The Measures Tax Letter December 2008 Buy a TFSA! The TFSA, or Tax-Free Savings Account, is the newest acronym to hit The best investments to put into a TFSA are those that generate interest, the Canadian tax world in a big way. We are now starting to see significant since those are the highest taxed when outside a TFSA. Capital gains are maketing of TFSAs by banks and other financial institutions. They come into only half-taxed, and dividends are also taxed at a preferential rate due to the operation on January 1, 2009. dividend tax credit. Cash, bonds, GICs, and other debt instruments are thus your best choice for a TFSA. We wrote about TFSAs in our April 2008 issue. The TFSA allows you to put $5,000 per year into a special account in which income and gains are Your spouse, and any children over 18, should also look at setting up TFSAs. not subject to tax. Contributions are not deductible, but withdrawals are (The attribution rules do not apply to your spouse’s TFSA if you provide the not taxable. funds, and the attribution rules do not generally apply to funds you give your adult children.) If you have any funds earning interest or invested in securities, there is no reason not to put $5,000 worth into a TFSA in January. There is absolutely no downside (other than any fees the financial institution may charge). There is no limit on when and how much you can take out of the TFSA, and you can replenish at any time all amounts that you have removed. The danger in letting your corporation go out of business With the current bad economic times, some businesses are failing. If you a liability for an earlier year). This will apply unless you paid fair market have a corporation that is on the verge of going out of business, be wary of consideration for whatever you got from the corporation. (To the extent you ways in which you may become liable for the corporation’s tax debts. drew down your loan to the corporation, the reduction in the shareholder loan owing by the corporation to you will be consideration and you will not First, if the corporation has unremitted employee source deductions or be liable.) GST (or retail sales tax in some provinces), the directors are potentially liable for these amounts. (This can also apply to de facto directors who are The Canada Revenue Agency will first try to collect the debt from the not legally directors but act as though they were.) We discussed this in detail corporation, but if it is unable to do so, it can come after you and assess you in our April 2007 letter. There are several possible defences against such for the amount that you extracted from the corporation (up to a limit of the an assessment, the most important being the “due diligence” defence. Also, corporation’s tax debt). once a director has legally and formally resigned (and, to be sure that the CRA cannot claim that it was unaware of the resignation, has notified the Thus, for example, if you have taken dividends during the corporation’s provincial corporations registry of the resignation), the CRA cannot assess taxation year, and the corporation has unpaid income tax for the year, expect the director after two years have run. the CRA to assess you for the amount you received from the corporation. Even though you paid tax on the dividends, so your net amount after-tax was, Directors are not normally liable for the corporation’s unpaid income tax. say, 70% of what you received, you can still be assessed for the total amount you received (due to the 2007 Federal Court of Appeal decision in Gilbert). However, you can be liable under section 160 of the Income Tax Act — whether or not you are a director — if you do not deal at arm’s length with the corporation, and you extract money from the corporation during any year for which it ends up with an unpaid tax liability (or if it already had Finding a mistake in a past year’s tax return What happens if you find a mistake in a past year’s tax return? Even if you are past the deadline for filing an objection and you just make an ordinary request, the CRA will normally review your request and accept it if Mistake Where You Paid Too Much Tax it believes that it is correct. If you forgot to claim a particular deduction or credit, you can write to the These changes can legally go back only 10 years from the year in which you Canada Revenue Agency and provide details of the amount you forgot to make the request. If you request a change for an earlier year, the CRA has claim. You can file a Form T1-Adj (T1 Adjustment), which can be found on no legal authority to make the change, so even if it is justified, your request the cra.gc.ca Web site, to “adjust” your earlier return. will be rejected. You can also do this if you have determined that the CRA assessed you Mistake Where You Did Not Pay Enough Tax incorrectly, such as if you have realized after filing your return that you could have reported your income differently than you did. What happens if you find that you inadvertently under-reported your income, or claimed a deduction or credit that you were not entitled to? You can also make such change requests, using www.cra.gc.ca/myaccount, over the Internet. As with the case where you paid too much tax, you can file a T1-Adj adjustment form to report the correction, or you can make such change If you are within the objection deadline for objecting to the assessment requests over the Internet, using www.cra.gc.ca/myaccount. for that year’s return, then you may wish to file a Notice of Objection to preserve your legal right to request these changes. The deadline for filing a If more than one year has passed since you filed the return, you may Notice of Objection is 90 days from the issuance of a Notice of Assessment wish to make a voluntary disclosure to eliminate any penalties that may (or Reassessment) for the taxation year; or one year from the original apply. See Information Circular 00-1R2. To be accepted, a disclosure must filing deadline for the return, whichever is later. So if you carry on business be “voluntary” in the sense that you are not currently under any audit or and your filing deadline is June 15, then you can still object to your 2007 enforcement action that might discover the error; and it must be “complete” assessment until June 15, 2009. If you do not carry on business and your in that you must disclose all errors in your tax filings for all years. filing deadline is April 30, then you can object to your 2007 assessment until April 30, 2009. You can only do a voluntary disclosure if there are penalties involved. Provided you filed