyond a reasonable doubt
      o If CRA thinks it may have difficulty proving the MR or AR they can proceed with civil
          penalties and under S 162, 163: can sue for the evaded amount.


Interpretive Considerations
  Words
       o The words of the act are what Parliament enacted and what they intended. These limit
          judicial decision making.
       o When words have numerous meanings they need to be interpreted.
                 Meaning of words is drawn from the words around it.
  Context
       o Words need to be read in context. Meaning depends on the structure of the provision.
       o ―Grammatical and Ordinary Sense‖
       o Internal Context: anything within the 4 corners of the act.
                 Words, headings, preamble, margin notes, …
                 Associated Words Rule: Words linked by conjunctive words (―and‖ or ―or‖)
                    influence each other.
                 Limited Class Rule: the meaning of a general word is limited by the list of
                    specific words following it.
       o External Context: information from the outside world that sheds light on the meaning of
          the act.
                 Common understanding, purpose of the text, background, …
                 L. Hand: Need to look at the text of the Act in context. Anything that
                    contributes to the meaning of the text other than the text itself:
                         Hansard, Academics, CRA‘s Technical documents
                         Background legal and cultural norms
                         Court decides on the weight to give these sorts of things.
       o The influence of Internal and External Context is intertwined.
  Statutory Scheme
       o The place of the words in the structure of the act makes a difference
       o Every word is used for a reason.
                 Consistent expression: parliament is presumed to use words consistently
                    (Identical words and phrases in different areas of the act have identical
                    meanings, while different words and phrases are given different meanings).
       o Courts assume no internal inconsistencies and that all parts of the act work together.
                 Implied Exception: Where 2 provisions appear to conflict the courts assume an
                    implied exception – preferring the specific provision to the general.
                 Implied Exclusion: the legislature intended to exclude something where it has
                    expressly included something else that is similar. Though this is unreliable
       o The courts should insist on clarity in interpreting statutes.
                 Implied Exclusion is often used to this end.
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  Statutory Purpose
       o Must take account of the political and social goals of the statute.
                  This ensures that interpretation is consistent with the statute.
                  Statutes can have multiple objectives
       o Most authoritative sources: Preambles, formal purpose statements
                  Absent these use inferences from the act.
                  Partisan Materials: very little weight.
       o Court only looks at the weight of these extrinsic materials not the admissibility of them.
                  Use material to ensure that individuals are not subjected to a law that parliament
                    did not intend to enact.
  Legislative Intent
       o The meaning the legislature would have given the statute in the situation before the
           courts.
                  This is a legal fiction that is unworkable in practice and in principle.
       o Amendment: not a declaration that the law has changed.
       o Re-enactment: not to be deemed to be an adoption of a judicial decision.
  Consequences
       o If the consequences seem wrong then another interpretation will be favored.
                  Strong presumption against unreasonable consequences
                  Greater weight to purposive and textual interpretation methods than to
                    consequential interpretation factors.

Applying Interpretive Considerations
  Phillips: Courts make a choice within constraints
        o Includes background values even if not expounded
        o The notion of a literal interpretation is illusory.
        o Judges are an unavoidable part of the law making process for tax
                   But it is wrong to suggest that there are no constraints. They are not free
        o The interpretive principles discussed above are used as guidelines.
  Duff: inappropriate to use interpretation to defeat legislative intent (legislative supremacy must
   not be frustrated)
  Phillips: how do we differentiate inappropriate interpretations from background norms (ex.
   The rule of law). These are inevitably at play.
        o One of these is the rule of law and the importance of avoiding arbitrary taxation.
        o Taxation is a threat to individual liberty. Proper approach is to demand a high standard
            of clarity on the legislature.
  Phillips: Duff maybe wants it both ways: the principle of legislative supremacy and the courts to
   ensure that the act is clear. BUT If the words do not have a clear meaning then the courts need to
   bring in some method of interpretation.

Interpretive Doctrines
  Depends on the approach of the courts to the act.
      o Traditional Approach (Strict Construction): statutory language was to be construed
          literally and ambiguities in taxing were to be resolved in the taxpayer‟s favour.
      o Modern Approach (Stubart Investments Limited v. The Queen): the words of an Act
          are to be read in their entire context and in their grammatical and ordinary sense
          harmoniously with the scheme of the Act, the object of the Act, and the intention of
          Parliament.

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   But the question remains: Is the modern approach really that different from the Traditional
    approach? There is debate over which approach the courts follow.


Strict Construction
   Traditional Approach: Statutory language is to be construed literally and ambiguities in taxing
    were to be resolved in the taxpayer‟s favour.
        o No equity in tax, nothing is to be read in.
   Presumption against taxation unless clearly stated in the statute.
        o Corollary: Taxes have the purpose of taxing not avoiding taxes. Construe
            credits/exemptions against the taxpayer.
   Look to the letter of the law. Ignore the spirit of the law and the consequences. Legislative
    purpose and intent is not important – only look to the strict and literal interpretation of the words

MNR v. MacInnes (1954)
Taxes must be expressly levied by the words of the act in order to have effect. Ambiguities are to be construed in
favour of the TP
If parliament had intended to capture multiple substitutions they would have expressly said so – ignore the
clear intent of the provision to avoid income splitting.
   Facts: MacInnes was given property by her Husband. She sold it multiple times. Did the
    attribution rules catch this?
   Held: The courts did not uphold the attribution rules because the Act did not clearly state that the
    attribution rules were to work ad infinitum.
         o Attribution rules catch a substitution but not a substitution for a substitution.
         o therefore strict interpretation – words are key here.
         o enforces a laissez-faire approach.
   Discussion:
         o The court did not look at the clear intent of the provision – to avoid income splitting.
         o McGregor: The plain meaning of the act is to prevent avoidance of the anti-attribution
             rules and include multiple substitutions. Court should have used a more purposive
             interpretation.
         o Sherbaniuk: Strict construction is what makes the act so complex.
         o Partington: The interpretation is based on the letter of the law not the spirit of the law.

   Strict construction is formally rejected by the courts in – Stubart.
        o Intro of tax credits and policy implementing purpose of the ITA spelled the end of strict
             construction.
        o Johns-Manville: However, the presumption in favour of the tax payer remains.
                            It is exceptional and residual.
        o Hogg: strict construction is a very much pro tax payer law. It is used to help the taxpayer
             and rarely to help CRA

Modern Approach
   There were some cases leading up to Stubart that signaled the change from the traditional
    Approach.
   Stubart signaled a reaffirmation of the traditional approach to tax avoidance and at the same time
    announced the demise of strict construction.

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Dominion Bridge
Court applied the Sham Doctrine to a puppet company being used to move profits off-shore because it was an
obvious tax avoidance scheme. Movement towards the business purpose test and away from the legal form of
the transaction to the substance over form test in which you look at the economic and commercial reality of
the transaction
   Facts: Dominion Bridge set up an offshore purchasing department (Span). Span has no customers
    other than Dominion and no other purpose than purchasing steel and selling it to Dominion. Span
    charges Dominion a mark-up on the steel it sold Dominion (no indication that Span could get a
    better price than Dominion Bridge).
         o Span collected ~18% of the profits that would have otherwise gone to Dominion. Span
             could give Dominion it‘s profits as a tax free dividend.
   Held: Dominion Bridge had to make an accounting for the tax avoidance.
         o Span was a mere puppet of Dominion Bridge. Span was really a part of Dominion.
                    (Phillips: this was a mere cloak – as in Duke of Westminster)
         o There was an obvious tax avoidance scheme. It was a sham.
                    The money never left Dominion. This was a sham to shift profits to Bermuda (of
                      shore) to avoid taxes.

Furniss v. Dawason (One of the Trilogy of UK Cases)
The Step transactions Doctrine: When there is inserted into a series of business transactions one step that has
no purpose other than tax-avoidance then the courts can ignore that step, as if it never took place.
   Facts: Dawson owns Op Co. He wants to sell his shares to a 3rd Party but avoid the significant
    capital gains. Dawson incorporates Hold Co. in the island of Man. He transfers all his shares in
    Op Co to Hold Co (corporate re-organization).
         o Hold Co. and the 3rd party enter an Agreement to sell Op Co.
                    This results in the realization of capital gains in the Isle of Man.
   House of Lords: Revenue Ministry was right to ignore the intermediate step of the transfer to
    Hold Co.
         o The Step transactions Doctrine: When there is inserted into a series of business
             transactions one step that has no purpose other than tax-avoidance then the courts
             can ignore that step, as if it never took place.
                    Though it may be more than one step that is removed. (Phillips‟
                      speculation)
   Discussion:
         o What if Hold Co was created well before negotiating the sale of assets.
                    Crave v. White: This was successful. The step transaction doctrine did not
                      apply.



Stubart v. The Queen
New Interpretive Approach of the Courts: SCC rejected the strict construction rule for interpreting tax statutes,
affirming the modern rule, in which the words of an Act are to be read in their entire context and in their
grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act and the intention
of Parliament.
   1) No bona fide business purpose for the transaction, GAAR may apply.
   2) Where GAAR does not apply, strict construction applies. But will not assist the Taxpayer
    where:

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        o (a) Legally Ineffective Doctrine applies
        o (b) Sham applies.
   3) The validity of the transaction may be insufficient where:
        o (c): may be rejected where the “object and spirit” of the act is defeated. Look beyond
            simply the text of the ITA.
The court proposes a new reading of the ITA and reaffirms the strict construction approach!
   Facts: A change to the ITA meant it was no longer possible for a parent company to deduct losses
    from a subsidiary against profits from another subsidiary. Finlayson had a number of subsidiaries.
    Two of them: Stubart (profitable) and Grover (unprofitable – has had losses for a number of
    years)
         o To make it possible for Grover to claim its losses, Stubart transferred all it‘s assets to
            Grover (so Grover could make a profit)
   Held: New interpretive approach to ITA is required to prevent the ―endless action and re-
    action‖ of Taxpayers and the Ministry. Transaction is permitted.
         o New Interpretive Approach:
                  1) Where there is no bona fide business purpose for the transaction GAAR may
                     apply. Though not here.
                  2) Where GAAR does not apply, strict construction applies. But will not assist
                     the Taxpayer where:
                          (a) Legally Ineffective applies
                          (b) Sham applies.
                  3) The validity of the transaction may be insufficient where:
                          (a) & (b): never used – no one knows what they mean!
                          (c): may be rejected where the “object and spirit” of the act is
                             defeated. Look beyond simply the text of the ITA.
                                 The words of the ITA are to be read in their entire context and in
                                     their grammatical and ordinary sense harmoniously with the
                                     scheme of the Act, the object of the Act, and the intention of
                                     Parliament.
         o Right after the object and spirit section the court says that tax payers are able to avail
            themselves of the clear and unambiguous beneficial provisions of the Act.
         o Transaction was Permitted:
                  The loss carry-over provision says nothing about a transaction of this type not
                     being OK.
                          The court ignores that the companies did not amalgamate so they are
                             not permitted to share losses and expenses.
                  This doesn‘t even come close to violating the object and spirit of the act.
         o Court does nothing to modify the form over substance requirements.
   Wilson: Concurs but is EVEN MORE CONSERVATIVE!!

   subsequent SCC judgments initially failed to settled on a preferred approach to the interpretation
    of tax legislation
   some favor purposive approach (first determine the purpose of the legislation and read the words
    in light of this purpose
   others a plain meaning rule, in which the provisions of the statute must be applied regardless of
    their object or purpose whenever they are couched in specific language that admits of no doubt or
    ambiguity in their application to the facts.


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   resent SCC decisions have returned to the modern rule, combining textual emphasis of the plain
    meaning rule with the purposive consideration. – Will-Kare Paving and Contracting Ltd. v.
    Canada

Anti-Avoidance Rules
Judicial Anti-Avoidance Rules
   Canadian and UK courts take a very permissive, laissez-faire attitude to Tax Avoidance.
       o Look to the words of the statute not the intention – strict literal interpretation
       o any ambiguities are to be construed in the favor of the TP
       o Form over substance principle: Tax rules should be applied to the legal form of a
           transaction not to the commercial reality.
                  Interpret the law and the facts.
                  Apply the law to the transaction in its legal form.
       o Motive of the TP to avoid tax vs. commercial motive is irrelevant: Irrelevant that the
           transaction was motivated by a tax avoidance purpose.
       o Individuals are entitled to arrange their affairs to avoid tax.

Sham Doctrine and General Approach
Commissioners of Ireland Revenue v. Duke of Westminster
Demonstrates judicial restraint, as opposed to the activist approach as seen with Gregory v. Helvering
Everyone is entitled to order their affairs so as to avoid tax liability.
Courts will look at the legal construct, not the economic reality.
Sham Doctrine: Courts will look beyond the legal relationships when there are documents that are not bona
fide and are not intended to be acted on. In that case the courts will look at the transactions the documents are
intended to conceal.
   Facts: Duke, instead of paying his staff of domestic servants, set up an annuity. He said that they
    could continue to collect their wages as well. But there was a side letter saying that they will be
    agreeing not to try to collect their wages by taking the annuity.
   Issue: whether certain payments made to the servants were annual payments within the meaning
    of the ITA and therefore admissible as deductions. CIR said that all payments were payments for
    services to be rendered to the Duke and therefore not allowable as deductions from his income.
   Held: the annuity is not wages. It is not taxable and can be deducted from income
         o Taxpayers are entitled to order their affairs to avoid tax liability.
         o Look to only the legal construct not the economic reality. Should not substitute the
             ―incertain and crooked cord of discretion for the golden and straight metwand of the
             law”
                    rejects substance that the servant was serving the duke for something equal to
                       his former wages and that while he is serving, the annuity therefore must be
                       treated as wages
         o The side letter was not a binding contract. It was an agreement and not a contract.
                    There is no legal right or obligation created by the letter. Therefore only the
                       deed creates liability for payments and they are not payments of wages. They do
                       not arise from employment. Cannot substitute different legal rights in place of
                       the legal right and liability which the parties have created under the deed.


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        o Substance of the transaction is the legal relationship between the parties and that which
            results from the legal rights and obligations that the parties have ascertained
        o plain meaning: conclusion necessarily flows from a literal or plain meaning approach to
            statutory interpretation. The subject is not taxable by inference, but only by the plain
            words of a statute applicable to the facts and circumstances of his case.
        o BUT may disregard the nomenclature used by the parties to a contract in favor of
            the legal substance which results from the legal rights and obligations created by the
            parties ascertained by ordinary legal principles– rejected the more expansive
            doctrine of economic or commercial substance over form adopted by the US.
        o Sham: Will not let legal documents that are not bona fide and are not intended to be acted
            on to be used as a cloak to conceal the true nature of the transaction.
   Dissent:
        o not denied that the deeds were made as a device by which the duke might avoid some of
            the burden of the surtax – but has the right to organize affairs to attract the least amount
            of tax; only function of a tax court is to determine the legal result of his actions
        o must not go beyond the legal effect of the agreements made, construed in accordance with
            ordinary rules

   Sham Doctrine is used when a legal relationship is created by acts or documents that the courts
    do not find to be credible. Act or document gives the appearance of creating legal rights and
    obligations between the parties different from the actual rights and obligations the parties intended
    to create
                   Some cases widened the shame doctrine to approach the Business Purpose Test
                     – however it has since been narrowed.
                   Snook v. London: emphasizes deception in applying Sham (creates the
                     illusion of legal relationships that do not exist)

   Canadian courts have on occasion favored the more broad doctrine of economic or commercial
    substance over form (Bronfman Trust: assessing taxpayer‘s transactions by looking at the
    commercial realities rather than classification of form may help to avoid the inequity of tax
    liability being dependent upon the TP‘s sophistication of manipulating a sequence of events to
    avoid tax.)

Ineffective Transaction Doctrine
Atinco Paper Products Limited v. The Queen
Ineffective Transaction Doctrine: if the details of the tax avoiding transaction are not complete and correct the
transaction will be set aside.
   cannot simply do something that may be correct in form, but not in all respects a legally correct
    legal transaction to avoid taxes. Where TP has failed to follow the necessary formalities through
    which specific legal relationships are established, courts may conclude that the transactions that
    they have sought to carry out are legally ineffective
   You must actually complete all the legal elements of the transactions you enter into. (Poor or
    incomplete transactions will be caught by this – live by the technicalities of the law you will die
    by them.)
         o High level of scrutiny as to whether you completed all your legal steps.
                    Where a transaction may be allowed on equity grounds in other cases, it will fail
                      in tax law.

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   usually invoked to challenge tax-motivated transactions involving partnerships, trusts and
    corporations. (IE in Atinco, attempted to divide the income of a partnership into 5 separate TPs,
    two of which were trusts that were designed to split income among various family members -
    trusts did not satisfy the legal formalities necessary to create a trust)
   Result: If legally ineffective, tax will be assessed on the basis of the transactions actually entered
    into and the legal relationships actually created
   like the Sham Doctrine, reflects the more general rule expressed in Duke of Westminster that the
    tax consequences are to depend on the legal substance actually created by the parties rather than
    the form or nomenclature they employ
   some decisions have suggested that the courts should more closely scrutinize transactions that are
    entered into deliberately in order to obtain tax advantages (Rose v. MNR)


Business Purpose Test
   US Approach: The US approach is far less permissive and very critical approach of tax
    avoidance.
        o BP test EXPRESSLY REJECTED IN CANADA

Gregory v. Helvering, Commissioner of Internal Revenue (1935)
Business Purpose Test: Transaction needs to have an independent business purpose beyond tax avoidance.
The economic or commercial substance of the transaction should prevail over the legal form of the transaction –
in characterizing transactions.
   Facts: Gregory owns United Mortgage Corporation (UMC). UMC owns shares of Monitor.
    Gregory wants to sell Monitor shares.
        o Problem: if UMC sells the shares and give her the profits it would be a dividend (taxed
            higher than a capital gain). Similar problem if UMC gives her the shares.
        o Solution: G does a corporate re-organization of UMC. Creates Averill which is given
            UMC‘s stake in Monitor. Averill dissolves the next day and G gets the stake in Monitor.
            G sells the shares directly and claims her profits as a capital gain.
   Held: This is really a dividend.
        o It must be something in pursuance of a plan of re-organization. The real purpose was
            not to re-organize the corporate assets. It was to get the monitor shares into G‘s hand to
            minimize taxes.
        o The transaction was outside the purpose of the re-organization provision.
                   If a transaction is entered into for no business purpose but only to avoid
                      tax, then it can be ignored for tax assessment purposes.
   Discussion:
        o Very different from Duke of Westminster.
                   Supports substance over form and look at the purpose of the code not the
                      words of it.
        o Canada had adopted the UK – strict construction approach – and it retains strong
            influence. But this has changed:
                   Bronfman Trust v. The Queen: Look at the economic reality and not just the
                      legal form.
   Canadian Approach: The Business Purpose Test was expressly rejected in Stubart

Stubart v. The Queen


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SCC expressly rejected the Business Purpose Test. ITA has a dual purpose, Business Purpose would defeat its
dual purpose because it is too wide.
Instead it found that the motive of the transaction, tax avoidance, is irrelevant.
   Held: SCC expressly rejected the business purpose approach and accepts the irrelevant motive
    test.
          o Business Purpose Test is too wide. It can catch people acting on a tax incentive.
                    ITA has a dual purpose: economic and fiscal policy implementation and revenue
                       collection.
                             Only want to catch behaviour that is designed to defeat the express
                               intention of parliament not use of policy provisions.
                    Rejecting the Business Purpose Test maintains the balance between taxpayer‘s
                       freedom and government‘s interest in revenue generation.
                    No good reason to adopt Judicial Anti-Avoidance rule in Canada because there
                       is a Statutory Anti-Avoidance Rule.
          o The motive of the transaction being tax avoidance is irrelevant.
          o Not mentioned but relevant: Personal purpose is protected by rejecting the business
            purpose test.
   Conclusion: reaffirmed traditional judicial approach to tax avoidance at the same time as it
    announced the demise of strict construction.
   Parliament effectively overruled this case by enacting the GARR, but still remains the most
    authoritative statement of judicial anti-avoidance doctrines in Canadian tax law

   Massey Ferguson Ltd v. The Queen:
       o point is to balance the TP‘s freedom to carry on his commercial and social affairs
           however he may choose, and the state interest in revenue, equity in raising revenue and
           economic planning
       o rejection of business purpose test:
             o would run counter to the apparent legislative dual intent in modern taxing statues
                – no longer a simple device to raise revenue to meet the cost of governing the
                community. It is also employed by government to attain selected economic policy
                objectives – therefore statute is a mix of fiscal and economic policy
             o economic policy element may take the form of an inducement to the TP to
                undertake or redirect a specific activity. Without the inducement, the activity
                may not be undertaken by the TP, for whom the induced action would otherwise
                have no BF business purpose. By imposing a positive requirement that there be
                such a BF business purpose, TP might be barred from undertaking the very
                activity parliament wishes to encourage
             o Business purpose itself can be tax avoidance: arguable that the TP was attracted
                to these incentives for the valid business purpose of reducing his cash given to tax
                and conserve resources for other business activities
             o therefore more appropriate to have a test which addresses the transaction which
                has the designed effect of defeating the expressed intention of Parliament
             o equity: should have rule which provides for uniformity of application of the act
                and reduce the attraction of elaborate and intricate tax avoidance plans and
                reduce the rewards to those best able to afford the services of tax technicians.
       o Guidelines for the court:
              1. where there is no BF business purposes for the transaction, may apply legislative section s.
                 137 (245 which disallowed any deduction for a disbursement or expense that would reduce
                 income artificially or unduly)
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           2. where legislative section does not apply, older rule of strict construction of a statute, as
              modified by the courts prevails, but will not assist the TP where: a) transaction is legally
              ineffective or incomplete; b) the transaction is a sham, according to classical definition (IE
              requiring an element of deceit or deception)
           3. formal validity of the transaction may be also insufficient where
                a) Sham - the allowance, deduction or benefit sought to be gained, clearly indicates a
                    legislative intent to restrict such benefits to rights accrued prior to the
                    establishment of the arrangement adopted by a TP purely for tax purposes (IE that
                    any transaction entered into for tax purposes cannot have any retroactive effect and
                    change the character for tax purposes of income that had accrued prior to the new
                    arrangement – close to classical shame doctrine));
                b) Where identified business function required by the Act (IE s. 18(1)(a))
                c) Transaction still contradicts the object and spirit of the Act - procedures blatantly
                    adopted by the TP to synthesize a loss, delay or other tax saving device which
                    contradicts the object and spirit of the act without attaining the heights of
                    artificiality in s. 137. TP‘s actions cannot by itself avail him of the benefit of the
                    allowance.
         otherwise, where the substance of the Act, when the clause is contextually construed, is
          clear and unambiguous, and there is no prohibition in the Act which embraces the TP, then
          the TP shall be free to use the beneficial provision in question.

Legislative Anti-Avoidance
  Carter Commission: Two legislative options
      o Sniper Approach: close particular loopholes with very specific anti-avoidance rules one
          by one as they become apparent (meet the court‘s explicit language requirements).
                Positives: Great Clarity, very targeted and precise
                Downsides:
                        Impossible to identify tax avoidance in advance.
                               By the time one loophole is closed another is opened.
                        Specific tax avoidance clauses often open up new loopholes
                               Based on the Exclusion Principle
                        Inequitable: in attempting to be clear and precise and catch everything
                           the legislature may cast their net too wide.
                        Adds greatly to the complexity of the act. It makes it complex, obscure
                           and labyrinthian.
      o Shot-gun Approach: draft broad anti-avoidance rules and direct the courts to give the act
          a more purposive reading.
  Canadian Government has tried, and continues to use both approaches.
      o Sniper Approach, in spite of shortfalls continues to be used.
      o General Anti-Avoidance Rules (GAAR) (S. 245): this provision is aimed at
          transactions whose primary purpose is to avoid tax.
                Parliament specifically cited the need for this rule was that the courts have
                   not altered their approach and have refused to use a business purpose
                   approach.

GAAR
  GAAR was meant to overrule the Stubart decision and bring a “business purpose test” in to
   Canadian law to prevent artificial tax avoidance arrangements



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         o was to reduce what was criticized in Stubart as the actions and reaction endlessly
            produced by complex, specific tax measures aimed at sophisticated business practices and
            the inevitable professionally guided and equally specialized TP reaction
         o intended to strike a balance between TP‘s need for certainty in planning their affairs and
            the government‘s responsibility to protect the tax base and the fairness of the tax system
         o introduced a business purposes test and step transaction concept into the ITA.
         o GAAR only applies after 1988
  Problem: GAAR has been construed quite restrictively – so as to cause some to say that it is close
   to its demise.
  GAAR is a provision of last resort when all other anti-avoidance rules fail.

