Commentary Archives - Page 6 of 13

What to expect when the Canada Revenue Agency (CRA) contacts you

Canadian citizens know who the Canada Revenue Agency (CRA) is, so if you’re contacted, be sure that you’re communicating with the real CRA. Scammers impersonating CRA agents are rising in numbers, and for this reason it is critical that Canadians know what a CRA agent would ask and would not ask. For instance, on a phone call, a CRA agent will never demand immediate payment or threaten you with imprisonment, and the same goes for mail. Additionally, CRA agents will never request payment over emails – so be wary.

Key Takeaways:

The CRA will never ask for financial information by email and ask you to click on a link to complete a form.
The CRA won’t demand immediate payment by Interac e-transfer, bitcoin, prepaid credit cards or gift cards.
The CRA may verify your identity by asking for personal information such as your full name, date of birth, and address; or for a business, they may ask for details about your account.

“When in doubt, ask yourself – Why is the caller pressuring me to act immediately? Am I certain the caller is a CRA employee?”

Many Canadian SMEs face taxing problems

Many small businesses can find themselves the subject of a CRA audit, especially if they are in certain industries or take a lot of payments in cash. Even companies that are the most compliant will lose time and money because of an audit. Because of the possibility of an audit, businesses such as restaurants that deal with cash should consider legal expense insurance or work with an accounting firm who know your business and have access to these specialists.

Key Takeaways:

In Canada, there are many mid-sized businesses that get audited by the CRA, but precisely how the CRA determines which businesses will be audited is understandably kept under wraps.
Some sectors are more likely to face an audit than others, especially in industries that are known to be less compliant.
It’s important to have a specialist and accounting professionals to work with you until the conclusion when you’re going through an audit.

“For many business owners, the stress of facing a CRA audit is as much about the additional work as the possibility that auditors might actually find something amiss.”

What you need to know about the tax consequences of employee stock options

Employee stock options are a popular tool companies use to reward existing staff and attract new employees. However, these options have major tax implications. The options – when exercised carry with them taxes. Usually, this is half the amount of shares optioned which goes to the tax authority. In the event of stock decline from when the shares were optioned – the decline is booked as a capital loss and is not deductible and will result in a mismatch on the individual’s yearly tax form.

Key Takeaways:

Stock option benefit is classified as employment income not capital gain.
If an employee decides to sell his/her stock, they become an investor and is no longer considered an employee.
The law was changed in 2010 which now allows the government to collect taxes when certain options are exercised and employees need to be mindful.

“A capital loss can only be used to offset other capital gains and cannot be deducted against the taxable employment benefit that arose upon acquisition of the shares through the option exercise.”

Canada: Indirect Income Verification

The CRA specifically targets small- and medium-sized businesses, because of the perception that their records aren’t maintained as well as other larger companies. One of the ways the CRA looks for tax evasion is through estimating indirect income. The problem is, these estimates are based on assumptions and are not always correct. As a business owner and taxpayer, if you feel you are wrongly being audited you have the right to challenge. Just make sure you have the evidence to back up your challenge and get professional assistance, if needed.

Key Takeaways:

Sections 231.1 and 231.2 of Canada’s Income Tax Act allow the CRA to issue a Requirement for Information, which is essentially a letter demanding that the taxpayer (or any relevant third party) release specified documents or information.
Using indirect income verification is a way for the CRA to estimate a taxpayer’s income when dismal recordkeeping bars the more reliable, regular tax audit techniques.
A taxpayer has two options: to challenge the propriety of the auditor’s use of an indirect income verification method, or to challenge the indirect audit by analyzing and disputing every assumption and calculation of the assessment on a line-by-line and item-by-item basis.

“The CRA invokes its most aggressive tactics when auditing small and medium businesses—groups that the CRA perceives as most likely to retain poor records or lack internal controls. These aggressive tax audit methods fall under a class of techniques known as indirect income verification methods.”

Some unusual tax facts about income, deductions and credits

If you are unsure of what can be a tax credit or deduction, do your research or seek out some professional advice first before you act, or you might face consequences down the road. Illegal activity, medical expenses, employment expenses, pet maintenance and other expenses may or may not be deducted depending on what you are paying for or where you derive your earnings from. Real-life examples are discussed in detail to give you an idea of what you might be able to do come tax time.

Key Takeaways:

Canadians can claim eligible medical expenses incurred in any 12-month period that ends in the calendar year, which means you can pick the period with the highest amount of medical expenses provided they haven’t already been claimed.
Employees are permitted very few deductions other than certain costs they are required to pay for personally, which can be found on CRA’s Guide T4044
Gambling losses cannot be deducted if it is a hobby, but if it qualifies as a commercial activity, then winnings are taxable along with losses being deductible.

“Are you wondering whether that item you just purchased is deductible for tax purposes? Or whether an amount you received is taxable? There’s no shortage of stories to tell about taxpayers who got it wrong – or right, for that matter.”

Income splitting is a dangerous tax game if you don’t know the rules

In Canada, income splitting – the practice of shifting income within a family to avoid high tax rates – is tempting due to steeply graduated tax brackets in many provinces. Anti-avoidance rules make the process tricky; nonetheless, there remain many opportunities to legally use income splitting to lessen one’s tax burden. For example, pension income can be shifted between spouses or partners. Even here, however, taxpayers must be careful, as the CRA will pursue unlawful activity in court.