your return on time and were not “grossly negligent”, Filing an objection is a good idea if the deadline is looming, even if you think normal mistakes will give rise to a requirement to repay the tax with interest, that the CRA will routinely accept your request. It gives you the legal right but not penalties. to force the CRA to listen to you. Also, the Appeals Division (which handles notices of objection) is often more pleasant to deal with, and more responsive What if you do not feel like reporting the correction to the CRA? and accountable, than the Client Services Division or Taxation Centre which Of course, as long as the reassessment period is open (normally three years processes adjustments. This is because Appeals is much smaller, and does after the date of your initial Notice of Assessment), you are subject to the risk not handle anywhere near the volume of transactions as Client Services or of audit and reassessment, if the auditor finds the mistake. If that happens the Taxation Centre. you will have to repay the tax plus interest at the prescribed rate (currently 7%), compounded daily. Starting a home business - points to ponder Are you considering starting a home business? Here are some planning GST or HST issues, tax ideas and tips to keep in mind. If your total taxable sales in Canada exceed $30,000 per year, you must Incorporation register for and collect the 5% GST (which is the 13% HST in Nova Scotia, New Brunswick and Newfoundland & Labrador). Until your sales top the Many people are not clear on the difference between a business and a $30,000 mark over four calendar quarters, you do not have to register for corporation, but the difference is extremely important, for both tax purposes GST/HST. and liability purposes. Even if you are under $30,000 in taxable sales, if your sales are to businesses You can carry on business without creating a corporation. Although you may rather than consumers then you may wish to register for the GST. You will give your business a name, it is simply you carrying on business as a “sole need to collect GST/HST from your customers, but they generally will not proprietor”. care since most businesses get back all GST or HST they pay. You in turn will be able to recover all GST/HST that you pay on your business expenses. If you create a corporation, then the corporation is a legally separate person (You may also be able to profit from the Quick Method of filing, which can from you, and the corporation, not you, carries on the business. Although allow you to make a little money out of the GST if you have few GST-bearing you control the corporation, the business is legally not “your” business. expenses.) This means that you are not liable for the corporation’s debts. (However, if the corporation needs to borrow money from a bank, the bank will insist You may need to register for and collect provincial sales tax as well, on a personal guarantee from you, so you will be liable if the corporation depending on the nature of the services you provide. The Quebec Sales Tax cannot repay the bank loan. Also, as a director, you are liable for certain is generally harmonized with the GST and applies on the same basis. BC, obligations of the corporation, such as an assessment of GST or employee Saskatchewan, Manitoba, Ontario and PEI have retail sales taxes. Make source deductions that the corporation fails to remit.) sure you are properly informed of the rules that apply to your industry. For example, in Ontario someone providing computer consulting services must If you create a corporation, then the corporation will have to file annual register and collect provincial retail sales tax on all services of installation, tax returns and pay tax on its profits. You should not simply take the testing or debugging of software other than pure custom software. In corporation’s money for yourself. When you want to extract profits from the Saskatchewan, a wide range of services is taxable, including consulting corporation you should either have the corporation pay you salary (which the services, accounting services, real estate commissions, laundry, security and corporation can deduct and is taxable to you), or have it pay you dividends account collection services. (which are not deductible to the corporation but are taxed to you at a lower rate, due to the dividend tax credit). These steps require certain paperwork Reporting Your Income and it is important to document properly what you are doing; otherwise the tax consequences can be serious if you or the corporation is audited. The When you are carrying on a sole proprietorship, any income earned by corporation can also repay any money you have loaned to it, with no tax the business is reported on your tax return under “Business income” (or consequences. Professional, Farming or Fishing income if you are engaged in one of those kinds of businesses). Sole Proprietorship The tax return requires you to show both gross revenues (total sales) and In most cases, a home business is simply carried on as a sole proprietorship. net business income (after expenses). You will also need to file an income There are no legal requirements for doing this; you are not required to have statement showing the details of your revenues and expenses (broken a separate business name, though you may wish to in order to appear more down by category — e.g. Advertising expenses, Office supplies, Meals & professional to your customers. (If your business will be visible, such as with entertainment, Telephone, etc.). The CRA provides a form www.cra-arc. customers regularly visiting you, then you should check whether you may gc.ca/E/pbg/tf/t2124/README.html” T2124, “Statement of Business run afoul of local zoning bylaws, or condominium or apartment rules if you Activities”, which can be used for this purpose. live in a building.) Your net business income is simply combined with your other sources of If you pick a business name which is not simply your own name (or perhaps income on your return, like employment income and investment income, to your own name plus something like “Consulting Services”), then when you reach “total income”. are paid by your customers, you will need a business account into which to deposit the cheques. For this purpose your bank will normally require that you obtain a business name registration from the province. This is usually a simple matter that requires a modest fee. Registering a business name in this way does not give you any special rights to that name if it violates someone else’s trademark; it simply allows