S. 245: GAAR
  S 245 (2)
        o Where a transaction in an ―avoidance transaction,‖ the tax consequences to a person
            shall be determined as is reasonable in the circumstances in order to deny a tax
            benefit that, but for this section, would result, directly or indirectly, from that
            transaction or from a series of transactions that includes that transaction.
  S 245(4): Courts have interpreted this section as a Precondition: for GAAR to apply there must
   be an abuse or misuse of the provisions of the Act. GAAR does not apply to a transaction
   where it may reasonably be considered that the transaction did not result directly or indirectly in
   the misuse and abuse of the provisions of the act.
                    Catches transactions that violate the purpose of the provisions. Can take
                       advantage of the technical provisions of the act and tax expenditures.
                    OSFC Holdings: Two stage test
                            Discover policy (object and spirit) of provision
                            Assess facts in light of policy.
                            GAAR should only apply when the abusive nature of the transaction is
                               clear
  S 245(3): Avoidance Transaction: any transaction or part of a series of transactions, that, but for
   this section, would result, directly or indirectly, in a tax benefit, unless the transaction may
   reasonably be considered to have been undertaken or arranged primarily for a bona fide
   purposes other than to obtain a tax benefit.
  Must have a tax benefit: S 245 (1) “Tax Benefit”: scope of GAAR virtually unlimited as applies
   to any transaction resulting in any advantage under the ITA or a tax treaty – deduction of amount,
   reduction, avoidance or deferral of tax or other amount payable under ITA (such as penalties or
   interest), or an increase or refund of tax.
                  Finding of a tax benefit depends a great deal on the benchmark the court sets
                  compare the tax consequences resulting from the transaction carried out by the TP
                     VS the tax consequences resulting from an alternative or benchmark transaction
                     that might reasonably have been carried out but for the existence of the tax benefit
                  where unreasonable to conclude that the TP would have carried out any
                     transaction but for the tax benefit, compare the tax consequences of this avoidance
                     transaction with the tax consequences that would have resulted had the transaction
                     not been carried out
                        But for this section:
                            Option of last resort. Only apply when it is not possible to catch it
                               any other way.
                        Unless it was for a bona fide purpose:

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                          This is a broader test than the business purpose test. It can include a
                           bona fide personal reason.
                         therefore the vast majority of business, family or investment transactions
                           will not be affected since they will have a BF non-tax purpose
                         objective test: not concerned with what was in the TP‘s mind, but with
                           what a reasonable TP in the TP‘s circumstances would have considered
                           to be the purpose of the transaction
        o Reasonable: Onus on the TP to prove that the transaction had a reasonable and
          rational basis and not undertaken primarily to obtain a tax benefit.
                compare: if the transaction could have been achieved in other ways
                transaction will not be considered to be an avoidance transaction simply because
                   it incidentally results in a tax benefit or because tax considerations were a
                   significant, but not primary, purpose for carrying out the transaction
                transitory arrangements IE the establishment of an entity, such as a corporation
                   or a partnership shortly followed by its elimination would be considered purely
                   for tax purposes.
        o Series of Transactions: consider the step transaction doctrine:
              o The Step transactions Doctrine: When there is inserted into a series of business
                 transactions one step that has no purpose other than tax-avoidance then the courts
                 can ignore that step, as if it never took place. Though it may be more than one step
                 that is removed. (Phillips‘ speculation)

  S 245(5): The tax consequences to a person shall be determined as is reasonable in the
   circumstances to avoid or deny the tax benefit.
                 Very broad remedial power. Limits on powers:
                         Must be reasonable consequences
                         Must be determined to deny the tax benefit.
                 Benchmark transaction sets the tax consequences.
                 Arnold & Wilson: A penalty is appropriate only for abusive transactions.

Steps to applying GAAR:
  Tax benefit (S 245(1))
       o To determine this element the court needs to determine what the benchmark transaction:
           what would have been the outcome had the TP not carried out this transaction?
  Transaction mainly for tax avoidance (S 245(3)).
       o If there is an objective bona fide purpose for the transaction GAAR will not apply. Either
           business or personal purpose.
  Misuse or abuse of the Act (violates the ―object and spirit‖ of the act). (S 245(4))
       o Department of finance wanted this to mean ―object and spirit‖ as Estey did in Stubart.
       o Done to avoid striking down tax expenditures.
       o Transaction or series of transactions:
                  Any transaction within a series of transactions can be attacked.
  Assess Consequences:
       o Courts will do what is reasonable to deny the tax benefit.



Jabs Construction v. The Queen


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There was a bona fide purpose for the transaction – giving to charity. GAAR does not apply when there is a
bona fide purpose.
   Facts: Jabs to sell properties to an Arm‘s length purchaser. Jabs gives the property to a charity
    and the charity sells it (to the same purchaser). The Capital gains are realized by the Charity (FF)
    tax free. FF is controlled by Jabs and loans the equivalent sale price of the property to Jabs. Jabs
    pays interest to FF (which is also tax deductible).
   Held: GAAR does not apply – it is an extreme sanction not to be used on tax efficient
    transactions.
         o Is there a tax benefit?
                    What would be the benchmark
                            Benchmark would be simply selling to the 3rd party. So there is clearly
                               benefit.
                            Without Transaction: there would be no interest deductions and there
                               would be tax on the capital gains.
         o Is there an avoidance transaction?
                    What is the primary purpose of the transaction?
                            Jabs: The purpose was to guarantee a strong financial base (endowment)
                               for a new charity.
                                   He has a history of philanthropy.
                                   The Charity had to invest somewhere. It got an excellent rate of
                                        interest.
                            CRA: purpose was primarily for tax purposes. It was not giving the
                               money to someone. It gave it back to Jabs!
                                   No argument that tax avoidance is functional as a business purpose.
                                   Is this really a good investment?
                                             It is an unsecured and substantial loan. Is this a wise
                                                way to invest the endowment of a charity in a risky loan
                                                like this one?
                                   The loan is so flexible that it was not a guaranteed long term return.
         o Misuse or Abuse:
                    This is what the court settles on.
                            S 110.1(3): intended to encourage charitable contributions. That is what
                               is going on here.
                    This transaction does not offend the object and spirit of the act.
                            He takes advantage of the tax breaks that were made available to him in
                               the act.
   Discussion
         o Question: does it misuse the charitable provisions or the Capital gains provisions.
                    Was this transaction beyond what parliament intended the provisions to
                      do? This is the question GAAR was seeking to address and it is not addressed.

McNichol v. The Queen
Surplus stripping is a misuse/abuse of the ITA. GAAR will catch a surplus strip.
   Facts: Bec, created to manage the building that the law firm was operating out of. Bec sells the
    building. After taxes, Bec had ~$318 K as its sole asset. Shareholders want to distribute that
    money. To avoid dividends, they sell to an arm‘s length investor and get the money as a capital
    gain. Shareholders sell to Beformac for less than the value of the cash in the business: Beformac
    borrows $300 K from CIBC – securing the loan on Bec‘s cash.

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  Held: GAAR applies to this transaction.
       o Anti-Avoidance Rules:
                 S 84(2): any distribution of assets or in-kind benefits to the shareholders are
                    treated like dividends.
                         Does not apply. The purchase of the business cannot be construed as a
                            distribution of the corporation‘s assets
                 S 84(1): can‘t sell the corporation to another corporation (surplus strip) through
                    a non-arms length person.
                         Does not apply. S 84(1) does not extend to an arm‘s length sale.
       o GAAR: Last resort.
                 Was there a benefit?
                         Unquestionably. Benchmark: dividend payout.
                 Was there an avoidance transaction?
                         Yes. The sale of the shares as opposed to the distribution of the dividend
                            was the avoidance transaction.
                 There is no bona fide non-tax avoidance transaction.
                         Tax Payers: the purpose was to terminate the corporation and that was a
                            commercial purpose.
                         Crown (and court): what is more relevant is the specific purpose of
                            selling the shares. Why was the partnership terminated by the sale of
                            shares? It was done to avoid tax.
                 Misuse or Abuse:
                         Rejects the extreme undermining of the act.
                                Extreme Undermining of the Act: GAAR is not to apply to
                                    ordinary tax planning.
                         The object and spirit of the act makes it clear that Parliament intends
                            corporate distributions to be taxed as dividends.
                                This surplus strip is an abuse/misuse of the act.
  Discussion:
       o Timing: if they had sold the corporation while it still owned the business they probably
           wouldn‘t have been caught.
       o Assets: if Beformac had assets of its own to purchase the corporation the case may have
           been decided differently.

Canada Trustco Mortgage Co. (2005 SCC)
GAAR preserves room for legitimate tax planning, it only applies when planning is abusive of the provisions of
the act.
  Facts: a sale leaseback transaction. CTM lends money and also leases properties. It is very
   profitable and is looking for somewhere to shelter its money. TransAmerica Leasing: uses trailers
   to operate it‘s business. CTM buys the trailers then leases them back to TransAmerica.
   TransAmerica pre-pays all its dues under the Lease arrangements. So in effect CTM gets its
   money right back and TransAmerica gets to use the trailers. CTM can now claim
   depreciation on the trailers. TransAmerica still has the trailers (probably received a net financial
   benefit) and it didn‘t care that it lost the ability to claim depreciation because it couldn‘t claim
   them (not profitable).
  Held: GAAR does not apply.
        o Restricts the application of GAAR.
                           Complains that the ITA is too complex and precise.

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                                 BUT the reason it is so complex is because the courts have
                                      refused to apply the act purposively.
                                 Look for express intent not underlying intent.
          o GAAR preserves room for legitimate tax planning. Only applies where it is abusive.
                           Default rule: If the existence of abusive tax avoidance is unclear the
                             benefit of the doubt goes to the tax payer. Minister must clearly show
                             abuse.
          o Entitled to claim a portion of the costs of your assets.
                   Minister: there was no real economic cost. It was a risk free investment.
                   Court: there are specific leaseback provisions. This isn‘t caught. So it mustn‘t
                      have been intended to be caught. This is against the very purpose of the GAAR
                      and the shotgun approach.

Mathew (2005 SCC)
Application of GAAR is a mixed question of fact and law. Appellate courts should defer to the trial courts.
   Facts: A mortgage company (Standard Trust) has bad loans. It transfers the loss to a partnership
    (of which it is a part). ST then sells its part in the partnership to an arm‘s length 3rd party.
   Held: This was subject to GAAR.
         o The anti-avoidance rules were never intended to allow the transfer of corporate losses
            to arm‟s length 3rd parties.
                    There was no intention to carry on business with standard trust.
                    This was a use of the partnership rules that was not in keeping with its object
                       and spirit.
   Discussion:
         o These 2 decisions have a lot for both CRA and taxpayer with respect to the applicability
            of GAAR.
         o Heavy onus on Gov‟t to show that it violates a clear parliamentary intent or
            purpose.
         o LOTS of deference to the trial courts: If you lose at trial you will likely lose on appeal.

Professional Responsibility:
   Rules of Professional Conduct 2.02(5): It is improper to instruct the client on how to violate the
    law and avoid punishment.
        o However, lawyers are permitted to bring a bona fide test case.
        o Position in Canada: Tax lawyers have different views about what the rules require in the
            Canada.
                  Hogg: in favour of active disclosure.
        o US: much more explicit rules around tax practice. In favour of open disclosure.

McDonnell, “Professional Responsibility and Tax Practice”
   There is a duty to advocate zealously in favour of your client.
   There is a conflicting duty to act in the interests of public.
        o Fulfill duties to both by: taking action that is supportable on a fair reading of the ITA.
   The highest ethical standards ought to be observed
        o Ethical is a higher standard than legal
        o System requires honesty on the part of lawyers to ensure the system operates properly.
   Ethical Constraint: shouldn‘t advise against the statute‘s intent
        o But this assumes that the lawyer knows the statute‟s intent!
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                  When it is not clear what parliament intended it is hard to say that the lawyer has
                   any ethical duty.
  Accepted View: it is valid to go the limits of the law in tax planning without moral question.
       o Not colorable to enter a transaction purely for tax avoidance.
       o The courts have pronounced that this it is valid to structure your affairs to avoid tax.
  Tax Professionals have a duty to ADVISE GOVERNMENT:
       o Not only about deficiencies detrimental to their clients but also those deficiencies
          unreasonably in favour of their client.
                 No answer to say you are too busy.
  Other opinions on Tax Avoidance:
       o Scheme or transaction has to have a reasonable likelihood of success – if reviewed by
          CRA or a court it would succeed. (Very high standard).
       o Scheme or transaction has to be probably upheld in the courts. (Much lower
          standard).
       o Has to be a 1/3 or ¼ chance of being upheld to be within the limits of professional
          responsibility (Very low standard).

McQuaig, “Behind Closed Doors: How the Rich won control of Canada’s Tax System”
  Tax Officials consult the industry professionals (even get their help in drafting the legislation) but
   tax practitioners are so a part of the system that they cannot be relied on to give objective and
   timely advice to the Government.
         o Not purposeful but Tax lawyers tend to take on the concerns of their clients –generally
             large enterprises are the only ones who can afford their services.
         o Ties to those clients – networking and socializing as well as personal friendships – tend to
             skew the views of tax lawyers.
         o Tax professionals are not objective. Giving them input is dangerous.
  Scientific Research Tax Credit (SRTC): taxpayers could donate to technology companies and
   then take a credit on that money.
         o Tech companies then often turned out to be shams and they would take the money out
             of the country – to where the CRA could not touch it.
         o This really was tax evasion and not tax avoidance. Some people were subject to criminal
             sanctions.
                    However, it was very difficult to prove beyond a reasonable doubt that
                        there was a conspiracy.
  Tax professionals saw this, and helped with it, but said nothing!
         o Very Surprising considering how vocal they are with criticism.
  Tax Lawyers and Accountants are very good at advocating for their clients (though they claim
   it is on the behalf of the business community in general)
         o Though that ignores the 90% of people not benefiting from the business community.
         o Argument: Government is an inefficient place to allocate resources. Corporations are
             better at generating capital than governments.
                    Governments still get lots of money to provide positive rights, so there is some
                        need to raise revenue… but where is the problem in helping clients minimize
                        tax revenue.
         o Also, it is like having Lawyers acting as advocates for both sides! If the lawyer acts for
             government they are acting against their clients.

Wilkins
  Not everyone takes the most self-interested route.
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        o All Corporations are concerned with public relations.
        o Some people feel morally obligated to pay taxes
  The tax lawyer does not walk into the meeting and take instructions. Lawyer‘s present options and
   clients decide between options.
        o The lawyer should not assume that the client wants to avoid tax. They may not. The
            lawyer should lay out a range of options.
                  Including all material information (risks, tax payable, …)
                  Clients will sometimes prefer a route that is less risky and avoids potential
                     conflicts with CRA.
  Discussion
        o How does this apply as a Jr. lawyer?
                  Need to have an equitable sense of the system.
                  Take the long view. What is an ethical career path given my power at different
                     stages in my career?
        o Do what you can in increments and at the margins to let the client know of certain risks.
        o Don‟t assume that clients want the lowest tax payable.



Employment Income
  Subdivision A of Division B of Part I of the Act: S. 5-8 is used to compute income from a
   source which is then put into S 3(a) as income from an office or employment
  The source concept of income requires a determination of from what source the income flows.
        o Incomes from different sources are taxed differently.
                  Majority of disputes are characterization issues.
  note: s. 3(d) permits taxpayers to deduct their loses from each office and each employment in
   computing their net income for the year.
  s. 5(1): defines income from an office or employment as the ―salary, wages and other
   remuneration, including gratuities received by the TP in the year‖
  s.5(2): defines the TP‘s loss from an office or employment as the ―amount of the TP‘s loss, if any
   for the taxation year form that source computed by applying, with such modifications as the
   circumstances require, the provisions of the Act respecting the computation of income from that
   source‖
  Note: Corporations cannot earn employment income

S 248(1): Defining Employment
  S 248(1) “Employee”: Includes Officer
  S 248(1) “Employment”: the position of an individual in service of some other person. Servant
   or employee means a person in such a position.
  S 248(1) “Office”: a position that entitles the employee to a fixed stipend or remuneration.
   Includes judicial office, office of a minister of the Crown, member of legislative assembly or
   house of commons or any other office, the incumbent of which is elected by a popular vote
   (politicians, directors of corps) or appointed in a representative capacity (appointed government
   positions).
        o Mayor, University Professor, Alderman
        o Not an officer: member of a Royal Commission.



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Characterization: Employment v. Self Employment
  Distinction between employment and business as sources of income
  Significance of the difference between Employment and Self employment:
        o Income from business or property in subdivision b - can claim deductions and expenses.
                  S 9: General presumption in favour of deductions.
        o Employees have much fewer deductions available to them.
                  S 8: General presumption is that you cannot deduct expenses from employment
                     income.
        o Employers must remit certain deductions on behalf of employees
                  Advance tax, EI, CPP and Other deductions.
                  Employer must make matching contributions for EI and CPP.
        o Self-Employed have much better options for tax avoidance
  Therefore for contract workers and businesses hiring contract workers will usually prefer that
   the source of an amount be characterized as business or property, rather than office or
   employment; CRA prefers characterization as an employee.
        o courts have traditionally distinguished between a “contract of service” between
            employer and employee and a “contract for services” involving independent
            contractors.
  There is no characterization issue for officers.

Factors in Distinguishing
  Modern Test: there is no one criterion or test that will be conclusive in determining the nature of
   the relationship. Look at the relationship as a whole and decide on balance.
        o Interpretation: Courts are reluctant to be governed by the legal form. They will look
            at what is actually going on.
                   Though the courts are starting to put more stock in what is in the employment
                      contract.
  Factors: Entrepreneur Test
        o Control (Traditional Test found in R v. Walker and Hopital Notre Dame): Degree of
            control/supervision over how the work is done by the Taxpayer.
                   No longer the only test that is used but still very important.
                   Indicia of Control:
                           Place where the work is done.
                           The times the work is done. (Does the worker determine the time the
                              work is done?)
                           Who controls the quantity of work? Does the worker have the freedom
                              to say ―I will not take that assignment‖
                           Exclusivity: is there an exclusive relationship. Can the worker provide
                              services for others?
                           Assistance: can the worker subcontract the work to others or are they
                              expected to do the work themselves.
                           The nature of the supervision or reporting.
                                  How does the employee/contractor get assessed.
                                  What kinds of reports are filed, how often
        o Ownership of Tools: self employed likely owns their own tools.
                   Accumulation of capital suggests you are in business for yourself.
        o Chance of profit/risk of loss: can profit be improved by doing work efficiently? Does
            failure to do so increase your loss?

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                    
                    Manner of payment
                        Employee: fixed hourly fee or fixed salary.
                        Contractor: fee for service.
                  Expenses:
                        Employee has the expenses paid by the employer.
                        Contractor pays their own expenses.
   Integration Test:
        o Is the worker integral to the business or a mere accessory to the business

Wiebe Door Services Ltd. v. MNR (1986): leading case on distinction between employment and
business (self-employed) as sources of income
Tests: to determine employment or self-employment.
     Control – rejected that this was the sole criterion to distinguish
     Ownership of Tools
     Risk of Profit/Loss
     Integration: apply from the perspective of the worker.
Need to apply multiple tests to determine contract of services (employment) or contract for service (self-
employment). No test on its own in sufficient. Must “search for the total relationship of the parties”
Collectively called the entrepreneur test or economic reality test
   Facts: WDS was holding back CPP, Taxes or EI. Decided its employees were not employees but
    independent contractors.
   Held: Back for lower court review.
        o Control: there was some control over the employees – it could go either way.
                  Company gave out the jobs.
                  They were free to accept or reject the jobs.
                  Work was rarely done at the place of business
        o Ownership of Tools: they owned their own tools and trucks.
        o Risk of Profit/Loss: there was a risk if the installers did a bad job of loss and a profit
           opportunity for doing a good job.
        o Integration: Should look at it from the point of view of the employee.
                  Does the employee consider it their own business or the business of the
                     company?
                  is the employee integrated into the other person‘s business…is he economically
                     dependant? was the employee‘s work an integral part of the employer‘s
                     business?

   Discussion
        o Lots of discussion and debate in Labour law circles about broadening the definition of
            employee for ―non-tax‖ purposes.
                 Make them subject to employment standards laws.
                         Vacation, maternity leave, compassionate care benefits, EI, workers
                           compensation.
                 This may unintentionally remove the tax benefits.
                         The two systems – tax and benefits (EI) – work together. So claiming
                           benefits can subject you to tax consequences.
        o This is in response to the trend towards hiring contract employees.


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Wolf (FCA 2002)
Temp workers are a reality in Canada. Tax needs to adapt to this emerging reality.
Puts a new spin on Wiebe Door:
   Risk of Loss/ Chance of Profit: Court looks at the other kinds of risks that the “new breed” of
    workers takes on.
   Losses: not just financial losses, look at other losses that the employee takes on.
Contractual intent cannot be disregarded in a close case such as this one. Legal form of the contract does have
an impact on characterization.
   Facts: Wolf is a mechanical engineer – very highly skilled and sought after. He has a fair amt of
    bargaining power. He chose to leave his employment relationship to become a contract worker –
    higher salary available. Details of the employment relationship: Only working for one firm at a
    time – contract is renewed at the company‘s discretion. Paid at an hourly rate and paid for
    overtime. Vacation pay bonus. Paid for statutory holidays. Bonuses for completion of projects.
   Held: This is self employment.
        o ¶ 64: ― the appellant submits that he belongs to a category of temporary workers, a breed
            that is on the rise in Canada‖
                    Temp workers are a reality in Canada.
                    Tax needs to adapt to this emerging reality.
        o Puts a new spin on Wiebe Door:
                    Risk of Loss/ Chance of Profit: Court looks at the other kinds of risks the ―new
                      breed‖ of workers takes on.
                           Losses: not just financial losses, look at other risks that the employee
                               takes on.
                                   No job security, hope for promotion, health insurance or benefits.
        o This is not a sham. This is genuinely a contract for services. Why second guess a valid
            contract?
                    ¶122: “Contractual intent cannot be disregarded in a close case such as this
                      one”
   Discussion
        o Neutrality argument:
                    People will have an incentive to take tax advantages.
                    Tax may be driving some firms/people to make the decision to become an
                      independent contractor.
                           Self-Employed: have to make CPP contributions on their own behalf –
                               at double what they otherwise would.

Inclusions
Basic Inclusions
S 5(1): Basic Inclusions in Income
   S 5 (1): a tax payer‘s income = salary, wages and other remuneration, including gratuities,
    received by the taxpayer in the year.
         o Received: when it is received on a cash basis or constructively received (when it is
            under your power to collect it).
         o Other Remuneration: could include fringe benefits, but because of interpretation more is
            required to include them.
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     Note: no definition for fee, salary or wage: dictionary definitions:
    Fee: sum payable to a public officer for performing his function (fixed payment in respect of an office)
    Salary: fixed payment made by employer at regular intervals, usually monthly or quarterly to person doing other than
     mechanical or manual worth
    Wage: amount paid at regular intervals esp. by the day or week or month, for time during which the workman or
     servant is at the employer‘s disposal.
    Gratuity: a gift or present (usually money) often in return for favors or services, the amount depending on the
     inclination of the giver – tip, bribe.
    Remuneration: based on statutory interpretation, is understood as a generic term that includes among other
     unspecified payments, fees, salaries, wage and gratuities.

     S 6(3): expands the scope of above provisions by including specified amounts that can
      “reasonably be regarded as having been received” from an employer or future employer not
      only as remuneration for services but also as consideration for accepting an office or entering into
      a contract of employment or as consideration for a covenant with respect to the employee‘s
      conduct before or after termination of the employee‘s employment
          o Payments deemed to be remuneration for services rendered:
                    Received while the payee is an officer or during the period of employment
                       where it is received by one person from another or
                    Signing bonus or retiring allowance etc: Payment is made on account, in lieu, or
                       in satisfaction of some obligation arising out of an agreement made immediately
                       prior to, during, or after a period of employment.
          o Unless the payment cannot reasonably be considered received:
                    As consideration for accepting the office
                    As remuneration for services
                    Consideration or partial consideration of a covenant to do or not do something
                       before or after employment.
          o This is an anti-avoidance rule designed to widen the tax base.

     s. 6(1)(b): must include allowances given to TP: requires TP to include all amounts received by
      the TP in the year as an allowance for personal or living expenses or as an allowance for any
      other purpose (except various allowances specifically excluded from tax in (i) to (ix)
     S 6(1)(c): directors and other fees received by the taxpayer in the year, in respect of an office or
      employment.
           o “In Respect of” is given the widest possible meaning.


Specific Inclusions - Benefits
S 6(1): Specific Inclusions in Income
     S 6(1)(a): the value of board, lodging and other benefits of any kind whatever received or
      enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of an office or
      employment, except the following: EXCLUDE the EXCEPTIONS from determining income:
          o S. 6(1)(a)(i): registered pension plans, group sickness or accident insurance, private
              health services plan, supplementary unemployment benefit plan, deferred profit sharing
              plan or group term life insurance.
                     These are tax expenses that the government wants to encourage. Very tax
                        efficient benefits.
                     Corps can provide the benefit without tax burdens on the employees.
          o S 6(1)(a)(ii and iii): these are not true exceptions. They are dealt with elsewhere: ii)
              retirement compensation; iii) use of a car
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       o S 6(1)(a)(iv): counseling services:
               Mental or physical health of the taxpayer or an individual
               Re-employment or retirement of the taxpayer.
       o S 6(1)(a)(v): amounts of a salary deferral arrangement.
               This is not a true exception. It is dealt with elsewhere.

