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BUSINESS/PROPERTY INCOME

81(4)

INTEREST DEDUCTIBILITY - MUTUAL FUND UNITS

In an August 21, 2007 Technical Interpretation, CRA notes that where funds are borrowed to acquire a mutual fund unit and, there is a Return Of Capital to the unit holder without any disposition of the property, if the funds received are not used for an income-earning purpose, the interest on that portion of the borrowed money that relates to the Return Of Capital would not be deductible since its current use is personal.

PERSONAL SERVICE BUSINESS CORPORATION

In a January 19, 2006 Tax Court of Canada case, a computer technician formed a corporation that received subcontracts from only one person. CRA successfully determined that the corporation was a personal services business and denied the small business deduction.

The Court agreed with CRA that there was an employment relationship resulting in a personal service business status.

Editor’s Comment

The corporation would have had a better chance of success had there been a signed bona fide independent contractor contract, and related performance, in accordance with the independent contractor criteria in CRA Guide RC4110.

MUTUAL FUNDS FOR INDIVIDUALS

CRA’s Guide RC4169 explains the tax treatment of mutual funds for individuals including:

1. A mutual fund trust will issue a T3 Slip and a mutual fund corporation a T5 Slip to report capital gains, dividends, foreign income, interest, other amounts, returns of capital, or a combination of these amounts.

2. When an investor redeems or cashes in the units or shares, you are taxed on the capital gain. The individual will receive a T5008 Slip from the mutual fund.

The Guide also includes example calculations.

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OWNER-MANAGER REMUNERATION

81(5)

APPROPRIATION OF PROPERTY

In an August 8, 2007 Tax Court of Canada case, Mr. and Mrs. D each owned 50% of the shares of CANCO. Mr. and Mrs. D transferred $96,000 of CANCO funds into an investment account held jointly by them to produce better returns on the combined funds. Approximately three years later, all the funds were returned to CANCO to restore the status quo.

CRA successfully assessed Mr. and Mrs. D for appropriating corporate property even though the funds were returned to the company.

THE BONUS DOWN DECISION

In the past, Canadian-controlled private corporations (CCPCs) ordinarily bonused down their active business income to the small business deduction amount. This approach has been complicated through the reduction of tax on eligible dividends paid out of the General Rate Income Pool (GRIP). In all provinces, there is a significant deferral in leaving income in the corporation at the top corporate rate versus the top personal rate. However, there is an overall cost when the amounts are taken out even though they are eligible dividends.

An additional complication is that by not bonusing down the corporation must make its final corporate tax installment payment two months after the year-end (not three months) and have much higher monthly corporate tax installments. Also, quarterly, rather than monthly, tax installments would not apply.

Other considerations include the shareholders’ current or future cash needs, the effect on any scientific research and experimental development claim, the effect on the small business corporation status through the buildup of surplus inactive assets, the loss of the small business deduction as taxable capital in the corporation exceeds $10 million, and the accelerated payment of corporate tax installments.

There are also provincial tax implications to consider.

REFUNDABLE DIVIDEND TAX ON HAND (RDTOH)

A corporation may pay an “eligible dividend” and still receive the 33 1/3% refund of RDTOH. As the tax rate on “eligible dividends” is significantly less than this 33 1/3%, having General Rate Income Pool income and investment income in the same corporation permits the RDTOH to be refunded through the payment of “eligible dividends”.

Making a Dividend Eligible

A dividend is made “eligible” by advising all recipients that it is an eligible dividend when it is paid including:

• CRA has indicated that Directors Minutes could designate the dividend, if all shareholders are directors.

• Otherwise companies may want to have letters dated on the date of dividend payment specifying the dividend is “eligible”.

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FARMING

81(6)

INTERVIVOS ROLLOVER OF FARM PROPERTY TO CHILDREN

The Income Tax Act generally permits a taxpayer to transfer, on a tax deferred basis, farm property to a child. This “rollover” is important, even if the taxable capital gain exemption would otherwise be available, because this taxable capital gain is included in net income, even though it is deducted in computing taxable income. This affects income sensitive items such as Old Age Security clawbacks, age credit clawbacks, Guaranteed Income Supplements, etc.

CONVERSION OF FARMLAND - CAPITAL GAIN EXEMPTION

In a September 17, 2007 External Technical Interpretation, CRA reviewed a situation where farmland is to be subdivided to provide for the future creation of a real estate development.

CRA noted that the taxpayer will have a notional capital gain (1/2 taxed) on the date of conversion however, this capital gain will not be taxed until the taxation year during which the ultimate sale occurs. Where the property is a qualified farm property, the taxpayer is entitled to claim the capital gains exemption.

The increase in value of the property between the date of conversion and the date of sale will be reported as a full inventory gain.

Editor’s Comment

The main disputes with CRA arise on the date of conversion and the value attributed thereto.

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