you to carry on business under that name, sue under that name if you need to go to court, and open a bank account under that name. Deducting Business Expenses Home office expenses When calculating your (net) business income, you can deduct the expenses of Home office expenses are deductible only if you fall into one of these two carrying on business. Here are some things to make sure you do not miss: categories: Office supplies • Your home is your principal place of business — that is, you do not This would include computer paper, printer toner cartridges, USB sticks, have an office elsewhere. Note that even if you have a major client that pens and pencils and similar items that you buy for use in the business. It provides you with an office on its premises, it is still the client’s may also include publications such as business magazines and journals. premises and it will not disentitle you to your claim for a home office. Keep your receipts! If you buy supplies for a combination of personal and business use, estimate the business proportion. or Telephone • The home office is used exclusively for your business, and is used “on a If you have a separate business line (or perhaps a business fax line), the cost is regular and continuous basis for meeting clients, customers fully deductible. If you are using a personal line partly for business purposes, or patients”. it probably falls within the “Home office expenses” category below. And You can only claim the expenses against your income from the business. You don’t forget to deduct your monthly Internet connection service fees (ISP, therefore cannot use home office expenses to produce an overall business cable modem, ADSL line, etc.), and cell phone costs if you use your cell loss that is applied against other income. phone for your business. However, losses disallowed because of this rule can be carried forward and Equipment used in any later year against income generated from the same business (you For expensive, long-lasting items like computers and furniture, you cannot will need to bring them in on each year’s return to carry them forward). deduct the expense directly. Rather, you can claim depreciation, called “capital cost allowance” (CCA), applied on a declining balance over many The allowable expenses will normally be based on the fraction of the home years. The CCA rate depends on the kind of equipment; for example, it is that is used for your office. When making this calculation, you can normally 55% for computers and 20% for furniture. You combine all assets of the exclude common areas, such as hallways and bathrooms, from both the same “class” into one pool and claim CCA on the pool. For the year in which numerator and the denominator. You can choose any calculation which is you acquire an asset, only 1/2 of the normal rate of CCA can be claimed for reasonable; for example, calculations based on square footage or number of that asset. After that you claim the regular rate based on the balance left over rooms are usually considered reasonable. from the previous year’s claim. The expenses you can claim include: Automobile expenses You will need to track your business use of your car as opposed to your • rent, if your home is rented personal use. It is advisable to keep a daily logbook recording business use, • mortgage interest (but not the principal portion of blended mortgage and note the odometer reading at the beginning and end of the year. You can payments) then figure out your business use proportion, and deduct that percentage of your gas, insurance, licence, car-washes, maintenance and repair costs. You • home insurance can also deduct that percentage of capital cost allowance (which is 30% per year for cars). However, note that there is a dollar limit on the cost of a car • property taxes which can be used as your base for claiming CCA. The limit is reviewed each year; for cars purchased in 2001 through 2008 it has remained at $30,000 • utilities: electricity, heat, water, gas (plus sales tax). • telephone, if your personal line is used partly for business Meals and entertainment • outside maintenance: lawn care, snowplowing (especially if they are You can claim restaurant meals and tickets to sports events, shows, etc. where justifiable because you have to keep the house presentable for business the expense was required for your business — e.g. you take a prospective visitors) client to dinner or a hockey game. However, you can only claim 50% of the cost as a business expense. • minor repairs, supplies (e.g., light bulbs) and maintenance You may also claim CCA (at 4% of the declining balance of the cost of the building) on the appropriate fraction of your home, but this is often not advisable. Around the courts Business expenses allowed despite many years of losses The Court allowed the appeal. The judge soundly rejected the CRA’s argument that, because the losses continued for so many years with no In the recent Kaegi case (Tax Court of Canada), Mr. and Mrs. Kaegi were in revenues, the Kaegis could not be engaged in a business and it must be a the business of recording and promoting music. They recognized that it can personal hobby. The judge noted there was “overwhelming evidence of take many years for a recording artist to break into the industry and reach commerciality”, and reminded the CRA that the old concept of “reasonable any kind of prominence. However, they persevered, producing CDs, hiring expectation of profit” was done away with by the Supreme Court of Canada a promoter who sent their music to radio stations, and at one point totally in 2002 (in the Stewart case). changing the direction of their music. In the end, therefore, the business expenses were allowed. Score one for the Over the course of nine years, the Kaegis claimed over $200,000 in expenses, taxpayers! with no revenues for the first eight years and only $597 of royalty income in the ninth year. These losses were deducted against their other sources of income. The CRA disallowed the losses, taking the position that the Kaegis were not really engaged in a business. The Kaegis appealed to the Tax Court of Canada. 1100 René-Lévesque Boulevard West, 20th Floor Montréal, Québec H3B 4N4 Telephone 514 / 878-9631 Fax 514 / 874-0319 www.demersbeaulne.com This letter summarizes recent tax developments and tax planning opportunities; however, we recommend that you consult with us before embarking on any of the suggestions contained in this letter, which are appropriate to your own specific requirements.
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