Steps to applying 6(1)(a)
 Is there a benefit?
                   Characterization as a benefit – main issue.
                   Material acquisition – ignore de minimus benefits.
 Is the benefit sufficiently linked to the employment to be in respect of, in the course of, by
   virtue of?
                   These are extremely broad words.
                            ―In respect of‖ are words of the widest possible scope. It is the widest of
                              any expression intended to convey some connection between two related
                              subject matter. (Nowegijick, Savage)
                   Waffle: A prize from the manufacturer (not employer) for his outstanding sales.
                       Court: this is ―in respect of” his employment so it is included in income.
                   Savage: received 300$ from employer for passing examinations of courses that
                       the TP voluntarily engaged in concerning life insurance company operations.
                       Payments were received in respect of employment as took courses to improve
                       her knowledge and efficiency in the company and for better opp for promotion.
                   Phaneuf: whether the benefit had been conferred on the TP as an employee or
                       simply as a person.
  If it is a benefit received in respect of employment, what is the value?
                   The act says nothing about how to value the benefit.
                            It is a difficult area. It is not a very principled approach. Generally the
                              courts just pick a value proposed by counsel.
                   Detcheon: value was deemed to be the FMV of the average cost to the school to
                       educate a student – what the other parents would have paid.

 Logic behind the provision:
       Tennant v. Smith: bank employee given free lodging. Revenue tried to tax it. JCPC:
         can‘t tax savings of the pocket, only what goes into it.
                Enacted to overcome this decision.
       Professor v. Krishna: it is intended to equalize the tax payable by the employees who
         receive their compensation in cash and those who receive compensation in cash and
         in kind. Otherwise, without this rule, the tax system would provide an incentive for
         employees to barter for non-cash benefits.
       Must protect the revenue base. Allowing this would result in a failure of the tax system:
                Equity: not equitable to ignore benefits in taxation – they increase economic
                   power.
                        Horizontal: need to tax people the same if in benefits or cash.
                        Vertical: only higher wage earners would be able to barter for these
                          services.
                Neutrality: don‘t want to influence people to take benefits over cash because of
                   taxes.
                Simplicity: simplest thing would be just to tax cash. Benefits increase
                   administrative costs and complexity of the system.
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Characterization as a benefit
   Decide between Personal Consumption and Employment expenses
   Traditional Personal Consumption Items:
           Food, clothing and shelter (including the cost of commuting from home to work)
           Health and fitness, education, leisure and recreation.
   BUT NOT ALWAYS Personal: sometimes these can be Employment needs.
            Special or Distinctive Clothing for on the job – i.e. a uniform.
                     Assess it on the preferences of an Objective person – whether a person would
                        wear it normally.
                     Huffman: special clothing grants for a plainclothes policeman is an
                        employment expense. It is not a benefit (Oversized and for the job only).
            On the job training. Education required by an employer.
            Appropriate transportation to and from the office.
                     Special transportation: paying for a cab if you work late.
            Recreation or Entertainment: what if it is to entertain clients or to meet prospective
              clients.
   It is difficult to draw the line between business and personal.
            Where there is a strong mixed quality to the item the courts tend to ask what was the
              primary purpose of the work?
                     Compensating the employee or to facilitate work.
                     Primarily for the employer‘s benefit or employee‘s benefit.

Lowe v. The Queen (1996): travelling expenses
Look at who the primary beneficiary of the expense was, the employer or employee. Considerations:
   Amount of time spent on business v. leisure activities. – was the principal purpose of the trip for
    business or pleasure? Was any pleasure merely incidental to business purposes?
   Ability to decide how to spend your time.
   Freedom to decline trip: This does not require a legal obligation to take the benefit – it can be
    practical obligation.
   Irrelevant if the trip was enjoyed.
Look for a material acquisition of something with economic value. Does the item provide the employee with an
economic advantage that is measurable in monetary terms?
Note: consider it for spouse too (if she went for personal enjoyment and not as part of “selling unit”, than one
half of expenses to be included.) or if any part of the trip represents a material acquisition for or something of
value to him in an economic sense (any kind of reward from the employer), unless it was a mere incident of what
was primarily a business trip
   Facts: The employer pays for an expense paid trip to New Orleans for Lowe and his wife. Trip at
    the request of employer and at his expense. The trip is a sales incentive for the brokers Lowe
    handles. Mr. Lowe was there supervising the trip and building relationships with his clients.
   Issue: is the trip a taxable benefit under s. 6(1)(a) that should be included in calculating his
    income?
   Held: This is not a taxable benefit.
          Characterization:
                   Was there a material acquisition of something with economic value?
                           Trying to rule out de minimus elements.
                           Does not have to be remuneration, any material acquisition

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                    If so who was the primary beneficiary – the employee or the employer? Was
                     the primary purpose business or pleasure? Considerations:
                           Amount of time spent on business v. leisure activities.
                           Ability to decide how to spend your time.
                           Freedom to decline trip.
                                 o This does not require a legal obligation to take the benefit – it can
                                     be practical
                           Irrelevant if the trip was enjoyed
                                 o Cannot vary tax treatment according to subjective preferences.
          Primary purpose of this trip was to benefit the employer.
                   primary purpose of the trip was business, any pleasure merely incidental
                   There were lots of recreational activities – but these activities were actually a
                     part of their work activities.
                   overwhelming portion of Lowe‘s time was devoted to business activities.
                   There was no ability to select how to spend their time and there was little time
                     left over for personal pleasure
                   It was strongly expected that Mr. Lowe and his wife attend.
                           There could have been negative consequences hade Mr. Lowe or his wife
                             failed to attend.
                   no element of ―reward‖ for the Lowe
                   spouse: her presence with her husband was at the request of the employer
                     primarily to serve the employer‘s business. Moreover she attended all the same
                     meetings
          Does not apportion benefit – uses on/off approach.
                   This was characterized entirely as non-personal consumption.
                   The incentive program was primarily for the customers NOT the brokers.
   Discussion:
          Gendered nature of business:
                   Women continue to assume more responsibility for unpaid family roles and are
                     symbolically associated with the family.
                           Family tends to be seen as the realm of the personal.
                   So will activities done by the woman be associated with personal consumption
                     more readily than the same activities performed by the man.
                           MNR seems to be falling into the above gendered view by suggesting
                             that the wife‘s role was personal.
                           Court is refusing to allow this, they saw her economic role.
          Wife has to actually contribute to the business before the courts will allow her presence as
            a business expense (Paton).

O’Brien
Though the taxpayer himself did not receive or enjoyed the taxable benefit, a benefit can accrue to the taxpayer
through his dependents.
   Facts: TP, employee for English company was posted in Canada. Family got holiday trips to
    Canada to see father paid by his employer
   Held: TP enjoyed a benefit through the immediate members of his family who were depending
    upon him for their own personal and living expenses. This benefit is included under ―other
    benefits of any kind whatsoever‖

Detchon
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Look for a legal obligation to accept the benefit – otherwise it is taxable. School is a presumptively personal
expense.
   Facts: D works at a boarding school. He is expected to dine with the children and stay on the
    campus. He is given free tuition from the school to send his children there so he could see them.
   Held: He was not required to send his children to the school in the contract. He could have sent
    his kids elsewhere had he so desired. It is a benefit.
           Court takes a legal approach to the case.

Guay
Non-taxable because he needed to enrol his children or he would forfeit the opportunity.
   Facts: re-imbursement for enrollment in a special school for his children. Needed to enroll now
    because it would be impossible to enroll later if he didn‘t.
   Held: non-taxable benefit. Simply puts him in the same position as if he hadn‘t moved.

Gernhart
Considerations of Horizontal equity will inform the courts in deciding if a benefit is taxable.
   Facts: US employee seconded to Canada. Gets an additional amount to ―top-up‖ her income to
    account for higher taxes in Canada. Argued that it was to keep her level of consumption steady.
   Held: The equalization payment is taxable.
          Horizontally inequitable to give her a lower tax rate – compared to other Canadian
            employees in the same office.

McGoldrick: meals
Lunches are more than incidentally beneficial on the employee. They are a taxable benefit.
   Facts: Employee worked at Casino Rama given one free meal at work. Employer did not allow
    the employee to bring food with them and impractical due to location to get food off site.
          Employer included on the T-4 ~$1000 per year on food (including hams and Turkeys) and
            entertainment.
   Held: Primary purpose was to serve the employer‘s needs.
          Health code or sanitary reasons to force the employee to eat on the premises.
          Eat the lunches more quickly.
          But the personal benefits were more than incidental.
                   Phillips: INCONSISTENT WITH LOWE!!
   Discussion:
          It is very difficult to understand this case in context of the other cases.
          The reasoning seems strained and it is difficult to reconcile with other cases.
          Could make free meals a taxable benefit.
          Phillips disagrees with the decision in this case.

Huffman: uniform clothing
Not a benefit, if the money is simply being used put in the employee in the position he was in before the
employer ordered him to incur the expense (clothes for undercover police officer).
   Facts: Employee needed to buy special clothes as an undercover police officer – oversized clothes
    to conceal a weapon that wore quickly because of his work.
   Held: not a benefit, he was simply being put in the position he was in before the employer ordered
    him to incur the expense.
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  CRA IT-470R does not consider an employee to have received a taxable benefit where the
   employee is required to wear a ―distinctive uniform‖ while carrying out the duties of employment
   or provided with ―special clothing‖ including footwear, designed for protection from the particular
   hazards of the employment. Nor are payments made by the employer to laundry or dry cleaning
   for such clothing

Deitch: professional liability insurance paid by employer
    Facts: legal aid lawyer sought to exclude professional liability insurance that the employer had
     paid on his behalf. Stated that it was a mandatory term of his employment from which he
     received no benefit
    Held: clearly an economic advantage as the TP would have been required to pay that amount or
     he would not have been employable as a lawyer. Benefit as the employer protected the TP from
     any personal liability in respect of any acts of professional negligence.

Faubert: Skills Training
  Facts: accounting skills training to become a CMA paid for by the employer. TP argued that the
   courses were undertaken primarily for the benefit of the employer, which had policy of
   encouraging employees to upgrade their skills and required employees to meet specific academic
   qualifications in order to hold particular positions in the department.
  Held: The skills learned are very transferable – this is a taxable benefit. TP was not legally
   obliged or faced with job loss consequences if he failed to upgrade skills. The decision to seek
   educational upgrading for that purpose was purely personal in nature.
         Consider whether the training is taken primarily for the benefit of the employer or the
            employee
  Three broad categories of training under CRA IT-470R:
         Specific Employment Training: courses which are taken for maintenance or upgrading
            of employer related skills, when it is reasonable to assume that the employee will resume
            his employment for a reasonable period of time after completion of courses. Courses
            related to current and future responsibilities of the employee (not taxable).
         General Employment Training: business related courses though not directly related to
            the employer‘s business (not taxable).
                   EX: employment equity, first aid, stress management, language skills
                   Normally in-house training is not a taxable benefit.
         Personal Interest: personal interest or technical skills not related to the employer‘s
            business. (taxable)

Housing Relocation
  When employers cause employees to move around and offer funds to assist in the move there is a
   benefit – but it is unclear if it is a taxable benefit.
  Court‟s approach:
         Ransom: reimbursement for lost money on the sale his former house in order to move to a
            new location is not taxable because the move was specifically for work purposes. This
            was a loss incurred in the course of the TP‘s employment and therefore is neither
            remuneration nor a benefit of any kind
                   S 6(19): now governs these. ½ the amount in excess of $15K must be included.
         Pollesel: reimbursement for moving expenses when received a new job is not a taxable
            benefit. The TP is not receiving an economic benefit.
                   S 62: moving expenses are non-taxable.

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         Phillips: TP received a 10G relocation payment after transferring from Moncton to
           Winnipeg. Employer offered a subsidy so Phillips could afford to purchase a similar
           house in a more expensive city. TP argued that the payment merely compensated him for
           increased housing costs associated with move, without conferring an economic
           advantage. Court found that lump sum purchase subsidy is taxable. It would enable the
           TP to acquire a more valuable asset.
                  Horizontal equity: Winnipeg people have to pay the same amount for a house
                     as he would. Ignores the intent of the subsidy.
         Hoefele: TP was transferred to Toronto; received a mortgage interest subsidy under a
           program established by their employer to compensate employees for increased interest
           charges on costlier Toronto homes. Court found that the mortgage interest subsidy does
           not increase their net worth. The principle value of the equity the home-owner has is no
           greater. No increase to net worth.
                  There is no improved standard of living – helped to keep the same amenities.
                  House valued at a higher price – but it has the same amenities.
         s. 6(23) creates greater certainty by deeming such to be a benefit received by the
           individual because of office or employment.
         Courts have gone both ways on interest subsidy.
  in 1998 Federal Budget proposed that employer paid relocation expenses be included in
   employee‟s income - to address fairness in the tax system – the exclusion from income of
   these amounts paid by the employer provides a significant tax advantage compared to those
   employees who must bear the costs themselves. BUT to recognize that many employers require
   employees to relocate inc circumstances where the employee would not have chosen to do so, the
   first 15G of amounts paid by the employer for a loss or diminishment in value of a former
   residence not be taxed. ½ of such amounts over 15G will be included in the employee‘s income.
                  s. 6(19): amount paid in respect of a housing loss (other than an eligible housing
                     loss) or on behalf of the TP in respect of or because of an office or employment
                     is a taxable benefit
                  also s. 6(20), 6(21), 6(22)
                  s. 248(1): eligible housing loss: a relocation that enables a TP to be employed at
                     a new work location, provided that the TP ordinarily resided at the old residence
                     before the relocation and at the new residence after the relocation and that the
                     new residence is not less than 40k closer to the new work location than the old
                     residence.

CRA Exclusion of Non-taxable Privileges
  provided that the privilege does not constitute a form of extra remuneration
         discounts on merchandise and commissions on sales
         transportation for employees to the location of employment for security or other reasons
         In-house fitness facilities are not taxable
         fees at a fitness facility or social club.
  Not taxable if it is primarily for a business benefit – networking and business development.
         transportation passes
         Subsidized meals are non-taxable if a reasonable fee is paid.
         Employee discounts are not taxable.

Valuation
  In administrative terms it is the employer‟s responsibility to value the benefit and include it on
   the T4 slip.
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            The employer can get in trouble for not reporting obvious benefits.
            But it is generally the employee‘s responsibility to decide this value when it is contested.
    If there is a disagreement courts turn to
            Valuation methods:
                      What would be the cost to the employer?
                      What would the employee have to pay to replace this benefit?
                      What is the FMV of the benefit.
    Duff: the on/off approach.
            Whatever is the primary purpose consumption/facilitation tax or do not tax the whole
               amount.
            This has been used lately (Lowe)
    Percentage approach: Proportion a percentage reflecting the consumption element of the benefit
     to the taxpayer.
            Huge complexity – used in older cases but not recently
    Detchon: Taxpayer argued that it should be the marginal cost to the employer. Court: no in this
     case it should be the FMV of the tuition – the average cost to the school of education the student.
            In many other cases it is the cost to the employer.
                      I.e.. If the employer pays for an extended stay from a business trip it is the cost
                         to the employer to extend.
    Giffen: Frequent Flyer Points: Court: Philip and Waffle are not authority for the proposition
     that the cost to the employer is a universally applicable measure of the value of a benefit
                      not valued at the marginal cost to the airline ($50) but the price which the
                         employee would have been obliged to pay for a revenue ticket entitling him to
                         travel on the same flight in the same class of service and subject to the same
                         restrictions that are applicable to reward tickets.


Stock Options
  employment income or capital gain?
  Includes stock options for equity and neutrality reasons.
          HOWEVER there is some risk attached to stock options.
                    Stock options are like an investment and we normally tax investments as capital
                       gains, thus one could argue to treat this differently
                    employee is taking on risk with this, in a way that is not like that of other
                       employment income, such that there is horizontal inequity for exec level
                       employees vs others.
                    layer of politics in the rules and attracts much attention – attractiveness of stock
                       options to companies and exec. level employees and also lobbying that occurs re
                       stock option in ITA
          So the Stock Options provisions strike a balance.
  stock option usually has an expiry date in which they have the right to exercise purchase of shares
   at historical rate instead of fair market value at time of acquisition. Able to buy them at a discount
   of market value at time of acquisition
  one could argue that there is a value attached to the option right itself prior to exercising it.
   But s. 7 does not include that option right as giving right to a value.
  stock options only taxable under s. 7; overrides general rules re employment benefits in s. 6



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S 7: Taxation of Stock Options
  S 7(1): an agreement for the sale or issuance of securities to an employee of a qualifying person
   (or a person the qualifying person does not deal with at arm‘s length) a benefit is deemed to be
   received in the year in which the securities are acquired by the employee because of his
   employment (s. 7(1)(a)(iii)).
                  s. 7(1)(a): if below exceptions do not apply, default timing rule: the benefit
                     will be included in the year that the shares are acquired (AKA the year that
                     the option is exercised)
  Process under s. 7(1) according to Taylor:
                  first determine whether the TP is an ―employee‖ of the employer‘s corporation
                     or of a corporation with which it does not deal with at arm‘s length
                  according to Taylor, presumption that all employees are in employment
                  if the TP is an employee, then did he receive them while he was an employee of
                     the corporation?

  S 7(7) “Qualifying Person”: a corporation or mutual fund trust. IE the employer who sells the
   shares to the employee…
          Non-Arm‟s length Person:
                   S 251(1): Non-Arm‘s Length is a related corporation.
                   S 251(2): Related corporation is one that owns a controlling interest in another –
                      50% of the shares that elect the board of directors.
          Where a qualified person has agreed to sell/issue securities of itself or a non-arms length
            qualified person to an employee.
  Need qualified person (or related qualified person), employment relationship and the offer
   to sell securities, in respect of employment (must be employed)
  S 7(5): must be employed: rules do not apply unless the option is made available in respect of
   employment.
  S 7(4): The rules continue to apply after your employment is terminated

  S 7(1)(a) Valuation of the Benefit: difference between the FMV at the time they are acquired
   and the acquisition cost.
         (value at acquisition) 7$ - (cost of acquisition) 6$ x 500 (number of shares) = 500
                  if there is a price for the TP to acquire her option rights  value of
                     acquisition – (cost of acquisition + price to acquire option right) x number of
                     shares
         take value of share – what paid for share x the number of shares.
        
         Value = FMV of the Shares at acquisition time – (Cost of exercising the option + price of
           acquiring the option) – there will only be a benefit if this formula produces a positive
           number – the amount, if any by which (i) exceeds (ii) + (iii)  Value = 7(1)(a)(i)–
           [7(1)(a)(ii) + 7(1)(a)(iii)]

          where the value of the securities exceeds the sum of the exercise price and any amount
           paid by the employee to acquire the right to have the securities, the amount of this
           difference is included in computing the employee‟s income in the taxation year in
           which the securities are acquired, rather than the year in which the shares are sold
           or disposed of.


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                     Any changes in valuation after the time the share is acquired are treated as
                      capital gains or losses and included in the taxation year in which the securities
                      are acquired.

  S 7(1)(a) Timing of the Stock Option: the benefit is included in the year the share is acquired.
   – see exceptions below
  S 7(3): You cannot claim a negative amount on a stock option.

Taylor v. MNR
    Facts: TP became a director for two corporations and received stock options in both. TP stated
     that the benefits of the stock options were not taxable because he was not an employee and he did
     not receive the options ―by virtue of his employment‖ as, as a director, he did not receive
     remuneration; therefore he would fall outside the ambit of s. 7(1)
    Held: TP is an employee and the benefits under the stock options are taxable
               o ―employee‖: according to s. 248(1), a directorship is an office, the holder of an
                  office is an officer and an officer is an employee
               o under s. 248, ―employment‖ means the position of an individual in the service of
                  some other person (including Her majesty or foreign state or sovereign) – TP does
                  not fit in here.
               o employment broadly defined is ―a person‘s regular occupation or business, a trade
                  or profession‖ – must make reference to the ordinary meaning of the word
               o presumption that all employees are in employment
               o TP argues that he received no remuneration as a director for the companies – court
                  holds that the options were granted in consideration of the services that TP was to
                  perform as a director

Timing Exceptions
  TP‘s who acquire securities of a qualifying person are deemed to receive a benefit in the taxation
   year in which the securities are acquired (the year that the option is exercised).
  This is subject to exceptions in ss. 7(1.1) and (8) which defer recognition of the benefit until
   the TP disposes of or exchanges the stocks.
  S 7(1.1): Canadian Controlled Private Corporation timing exception
          If it is a CCPC offering the Stock Option then you tax the benefit to the employee of the
           CCPC or non-arm‘s length CCPC in the year that the share is disposed of.
          TEST: S 125 (7) CCPC: a corporation with the following features:
                    Private (not listed on a stock exchange)
                    It is resident in Canada
                    It must not be controlled by non-residents, public corporations or any
                      combination of the two.
                    employer must be the CCPC
                    employee must be at arms length from the CCPC
  S.7(8): Brain Drain Exception – created, according to Finance Minister Martin, to assist
   corporations in attracting and retaining high-caliber workers and make tax treatment of employee
   stock options more competitive with the US
          You tax the benefit to the employee when the share is disposed of if it is a Qualifying
           Acquisition.
          S 7(9) Qualifying Acquisition Criteria:
                    Only applies to shares acquired after Feb 27, 2000.
                    The employee is not a ―Specified Shareholder‖
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                            Specified shareholder: is a shareholder that owns 10% or more of the
                             shares of any class of shares.
                    Meet the S 110(1)(d) requirements (so they must be prescribed shares)
                    Must be a public company
                    must be resident in Canada at the time that the acquisition occurs
                    There is a cap of $100,000 per year based on the value of the option
                     (employee can obtain a deferral on no more than 100G worth of the stock
                     options obtained in a particular year, measured by the value of the shares
                     at the time the option was granted).
                    s. 7(10) requires that the Employee has to opt for the deferral and file a
                     prescribed form before Jan 16 of the year following the year in which the
                     acquisition occurs, otherwise included in year that you acquire the share. This
                     may be desirable if the TP has a low tax rate in one or both of those years, or has
                     losses to offset the stock option benefit.

Stock Option Deductions
  2 Options, cannot claim both, it is either/or:
     1. S 110(1)(d): Prescribed Share Deduction (Section C deduction – After S 3)
         A classic common share - regulation 62.04:
                 There is no guarantee of return and there is no limit on the potential upside of
                    the investment (suffer the most if the company does badly, but gains the most if
                    the company does well)
                 There can be no redemption right.
                 There must be no minimum or maximum dividend.
                 No preference or guarantee on the wind up of the corporation – no preference
                    over other shareholders; may simply lose your money
                 Provides relief to those providing true equity capital to the company.
         The price paid by the employee must be no less than the price of the security at the
           time the option was granted.  this deduction only applies to actual risk that you
           are taking on. Therefore if share is sold to you at 4$ by employer but worth on that
           day 6$, then deduction does not apply  There can be no immediate benefit from the
           option
         The employee must be dealing at arms length with the corporation.
                 If they are only an employee – they are considered to be arms length.
                         Employee: includes Sr. Management, Directors, Officers
                 This really only catches the Controlling shareholder of the corporation.
                         There is not much to be gained by giving the stock option – they are
                           already heavily invested in the corporation.
         Can deduct ½ of the value of the benefit under S 7(1).
                 *** must have taxable income for the year to deduct from.***

     2. S 110(1)(d.1): CCPC Share Deductions (Section C deduction – After S 3)
         obviously must meet CCPC criteria (above), therefore applies only to benefits
           included under s. 7(1.1)
         A CCPC share that is held for 2 years (must put capital at risk for at least 2 years after
           you have acquired it)
         No restriction on exercise price
         There is no arm‘s length provision.
                 A controlling shareholder could claim the deductions.
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          Again ½ the value of the benefit under S 7(1).

  If deferral is obtained, any increase in value after the shares were acquired are taxed as
   CAPTIAL GAINS – the cost base of each share is increased by the amount of the
   employment benefit included in income for that share
       S 53(1)(j): if you have had to include a benefit under S 7 then that benefit is added to the
         accumulated cost base of the shares. (Subdivision E deduction – part of S 3(c))
              Definition of ACB: the actual cost of the property plus or minus any adjustments
                 required by s. 53
              Add S 7 benefit to acb of share in taking account of any capital gains.
              Calculation: cost of the share + adjustment under this section (the benefit) = ACB
                 (value of shares at the time they were acquired)  take the original price paid +
                 different between price and FMV of the share (ie price of 6$ and then rises to 7$ =
                 6+1 = 7)
              this is then plugged into calculation for capital gain  kg is computed: proceeds
                 of disposition – ACB
                                 o EX: if the TP disposes of the shares for 12$ then it would be 12
                                   minus 7 x amount of shares = 2500.
                                 o then TP must include ½ of this amount in her income under
                                   3(b)(i) as taxable capital gain.
                                 o in determining income for that year – would be 2500 of
                                   employment income and taxable kg of 1250.

  Capital Loss - What if the FMV drops after you exercise the option? Then the benefit would
   still accrue to employment but there would be a capital loss in the year the shares were disposed
   of.
           Recommendation: that a capital losses on shares that were acquired by a stock option
             should be fully deductible against employment income.
                    Minister of Finance rejected the recommendation!
                    Argument: Employees took this as an employment benefit. They made a
                      separate decision to hold the shares – they chose to take the risk as the ordinary
                      investor. It would be unfair to treat these investors differently from others.
                    Though some employees are not permitted to sell their shares – for investor
                      confidence reasons.


Deductions from Employment Income
  Employment deductions are very restricted.
          S 8(2): in Division B only deductions permitted by S 8 can be made in computing
           income – S 8 is a complete code.
          VS income from business or property which allow TPs to deduct a much broader range of
           expenses incurred to produce the income.
          Judges: go both ways on this. Some will extend the act to include things others will not.
  In Subdivision E and Division C it is possible to have other deductions (miscellaneous
   deductions that can be claimed from more than one source other then employment)
  note: 2006 Federal Budget proposed to create a new non-refundable Canada Employment Credit
   that by 2007 would effectively remove tax on 1000$ of the employment income to give TPs a


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    break on what it costs to work (uniforms, computers, supplies…expenses that are non-deductible
    for employees under the rules in s.8)

S 8(1): Employment Deductions
  S 8(1): taxpayers may deduct specific amounts enumerated in the remainder of the S 8(1), as ―are
    wholly applicable to that source‖ or may ―reasonably be regarded as applicable thereto.‖
                     The employee is allowed to deduct employment expenses. The Act tries to
                        distinguish between personal consumption and business consumption.
 Specific deductions permitted:
   8(1)(f): sales expenses: must prove that you are in employment that requires selling and buying;
     IE a traveling, commissioned sales person; basically someone that appears to be self-employed
     that gets some or all of income from commissions; can deduct any expense for the purpose of
     earning your employment income
   8(1)(h.1)&(h): motor vehicle and travel expenses (must not be reimbursed or given allowance,
     must be ordinarily required to carry on duties of the office or employment away from the
     employer‘s place of business and required under contract of employment to pay the expenses)
            theses expenses will be regarded as a cost of earning the TP‘s income from the office or
                employment and ought to be deductible in computing TP‘s income from this source.
            s. 81(j): allows TP to deduct interest payments and capital cost allowances related to the
                acquisition of a motor vehicle that is used to perform the duties of the TP‘s office or
                employment  claim capital cost allowances where something bought that has a
                enduring use (car, but not computer etc) – can deduct it over a period of years.
  note: where travel expenses are reimbursed by the employer, the amount of reimbursement is
    generally not regarded as a taxable benefit within the meaning of s. 6(1)(a) nor an allowance
    within the meaning of s.6(1)(b). Nor are reasonable travel allowances taxable, provided that they
    satisfy criteria for exemption in 6(1)(b)
  8(1)(i): membership dues and other expenses of duties.
                     (i) Payment of professional membership dues (doesn‘t count if you are
                        reimbursed)
                     (ii) Office rent required by a contract
                     (iii) Costs of supplies that were consumed directly in the performance of the
                        duties of the office or employment.
           8(1)(p): Musical instruments
           8(1)(r): Mechanic‟s tools.
                             Overcomes a problem in the case law (Martin) that held tools/uniforms
                                are not consumed fast enough to be considered supplies.
  S 8(2): only those expenses permitted to be deducted under S 8(1) may be deducted in
    determining income.

  NOTE: Further Restriction on S 8(1): Subdivision F S 67
       S 67: Deductions can only be made if they are reasonable.
              Only the reasonable portion of the deduction is allowed if it is determined to be
                 unreasonable.
                     Reasonable can mean that in the circumstances it is a reasonable
                        expense.
                     Minister is not overly aggressive in using this provision. Often used for
                        extravagant or flagrant expenses.
                            o I.e.. Providing a salary to a teenage offspring for summer
                               employment of $200,000.
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                                o court may find that they are entitled to a deduction for such an
                                   extravagant expense, but decide that the deduction must be
                                   limited for it.
           S 67.1: deduction for meals and entertainment has been reduced to ½ of the amount
            otherwise deductible. (Due to personal consumption element of it (meeting a personal
            need anyways))

   8(10): the employer must certify that the expenses under this provision were required by the
    employment.
                  Generally the revenue authorities will take the expense at face value for the
                    requirement for employment.

Section 8(1)(i) Deductions
Deductibility of Supplies
   8(1)(i)(iii): the cost of supplies consumed directly in the performance of the duties of the
    office or employment and that the officer or employee was required by the contract of
    employment to supply or pay for.
           It must be required by employment:
                     It may be an implicit expectation. It doesn‘t need to be in your employment
                       contract.
                     If there is a choice it will not be deductible.
                     many cases turn on the definition and application of ―consumed‖ and to a lesser
                       extent, whether what is claimed can be classified as ―supplies‖

Martyn (1964)
The meaning of “supplies” is construed very narrowly to mean some kind of fungible commodity that is
consumed in the performance of the taxpayer’s duties.
Consumed – refers to a current expense – not something that last over time (capital expense)
   Facts: an airline pilot tried to deduct the cost of his clothing required for work.
   Held: Clothing is not ―consumed‖ it wears out over time.
          Clothing is a capital expense and not a current expense.
                    Employees do not get Capital Cost Allowance – so supplies consumed directly
                      (rather than those that last over time) is more like a current expense.

Fardeau (2002)
Time to re-think the meaning of “supplies.” “Supplies” includes clothing like shirts and socks not just
fungible commodities.
Consumed does not mean instantly annihilated, it can be more gradual than that. Gradual wearing out
should be included in consumption
Cell phone expenses can be deducted – both air time and network connection charges.
   Facts: the taxpayer, an RCMP officer tried to deduct his cell phone, pager, and clothing (socks
    and shirts)
   Held: The court allowed some clothing expenses for RCMP officers.
          Court needs to re-consider the meaning of supplies:
          Court willing to re-examine the limits to 8(1)(i)(iii) in light of changes in the employment
            environment.
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                    Consumed: is a more elastic definition than something that is instantly
                     annihilated in the course of employment. Consumed can be more gradual.
                         Takes a purposive approach.
         While it might be right for tools (they wear out very gradually), things like shirts,
           socks, and boots must be replaced often and at the expense of the employee in the
           modern employment environment. They should not be considered capital.
         Court overruled a CRA interpretation bulletin
                  CRA: can only deduct air time for phones required for work purposes – not the
                     network connection fee.
                  Court: this is too fine a distinction.
  Discussion:
         Definition of Supplies appears to have been expanded.
                  But it seems that neither Martin or Fardeau could be followed in the future:
                     socks and shirts – is this any socks and shirts, or regulation wear for the RCMP?
                     Very ambiguous.
         Policy and Equity: In deciding on what approach to take the courts need to look to
           policy – They need to look beyond the page of the statute – what is an equitable result,
           what is the real ability to pay? For example, with trades people, the cost of their tools,
           though they don‘t wear out quickly, it costs a lot to purchase the tools to complete their
           duties required. In many cases, their tools were held to be not supplies that are consumed,
           but equipment that wears out over time (Payne, Kormarniski). Note also that unlike TP‘s
           earning income from business or property, employees are generally not entitled to deduct
           a percentage of such costs of tools or equipment annually as capital cost allowance.

Glenn
Computer software is permitted as an expense. It is a supplied consumed.
  Facts: Primary job was a real estate appraiser and also a York U professor. Deducted a number of
   expenses – totaling $20K as an employee.
  Held: Some of these expenses were permitted and others not.
         Nothing in S 8 allows you to deduct payments made to accountants.
                  NOTE: for running your own business it is deductible but not as an employee –
                     wider deductions for business.
         Costs of computer software were permitted to be deducted.
                  Allowed as a supply!
                         Phillips: but it doesn‘t disappear as you use it. It can last for a number of
                            years.

Strauss, “Teachers Getting More than an Apple”
  Teachers are getting a classroom with the bare minimum.
  They pay for things to make the class-room more interesting, organized, and stimulating. (An
   estimated $180-Million in 2001)
          Everything from books to Bristol boards, daily planners, duo tangs, stickers, pencils, …
          Report card software, wall charts – of the A,B,Cs – many things for pedagogical
           purposes.
  Phillips:
          Carson: recent case on teachers.
                 Pens, pencils, … were deductible as supplies.
                 Things like books look more like capital.
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           A lot of these things are very clearly not related to personal consumption – what use
            does a teacher have for a wall chart of the A,B,Cs. It is clearly a case of consumption for
            work.
           BUT are these things required?
                  Is it a tacit expectation – in order to excel at the job, get a good evaluation?
           Note: Prior to 1995 it was possible for all employees to deduct $500 dollars.
                  Is this too crude of a measure – some employees have far more employment
                      expenses than others.

Deductibility of Office Rent
  Two places to deduct home office expenses in S 8. But neither deals expressly with home
   offices.
                  S 8(1)(i)(ii): Office Rent required by a contract.
                  S 8(1)(i)(iii): Office Supplies
  Allowed deductions for the Home office:
          Light bulbs, minor maintenance, cleaning supplies, …
          Rent: If you rent your house and use a portion as a home office you can deduct a
            reasonable part of your rent.

Prewer (1989)
It does not have to be a formal part of the contract of employment to be able to deduct office rent under s.
8(1)(i)(ii) it is enough to be a practical requirement.
Quantum of the deduction will depend on the amount of space taken up in the house.
  Facts: She worked at home in the evening and during the day at work. Had a home office and
   made some deductions for that office
  Held: It doesn‘t need to be a contractual requirement that she have a home office.
         It can be a practical requirement.
                 Office in an unsafe neighborhood.
                 She needs to have time with her family.
         Rent:
                 She could have gone to her neighbor and rented a room for an office and that
                     would have been deductible. It is illogical that she can‘t deduct expenses in her
                     own home. So court permits the deduction.
         Quantum:
                 She can make a valid deduction of 1/10 of the costs of maintaining the house –
                     the office only took up 1/12 of the house.
  Discussion:
         Consumption value vs. convenience value?
         Courts: office rent – goes both ways.
                 Drobot: should include all costs whether an employee is a renter or a home
                     owner. In this case, the TP was required by employer to maintain an office in
                     his house. He sought to deduct various expenses associated with the
                     maintenance of the office, including electricity, gas, repairs. Court allowed
                     the deduction of such under Act as “office rent” but rejected the
                     characterization of such expenses as the “costs of supplies consumed
                     directly” as these were not “consumed” as according to purpose of statute
                     and not supplies within meaning of provision.

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                          allowing all costs under ―office rent‖, whether renter or home owner
                           doesn‘t follow the requirements of the statute!
                 Thompson/Felton: it is nonsensical to only allow the deduction for those that
                   rented. BUT it is what is in the statute! Courts don‘t have a choice. Office rent
                   means only rent that is paid to a landlord – it doesn‘t include a mortgage, …it
                   can only arise from a landlord and tenant relationship.
                        This line of cases (Thompson/Feldman/Horbay), which focus on the
                           plain meaning of the words “office rent” appears to be more likely to
                           be followed.
          But does the Thompson line of cases follow the new interpretation principle in the
           GAAR cases!!?! Potential to move away from this line of cases.

S 8(13): Work Space in the home
  If the expense is allowed by S 8(1), certified by the employer 8(10) then we look to see if the
   expenses can be deducted under 8(13).
  S 8(13)(a): The home office expenses can only be deducted if:
          Place where the individual principally performs the duties (perform over ½ of the
            duties for that source of income); OR
          Used exclusively for the purpose of earning income from the office or employment and
            used on a regular and continuous basis for meeting customers or other persons.

  S 8(13)(b): Office expenses cannot exceed the employment income! (Cannot have a loss in
   employment income due to office expenses.)
                  S 8(13)(c): If there is a loss, the amount of the office expense that cannot be
                     claimed because of S 8 (13)(b) can be carried forward to future years.
  It must be a reasonable amount? (S. 67)

Timing Issues
  Employees are taxed on the basis of what is called the “cash method” of accounting
         thus, all items of income actually received in the accounting period are recognized for that
            period, and all expenses actually paid in the accounting are recognized for that period.
         TPs may deliberately delay the receipt of income in order to defer its recognition to
            subsequent taxation years. Act may limit this on an ―accrual basis‖ (at the time earned)
                  in s. 5(1), income for a taxation year from office or employment is the salary
                      etc received in the year; s. 6(1)(a) re benefits also requires TP to include the
                      value of the benefits received or enjoyed by the TP in the year.
  An exception to this is RRSP deductions S 56(1)(a)(i), and also deferred profit sharing plan s.
   56(1)(i)
  Benefits may have a wider definition because of the use of ―enjoy‖ – not just when the benefit is
   received, but can be once it is enjoyed.
  Employers are taxed on a liability basis – when they legally are owed/owe.
                  Avoidance Opportunity: employers can declare a bonus – and deduct it then
                      but not have to pay until later – the employee is not taxed until later anyways.
                           S 78(4): helps control this tax avoidance method
                  If the bonus or salary is not paid 180 days after the financial period in which
                      the bonus or salary is declared it is not counted as an expense for the employer
                      until it is actually paid.


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  Meaning of Receipt: dictionary definition: to acquire of accept, legal concept is associated with
   the acquisition of a legal entitlement to the payment or item that is received. – therefore s.
   5(1), and 6(1)(a) means that income from these sources will generally be recognized in the
   taxation year in which the recipient is legally entitled to the amounts in question (salary, wages,
   etc)
  Meaning of Enjoy: dictionary definition: have the use or benefit – therefore benefits means that
   the value may be included in a taxation year in which the TP obtains the use of a good or
   service (car, free education)
  Cliffe v. MNR: no evidence that the employee had received salary that was owed to him; not
   listed in the company books. Note though that the company had charged the balance of these
   salaries as expenses in determining its income, and also the TPs were controlling shareholders of
   the company and it was their decision which resulted in the non-payment of the balance of the
   salaries. Therefore court took very literal meaning of ―received‖




Income from a Business or a Property
  Business and property are two distinct sources, according to s. 3(a).
          Each business and each property is identified separately.
          This distinction is largely irrelevant for the computation of income but must draw
            distinctions due to the source concept nature of income
  computation of TP‟s income or loss from a business or property is governed by Subdivision
   B of Division B of Part I
  ss. 9(1) defines the income of a TP from a business or property as the “profit” from that business
   or property, a concept that implies the deduction of reasonable expenses incurred in order to
   obtain the income.
  When does the distinction between business and property matter?
          Attribution rules: apply to income from property but not from business income.
          Allowable Business Investment Loss: dispose of shares of a small business corporation
            (using all or substantially all of its assets to carry on a business)
          18(1)(h): when computing income from business or property you cannot claim personal
            or living expenses.
                   But traveling expenses incurred to earn business income can be deducted. Only
                      for earning income from business not from property.
          Child Care / RRSP: can only be attributed against earned income – certain kinds of
            income from property cannot be claimed.

  S 248(1) “Business”: a profession, calling, trade, manufacture or undertaking of any kind
   whatever and…an adventure or concern in the nature of trade (has some of the characteristics
   of a trading enterprise, bold, risky, imaginative) but does not include office employment.
          Widens the dictionary definition of business and ordinary definition stated in Smith v.
            Anderson  organized activity of any kid that is carried on for the purpose of making a
            profit.
          courts have held that there is a wide ambit as to what will be categorized as ―business‖ –
            could even be a one-time transaction


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  S 248(1) “Property”: property of any kind whatever whether real or personal or corporeal or
   incorporeal.
         S 9(3): Income/loss from a property does NOT include a capital gain/loss from the
           disposition of the property.
                  where a gain or loss is of a capital nature, only one-half of the gain is taxable (s.
                     38) and the loss is only one-half deductible (s. 38) and deductible only against
                     taxable capital gains for the year (para 3(b))
         s. 9(1) and para 3(a): where the source of a profit or loss is characterized as a
           “business” or “property”:
                  income is fully taxable under these two sections and
                  losses are fully deductible in computing the TP‘s aggregate income for the year
                     under para 3(d)
         Therefore where gain from property: advantage to argue that it is a gain not contemplated
           by the act (as it will not be included for tax purposes) or (less advantageously) that it is a
           capital gain rather than a business or property.
         VS. where TP suffers economic loss, generally more advantageous to characterize loss as
           from business or property rather than an akl

Characterizations:
Business or Property
  In general: Active v. Passive
         Business income is generated from the combination of Labour and Capital in
           commercial enterprise (Active).
         Property income is generated purely from the ownership of property – from capital
           alone with little or no effort needed – frequently described as investment income
           (Passive).
  Active v. Passive
         Depends on the circumstances of what you are doing to earn the income.
                 Interest on a personal promissory note: little that needs to be done other than
                    own the promissory note to collect the interest.
                 Commercial Lender: they lend money but also perform other services. There is
                    lots of management.
         The key is the amount of services provided.
                 If the LL of a property goes beyond the fundamental services then they are a
                    business.
                         Maid services, laundry services, breakfast services, …
                 if all you do is provide the minimum service and collect rent it looks like
                    property income  just management of property
         The active element does not necessarily need to be provided by the taxpayer.
                 Hollinger: share in ownership of a bottling plant is not income from a property
                    but income from business.
                         Irrelevant that the taxpayer did nothing on his own.
                         A passive stake in a partnership is not property.

Capital Gains or Business Income.
  There is a distinction between capital and business inventory:
        If it is inventory of business then it is not capital but business income when disposed.

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          If it is capital of a business then it is capital when disposed of.
   The type of asset does not conclude the discussion:
          Commercial Real Estate Developer: any gain on sale of the office tower they build is a
           business profit. – this is their business
          Business: operates out of a building for a long time. Any gain on sale of the office tower
           is a capital gain. – not their business.
   What about a one time transaction?
          S 248(1) “Business”: a trade or an adventure or concern in the nature of trade.
                    Courts: wide ambit of what can be considered business.

Taylor v. MNR (1956)
When considering if it is business income or income from a property courts will look at a number of factors to
assist in their decision:
   Singleness or isolation of a transaction is not decisive that it was an adventure in the nature of
    trade. But singleness of transaction may be a factor (may need only one transaction)
   Completely unrelated to the taxpayer’s normal business (IE sale of building that the law firm
    worked in)
   Nothing had to be done to the property to generate the gain.
   The taxpayer’s behaviour: did they act the way a trader in the property would have acted?(“an
    adventure in the nature of trade” is capable of encompassing more than “trade)
   The nature and quantity of the goods in the transaction.
   Was there a speculative purpose (same motivation as a trader? adventurous, daring, risky,
    imaginative ventures)?
   Length of time the investment was held.(the fact that it was held for a long period of time, may
    support that it was an investment and capital gain)
It is really a question of fact based on the circumstances of individual cases
   Facts: Taxpayer is president and general manager of a metals company. He is only permitted to
    buy supplies of metal 30 days in advance. He obtains permission to purchase lead himself further
    in advance – for sale to the company. He makes a lot of money. One time transaction. The profit
    from the transaction was assessed to him and taxed. He appealed.
   Issue: whether the purchase and sale of the lead was an adventure or concern in the nature of
    trade, in which it would be taxable as income from a business, or whether it was property (capital
    gain)
   Held: This was income from a business. Purchase and sale of lead was an adventure in the nature
    of trade. Nature and quantity of the goods excluded any possibility that it was an investment
    involving the realization of a security or accretion of capital.
           The definition of a business can include one transaction if it was characteristic of how a
             trader would operate. TP does not have to be a ―trader‖ for the transaction to be ―an
             adventure in the nature of trade‖ and does not need to have an organization set up.
           California Copper Syndicate Limited v. Harris
                     Where the owner of an ordinary investment chooses to realize it, and obtains a
                        benefit – that is not a profit. It is a capital gain.
                     But there are companies formed for the very purpose of trying to sell the
                        investment for a profit. This is business income.
           Did they intend to hold the property and realize a stream of income or did they intend
             to flip it for a profit?
           Negative Factors:

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                    
                    Singleness or isolation cannot be decisive of if it is an adventure. But singleness
                    may be a factor.
                         One time transaction points towards a capital gain.
                         Though courts hold that this is not a factor, only the nature of the
                            transaction
                  Completely unrelated to the taxpayer‘s normal business.
                  Nothing had to be done to the property to generate the gain(but if you did do
                    something to the property to improve the marketability, then this suggests that
                    you got it to sell it)
          Positive Factors:
                  The taxpayer‟s behaviour: did they act the way a trader in the property would
                    have acted? (IE, here the TP bought it from abroad and sold it to a company of
                    lead in Canada, just like a trader would) Did the TP buy it solely for the purpose
                    of selling it? Did the TP have any considerations of a capital nature in mind?
                    (Livingston, Rutledge). To determine if income from business, compare what
                    dealers in the same kind of goods/property would ordinarily do with what the TP
                    did when he bought and sold it.
                  The nature and quantity of the goods in the transaction: Did the nature and
                    quantity of the goods exclude the possibility that it was other than a transaction
                    of a trading nature? Could the TP do anything with the good except sell it?
                         Only real value lies in re-sale. It‘s only possible use is to be re-sold at a
                            profit – business.
                         did the TP take steps to improve the marketability of the property?
                         Consider whether it was sold in a short period of time
                         He wouldn‘t use it for personal use or to produce a stream of income, but
                            its only use could be its re-sale. (ie property bought was a large quantity
                            of one type of good (whiskey, toilet paper)
                         some kinds of property (business, security) are prima facie of an
                            investment nature in that they are normally used to produce income
                            through their operation or mere possession – merely to sell at a profit is
                            not sufficient by itself to establish TP was involved in adventure.. as
                            circumstances may arise in which it is financially more beneficial to sell
                            the investment than continue to hold it
                  Was there a speculative purpose?
                         Speculating on a short term change in the market price.
   Discussion:
          Other Factors:
                  Length of time it was held for.
                         10 years – probably a capital gain.
                         3 months – probably a business
                         BUT it is not determinative – it is a matter of facts (unexpected
                            change in circumstances.)

Regal Heights Case
Transaction may be characterized as a business (an adventure or concern in the nature of trade) only where the
possibility of resale at a profit was one of the motivating considerations to buy the property in question.
But for test: TP would not have acquired the property but for the possibility of resale at a profit


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Double intention: Though primary intention was to hold the property as an investment, should look to whether,
at the time of buying it, there was a secondary intention to sell the property if the primary intention could not be
fulfilled. Look at the circumstances: IE if there was little likelihood of the property being retained by the TP
because of lack of financial resources. Also look to whether the intentions of the TP change from time of buying
to time of selling (Friesen, CRA interpretation bulletin)
       Facts: TP bought a parcel of vacant land in Calgary for the purpose of building a shopping
        centre, but then sold it.
       Held: gain is business income from an adventure in the nature of trade as TP had a secondary
        intention to resell the property, notwithstanding its primary purpose in buying the property was
        to develop a shopping centre
       plans were heavily suspect that the shopping centre plan would go through – speculative nature
        of the transaction.
Note: difficult to determine an individual’s motivations, especially if it is determining the intentions of a
corporation – where the shareholders disagree on the purpose of why the property was bought or held,
application of a “directing mind” test may be hard.



Reasonable Expectation of Profit
   If an activity is not carried out for the purpose of making a profit it is not a business.
                   also consider hobbies and personal endeavors – EX. Gambling – gambling
                       winnings are not generally included in computing the TP‘s net income in s.3,
                       nor would gambling losses be deductible in computing the TP‘s income, since
                       the source of loss would be a form of personal consumption (hobby,
                       entertainment) not a business or property as required by para 3(d)
   in order to decide whether the source of a TP‘s loss is a business or property within the meaning
    of the Act, cases have developed a test which asked not only whether the purpose of the enterprise
    was to produce a profit but whether the enterprise had a ―reasonable expectation of profit‖
   test originated in Moldowan v. The Queen: found that if there is no REOP, then there is no
    source of income – Stewart however found that the REOP analysis cannot be maintained as an
    independent source test, as this purpose is not specified in the Act. Rather, purpose of the test is to
    distinguish between commercial and personal activities

Stewart v. Canada (2002)
Approach to REOP: A 2 Step approach to determining if it is profit from a business or property
   1) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavor?
    (REOP)
            There needs to be a subjective intention to profit backed by objective factors, as listed by
               the court in Moldowan:
                      Profit or loss experience of the business in past years.
                      Taxpayer’s training
                      Taxpayer’s intended course of action
                      Capability of the venture to show profits, after capital cost allowance
            It is possible to be a personal endeavor in pursuit of a profit!
   2) If it is not a personal endeavor, is the source of the income a business or property?
An intention to realize a capital gain can be considered a profit of the venture.
   Facts: Stewart owns a condo that causes a loss. Bought with $1000 of his own money and then
    borrowed the rest. The interest cost was to exceed the rental income for the first 10 years.
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 Held: This was a business and he was entitled to the deductions.
       Where there is no hobby or personal element (not rented to family members etc, but
         only to those at arm‘s length from him) to the source of income and the venture is
         undertaken with a view to profit the activity is commercial and the taxpayer‘s pursuit of
         profit is established.
       even if there is a personal element, (personal use or benefit) – tax payer still has
         opportunity to show that it was operated in sufficiently commercial manner. Must show
         that predominant intention is to show a profit.
       Reasonable Expectation of Profit:
                Should only be used to prevent losses from hobby activities.
                It should not be used to prevent losses from activities that no bona fide profit
                    generating potential.
                         It is unfair to the investor. The court should not second guess the tax
                            payer‘s business judgment.
                         Though there will come a time when CRA is entitled to determine that
                            the REOP has become an impossible dream
                         must ensure that the tax burden is not shifted to other people because this
                            person               is             circumventing                 losses.

        Criticisms of the REOP test and constraining of the Modern Approach to
          Interpretation:
             ITA does not support a broad application of the REOP test - criticism that the test
               was applied in a broad spectrum of ways – courts would use it aggressively to deny
               losses from bona fide business enterprise
             test is applied in aggressive way which acts to discourage tax payers to make
               investments, thus decreasing efficiency.
             Too vague – what does profit mean, and should it include the capital gain that might
               be realized down the road?
             more of a ―ritual incantation than a legal test.‖
             invites retrospective application – the more aggressive second use of the test invites
               courts to second-guess the tax payer‘s intentions
             caused uncertainty and unfairness to tax payers
             REOP test exceeds the proper role of judges in tax cases. There is no clear statutory
               basis for this test, no where in the act that says that you cant have a source of
               income unless there is a reasonable expectation of profit. Courts therefore in
               developing this test have crossed the line. Courts should avoid judicial innovation
               and rule making; this is distinguished with judicial interpretation. In light of the fact
               that there are anti-avoidance rules in the act, judges should not be adding their own.
               Courts must rather focus on the words and scheme of the Act in interpreting
               (different take on the modern approach, which should also consider intent of the
               Act)
             need for certainty for tax payers – this must be considered in interpreting the act.
             with tax law, it is unique and special and should not use innovation and
               embellishment in interpretation.
 Discussion:
        It can be difficult to determine what activities are personal and what activities are
          “business.‖



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                     The gendered approach to the law may come into play here – is it more likely
                      that a woman running a daycare will be seen as a personal activity and a man
                      fixing a car will be seen as a personal activity.
                     Courts give NO guidance as to when an activity is personal – giving rise to
                      the specter of stereotypical ideas forming the basis of determining personal and
                      business.

Note: tax shelter: a investment that is purchased when you know that it is going to produce losses – it
protects other income from tax. Might later sell at a capital gain, which is taxable many years down the
road at half the rate. Problem is that investment still has to be good. In above case, the losses were
larger than the applicant thought they would be.

So, Key consideration: REOP only comes into play if personal element and if there is a
commercial element of it – do not assess whether commercial element accrues profit. Can‟t just
rely on subjective purpose that tax payer claims. To determine if there is an REOP, look to
objective factors in Moldowan

Proposed REOP Amendment
  S 3.1(1): Can deduct a loss only if it is reasonable that the taxpayer can expect a cumulative
   profit for the period in which the taxpayer has held it, and can reasonably be expected to hold it
                   Limits on loss - This is stricter than the law before Stewart.
  S 3.1(2): determination of profit - Ordinary business income does not include capital gains!
  is a response to deal with Stewart and concern of what is income and what is profit
          This is designed to specifically target transactions such as Stewart‘s that lose money early
            and payout via a capital gain in the end.
  There have been a lot of objections to this proposed amendment:
          It is overly harsh – it denies losses completely!
          It would be better to add the losses to the cost of the property – less capital gains to pay
            taxes on.
  At this point it seems unlikely that it will be passed. There was an extremely powerful response
   from the tax community. But now they state that they are going to draft a more moderate
   response, where profit may include capital gain.
  s. 3(d) amendment: wants to add in ―source‖


Inclusions in Business Income
  There are both general and specific inclusions in income.

General
S 9: General Inclusions for Business and Property Income
  S 9(1): the income from a business/property is the tax payer‘s profit from the business/property.
         Imports concepts of natural deductibility of expenses.
         Profit: is the net amount after deducting your expenses that are consistent with well
            accepted principles of business practice or accounting principles.
                   accounting principles, as modified by the Act – however, profit is a legal
                     definition to the extent that it takes into account other things than accounting.


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            trying to get a true picture of the income of the business – not that it has more assets
               than it really does.
     S 9(2): the loss from a business/property is the taxpayer‘s loss from the business/property.
     S 9(3): income from the business/property does not include capital gains or losses (KG/KL is
      calculated under Div B subdiv c, according to s. 38)

Interest
     S 12(1)(c): applies to payments ―as, on account of, in lieu of payment of or in satisfaction of,
      interest‖ - the taxpayer can choose to adopt the cash or accrual method in including interest
      in its income.
             Include things that may not even be termed or identified as interest by the parties
             includes the interest when paid or when payable  But choice here as to what timing
               rule the TP will use, therefore distinguishing between the cash method (year in which
               received) VS the receivable method (include in the year in which it is supposed to be
               received, but not yet received) – must be consistent in which method you use.
     Definition of Interest: basic cost of being able to borrow someone else‘s money or buying
      something on installment contract. Interest will accrue from day to day for the payor. OR buying
      property on installment (agree to pay purchase price and get property, but will not pay the whole
      price immediately, but over time. Combined payment of the principal part of the loan: interest to
      be paid and purchase price to be paid)
             IE, mortgage, promissory note, loan from bank etc.
     When will it be interest? – nomenclature is not important.
                      It doesn‘t have to be called interest to be interest.
                      The return may take a different form.
             Determining when it is interest is one area where the courts will look at the economic
               reality instead of the legal form. S. 16(1) seems to statutorily require this.

        s. 12(4): Accrual Method: Third method of including interest: must include dead interest
         accrued that has not been paid. Might not have right to receive interest for many years, but must
         include. For example: Purchase bond in 2004; no interest to be paid to you until redeem date of a
         bond – anniversary date might be 2005 – on this date, include all income since you bought bond.
         Redeem date not until 2009.

Payments of Interest and Capital Combined
     S 16(1)(a): Where an amount can be reasonably regarded as interest in the sale of capital it is
      characterized as interest.
            applies ―where under a contract, an amount can reasonably be regarded as being in part
              interest….and in part an amount of a capital nature‖ – in these circumstances, the
              provision says that ―the part of the amount that can reasonably be regarded as interest
              shall, irrespective of when the contract or arrangement was made or the form or legal
              effect, be deemed to be interest on a debt obligation held by the person to whom the
              amount is paid or payable‖
            Anti-avoidance provision to ensure that a reasonable amount of a mixed capital and
              interest sale is attributed to interest.
            looks at economic or commercial substance of the contract rather than form

       Definition of FMV: the highest price available in an open and unrestricted market between
        informed, prudent parties acting at arm‟s length and under no compulsion to act, expressed in

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    terms of money (Connor) – problem is that it is the price agree by two different parties – many
    people would disagree as to what is the FMV of something

Groulx (1967)
When a purchase is HIGHER than the FMV, in an industry that generally charges interest, and payment is
deferred, it is likely that a component of the elevated purchase price is interest.
   Facts: A farmer played hard to get with developers. Negotiated a deal with the developer for his
    land at 395K, which was still considered too high by the purchaser, so farmer waived interest.
                    Developer Pays $395 K over time in annual installments and does not pay
                       interest.
                    If the developer pays early there is a 5% deduction.
   Issue: whether the two sums received by the TP in 1958 and 1959 may reasonably be considered
    as interest received by him
   Held: There is an interest component in this purchase. In waiving interest, TP knew he could
    avoid tax and intention was to insure he received capital price of 395K
           Ability to discount if paid early.
                    Parties took some account of the time value of money
           The taxpayer has some investment savvy – he had a portfolio and had engaged in real
             estate transactions before.
           Consider whether the property was sold at a price more than its FMV - The $395 K was
             more than FMV if all paid immediately.
                    But it is difficult to see this because this is what was agreed (isn‘t that the
                       definition of FMV?) – court is really saying that there is always some element of
                       compensation when money is paid over time.
                    This is particularly true when there are 2 finance savvy parties involved.

Vanwest Logging
Look at 4 factors:
1) the terms of the agreement reached between the parties
2) the course of the negotiations between them leading to the agreement (was interest even considered by the
        vendor? did it effect the price that he charged?)
3) the relationship of the price paid VS the apparent FMV at the time and
4) the common practice with respect to payment of interest normally on that sale of goods.
       Facts: TP had sold tract of timber for 7.5 mil; 1.5 mil was payable on closing with remainder
        due over 5 years in 5 equal installments; interest only in case of overdue payments.
       Held: no evidence that interest was considered by the vendor nor did it affect the price he
        charged. No evidence that there was an invariable practice to charge interest on deferred
        payments in such sales of timber.
           o Also no evidence that it was more than FMV nor that a high price could only be
               justified by not charging interest on the deferred installments.
           o It is possible to have a genuinely interest free agreement.
                    section not to be applied in all cases where no interest is claimed on
                       deferred payments; only should be used when something in the evidence
                       indicates that it was the intention of the vendor to avoid taxation on interest
                       by including it as part of a larger capital payment than would otherwise
                       have been made.

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  Discussion: What about finance savvy parties or those with proper legal advice - they are
    aware that they should not discuss or write down anything in the contract re interest to comply
    with this. Or the unsophisticated seller, who doesn‘t know if they are selling at the FMV and that
    they did not know to ask for interest and this opens up a massive opportunity for the sophisticated
    purchasers?
  Also, does s. 16(1) not require an implied interest payment?
           o Rodmon Construction Inc: well established that the prime factor to consider is
               whether or not the FMV has been paid: if the price paid is in excess of FMV, the
               excess is deemed interest; If the price reflects the FMV then there is no element of
               interest in the payment
           o subsequent cases have considered the 4 criteria in Vanwest, but have tended to regard
               the relationship between the price paid for the property and its FMV at the time of
               the purchase as the most important factor.
   CRA Interpretation Bulletin: where property sold on a deferred or installment payment basis
     and no interest is specified in the contract, it will be a question of fact whether or not each
     payment received by the vendor contains an income element. Possible for a vendor and a
     purchaser to agree on a total selling price which will be payable over a period of time without
     interest charges.
                    section will not apply unless there is sufficient evidence that the selling price
                       of the property is greater than its fair market value. If it is, the interest
                       portion of the blended payment will be no more than the lesser of:
                             a) excess of the selling price over the FMV or
                             b) amount computed with reference to the normal rate of interest
                                prevailing at the time of purchase.

  Annuity Payments: fully taxable under para 56(1)(d), though a deduction is available under
   para 60(a) for the capital element of the payment. Annuity contracts are also subject to special
   accrual rules under s. 12.2. For lump-sum payments for the annuity contract, gains are generally
   subject to tax under s. 148(1), while losses deductible under para 20(20)(b)

  ss 16(5): s. 16(1) will not apply where ss. (2) and (3) apply. These apply to certain debt
   obligations issued at a discount by various non-taxable issuers, under terms whereby the effective
   annual yield from the discount exceeds 4/3 of the stipulated interest payable on the obligation.

Dividends
  Dividends are normally treated like income from a property.
         S 12(1)(j): dividends from resident corporations are taxable.
         S 12(1)(k): dividends from foreign corporations are taxable.
  There is some tax relief for dividends over other ordinary sources of income.
         An individual receiving taxable dividends from a Canadian resident corporation can
           claim a dividend tax credit.
  Recent Change: instead of removing the ability to put income trusts in place, the government will
   increase the dividend tax credit.




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Deductions from Business or Property Income




  S 9(1): Remember, profit: is the net amount after deducting your expenses. Expense must be
   consistent with ordinary business practices.
  S 9 is the authority for all business deductions.
  First step to determine the deductibility: whether it was made or incurred by the TP in
   accordance with ordinary principles of commercial trading or well accepted principles of
   business practice (ALWAYS START ANALYSIS HERE per Symes and Royal Trust)
                  Test: Common law (Symes): was the expense incurred by the taxpayer in
                     accordance with ordinary principles of commercial trading or well accepted
                     principles of business practice or accounting?

  Apply S 18(1): Limiting Clause for deductions under s. 9:
        S 18(1)(a): The ―current‖ or ―ordinary‖ expense must be incurred for the purpose of
          generating income from business or property - expense MUST have an income
          producing purpose.
        S 18(1)(b): No capital expenses, (IE depreciable expense: equipment cannot be
          deducted immediately, as it is to be consumed over many years in your business)
          except as allowed by capital cost allowance rules. (What if it is non-depreciable? IE
          something intangible, like good will - can have cumulative eligible capital deducted).
          Note: with land, for income for the business, cannot claim cost of the land.
        S 18(1)(h): No personal or living expenses (other than travel expenses incurred by
          the TP while away from home in the course of carrying on the TP‟s business (not
          property income))

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   S 67: Further limitation on deductions: The expense is only deductible to the extent it is
    “reasonable in the circumstances”

   S 67.1: Only 50% of entertainment expenses are deductible (due to unfairness that some can
    deduct their personal consumption expenses and due to the fact that it is part of consumption)

   S 20(1)(c): interest that is applicable to the source of income may be deducted.


Fines and Penalties
   These are generally deductible if they are unavoidable and incurred for an income earning
    purpose.
         Traditionally, fine might be non-deductible if the fine was not incurred for the purpose of
           gaining or producing income or if contrary to public policy to allow deduction (should not
           be allowed to share with the public revenue the loss).
         Generally courts disallow avoidable fines (Horton Steel Works Ltd and Commissioners
           of Inland Revenue v. Alexander Von Glehn)
         Consider whether incurred for income-earning purpose, avoidability and public policy:
           incurring the penalty was an unavoidable incident of carrying on the business;
           consider whether fined due to intentional scheme, lack of reasonable care to avoid
           tax (Amway))
   Do not want CRA to help pay fines that were avoidable.

Imperial Oil

   Held: yes, tort liability is for the purpose of earning income; it was not too remote from the
    purpose of earning interest

65302 British Columbia Limited SCC considered deductibility of fines for the 1st time:
Affirms income-earning test: Look for the income producing purpose. Was the fine incurred in order to earn
income?
   Needs to be connected (some nexus) to earning income.
   There is no avoidability requirement for deductibility. It is not established in the case law and is not
    supported by 18(1)(a).
Affirms possible basis of public policy: It is possible to have the fine be for actions so egregious that the
deduction would be contrary to public policy. Subsequent Cases have all but shut the door to the applicability of
this statement (McNeil).
Need to balance objective of taxing only net income VS Parliament not intending fines to be deductible.
   Facts: TP had an egg producing operation. He was part of an Egg marketing scheme – this
    restricted the number of hens it was permitted to have. The TP was caught violating the rules of
    the scheme and fined ($250 K)
           Deducted the fine, interest expenses on the fine and legal expenses for the levy.
   Issue: is a fine deductible and thus, sufficiently connected for business purposes?
   Held: the levy is deductible.
           court looked to certainty, doctrinal coherence, and equity and neutrality and also
             the courts role in tax matters.
           Look for the income producing purpose.
                    Without an income producing purpose it cannot be deductible
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         Avoidability: not to be applied!: Avoidability requirement is not established in the case
          law and is not supported by 18(1)(a)
                  remoteness test also rejected.
         Court notes that Parliament did not intend to allow deductions of fines and penalties but
          this is weighed against the need to only tax ability to pay.
                  Equity would be impacted by a failure to take account of ability to pay.
         Minority approach is too uncertain.
                  Too difficult to determine the purpose of the fine.
         Public Policy basis also rejected: public policy is up to parliament – they need to
          determine if fines and penalties are deductible not the courts. Though found it is possible
          to have the fine be for actions so egregious that the deduction would be contrary to
          public policy and therefore could not be for the purpose of producing income

 Minority:
       Read ITA in context with other statutes.
                Let statutes impact one another – presume that the legislature does not intend to
                  contradict itself.
       If allowing the fine to be deductible would frustrate the purpose of the fine then it should
         not be deductible:
                If it is punitive – deduction cannot be allowed.
                If it is compensatory – deduction can be allowed because it would not frustrate
                  the purpose.
       Levy is deductible because it is compensatory in nature and incurred for the purpose of
         making income.

 Discussion:
        Duff: The avoidability requirement may have survived if the courts had considered 9(1).
               If expenses are unavoidable then they are in accordance with principles of
                  business… but if they are avoidable then they are unlikely to be in accordance
                  with the principles of business.
               Canadian cases have tended to ignore the business practices test in s. 9(1),
                  conflating it with the income earning purpose test in s. 18(1)(a)
               by making the income earning test the only test, the court ignores the scheme of
                  the ITA and its own jurisprudence and by disregarding the business practices
                  test under s. 9(1), SCC overlooks the possibility that avoidability and public
                  policy considerations might be relevant to this more basic test of business
                  expense deductibility.
        Duff: remoteness test.
               The actions leading to the fine must be well connected to making income.
               should be expended for the purpose of the TP‘s trade or connected or arising out
                  of such trade as stated in Alexander von Glehn
                        Don‟t need direct causal but do need some relation.
               courts have often employed this remoteness test under the ITA to decide
                  whether an expense was truly incurred for the purpose of gaining or producing
                  income from the TP‘s business.
        Majority is still creating a small policy objective: ―Conduct not egregious or repulsive.”
               But in subsequent cases the courts have essentially shut the door to the use
                  of this policy objective (McNeil).

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S 67.6: Amendment to Catch Fines
   Section 67.6: No deductions shall be made in respect of any amount that is a fine or penalty
    (other than a prescribed fine) imposed under any law of a country or of a political subdivision
    of a country. Effective March 22, 2004
   Ministry‟s Suggested Treatment: not binding.
           Finance wants the courts to look at the statute that is imposing the fine:
                   If that statute characterizes it as a punitive sanction then it is not deductible.
                   If it is otherwise characterized (a remedial fine – meant to compensate) it is
                      deductible.
           Also, will this or any future government explicitly say that a levy is a fine a penalty or a
            remedial levy!
                   Fines under a private contract are not included in this section.
   Note: under the US Internal Revenue Code, s. 162(f), TP‘s may not deduct any fine or similar
    penalty paid to government for the violation of any law – interpretation of ―fine‖ or ―penalty‖
    found to bar fines that has a deterrent or punitive purpose, not those that are compensatory in
    purpose.


Business v. Personal Expenses
   Courts are reluctant to look at expenses as dual – personal and business. They tend to select one or
    the other.
   issue: although recreation, meals, entertainment are often incurred for the purpose of business
    promotion, they also confer personal benefits both on the object of the promotional activities and
    on the persons who conduct these activities on behalf of the business.
   Policy: purpose of limit on deduction re 18(1)(h) for personal expenses: for those earning
    business income, vertical equity requires that we do not deduct personal expenses because those
    with higher income will be able to deduct more as able to spend more and higher tax bracket; also
    only certain employees would be able to claim personal expenses. In order to maintain like
    treatment of people in like circumstances, we must limit personal expenses as it would be against
    horizontal equity, therefore important that we limit all personal expenses. In terms of neutrality,
    if personal expenses could be deducted then business earners would spend more (buy a lodge, buy
    a nicer car etc), thus changing their spending habits.
   problem with s. 18(1)(h): treats personal and business expenses as completely mutually
    exclusive, but often the goods consumed have dual purposes; this creates problems for the TPs
    and the court to distinguish – therefore against simplicity and certainty. Also important for
    enforceability for the government. Hence the reason why government intervenes to create bright
    line arbitrary rules to limit deduction of personal expenses. Courts take a very dichotomous
    approach to personal vs. business and tend to think of context in terms of what we consume in
    every day life – however, what is business and what is personal can shift over time.

Entertainment Expenses
Royal Trust (1957)
Something is deductible under S 9 if:
   must be deductible according to the ordinary principles of commercial trading or well accepted
    principles of business and accounting practice.
If the expense passes the above test than look to S 18(1)(a) to determine if the expense is deductible: was it
incurred for the purpose of earning income. Factors:
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  Generated business (no need for a causal connection; the expense only needs to be for the
   purpose of earning income).
  Do competitors incur a similar expense
  Evidence about who joined which social club.
  Evidence that the company required executives to participate in the community.
  The type of business was important
  Accountant’s evidence: accountants said it is normally deductible.
         Accountant’s evidence is questionable (different objectives – accountants err on the side
           of conservatism).
Social Club memberships are deductible – later overruled by S 18(1)(l)
  Facts: Social club membership fees. Much business was conducted at and obtained through the
   social club.
  Held: social club fees are deductible.
         S 9 is the authority for and S 18 is a restriction on deductibility.
         Something is deductible under S 9 if:
                  It is deductible according to the ordinary principles of commercial trading or
                     well accepted principles of business and accounting practice.
                  If the expense passes the above test than look for restrictions from S 18 to
                     determine if the expense is deductible.
         S 18 Factors that show the expense was incurred to earn income:
                  Evidence show that there were new clients and files opened from the club.
                          But even if they failed to find this – there is no need for a causal
                             connection.
                          S 18(1)(a) it is not necessary to show that there was income earned from
                             the expense – it just needs to be for the purpose of earning business
                             income.
                  Looked at what other companies did:
                          Competitors were following the same approach.
                          This is almost a section 9 argument as well: ―part of regular commerce‖
                             if competitors do it.
                  Evidence about who joined which social club.
                  Evidence that the company forced the executives to participate in the
                     community.
                  The type of business was important
                          Very personal business where there is a need to make relationships to
                             generate business.
                  Accountant‟s evidence: accountants said it is normally deductible.
                          Accountant‘s evidence is questionable.
                          Where there is a judgment call about deductions accountants would err
                             on the side of conservatism – would prefer to understate earnings – to
                             ensure that no-one is misled.
                                 o In a tax setting the courts do not want the earnings of the
                                     company understated.
                                 o note: in judgment, Thorson stated that should omit reference to
                                     accounting practice – GAAP connotes a degree of control by
                                     professional accountants which is inconsistent with a legal test
                                     for ―profit‖ under s. 9(1). Also, where accountant questioning the
                                     propriety of a deduction may be motivated by desire to present
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                                    conservative picture of current profitability, ITA motivated by a
                                    different purpose: raising of public revenues.

18(1)(l):Social club memberships are not deductible
  No amount may be deducted in respect of:
          The maintenance of property that is a yacht, a camp, a lodge, or a golf course or facility
            – unless the above property is in the ordinary course of business provided for hire.
                           Lodge: a hotel with a whole number of recreational activities attached to
                              it.
                           Doesn‟t need to be long term use – any use!
          Any membership in a club the main purpose of which is to provide dining,
            recreational, or sporting facilities for its members. (CRA bulletin: to determine
            whether the main purpose look to the instruments creating the club, such as content of the
            club‘s bylaws to regulate its affairs and whether more than 50% of the club‘s assets are
            used in providing dinning, recreational or sporting facilities.
  NOTE: the payment or reimbursement of club dues or membership fees by an employer
   would generally be considered to be a taxable benefit to the employee – unless Fringe
   Benefit: if an employer pays fees required for an employee to be a member of a social or athletic
   club, the employee is not considered to have received a taxable benefit when the membership
   is principally for the employer‟s advantage rather than the employees – consider: is it mainly
   for the employee‘s benefit or the employer‘s benefit. If little or no advantage to the employer‟s
   business, then the cost of the membership is considered to be a taxable benefit even though
   fees are not deductible by the employer.
  use of an in-house recreational facility or physical fitness facility that is owned by the
   employer does not give rise to a taxable benefit to the employees
                    no taxable benefit will generally arise to employee if the employer pays a related
                      or unrelated organization to provide such facilities, as long as facilities are
                      equally available to all employees
  s. 18(1)(l)(i): where TP spends amount to ―use‖ or ―maintain‖ a yacht, camp, lodge, or a golf
   course or facility, this expenditure is non deductible, unless it is made or incurred “in the
   ordinary course of the TP‟s business of providing the property for hire or reward”
                    not restricted to a TP who is the owner of a property; also applies to a TP who
                      rents or uses such a property from the owner and the use of the property made
                      by the TP or the TP‘s clients, suppliers, shareholders or employees.
  Sie-Mac v. MNR: TP sought to deduct a sum of money which it spent to send 7 customers, 5
   employees and two employers of a related company on a 3 day fishing trip at a lodge to show
   appreciation to customers and inform them of new equipment and techniques. Court found that
   none of the expenses (food, fishing gear, lodge etc) were deductible, even though it may have
   been incurred for the purpose of producing income, as it fell within the language and
   purpose of s. 18(1)(l)(i) – to curb TPs from taking unfair advantage, as they had before, to
   provide recreational activities to its customers where the direct business purpose of the
   meeting may have been only marginal. As such, parliament put in the section a list of
   recreational sites that were prone to this type of abuse

  Note: Capital Cost Allowance: above section does not prohibit the deduction of capital cost
   allowance for capital cost of the property - for property acquired after Dec 31, 1974, reg
   1102(1)(f) prohibits the deduction of capital cost allowance re property for which the costs of
   use or maintenance are non-deductible by virtue of s. 18(1)(l)(i)

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  Based on the text of the section and the above case, this can lead to some bizarre contrasts:
        If you take your client to a golf course and then take him to lunch at the clubhouse– it is
           not deductible as it is all payment for the use of the facilities and all incidental expenses
           paid at that facility and the cost of getting the persons to the facility.
        if you go and play golf, and then take the client across the street to a restaurant, the golf is
           not deductible, but the lunch may be, if it was for the purpose of earning income.
        BUT if you go play tennis then go to the golf course restaurant the meal is deductible!
                  It is not using the facility of the golf course, so it is deductible.
        If you go to a different restaurant then the golf course restaurant then the meal is
           deductible!
  Recall: benefits – health club firm membership is considered primarily for the benefit of the firm.
        Part of the reason for this lenience is that the health club membership is not deductible
           under S 18(1)(l) so the CRA is not too interested in taxing the employees because they
           already tax the employer.

67.1: Limit Deductions to ½ of Meals and Entertainment Deductions
  Because of the difficulty in separating personal from business there is a 50% limit on meals and
   entertainment expenses.
  s. 67.1(4)(b): entertainment includes amusement and recreation
  s. 67.1(4)(a): no amount paid or payable for travel on an airplane, train or bus shall be considered
   to be in respect of food, beverages or entertainment consumed or enjoyed while traveling thereon.
   – excludes airplane meals and in-flight movies
  s. 67.1(3): applies to amounts paid for conferences, conventions, seminars or similar events at
   which food, beverage or entertainment are provided.
  New characterization of necessity of meals: Scott v. Canada: TP was a courier who delivered
   packages by foot and public transit; sought to deduct the cost of additional food and water that
   he consumed as part of his daily routine. Court rejected that these were personal consumption
   expenses and analogized that the food and water to the gasoline used by couriers who deliver
   packages with their car – if they can deduct the fuel used for a business purpose, then so can
   the TP here deduct extra food and water he must consume above and beyond the avg
   person‟s intake in order to perform his job (found up to 8$ for extra food and 3$ for extra
   water). Encourages new environmentally responsible ways of producing income and
   characterization of the expense may change with the times.

Child Care Expenses
      traditionally a non-deductible personal expense
      as of Jan 1, 1972 the Act was amended to allow a limited deduction for child-care expenses
       under s. 63. During this time, it was 1000 per child, but capped the amount of children you
       could claim. Then raised to 2000 per child. Gone up significantly since then.
      Current Amount: Now it is 4000 per year for children over 6, 7000 for a child under 7 and
       10G for a child of severe and permanent disability, if child qualifies for disability.
      No cap on the amount of children you can claim.
      must be claimed by the lower earning parent
      Cap: can only claim 2/3 of their earned (business or employment) income in the year
       (consider the source of income: if property, no deduction if that is only income; if social
       assistance, this is not earned income, and therefore if this is only income, then no deduction)
      eligible child defined in s. 63(3): a child of the TP or of the TP‘s spouse or CL partner or a
       child dependent on the TP or the TP‘s spouse or CL partner for support and whose income for
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       the year does not exceed the basic personal credit for the year, found in para (c) of the
       description of B in ss. 118(1)
           o provided that the child is under 16 or is dependent on the TP or on the TP‟s spouse
               or CL partner and has a mental or physical infirmity
      Child Care expense defined in s. 63(3): an expense incurred in a taxation year for the purpose
       of providing in Canada, for an eligible child of a TP, child care services including baby sitting,
       day nursery, or services provided at a boarding school or camp if the services were provided
           o (a) to enable the TP, or the supporting person of the child who resided with the child at
               the time the expense was incurred to
                    (i) perform the duties of an office or employment
                    (ii) to carry on a business either alone or as a partner actively engaged in the
                       business
                    (iv) to carry on research or any similar work in respect of which the TP or
                       supporting person received a grant or
                    (v) to attend a designated education institution or a secondary school, where the
                       TP is enrolled in a program of the institution or school of not less than 3
                       consecutive weeks duration and each student spend not less than 10 hrs per
                       week on courses or work in the program or 12 hrs per month on courses
           o (b) by a resident of Canada other than a person
                    (i) who is the father or mother of the child
                    (ii) who is a supporting person of the child or is under 18 and related to the TP
                    (iii) in respect of whom the amount is deducted under s. 118 (personal tax
                       credits) in computing the tax payable under this Part for the year by the TP or by
                       a supporting person of the child.
           o (c) limits the amount that may be deducted re camp and boarding school fees to a max
               dollar amount a week.
           o (d) prohibits any deduction for amount paid for ―medical or hospital care, clothing,
               transportation, or education, board or lodging
      Supporting person: defined in relation to an eligible child of a TP as a ―person, other than the
       TP who is‖ the child‘s parent, the TP‘s spouse or CL partner., or an individual who claimed the
       child as a dependant for the purpose of calculating tax credits under s. 118, provided that the
       person resided with the TP at any time during the year, or within 60 days after the end of the
       year.
      Criticism: considers child care expenses a private cost for parents; not enough for low income
       earners.
      Summary: To satisfy s. 63, expense must satisfy 3 criteria:
           o must be for the purpose of providing child care services
           o child care services must be provided to allow the TP or supporting person to do work,
               research, employment, attend school etc
           o child care services must be provided by someone else other than the child‘s father,
               mother or supporting person or related person under the age of 18.
                    see handout exercise on calculating deduction.



Symes (1986)
Section 18(1)(a): test to determine if the expense was for an income earning purpose?
  Would an accountant say it is deductible?
  Is this an expense many business people would incur? (Common Practice)
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   Would the expense have been incurred but for the business? (Looking Subjectively at the worker)
   Would the need that gave rise to the expense still exist in the absence of the business?
   Is it a personal choice or active consumption?
S 63 is a complete code so there is no need to make the difficult decision between allowing and not allowing.
   Facts: Symes was a partner in a law firm. She sought to deduct the salary of her nanny as a
    business expense. 2 pronged argument: proper interpretation of the Act and charter argument
   Held: should not be allowed (Iacobucci – all male majority)
          The law may be out of step – massive increase in women‘s participation in the work
            force. Re-examine the issue due to societal change, do not follow precedent of old cases
            that say it is not deductible.
          Section 18(1)(a): was it for an income earning purpose?
                   Would an accountant say it is deductible?
                            No. In favour of personal expense.
                   Is this an expense many business people would incur? (Common Practice)
                            Yes, on basis of data. In favor of business expense.
                   Would the expense have been incurred but for the business? (Looking
                       Subjectively at the worker)
                            No. In favour of business expense.
                   Would the need that gave rise to the expense still exist in the absence of the
                       business?
                            Yes, regardless of whether in business. This expense is addressing the
                               need to care for children. In favour of personal expense, as it merely
                               makes the TP available to the business.
                   Is it a personal choice (lifestyle choice) or active consumption?
                            Child rearing is not a personal choice as element of public policy, not a
                               consumption choice.
                                   o There are societal and religious pressures to bear children and
                                       there are societal benefits but women should not bear all the
                                       social costs of raising children.
          Pretty even. However, there are policy concerns
                   Need to be careful in looking at these types of cases to ensure that the
                       expenses are not gendered.
                            Male dominated field allowed social club expenses to be deducted.
          S 63 is a complete code so there is no need to make the difficult decision between
            allowing and not allowing.
                   overrides other business deductions.
                   Olympia case: Facts: corporation makes donations to charities as part of
                       business. There is a limit on the amount of charitable deductions to be made.
                       Held: Olympia was able to make a larger than prescribed deduction by
                       claiming the deduction as a business expense. Therefore donations had a
                       business purpose. In this case, there was 2 different purposes, whereas here,
                       child care has no additional purpose that Symes can link her claim to.
                   S 63 is not only limited to business income it extends to employees.
                            Seems to fear that this will really end up being a subsidy to male
                               business people and will not benefit women.
         not against s. 15 rights - though women disproportionately incur the social costs of
            child care, the TP could not show that women disproportionately pay child care
            expenses.
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  Minority (LHD – all women minority): Child care deductions should be allowed.
         Very persuaded that the definition of a business expense is very gendered and is shaped
           by the needs of men.
                  It is understandable that many men would see child care as a personal expense.
                     However, for women the two are intrinsically intertwined.
         Highly disagrees with S 63 as a complete code.
                  It is a permissive provision, and at best ambiguous to say that S 63 is intended
                     to limit S 9. Does not specifically reference s. 9.
                          Permissive: Should read the section in a non-exclusive way to allow
                             women to claim deduction in recognition of the social reality of change
                             of number of women in the workforce.
                          Strict construction – why isn‘t it applied here? Ambiguities in favour of
                             tax payer (interesting that she would say this though, due to Stubbart
                             which said that strict construction should not be applied)
                          s. 9 should not be restricted by s. 63
         Olympia Tile: Majority distinguishes. Minority says it should be followed.
           Indistinguishable
         Fairness of deductions: Employees are more limited elsewhere in what they can deduct.
                  Inequity is structurally imbedded in the Act
                  the fact that there is a personal element to the deduction has never limited the
                     court before as long as the purpose is sufficiently for a business purpose.
                     Women must have child care if they want to be in business. Should not assess
                     fairness for business people in terms of other employees.
  Discussion:
         This case discusses policy underlying the ITA
                  Excellent case – because of openness to policy.
                  Vertical and Horizontal equity are discussed.
         Criticism: Duff: although the majority made a strong case that the deduction of child-
           care expenses as a business expense could ―substantially undermine‖ the effect of s. 63 to
           provide a limited deduction ―under carefully controlled terms‖ it is difficult to dispute the
           minority‘s conclusion that this provision is itself shaped by the traditional assumption that
           child-care expenses are non-deductible personal expenses and should not, in
           contemporary society which sees an increasing amount of women working, be interpreted
           to preclude the possibility of a business expense deduction under general rules governing
           the computation of business income
         section does appear to be ambiguous
         if the tax payer had won, parliament would have responded by eliminating the disparities
           in tax treatment between business persons and employees. This would have highlighted a
           more pervasive inequity in the Act arising from the general limitation on the deductibility
           of employment expenses under s. 8(2) and brought about the need for a more
           contemporary analysis of the purpose and structure of s. 63.
         If the TP had won, it would have fostered democratic debate and placed the ultimate tax
           policy decision in the hands of the legislature, where it belongs.
         Child Care deduction has been widely criticized – lots of arguments for change.
         Note: if Symes had won her case, it would help business people but not the employees.

S 63(3): Deductibility of Child Care Expenses (Subdivision e – deduct under 3(c))
  S. 63 (3): up to $7000 is deductible in any given.

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         Where there are 2 parents – the lower earning parent needs to claim the deduction.
                  The lower earning parent cannot claim more than 2/3 of their earned income.
  The child care deduction is an upside down subsidy. The more you earn the more you are able to
   deduct – because of the higher marginal rate!
         Two ways to look at it:
                  Is it tax expenditure – then this is a poor policy! The expenditure over
                     compensates those that do not need it and under compensates those most in
                     need.
                  Is it simply a part of the base tax system – then it is a fair system and the
                     above equity concerns do not apply.
  After Symes this is a complete code for the deductibility of Child Care expenses.

Interest
  Deductibility of Interest:
         Scholars: should be treated as a current expense.
         But courts look at interest as an account on capital – making them non-deductible
           under 18(1)(b).
         Gifford (SCC 2004): at common law, interest is treated as an expense on account of
           capital.
                  Interest is non-deductible under 18(1)(b).
  Interest deductions may be permitted only if they fall within 20(1)(c).

  ORDER: for all deductions, must go to s. 9 (this is the authority), then s. 18 which prohibits
   certain deductions and s. 20(1)(c) is the exception to the exception (notwithstanding that it
   may contravene 18(1)(a) and (h)


S 20(1)(c): Deductibility of Interest
  Interest can be deducted from money used for the purpose of earning income from a business or
   property
  borrowing money may be necessary to earn income - although debate as to whether it is capital
   account or current account…
  Policy: Purpose: According to Parliament, this is to facilitate or encourage productive capital
   investment

  Conditions to apply S 20(1)(c) exception: (Shell)
        It must be paid or payable in the year in which it is sought to be deducted
        There has to be a legal obligation to pay.
        20(1)(c)(i): The borrowed money must be used for the purpose of earning income
          from a business or property.
        Needs to be reasonable – redundant already in S 67.

  S 20(1)(c)(ii): the deduction does not apply if the income you are earning is tax exempt.

  Due to the phrase, “must be used for the purpose of earning income”, courts have applied a
   concept of eligible v. ineligible uses.
         Eligible: purpose of directly earning non-exempt income from a business or property

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                    Exceptional eligible use: if the loan can be seen as preserving income-
                     producing assets
           Ineligible and non-deductible:
                   Personal expenditure: jewellery, home, vacation…
                   personal consumption
                   Something with no income earning potential
                          Parcel of land, bar of gold, …
                          BUT do capital gains count as income? (see Bronfman: says they are
                            not income and ineligible use)
                   also interest on borrowed money used to buy life insurance policies

           Focus of the inquiry is on the use to which the TP put the borrowed funds: not
            sufficient if the purpose of the borrowing itself is to earn income, but it is the use
            (Auld v. MNR and Bronfman)
                   What matters is the current use and not the intended use or original use
                           If you borrow money and buy a cottage. Not deductible.
                           If you sell the cottage to buy shares. The loan is deductible, as the
                             proceeds of the sale are used to purchase eligible income earning
                             property.
                                o Think of what the current use is! If it was once ineligible, can
                                    still become eligible depending on the current use.
                                          If you sell an investment and buy something personal.
                                            You will subsequently be barred from deducting income.
                                          if the TP borrows money to purchase income-bearing
                                            assets, after he has sold those assets and puts the proceeds
                                            of the sale to an ineligible use, cannot continue to deduct
                                            interest payments.
                                          but if you borrow money originally for an ineligible
                                            purpose, and then later use the money to earn income
                                            from a business or property, then can deduct.
           There needs to be a bona fide purpose of earning income  reasonable expectation
            of earning income for earning potential to be present.
                   As long as there is a reasonable expectation of some dividend income then the
                     income earning potential is present.

Sinha
The use of the money must be for the purpose of earning income. The original purpose the money was
borrowed for is irrelevant.
  Facts: a student took out a student loan. Original purpose: educational or living expenses; current
   purpose: decided to invest it in the stock market. He made an excellent return.
  Held: He is entitled to deduct the interest payments because it was used to invest in income
   earning profits.
  look to how the TP had used the funds to earn income, regardless of the original purpose for
   which they were borrowed.

Meaning of Income Earning Use – Direct v. Indirect
Two issues in the following cases:
  Direct v. Indirect

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        To satisfy the purpose test is it sufficient that the money is being used indirectly to
          preserve or protect a stream of income?
                 OR
        Is it essential that you trace the money directly to a specific use which has an immediate
          income earning use?
   What counts as Income
        Does earning a capital gain on the property count as for the purpose of earning income?
        is it gross income, or for the purpose of earning net income?
        Does the stream income have to exceed the interest expense?

Trans Prairie Pipelines (1970):
Borrowed money used to replace equity that was used to earn business income generates interest that can be
deductible.
The money it is replacing was being used for an income earning purpose. Borrowing to preserve income
earning capacity may be deductible.
Narrowed by Bronfman, not overturned: only in exceptional cases can the purpose be to preserve income.
(Bronfman says it is based on these facts)
   Facts: Company wanted to borrow to expand the business. Wanted to restructure financing to re-
    purchase its preferred shares and expand business through the issuing of bonds.
          Issued $700 K in Bonds: Used $400 K to redeem shares and $300 K to expand business.
          Deducted the interest on the full $700 K.
   Held: It was being used indirectly to preserve the capital earning potential of the corporation.
          Being used to fill the hole left by the redemption of the shares – filling the hole in the
            company‘s capital left by the shares.
          The equity (share money) was used to earn business income and the bond money that
            was used to replace it.
                   Fundamental purpose was to earn business income
                   do not look at direct purpose of borrowing, but the overall usage of it.

Sternthal (1974)
Look at the fundamental purpose the borrowed money is used for – is it personal or income earning?
   Facts: TP borrows money at interest and uses that money to make interest free loans to his
    children. He continues to own his income earning capacity.
   Held: Ineligible use and non-deductible
          The fundamental purpose was for a personal, non-income earning purpose.
          Loan was not to preserve a portfolio of investments, but to get money for the interest free
            loan to the children – not income producing use.

Zwaig (1974)
Look at the economic reality to determine the fundamental purpose of the use of the money. One must look at
the whole picture of the transaction to discover its substance and whether the borrowed money was used to
earn income
Seems to say do not just look at the current use, but the whole purpose of the transaction!
   Facts: Owned securities. Made an arrangement to sell the securities and re-purchase them later
    that day. Sold the securities and used the money from the sale to buy a life insurance policy. Then
    borrowed money from the bank to buy securities back.

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   Held: The fundamental purpose was to buy the insurance policy.
         The economic reality is important. May have arranged this to look like it is in line with s.
           20(1)(c), but the mere fact that it was ordered superficially is not enough. Need to
           look at the economic reality and true purpose for which the borrowed money was used.
         if his true purpose was to change investments, he may have been able to deduct it. But the
           true purpose here was to buy the life insurance policy.

**Bronfman Trust v. The Queen (1987) (this is to apply to all TPs)**
Onus is on the taxpayer to trace the borrowed funds to an identifiable, eligible use.
Is there a formal tracing requirement – to show that it was to earn income? Or is it sufficient to show that the
substantive purpose was to earn income? Unclear which is the proper approach – both are used here.
Eligible use must be the direct use – TP must show a direct use to which he put the borrowed money
This case is the high water mark for economic substance over legal form
In an exceptional case the bona fide purpose may be to preserve income earning potential (see Trans Prarie)
   Facts: The investments of the trust were very low yield, geared to earning capital gains. Only one
    beneficiary of the trust. Because of the low yield of the investments the trustees decided to give a
    capital allocation to the beneficiary. Funded the capital allocation by borrowing money from the
    bank – disposition of assets not possible at the time. Gradually over 3 years, repay the loan with
    the capital gained on other assets and selling of shares once they were able to do so.
   Held: Cannot deduct interest. Borrowed money was originally used to make capital allocations to
    the B, and the trust received no property or consideration of any kind. Use of the borrowed money
    was not for an income-earning purpose.
           Onus is on the taxpayer (both corporations and individuals) to trace the borrowed funds
             to an identifiable, eligible use.
                    “A direct ineligible use ought not be overlooked in favour of an indirect
                      eligible use.” (eligible use must be the direct use, not indirect)
                            The direct use was to pay the allocation, not to preserve the investment
                               and assets of the trust. Allocation to the beneficiary is an ineligible use.
                            neither the ITA nor case law permits the courts to ignore the direct
                               use to which the TP used the borrowed money.
                            If TP is using the tracing to manipulate the ordering of events to produce
                               an ineligible purpose, then look to the substance.
           Policy:
                    Vertical Equity: if an indirect use satisfies the purpose then we are saying: ―if
                      you are wealthy enough to own interest earning assets you can always deduct
                      interest. No matter what you really borrow for.‖ A poor TP will not have this
                      option available if they did not have income-earning assets
                    Parliamentary Intent: if we allow ineligible indirect uses we make a mockery
                      of the intent of parliament. (note: if the true purpose is to earn income, does it
                      matter if it is indirect??)
           In an exceptional case can have indirect use - can get deduction if the bona fide purpose
             may be to preserve income earning potential. But bona fide purpose in using the
             funds must be to earn income – here it was not.
                    Court recognizes that the recent trend is toward ascertaining the true economic
                      reality, rather than juristic classification of form - may help to avoid the
                      inequity of tax liability. More economic, commercial substance over form in
                      interpretation (Same with Stubbart)
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                     
                     But generally holds that despite the fact that it can be characterized
                     indirectly as preserving income, borrowing money for an ineligible purpose
                     ought not to entitle a TP to deduct interest payments.
          Direct Tracing is not always sufficient:
                  Blatant manipulation of an ordering of events to achieve an aura of meeting the
                     requirements should not be allowed (exactly what TP in Zwaig tried to do)
                  Can‘t get the interest deduction when the economic reality of the transaction is
                     not for an income earning objective.
                  Court should view as a Sham: Sell income earning assets, use proceeds to buy
                     non income earning, borrow to buy back income earning.
   Discussion:
          Not clear if the test for interest deductibility is a formal or substantive one.
                  Is there a formal tracing requirement – to show that it was to earn income?
                  Or is it sufficient to show that the substantive purpose was to earn income?
                          It appears to be both, unless exceptional case of Trans Prarie
                          In this case it is denied on either approach.
                          But when is one to be applied? when are both to be applied? When is the
                             exception to be applied?
          This case is the high water mark of Canadian cases looking at the economic substance of
            the case over the legal form.
          Since 1990s:
                  SCC has been backpedaling on Bronfman.

New round of interest deductibility cases
Tenant (1996)
If the borrowed money is still being used for the purpose of earning, even if it is severely reduced by losses, it is
still fully deductible.
   Facts: Borrows $1 Million to buy shares. Sells a short time later for $1000 at FMV to Hold-Co (a
    holding company), in exchange for 1000 class B common shares in this company. Continued to
    deduct interest on the full 1mil borrowed
   Held: this is deductible.
          TP must establish a link between the current eligible use property  the proceeds of
            disposition of the original eligible use property  the money that was borrowed to
            acquire the original eligible use property.
          This link was shown – both the original shares and the new shares in holding co are
            directly traceable to the loan. Can trace the proceeds straight to his next investment in
            Hold-Co.
          So it is still for an income earning purpose.
   Discussion:
          What happens if a source of income is all together lost?
          S 20.1: if the FMV of the property drops you can continue to deduct the interest on
            the full amount of the loan.

Robitille (1997) (Post-Bronfman)
Look at the ultimate economic objective to determine the fundamental purpose of the use of the money



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  Facts: A lawyer, a partner in the firm, and makes a capital account in the firm. He withdraws
   capital from the partnership account in the firm and uses it to buy a home. He later that day
   borrows money to refinance the partnership capital – which is used to generate income.
  Held: The fundamental purpose was to buy a home and not to increase the capital in the
   partnership account.

Singleton (2002 SCC)
Looked only at the tracing requirement to determine if the money was for an income earning purpose.
Do not go searching for economic realities. View the transactions independently and on their face. – look at
the form, not the substantive economic reality
  Facts: Partner in a Law Firm borrows $300 K to put into his capital account. Withdraws the
   equivalent amount from the capital account to pay for the house.
         A little different from Robitaille: Adds to capital account first then withdraws.
  Held: This was deductible.
         He has met the tracing requirement.
                  Have to take the transactions as they are – on the face of the transactions
                     the conditions are met; order does not seem to be important.
         Do no go searching for underlying economic realities.
                  REJECTED THE SUBSTANTIVE SIDE OF THE REASONING IN
                     BRONFMAN.
  Dissent: retained the substantive portion of the reasoning in Bronfman and rejected the deduction.

Ludco (2002) SCC
Look for income from the property not profit from the property. Some income will satisfy the income earning
purpose, even if it does not balance interest.
More liberal interpretation of s. 20(1)(c): Income does not need to be the sole purpose of the transaction,
making capital gains may be a part of an eligible use.
  Facts: Borrowed money (6 mil) to purchase in shares in an offshore company in tax-haven
   jurisdiction that would generate income. The offshore company would pay little in dividends,
   would retain to make the money a capital gain. TPs received only $600Gs in dividends, and when
   shares were sold, Ludco received substantial capital gain of 9.24mil. Express purpose from the
   outset was to invest in capital gains securities, pay minimal dividends and obtain substantial
   capital gain. CRA said met tracing requirement but not substantive purpose.
  Held: Deductible. If the borrowing was to generate some amount of taxable income it is
   deductible.
          Income here is considered gross income not necessarily net income (or profit). There
            was some dividend paid.
                   Even if the main purpose is to generate capital gains. As long as there is
                     some ancillary purpose to generate income (even if not at a profit!) it is
                     deductible.
          It may not even matter if the income is the whole return. It is fine to make capital gains
            and claim the deduction.
                   Bronfman claims that capital gains are an ineligible use.
  Discussion:
          Legislative Response:
                   This is part of the reason for the attempt to enact S 3.1 (REOPs) – though
                     Finance has had little success to date on this issue.

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                      Proposed amendment to S 9(3) – income does not include a capital gain or loss.
                       This is in response to Ludco.
            There has been a lot of protest to these amendments – don‘t want to discourage riskier
             types of amendments. These may never be enacted.
            CRA: accepted the results of these cases in its latest interpretation bulletin on the matter.
                    Reasonable expectation of some gross income generally common shares will
                       meet this expectation. – as long as there was some income earned and some
                       intention to this.
                            Difficult if the company has expressed it has no intent to pay dividends.

   s. 20(3): any money borrowed to repay the borrowed money is also deductible. Interest on
    the new loan is deductible, even though the direct purpose of the new loan is not to earn
    income but to repay loan

Lipson
   Facts: W uses borrowed money to buy shares from H so H‘s company has money and W is
    receiving dividends on her shares and deducts interest on her loan and net amount of the dividends
    is attributed to H under s. 74.1. Then H and W go together and take out 2nd mortgage loan to buy a
    home. Then use the second loan secured on the house to repay the 1st loan. They argue, per s.
    20(3), that any interest on the new loan to discharge the 1st loan should be deductible. Minister
    says that should not be able to deduct. Real purpose was not to earn income and s. 20(3) cannot
    apply.
   Decision: GAAR prevents this transaction. Obviously an avoidance transaction and this was the
    primary purpose of their actions. There was clearly a misuse or abuse of the provision s. 20(3).
          o the true purpose of the whole arrangement was to buy a family home. Fleeting use that
              was never intended to be used for the purpose of refinancing the shares.
          o Prof: not sure why the court agreed with the Crown. But clear policy in the act that
              interest for a mortgage on a home is not deductible in the act. Therefore vertical inequity
              if these TP‘s would be able to deduct it.

Leslie
Interest for generating human capital is not deductible. It is too personal.
   Facts: TP sought to deduct interest on student loans under para 20(1)(c) on the basis that the
    borrowed money was used for the purpose of earning income from the business of working as a
    salaried employee
   Held: Not deductible to invest in human capital.
           This is too personal. Expense of gaining an education and interest paid upon money
             borrowed for the purpose of paying those expenses are persona or living expense.
           need an ongoing business with a reasonable expectation of profit against which the
             expenses might be set. this was for employment, not business



Capital Expenses
   S 18(1)(b) capital expenses are not deductible. This section prohibits any deduction in
    respect of “an outlay, loss or replacement of capital, a payment on account of capital or an
    allowance in respect of depreciation.
          Current Expenses are deductible, difficult to distinguish the two.
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            for capital loss: allowable portion of the loss (currently ½) is generally deductible
             only against taxable capital gains for the year (s. 3b, 39(1)(c)) and is excluded from the
             rules governing the computation of a TP‘s income or loss form a business or property.
            because there is no definition in the act of ―outlay of capital‖, ―replacement of capital‖ or
             ―payment on account of capital‖ the characterization of an amount as a capital
             expenditure depends on legal tests developed by the courts.
            no expense is inherently capital or current – in this case had to look at all the surrounding
             factors to determine if land was a current expense.

Characterization: Capital or Current Expense
Johns-Manville Inc. v. The Queen (1985)
There is no single test. But look at the factors to determine characterization
   Is it a recurrent expense or a one time outlay?
   How big is the expense in relation to the operation as a whole? (What percentage? large or small
    amount relative to operating costs)
   Is there a lasting addition to the assets or is the item consumed in production? was it consumed
    immediately or does it endure
   Was it expended on the income earning structure or in the process of earning income?
   Is it an expense of acquiring the assets or simply using them?
   Is there any other method of recognizing the bona fide business expense?
Note: classic test and BP Australia case – no one rigid test.
Residual Rule: Where it is not explicit, ambiguity should be resolved in favour of the taxpayer. If one
reasonable interpretation leads to a deduction and one leads to no relief, interpretive principles should prefer
the first.
   Facts: In order to mine Asbestos the TP needs to buy land. The extra land is needed to keep the
    slope of their pit at a safe angle. The TP deducted the cost of the land acquired as an ordinary
    business expense. This has been an expense that represented 3% of the mine costs for 20 years.
          Land does not qualify for any depletion or capital allowance:
                   So the recognition of the costs will be at the END of the process when they sell
                      the lands at a capital loss.
                   there is a depletion allowance for land that is used for mining – depletion of the
                      resource. Here they cannot claim this because it is not land that has ore, but
                      simply land adjacent to it.
                   not a capital gain, because once it has been mined, then the TP will recognize a
                      capital loss, because land no longer profitable.
   Held: This is a current expense and deductible on an annual basis. It is a production expense
          There is no single test.
          Look at all the facts and determine which characterization seems to fit the expense best.
                   It is very difficult to determine the characterization.
          Factors to examine:
                   Is it a recurrent expense or a one time outlay?
                           Incurred year in and year out for 40 years as an integral part of the day to
                              day operations – simply cost of operation
                           constant element and part of the daily and annual cost of production
                   How big is the expense in relation to the operation as a whole? (What
                      percentage?)
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                          This is 3% of expenditures
                   Is there a lasting addition to the assets or is the item consumed in production?
                          It is consumed according to the Trial Court. Not for intrinsic value but
                            for location.
                  Was it expended on the income earning structure or as part of the money earning
                    process?
                          ¶9: Did not increase the productive capacity. They are expenditures for
                            the removal of the ore. Expense was part of the essential profit-seeking
                            operation of the TP
                          expense of the land did not add to the ore body, nor did they increase the
                            productive capacity to the mine; simply are expenditures which is not
                            made, would bring mining operation to a halt.
                  Are they acquiring the assets are simply using them?
                          did not acquire land for any intrinsic value but merely by reason of
                            location and after the mining operation, the land acquired no intrinsic
                            value; was simply consumed in the mining process.
                          asset disappears as the wall of the cone will recede and be consumed in
                            the ensuing taxation years. Land is simply for transitional location of the
                            wall
                          although the hole itself and part of the wall might have some value,
                            hardly can be described as an asset which by itself has a real value
                  Is there any other method of recognizing the bona fide business expense?
         How do you interpret when it is ambiguous?
                  If one reasonable interpretation leads to a deduction and one leads to no relief,
                    interpretive principles should prefer the first.
                  Residual Rule: Where it is not explicit, ambiguity should be resolved in favour
                    of the taxpayer.
  Discussion:
         Seems to be going back to the Strict construction rule
         Characterization of Capital expenditure is one of policy!
                  Allow bona fide expenses where applicable.
         What policy considerations:
                  Horizontal Equity: should not punish because the business input is land – it is
                    still a current expense. Should not be punished because of the nature of the
                    business.
                          But farmers and amusement parks are unable to claim a deduction for
                            land.
                          What about a business that buys all the land up front. They would have a
                            difficult time too
                  Neutrality: does this encourage the business to purchase the land incrementally
                    rather than up front?
                          It seems that this is not a neutral policy – it encourages a method of
                            running these mines.
         Note: they may be able to sell the land and claim it is a capital loss! Though it should be
           reported as business income since the land was business expenditure.

Repairs for a capital asset v. Replacement/Renovation
  if you are doing just regular repairs for the normal wear and tear = current expense. But if you are
   replacing the building or some chunk of it, or significant upgrade = capital expense.
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  Gifford: sold customer list, court held that this was a capital expense – purchasing contacts and
   good will that had already been arranged. Client list not only significantly expanded employment
   income, but secured the discontinuance of competition. and the payment was made with the
   intention of securing an asset of enduring benefit that would provide the TP with a lasting
   advantage. Moreover, purchase of someone else‘s good will is not the same as the recurring
   marketing expenses the TP would have to incur to create his own goodwill. The fact that the asset
   may decrease in value if not properly cared for, cannot determine the question of what the asset
   was to the purchaser at the time of the acquisition. ―A building purchased as a rental property does
   not lose its characterization as a capital asset if it burns down on the day after the sale closes‖

Capital Cost Allowances
S 21(1)(a): Capital Cost Allowance
  notwithstanding s. 18(1)(b), section 20 allows TPs to deduct a number of expenses that might
   otherwise be non-deductible capital expenditures.
  S 21(1)(a): A portion of the costs of the capital of assets are permitted to be deducted each
   year – match cost of earning income against income. Specifics of deductions are contained in the
   Regulations.
  capital cost allowances: allow the TP to deduct costs incurred in getting capital – capital cost
   allowances are the tax equivalent to depreciation for accounting purposes.
  Can claim CCA for depreciable property.
  Methods:
          Accounting: this is called depreciation and is based on the estimated useful life of the
            asset. There is a lot of flexibility in how to depreciate the asset for accounting purposes.
          “straight line method”: the cost of the property is deduct in equal annual increments
            over the course of its useful life until the unrecovered or undepreciated cost reaches zero.
            If the cost of an asset is 1000 and is expected to last for 10 years, divide 1/10 of income
            Owner is required to deduct 100 in each of the 10 years
          Most CCAs computed on a Declining balance method: a percentage of the
            unrecovered or underpreciated cost is deducted each year, causing the book value to
            approach but never reach zero.
  CCAs generally computed by a ―class method” according to which the rates specified in part XI
   and schedule II of the Regulations are applied not to the undepreciated cost of individual assets
   but to the undepreciated cost of similar kinds of property, the cost of each of which is aggregated
   to produce an undepreciated capital cost of the class as a whole
  Capital Cost Allowance:
                   Neutrality: everyone uses the same system, everyone gets the same tax
                      treatment.
                   Prevents manipulation.
                   Can be used as a tool of economic and social policy and encourages raising of
                      revenue.
  Approach: group assets into classes and rate of appreciation for each class on declining balance
   method
  CCA entitlement determined at the end of a taxation year – note: unlike accounting
   depreciation which must be deducted in the relevant accounting period, use of the words “there
   may be deducted” in the preamble to s. 20(1) suggests that deduction of CCAs under para
   20(1)(a) is optional. Therefore TPs may maintain the undepreciated capital cost of one or more
   classes of property by deferring tax value of these deductions to subsequent accounting
   periods.
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 Regulation 1100(1): Declining Balance Method
        Set a percentage rate and apply percentage of the class to the Undepreciated Capital Cost
          (UCC) of the asset.
                 Ex. 40% on a $1000 asset.
                         $1000 - $400 = $600 x .40%
                         $600 - $240 = $360
 S 13(21) “Depreciable Property”: a property acquired by the taxpayer that is eligible for CCA
  deductions under the regulations.
        Acquired: when the purchaser has acquired all the incidents of title (usual incidents
          of ownership such as possession, use and risk), although legal title may remain in the
          vendor as security for the purchase price (Wardean Drilling). Although, contrary
          rulings by the tax court have been made since. Thus s. 16.1 enacted, which allows arms-
          length parties can characterize the lease as a contract of purchase and sale, but when they
          do not file such an election, tax consequences are to be determined according to above
          case.
                 This definition can capture leases. – lease arrangement constituted an
                    acquisition of property by the lessee, thus the lessee and not the lessor may
                    deduct.
                 also, sales commissions, legal fees – any acquisition expenses.

 Schedule II (pg. 2440): sets groups of assets as ―pools of assets.‖
       Then allow those classes to be depreciated at a regulated maximum rate set in 1100(1).
       The maximum rate in 1100(1) reflects the life of the asset.
 Regulation 1100
       Specifies the highest possible rate on the total assets in a class! Of the un-depreciated
         capital costs of the assets in the class.
                Can deduct lower rates, but don‘t have to.
 Schedule II:
       Class 1 – 4%: things with a long life.
                Included buildings; or component parts of a building or structure, including
                   electric wiring, plumbing, sprinkler systems, air-conditioning and heating
                   equipment, lighting fixtures.
                also includes property not included in any other class
       Class 5 – 10%
                pulp mills.
       Class 6 – 10%: things that are used up more quickly.
                Buildings again… but this time it is buildings with inherently shorter lives. Ex.
                   buildings of frame, log, stucco, corrugated metal construction – farming or
                   fishing, with no footings or any other base support below ground level.
                less permanent type of building
       Class 7: 15%
                canoes, spare engines, marine stuff etc.
       Class 10
                automotive equipment, or general purpose electronic date processing equipment,
                   and systems software
                other property that is a passenger vehicle, the cost of which the TP exceeds 20G
       Class 8 – 20%
                (i) Tangible capital property that does not fit into any other class.
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                      With the exceptions of: Land is not depreciable, even though tangible,
                       animals, …
           Class 12 – 100%
                    Things that are used basically monthly like plates for a restaurant.
                           also consider motion picture file or videotape, computer software.
                           Also so policy tools:
                                  o Metric scales: to help people smooth the cost of compliance to
                                      switch to metric scales.
                                  o The equipment needed to impose the GST.
    Things not covered:
           Intangible property (IP, franchises, Leases, …) are for the most part these are not
             covered.
           example of intangible property – purchased goodwill
           Intangible Capital is covered in the Cumulative Eligible Capital (CEC): eligible
             capital property, a % of which may be deducted on a declining balance basis under para
             20(1)(b)
                    CCA limited to tangible property.
           Land is not depreciable.
    Regulation 1102(1): Reg 1102(1)(a) prevents the deduction as CCA of amounts that are
     already deductible in computing a TP‟s income.
    Regulation 1102(1)(b): prohibits a deduction for CCA in respect of property acquired or
     manufactured by the TP for the purpose of sale.
    Regulation (1)(c): is consistent with policy underlying para 18(1)(a), which prohibits any
     deduction for an outlay or expense except to the extent that it was made or incurred for the
     purpose of gaining or producing income. Also consistent with para 18(1)(h), which prohibits
     the deduction of personal and living expenses.
    Regulation 1102(2): Clarifies things that we already know.
           Can‘t get CCA on all land
           Can‘t get CCA on property you have already claimed a deduction on elsewhere in the act.
             (Inventory, R&D, Non-Canadian Art, …)
    Criticism with regulations: not too many TPs know about this type of support to industrial
     businesses. Not monitored to see if it is having its intended effect.


Calculation
  s. 13(21): calculation: reduced to bear essentials, UCC of a class of depreciable property at any
   time = (A+B) – (E+F)
 A = the capital cost of all properties acquired in the class
 B = any “recapture” previously included in income under 13(1)
 E = total depreciation previously claimed on the class
 F = for all properties disposed of from the class the less of: the proceeds of disposition of the
 property and the capital cost of the property

 Example: GT company is incorporated in 2000 and it is a home and garden plant business. During
 first fiscal period, going to acquire its first class 6 asset – water storage tank 1 at cost of 8G.
 Q. What is the company entitled to deduct for its class 6 assets. What is its max CCA under s.
 20(1)(a) – 800$ as it is 10% x 8000. The UCC of class 6 assets is 800 at the end of the year. This
 went in under A of the definition of UCC.

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   This would be the right answer except for the ½ year rule: before this rule, TPs often bought a
    bunch of assets in the middle of the year to bulk up on assets at the end of the year. Net additions
    to the UCC of a class in a year can be depreciated at only ½ the normal rate (A and B are
    more than E and F in the year – usually when you require new assets and net addition to the
    whole class. Additions must be more than the subtraction). Very arbitrary bright-line rule.
    Therefore the true max of above is 400$. Therefore you are deferring your CCA claim for a later
    year.
   what if the company makes an actual claim of 100$ - take opening balance of UCC = 7900$. 8000
    added under A – E (total depreciation previously claimed on the class)
   first effect: provides deduction in computing income
   second effect: also reduces their UCC for the class. This will effect how much they can deduct in
    the subsequent years.
   Q: if nothing else happens to class 6, then what happens = 7900 is the closing balance at the end of
    the taxation x 10% = 790 as the max CCA entitlement. ½ rule does not apply, as there were no new
    assets acquired and nothing new added to the class. ½ year rule applies to the capital cost added
    to the class.
   Q5: assume this year the company claims the max CCA, what will be its opening balance of UCC
    for class 6 in 2002: A: 7900-790 = 7110
   Q6: assume that in 2001, company does claim (deducts) max CCA, and during 2002, the company
    purchases 2 new water tanks at 8000 each. What would be max CCA for 2002?A= A8000 + (1/2)
    16,000 – E(100 + 790) CCA = 1511 – this is the max CCA claim for 2002.
   Q7: opening balance for 2003 – 3110-1000 = 22110 (Real UCC at end of 2002: 8000 + 16000 –
    100 + 790 = 23110.
   Q8: A is 24000 (cost of three tanks) – E (100+790+1000) + F 7500 = 14610 x10 = 1461 Max CCA
   F when you dispose of a property from the class, you + the less of the proceeds from the
    disposition or the capital cost – therefore reduces the CCA to be depreciated.
   Q9: if the company claim 1000 of CCA, what will be the opening balance: 13610 (just subtract
    1000 from the running balance.)
   Q10: if the company disposes of 2nd water tank (8400), what will be the max CCA; also does this
    give rise to capital gains rules: take running balance and – F (8,000) = 5610 (UCC at year end);
    Max CCA 561 (x 10%)
   kg: proceeds – capital cost = 8400 – 8000 = 400kg; taxable kg is 200, and this income would go
    under 3(b)
   Q11: assume the last water storage tank is sold (7000) and the company has no remaining class 6
    assets? opening balance of ucc: 5610-500 (CCA from 2004) = 5110 – F 7000 = - 1890 - negative
    balance is a recapture. UCC is to reflect its depreciation in value. Would have to include negative
    balance back into income per 13(1). It is added to your business income as a positive amount.
   opening balance for 2006: 1890 + recapture (B) = 0. If you have recapture, you cannot have CCA.
    To avoid recapture, buy something new in the class at the end of the year.
   Q11(b): 5,110 as opening balance. Take less of cost of proceeds = F 4000 = 1110. Positive balance.
    But no assets left in the class so cannot claim CCA, so this is terminal loss that can be fully
    deducted but must be in that year per 16(1). This is imbedded in your net income under 3(a)

   UCC and CCA are two different things. UCC is the declining cost that you have – accumulated
    total costs of loss; no immediate direct effect on current tax year; CCA is just the current
    deductions



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Half-Year Rule
     Reg 1100(2) (for property acquired after 1981)
     where at the end of a taxation year, the amount added to the UCC of a class in respect of
      acquisitions EXCEEDS the amount subtracted from the UCC of the class in respect of
      dispositions, the maximum CCA for the year shall be determined as if the UCC of the
      Class was reduced by 50% of that excess.
     note: some properties are expressly exempted from the ½ year rule, including most of the items
      listed in Class 12 (100%)
     only used when there is a net addition to that class – IE bought new water tank.


Terminal Loss
  s. 20(16): the end of the year, the positive amounts of the UCC of the class exceeds the negative
   amounts and the tax payer no longer owns any property in the class.
  only applies where there is no more property in the class – if you did, and you had positive
   amount than could claim CCA
  consider, where the money of the sale of the depreciable property is less than the
   undepreciated cost of the property. Therefore person disposing of the asset will suffer a loss.
  Ex: 50 cap cost; 20 UCC; 10 proceeds = A 50 – (E 30 + F 10) = 10 Terminal loss.
  S 13(1) Terminal Loss: occurs when the proceeds of disposition are less than the UCC. The
   difference between the two is the terminal loss.
          This is an acknowledgement that the property depreciated more quickly than was
           allowed for tax purposes.
  Qualities of a Terminal Loss:
          Must be deducted in computing income from the business in the year the property is
           disposed of (there is no option to defer the deduction).
          It is fully deductible in the same manner as an ordinary business expense.
  Note: there is no such thing as a capital loss on depreciable property.
          S 39(1)(b): ―other than depreciable property‖
                   Part of Business income under 3(a) – this is really an expense of the business.
                   effect: there is no capital loss on depreciable properties by definition. Any
                      loss of value in depreciable property is deductible; treated as an ordinary
                      business expense. But remember there can be capital gains.
  Terminal Loss only occurs once there are no items left in the pool of assets.
          Thus, due to pooling, terminal losses are often deferred.
  where the TP disposes of all depreciable property of a class for proceeds less than the UCC
   of the class, such that the TP owns no property of a class that retains a positive balance in
   the UCC account, ss. 20(16) prohibits the deduction of any CCA and requires the deduction
   of a terminal loss equal to the amount of the remaining UCC – amount of this terminal loss
   is included in the definition of “total depreciation” in ss. 13(21) and subtracted in computing
   the UCC to a TP of depreciable property of a prescribed class by virtue of the description of
   E in the definition of UCC in ss. 13(21), therefore reducing the UCC account to nil


Recapture
  S 13(1) Recapture: occurs where the proceeds of disposition are more than the UCC. The
   difference between the two is the recapture.

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 person sells the depreciable property and receives a price greater than the undepreciated
  cost of the asset, therefore realizing a gain on the disposition, equivalent to the excessive
  depreciation recognized in the previous accounting periods
 Where capital gain will occur: where the proceeds exceed the original capital cost of the asset,
  the person disposing of the asset will realize a further gain – this excess is subject to tax as a
  capital gain.
 representing this appreciation in the value of the asset above its original capital cost.
        EX: A = 50 – E = 30 + F = 40 = -20. CCA rate was too fast or too high.
        therefore it reconciles the CCA with how fast the asset has actually depreciated.
        This is an acknowledgement that the property depreciated slower than was allowed by
          CCA.
 When proceeds exceed UCC, the amount of proceeds up to the original cost must be fully
  included in business income as recapture.
        Recapture only goes up to the cost of the asset
        occurs where the aggregate of the CCA claimed for a class of depreciable property and
          proceeds of disposition of depreciable property of the class (up to the capital cost)
          exceeds the capital cost of depreciable property acquired by the TP (causing the UCC of
          the class to become negative) at the end of the taxation year. – excess amount will be
          added to the TP‟s income under subsection 13(1)
 Recapture only occurs once the UCC of the items in the pool becomes negative.
        Need to pay recapture to get UCC back to $0. It can occur while there are still assets
          left in the pool.
        Ex: 75 proceeds, 50 cap cost, 20 UCC = -30. But on top of this is a capital gain, and ½
          must be included in income.
 can get rid of recapture if you acquire another property in that class; but cannot get rid of
  any capital gain

 Note: because the rules for recapture and terminal loss apply to classes of depreciable property
  rather than individual assets – where an asset is one of many depreciable properties of the
  same class, its disposition is unlikely to trigger R or TL (the capital cost of other depreciable
  properties likely to maintain a positive balance in the TP‘s UCC account for the class
        but, where the depreciable property is the only property of its class = likely to have R
           or TL - whenever the proceeds differ from the property‘s UCC
        therefore the ITA requires or permits specific kinds of depreciable properties to be
           categorized as separate classes for the purposes of computing CCA, recapture and TL
                  R 1101(1ac): separate class generally prescribed for each rental property
                     with k cost of 50G or more, making it impossible to avoid the recognition of
                     recaptured depreciation on a disposition for proceeds exceeding the UCC of the
                     property.
                  R 1101(1): also makes a separate class for properties that are bought for the
                     purposes of gaining or producing income from different businesses.
                     Therefore TP is not able to rely on the UCC of the property of one business to
                     shelter recaptured depreciation on the property of another business.
                  R 1101(5p) and (5q): allow TP who have bought rapidly depreciating
                     electronic equipment to treat the property as a separate class. therefore
                     eligible for TL




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Allocation of Purchase Price
   There is tension between the purchaser and vendor on how to allocate the purchase price where
    they are selling various kinds of property or services included in the sale
                    how to allocate the assets between CCA property and non-CCA property to
                      avoid Recapture or attain terminal loss. Purchaser and seller may agree to sell
                      at lower price if P can attain terminal loss and S can get capital gain on the sale.
                      Also P may not want to buy if there is too much recapture that they may take on
                      – may just buy shares, as opposed to the whole property.
          To limit the opportunities for abuse, anti-avoidance rule: S 68(a): minister is entitled
             to reallocate proceeds of a sale between vendor and purchaser as is reasonable,
             regardless of contract between the parties.
          But how do the courts determine what is reasonable, based on FMV of different
             properties? And how do they determine FMV?

Golden (1983)
Narrow Reading to s. 68: if parties are dealing at arm’s length than the price they agree to pay after
bargaining at arm’s length is the FMV and they are allowed to take into account tax avoidance ideas when
making this bargain.
Private Arm’s length parties are to be given wide berth in deciding on the allocation of purchase price between
the assets.
Should be accepted, as long as the allocation is within the range of reasonableness, it is acceptable – does not
have to be the most reasonable allocation
Note: Reciprocal effect: better deal for vendor is worse for purchaser. Vendor and purchaser’s interests in an
arm’s length transaction are a check on one another.
   however, subsequent cases in which the court has held that if there is a gross over or
    underestimation of the FMV, then the minister will be allowed to reallocate.

Steps in Applying CCA
   Deduct CCA in computing the income from the source.
   Deduct CCA from UCC to determine the new value of UCC.
   Consideration.
           It is not necessary to deduct the full amount of CCA available. Regulation 1100(1) only
             sets maximum rates for one year.
                    You can choose how much CCA to take up to the maximum amount allowed for
                      each year.
           In a sale of assets you can allocate the sale price amongst depreciable and non-
             depreciable assets.
   If there are no more assets in the pool then calculate terminal loss. If UCC is a negative number,
    then add recapture to your income to bring UCC to zero, or (if applicable) pay Capital Gains and
    add recapture on your income.

Capital Gains
S 39: Capital Gains
   Definition: S 39(1): Capital gain is any amount that would not be included in income if S 3(b) did
    not explicitly include it. (Adopts the common law definition)

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              the ITA does not define the concept of capital for the purpose of determining the source
               of a TP‘s gain or loss.
            although other provisions deem specific kinds of gains and losses to be capital, paras
               39(1)(a) and (b) define capital gains and losses as residual – that is, as gains or losses
               that would not otherwise be included or deductible in computing a TP‟s income.
               According to s. 248(1), these definitions apply for the purposes of the act as a
               whole
   Property: s. 248(1): property of any kind, whether real or personal or corporeal or incorporeal
    (Note: dictionary definitions of property: the right (esp exclusive right) to the possession, use or
    disposal of anything. In Manrell, however the FCA held that the concept of property in the ITA
    requires an exclusive and legally enforceable claim
   Definition of types: capital property: a gain or loss from the disposition of property. Inventory:
    where the gain or loss would be characterized as income from a business. Gain or loss from the
    disposition of property will be characterized as income or loss from a business, if the property is
    disposed of in the course of a business or pursuant to an adventure or concern in the nature of
    trade.
   para 3(b): includes the TP‘s net taxable capital gains for the taxation year
   para 3(b)(i): TP‘s taxable net gain for the year from the dispositions of listed personal property
   para 3(b)(ii): from the above two, deduct the TP‘s allowable capital losses for the year (do not
    include LPP, or allowable business investment losses)
   unlike business investment losses, which may be deducted in computing a TP‟s net income
    from all sources under para 3(d), k losses are generally deductible only against the kg under
    para 3(b)
   also, losses from the disposition of LPP are deductible only against LPP gains – net amount
    brought into income under clause 3(b)(i)(A)
   Capital Gains are not a source, so they are specifically included under S 3(b).
           Included at ½.
           This varies with the political climate and the US
                    Carter Commission recommended full Inclusion
                    1972: ½, 1988: ¾, 2000: 2/3, 2000: ½.
                    note: with charitable gifts of publicly traded shares and ecologically sensitive
                      land at ¼)
   for LPP, s. 41(1) defines the taxable net gain from dispositions of listed personal property as ½ of
    the net gain
   Exceptions to Capital Gains Tax:
           Principle residence exemption: Not taxed on the gain when it is your personal
             residence.
                    “When”: Can only claim the exemption on the gain that is attributable to the
                      time you are living in the property as your personal residence.
           Capital gains exemption of $500 K for ―qualified small business‖ or ―qualified farm
             property.‖
   Policy: For full inclusion
           A buck, is a buck, is a buck – Carter commission.
                    Capital gain increases economic capacity in the same manner as any other
                      income.
           Horizontal and Vertical Equity
                    Horizontal Equity: everyone with the same income (no matter where they earn
                      it) is taxed the same.
                    Vertical Equity: Capital gains mostly earned by the rich.
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         Neutrality: people try to arrange their affairs to make capital gains to avoid taxes.
                  The means the ITA needs lots of anti avoidance rules
         Simplicity: there is a lot of uncertainty as to whether it is taxable or not. It is very
           difficult to tell.
  Policy: Against full inclusion
         Inflationary gains: many nominal capital gains do not, in fact, reflect greater economic
           capacity, they just reflect inflation.
                  Should adjust the capital gains for inflation.
                            Australia recently changed to a ½ inclusion rate from a 100% inclusion
                              indexed rate.
                  We tax the whole amount of the gain – without taking account of inflation.
                            If we index Capital gains we should index other sources of income.
         Bunching Argument: only on the disposition of the asset. So the TP may receive a large
           sum that will bump them to a higher tax bracket. (Bunched all together in one year.)
                  Bunching is offset by the advantages of deferral.
                  Most of capital gains earners are in the top tax bracket anyways.
                  You can normally control the timing of capital gains losses.
         Stimulates Growth: by encouraging capital gains we encourage industry by adding the
           necessary factors of production.
                  It may be legitimate to encourage investment. But the ½ Capital gains inclusion
                      is ineffective.
                            It is only provided at the end of a successful venture.
                            Better to provide full inclusion of capital losses to promote investment
                              in factors of production.
         Politics: Cap gains earned by very high income people who are also very influential.
                  2002: $100 K income plus – 6% of tax filers. Earn 66% of capital gains.
                  Capital gains are received by all people on the tax spectrum.

Election for Canadian Securities
  S 39(4): Election concerning disposition of Canadian Securities (S 39(6)).
         Permitted to file an election to have the property treated as a capital gain or capital
            loss.
                   When you file this election every single trade in a security will then be treated
                     on a capital account.
                   This is irrevocable.
                   therefore allows TPs to characterize all gains on the disposition of all
                     Canadian Securities as kg, so long as all losses from the disposition of these
                     securities are characterized as k losses.
         If you do not file the election, you fall within the common law definition.
         S 39(6) Canadian Securities: A security issued by a corporation that is resident in
            Canada. A security is a share of the capital stock of a corp, a unit of a mutual fund trust or
            a bond, debenture, bill, note, mortgage etc.
  Section 6200 Reg: excludes from the definition of ―Canadian security‖ shares whose value is
   primarily attributable to real property or resource property, debt of a corp with which the TP does
   not deal at arms length, shares acquired from a non-arm‘s length corp.
  S 39(5) Exception: Brokers, traders, dealers in securities, corps whose principal business is the
   lending of money or purchasing of debt obligations, nonresidents, those taking part in the trading
   of Canadian Securities are not permitted to use the S 39(4) election.

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           will include anyone who acts as a trader or dealer who carries on a business of trading or
            dealing in securities, not only brokers and professionals who are registered or licensed
            (Vancouver Art Metal Works
           This can catch the individual investor if they take part in a number of transactions.
           But this would not catch the “adventure” in the nature of trade only the concern.

Characterization
  the ITA does not define the concept of capital for the purpose of determining the source of a TP‘s
   gain or loss.
  Issue: although a TP‘s income from each office, employment, business or property is fully taxable
   under para 3(a), only ½ of each capital gain is included in computing the TP‘s net income under
   para 3(b).
  But while losses from each office etc are fully deductible in computing net income from all
   sources under para 3(d), capital losses are only ½ deductible in computing a TP‘s net income and
   generally deductible only against taxable kg under 3(b)(ii) or in computing a TP‘s net gain from
   disposition of LPP under ss. 41(2)
                  therefore where TP dispose of property at a gain, generally to their advantage to
                     characterize the source of the gain as capital, not business or property.
                  where the property is disposed at a loss, generally advantageous of the TP to
                     characterize the source of the loss as a business or property rather than capital
                          this is the reason why characterization is so important
  Look at the definition of Business: an adventure or concern in the nature of trade (Taylor).
          Acted like a trader
          Nature and quantity of the property (Key factor)
                  No personal use, no enjoyment potential
          TP was speculating.
                  Trying to capture a person who makes a quick sale at a profit.

Regal Heights (1960)
The secondary intention to sell the land at a profit can make the sale taxable as business income even if the
primary purpose would have made it.
  Later Addition: Secondary intention will only be relevant if it existed at the time the asset was
   purchased.
Courts swayed by the speculative nature of the mall venture and the desire to avoid an easy tax avoidance
scheme.
  Facts: Developers buy property near the Trans-Canada highway outside Calgary. They plan to
   build a shopping centre. They end up holding the land for 2 years and are unsuccessful in
   developing it into a shopping centre. They sell the land at a profit.
  Held: This was taxable as a business profit
         Secondary intention: this was an adventure or concern in the nature of trade.
                  Shopping centre venture was speculative – needed lots of things to fall into
                     place to make it work.
                  They had the secondary intention of selling the land.
         Looked at the work done for the mall as – merely promotional.
         Because of the secondary intention to sell it was taxable.
  Dissent:
         This was a frustrated intention. It was beyond the taxpayer‘s control.
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                       It should be capital gains.
   Discussion:
          CRA really hammered on this “secondary intention” doctrine.
                   But at some price everyone will sell. Does that mean that they had a secondary
                     intention?
          Addition:
                   Secondary intention will only be relevant if it existed at the time of purchase
                     and was a motivating intention.
                          There needs to be evidence of active consideration of sale as an
                             alternative to developing the land or some other use.
          CRA IT Bulletin: Factors in determining if the land is sold as a business property or
            as a capital gain:
                   Intention at the time of purchase
                   Feasibility of the purpose
                   Geographical location and zoned use
                   Extent to which intention carried out by TP
                   Experience of TPs involved.
                   Borrowed money
                   Length of time it was held (important)
                   Nature of occupation
                   Unsolicited offer to buy – weighs in favour of Cap Gain
                   Evidence that the TP and or associates had dealt extensively in real estate.

Manrell (2003)
Property is construed narrowly. It draws its meaning from traditional forms of property. Anything else needs to
be added by parliament –here non-compete payments are not property
   Facts: TP was engaged in the bottling industry. He decides to sell his stake in a bottling
    corporation to an arm‘s length entity. The sale price included both a price for the shares and a
    non-compete payment.
   Held: There is no disposition of Property in a non-compete payment, this is not a taxable gain – it
    is a windfall.
           How does the Appeal court apply the SCC‟s guidance.
                    Cites the modern approach (Stubart): interpret the act in context with the
                      surrounding provisions.
                    Then cites (Ludco): When interpreting the ITA court must be mindful of their
                      role – look for clear statutory language.
                           Be very careful of engaging in judicial rule making under the guise of a
                              purposive interpretation.
           Did Parliament intend to include this “non-compete” promise as a type of property
                    Finds that this would be too broad.
                           Just look at traditional forms of property. This is too unlike traditional
                              forms of property.
                    It is parliament‘s job to deal with this sort of expansion of the act.
   Discussion:
           Phillips does not like this decision: the outcome does not make sense.
                    Why wouldn‘t parliament intend this to be included – there is a complete lack
                      of analysis.


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                    The outcome and analysis is intertwined. If the outcome is so absurd then maybe
                     the analysis is wrong.
                    Ignores the wording of property ―any right whatever.‖ It looks like she is
                     reading the statute and making policy.
                    She easily could have re-characterized the facts – it was really a part of the
                     payment.

S 56.4: Non-Compete Payments are Taxable
  S 56.4: payments of a ―non-competition‖ agreement associated with the sale of shares, is included
   in the proceeds of the shares.
  Conrad Black:
          Sold some subsidiaries and got some large non-compete agreements.
                  There was really no justification for these.
          The transaction happened around the time of Manrell – so at the time they were non-
            taxable!
                  BUT was it fraud to say that they were non-competition payments.

Computation of Capital Gains
Valuation
  Calculation for Kg loss and gain: kg is determined by subtracting the cost of the property and
   the cost of selling the property – the proceeds received in selling it. Loss occurs where the sum of
   the cost and selling cost exceeds the proceeds
  S 38: A taxable capital gain is ½ of the capital gain. An allowable capital loss is ½ of the capital
   loss.
  S 40(1): Value of the Capital Gain.
          (a) gain = proceeds of disposition – (adjusted cost base + expenses of disposition)
          (b) loss = (ACB + expenses of disposition) – proceeds of disposition.
  S 54 “Adjusted Cost Base”: this has a different definition for depreciable property rather than
   non-depreciable property. In no event shall ACB be less than $0.
          Non-depreciable property can be adjusted by the provisions in S 53.
                   Non-Depreciable: examples - land and shares.
                   Inclusions in ACB:
                           Purchase price
                           Expenses of acquisition (Inspection of property, legal fees, delivery
                              costs, survey fees)
                           Any renovations on the property (beyond mere maintenance)
          Depreciable Property: the UCC of the property.
  S 53: Takes account of costs in very specific circumstances.
          S 53(1)(j): stock options.
  S 39(1)(b): capital loss cannot be claimed on any depreciable property.
          There is a terminal loss on depreciable property – which is better than a capital loss.
  S 39(1)(c): a business investment loss (a capital loss on a share of a small business corporation
   – a private Canadian corporation) is an ABIL and cannot be included in the computation of a
   capital loss.




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Dispositions
     computation of capital gain or loss depend on the existence of a ―disposition‖, which triggers the
      recognition of accrued gains or losses for tax purposes.
     S 54 “Proceeds of disposition”:
            The sale price of property that is sold
            Compensation for property unlawfully taken
            Compensation for property destroyed, and any amount payable under a policy of
              insurance in respect of loss or destruction of property.
            Compensation for property taken under statutory authority of the sale price of property.
     S 248 “Disposition”: Any transaction entitling a tax payer to proceeds from disposition
            Shares are disposed of when: Converted as a result of an amalgamation (value of the new
              share issued)
            Does not include:
                     Any transfer of property for the purpose of securing a debt.
                     Issue of a bond for money
                     Issue of a share for money
                     issue of debt for money
                     also transfers of property resulting in a change of legal ownership without a
                        change in beneficial ownership.
            SCC has held that the words disposition of property should be given the broadest
              possible meaning, including the destruction of tangible property (a building) or the
              extinction of an item of intangible property(a patent or leasehold interest)
            according to CRA bulletin, re debt obligations, if there is a change in the economic
              interest in the property that is fundamental = disposition (ie change from interest-
              bearing to interest-free, change in the repayment schedule, an increase or decrease
              in the principal amount)
            some courts have held that in the context of a sale of property, there is a disposal of
              the property as soon as the TP is entitled to the sale price of the property sold
                     where the property is not sold outright, but is subject to a lease with an option to
                        purchase, a disposition of property has been held to occur when the transferor
                        divests itself of all the duties, responsibilities and charges and incidents of
                        ownership even though they retain legal title.

     S 40(2)(g): Losses that are deemed to be nil:
            Superficial loss
            (iii) A loss from the disposition of any personal-use property.
                     Except for Listed Personal Property (stamp collection, sculptures, coins, rare
                        folios, …)
            Note: you do have to include capital gains on LLP but cannot claim capital losses.

Reserves
    s. 40(1)(a)(ii) and (iii): permits TPs who dispose of property for proceeds some or all of which are
     payable after the end of the taxation year to defer the recognition of a portion of a gain through the
     deduction of a reserve.
    allows you to bring your kg income in gradually
    you deduct your reserve under s. 40(1)(a)(iii) and then in the following year you bring it back into
     back into definition of gain in (ii), subject to any subsequent gain you earn in that year


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      EX: capital property = 75,000; sale of the property in 2006 and the proceeds are 100,000.
       Terms for payment of the proceeds allow purchaser to pay in 5 annual instalments, therefore
       not all proceeds will be included in the taxation year.
      s. 40(1)(a)(i) = Proceeds – cost = 25000 gain. It is the gain that is eligible for the reserve;
       not the proceeds from the sale.
      Under (iii), deduction of lesser of two amounts – (C) reasonable amount of a reasonable
       reserve. (D) maximum reserve that you can deduct: 1/5 of that gain, so 25000/5 = 5000 x4 =
       20000. 1/5 can be deferred or spread up to 5 years. Must recognize at least a fifth of your gain
       in each year. Therefore only gain in 2006= 5000.
      In 2007 you will have to compute again; didn‘t dispose of property in 2007, so you do not go
       under (i), go to (ii) – amount claim as reserve in (iii), must include this amount in 2007. So for
       2007, (i) 0; (ii) 20000; (iii) max reserve is 1/5 of the total amount under (i) which is 25,000 =
       5000, x4 – 1(number of preceding taxation years), so 5000 x3 = 150000.
      so under (iii) – where some or all of the proceeds remain payable after the end of the
       subsequent taxation year, the TP may again claim a reserve under (iii)
      it is the part of the capital gain left over that you have not included in your income.
      therefore, under reserve allowance, gain is defined as (i)+(ii) – (iii) under s. 40(1)(a)

Deemed Disposition
  ITA will deem a disposition to have occurred OR will deem the tax payer to have received certain
   amounts.
  requires TP to recognize gains or losses in the absence of an actual disposition by deeming them
   to have disposed of capital property under special circumstances.
         This forces capital gains and losses to be realized at certain times.
                  Anti-Avoidance
                  Limits the deferral period.

S 70(5): Deemed Disposition on Death
  On the death of a taxpayer:
         s. 70(5)(a):Taxpayer is deemed to have disposed of each capital property immediately
           before their death at FMV.
                  Perform a valuation – the expense of that valuation is related to the expenses of
                     disposition.
         The beneficiary is deemed to receive the capital property at FMV immediately before the
           TP‘s death (s. 70(5)(b)).
         s. 70(5)(c): if depreciable property, and the original capital cost of the property exceeds
           its FMV immediately before the TP‘s death, capital cost of the property is deemed to be
           the original capital cost of the property to the TPand the difference between this amount
           and the FMV to have been allowed to this person as a CCA in previous years.
         therefore beneficiary is liable for recaptured depreciation
         will be included by the beneficiary as taxable net gain on LPP in s. 3(b)(i): note, only
           taxed on any increase on valuation of the item.

S 69(1): Deemed Dispositions for Non-Arm’s Length Transactions
  targets transactions which might be used to avoid tax by allocating gains to low-income TP and
   losses to high-income TP. Therefore prevents income-splitting.
  S 69(1)(a): Where the Taxpayer acquired anything from a non-arm‘s length person at a cost in
   excess of FMV – the tax payer is deemed to have acquired it at a cost equal to FMV.
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  S 69(1)(b): Where the Taxpayer sold anything to a non-arm‘s length person at less than FMV, or
   made an inter vivos gift, the tax payer is deemed to have disposed of the property at FMV.
  S 69(1)(c): Where a taxpayer acquires a property by a gift or because of a disposition that does
   not result in a change in beneficial ownership (allocation rules) the taxpayer is deemed to have
   acquired the property at FMV.
         This only applies to an outright gift. It helps the taxpayer avoid excessive capital gains.
         ―anything‖ is extremely broad and therefore would presumably include both intangible
           and tangible property as well as services.
         remember: non-arms length, per s. 251(1)(a): related persons are deemed not to deal
           with each other at arms length. According to (1)(c) this is a question of fact. Related
           persons under (2)(a) includes persons connected by a blood relationship (lineal
           descendants and siblings), marriage or CL partnership (also persons connected by blood
           relationship to a spouse or CL partner) or adoption (adopted children and their adoptive
           parents, as well as adopted children and persons connected by blood relationship (other
           siblings). (2)(b): a corporation is related to a person who controls the corp, members of a
           related group that controls the corp, persons related to controlling persons and members
           of controlling related groups.

Rollover
  AKA non-recognition transaction
  Permits or requires a deferral of tax by allowing a disposition to occur without realizing tax
   consequences.
  under s. 13(4), 14(6) and 44(1), permits TP who disposes of specific kinds of property to defer
   any tax consequences from these transactions where they acquire a replacement property within a
   stipulated period of time. Replacement property will also be allowed where the property is
   unlawfully taken, destroyed or expropriated.
  Purpose:
          To recognize a relationship of economic sharing, mutuality or dependency.
          to encourage or facilitate certain types of transfers that are deemed economimcally
            desirable and to remove possible disincentives to certain kinds of transactions.
                   Good thing for spouses to share capital property between them – good to remove
                      disincentives.
                   Corporate rollovers: don‘t want to discourage efficient capital allocations.
  Two parts to a rollover.
          Transferor is deemed to receive proceeds equal to the ACB of the property (i.e. zero
            capital gains).
          Transferee is deemed to incur costs equal to the ACB (i.e. Essentially step in to the shoes
            of the transferor)
          These deemed costs and proceeds override the actual costs and proceeds that were
            actually made on the transaction. Substitutes deemed proceeds and deemed costs.
          Therefore, net effect is that there is a ZERO gain to the transferor.

S 70(6): Rollover to a Spouse on Death
  S 70(6): Transfer or distribution to spouse or common law partner (who is resident in Canada)
   will cause a roll over immediately before their death.
          Surviving Spouse steps into the shoes of the deceased spouse.
  S 70(6)(c): This will override the death provision (70(5)) for spouses and transfer to the
   surviving spouse at the ACB.
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  S 70(6.2): it is possible to elect out of this rollover. The legal representatives of the transferor
   are able to make this election to have S 70(5) apply instead.
          This may be done to use up capital losses that might otherwise expire.
  s. 70(5)(e): where the property subject to the rollover was depreciable property, deems the capital
   cost of the property to the spouse or whoever to be the original capital cost of the property to the
   TP and the difference between this amount and the cost of the property to the spouse or CL to
   have been allowed to this person as a CCA in previous taxation years – therefore spouse or CL
   partner liable for recaptured depreciation on a subsequent disposition of property.
  remember, in the year of death, if the deceased has property that has an accrued capital loss
   – loss can be applied to reduce income of any source. In order to realize the loss, must elect out of
   the rollover. Otherwise the loss is transferred to the disposing spouse. Loss carryovers are
   computed in s. 3(c)

S 73(1): Inter Vivos Transfers by Individuals
  S 73(1): a transfer or distribution to a spouse or common law partner (who is resident in
   Canada) will cause a roll over on an inter vivos transaction.
          Section 73(1) overrides S 69(1)(b), as s. 73(1) governs transactions between spouses.
          s. 73(1) to apply unless the taxpayer (transferor) elects out of it. Important as TP will not
            receive any kg or loss. If you elect out, the Act then applies the deemed disposition rules
            under s. 69(1)(b), in which transactions between non-arms length parties are deemed then
            to be disposed at FMV.
          Rollover will apply under s. 1.01, when transfer of property is (a) to spouse or CL partner,
            (b) a former spouse or common law partner in the settlement of rights arising out of their
            marriage.
  Transferor can elect out of the application of this provision.
          Then S 69(1)(b) takes over.
  Transfer of farm property to child: s. 73(3) and 70(9): permit a rollover on this transfer of
   capital property to a TPs child, but only for land or depreciable property that was, before the TP‘s
   death, used principally in the business of farming in which the TP, TP‘s spouse or CL or any of
   the TP‘s children were actively engaged on a regular and continuous basis. s. 73(4) and 70(9.2)
   apply where the property transferred to a child consists of shares of the capital stock of a family
   farm corporation of an interest in a family farm partnership. TP‘s legal representative can elect as
   to the property‘s proceeds of disposition between any amount from the cost and its FMV.

Capital Gains Attribution
  Attribution Rules for Income from Property (S 74.1): Attributions applies to a spouse or
   common law partner, minor child, niece or nephew.
  S 74.2(1) Capital Gains Attribution: Attribution only for spouses!!
         only non LPP dispositions.
         attribution lasts over length of relationship and joint lives – attribution stops at divorce
           or separation.
         it will be the net taxable capital gains or losses that will be attributed back to the
           transferor
         if there is a net loss under (b), this is an allowable capital loss that is attributed to the
           transferor as well.
         For minors the attribution rule is very easily avoided by hanging onto the asset for an
           extra year or two.


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  To prevent spousal attribution of income and capital gains under s. 74.5(1): transferee spouse
   must pay FMV of the asset. Also, if it is property being transferred, transferor spouse must elect
   out of 73(1) rollover
  Ex: parcel of vacant land which he received as a gift from his spouse in 2002. Sam‘s spouse had
   purchased the land for 20G in 2000. But it was valued at 25G shortly before she gave it to Sam.
   The spouse has filed no election under s. 73(1) when she gave the land to sam in 2002. Sam sold
   the parcel to an arms length buyer in 2004 for 20,600. A: Spouse transfer. No election, so received
   at ACB at 20G due to rollover, Taxable capital gain of 5G realized will be attributed back to the
   spouse and reported on his or her tax return. To prevent, do above steps.

S 74.2(1): Capital Gains Attribution
  S 74.2(1): Attributes the capital gain back to the transferring spouse.
         How do you avoid attribution:
                  Spouse pays FMV, and
                  Transferor elects out of the roll over.
         Attribution always accompanies the rollover because when you transfer on a rollover
           basis you never really disposed of the property for tax purposes.

Capital Gains Exemption for small Business Corporation Shares
  Deducted under division C.
  Came up in McNichol: Shareholders in computing their income can apply the $500 K exemption
   to a taxable capital gain to avoid taxation. Only available to an SBC.

Adjustments to Find Taxable Income
Other Income and Deductions
Subdivision d of Division B of Part I: miscellaneous sources of income
  Specific inclusions into income from other sources, which is included in computing their net
   income from all sources under para 3(a)
          These are added to overrule tax cases.
          These raise issues as to their scope.
  any types of sources that may not be included in the common law source concept of income –
   this section brings in expressly other types of amounts.
  Two ways to capture into taxable income
          Income from a source
          Expressly brought in as a miscellaneous inclusion under Subdivision d.
  Ex. Schwartz: 56(1)(a) Retiring allowances, pension benefits (any amount received out of or
   under a superannuation or pension fund or plan). Includes old age security act allowances, CPP or
   provincial pension plan, also amount of any payment under a foreign retirement arrangement)
  in addition to amounts that may be deducted in computing a TP‘s income from an office,
   employment, business or property, para 3(c) allows TPS to deduct other amounts listsed in
   subdivision e

Income to Taxable Income: Div C
  S 2(2): taxable income equals income (Division B) subtract deductions or add income
   (Division C – only currently has deductions).

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  Division C are further deductions
         Cannot carry over division C deductions if you have no income
         Capital Gain deductions up to 500,000
         S 110(1)(d) & 110(1)(d.1): Stock Option Benefit deductions
         S 111: Non Capital Loss carry over/back from previous years (capital and non-capital)
           (excess losses from previous years that could not be deducted in the past and carried over
           to another year) – used to compute their taxable income, not their income. Non-capital
           loss under 3(d) (employment, business, abils etc) which you could not deduct because you
           did not have enough income from which to deduct it from in previous taxation years. Can
           carry forward losses from up to 20 years ago. Business losses arises in 2006 that cant be
           deducted now can be carried forward for 20 years. Losses incurred in 2004 and 5 = 10
           yrs; 2003 or before is 7 years.
         net capital loss – 3(b) – when (ii) losses exceeds (i) gains – can be carried 3 years back
           and indefinitely forward to subsequent taxation years. Can only be carried over to the
           extent that you have net taxable capital gains for that year reported under 3(b).
                  Note: cannot deduct net losses from LPP.
                  under 3(b)(i) is tkg minus (ii) which is allowable kl = net taxable kg.

Taxable Income to Tax Payable
  Apply the rates (Division E)
  Apply the credits (Division E – basic personal credit) after you apply the rates under Div E

  Canada Employment Credit: apply whenever the TP is employed, and the question asks you to
   determine tax payable
                 it is under s. 118: A x B where A is the appropriate percentage of the taxation
                    year (15.25) x the less of 250 or if the amount of the person‘s income is under
                    250 for the taxation year from all offices and employments.




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