Key Takeaways:

Our Income Tax Act has a variety of anti-avoidance rules, known as attribution rules, meant to block attempts at income splitting by attributing the transferred income back to the original source.
Here are the outcomes of three different income splitting scenarios: (1) if you give your minor kids money to invest, then any interest or dividends earned on those funds will attribute back to you but not any future capital gains; (2) if you gift funds to your spouse or partner for investment, all future income as well as capital gains will attribute back to you; and (3) if funds are loaned between spouses or partners at a minimum of the CRA’s prescribed rate, then the attribution rules won’t apply, provided the interest on the loan is paid by January 30 of the following year.
The easiest way is to split pension income, which can result in substantial tax savings if one spouse is in a lower tax bracket, and it can also help preserve benefits like Old Age Security.

“If you don’t understand the complex rules surrounding what is and isn’t allowed in income splitting, you could find yourself facing off against the tax man in court.”

Time to do some active planning to beat the passive income tax changes

Small businesses who earned over $50,000 in passive income in the past year may no longer qualify for the small business deduction (SBD). Some business owners will be affected, but all should take note of the changes. One way to prevent the loss of this deduction if your “adjusted aggregate investment income” (AAII) is close to or exceeding the threshold, is to withdraw funds that would have been invested or invest in growth potential rather than interest earnings. Life insurance and pension plans can also be utilized to limit the amount. Whatever you choose to do, start planning now.

Key Takeaways:

The loss of the small business deduction will go into effect in 2019 for corporations with more than $50,000 in passive investment income from 2018.
Currently, the small business deduction allows for a low rate of corporate tax on the first $500,000, which is known as the SBD limit, for active business income per year.
Under the new rule, the SBD limit will be reduced by $5 for each $1 of AAII that exceeds $50,000 and will reach zero once $150,000 of AAII is earned in a year.

“If you are going to take the after-tax business income out of the company in the year it’s earned, then you’re not enjoying any tax deferral and the loss of the SBD is likely immaterial.”

Your personal business better be real if you are using it to claim expenses

Canadian taxpayers who claim business expenses need to take care to ensure they’re valid. As a recent case involving an Ontario resident demonstrates, if the business is sketchy (aka not a valid commercial business), the Canadian Revenue Agency will pursue legal action against such activities, and win. In this case, a man ran an unincorporated business for years, claiming a level of business expenses that far exceeded his company’s revenue. He also kept poor records, which didn’t help his case. In court, the judge ruled against him, finding that the business wasn’t designed to make a profit, and his write-offs were thus in violation of tax law.

Key Takeaways:

Do not try to claim losses on your personal business unless it is really a legitimate business.
Make sure you keep all receipts in order, so that expenses claimed on your tax form match individual receipts.
Be forewarned that your case may go to court to be decided upon if you are claiming a loss on your personal business.

“Notwithstanding the reasonableness of his expenses, the real issue before the Tax Court was whether he could deduct any expenses as the CRA argued that the taxpayer did not actually have a commercial business.”

Four tax tools to boost investment returns

Taxes are usually the bane of investors, because they nibble away at investment earnings. However, there are several tax tools that could safeguard or even plump up your investment dollars. For example, using a tax-free savings account, or a registered retirement savings plan, allows investors to grow their dollars in a tax-free way, using any of a wide array of available securities. Other ways that investors can potentially avoid losing some of their investment earnings include using a capital gains exemption or a dividend tax credit.

Key Takeaways:

One main difference between a registered retirement savings plan (RRSP) and a tax-free savings account (TFSA) is that in the latter, you cannot deduct contributions from taxable income.
Contributions and gains inside an RRSP are not taxed until they are withdrawn – ideally in retirement when the plan holder is in a lower tax bracket.
An investor should also consider the capital gains exemption (only half of equity gains are taxed), using equity losses to offset gains, or the dividend tax credit (for eligible dividend stocks) to boost returns over the long-term.

“Taxes are normally seen as a drain on investments but there are four tax tools available to the average investor that could actually boost returns over the long term.”

Can I win by shifting funds from my RRSP to my TFSA?

If your RRSP account is where the majority of your money is held, what are the implications of transferring some RRSP money each year to a TFSA account to catch up to the maximum limit? Unfortunately, there is no right answer for everyone. Because this is a tax question, it really depends on your annual income, retirement income and financial goals as to whether it is wise to shift funds. For instance, if you’re not currently working or have a small income for this year, then withdrawing from your RRSP so that in retirement your income is reduced would be beneficial. However, at a certain income level, there isn’t any difference between leaving it in an RRSP or transferring to a TFSA.

Key Takeaways:

When considering shifting money from an RRSP to TFSA, taxes are an important factor.
You may not benefit from shifting funds depending on your current income as well as your after-tax retirement income, so consider your entire financial situation.
There’s a slight advantage to keeping your withdrawals under $5,000 because there’s less withholding tax, but this may be temporary as you may owe more tax when you file your annual tax return.

“An RRSP drawdown to fund your TFSA can mean more retirement income [but] this is a tax question so your annual income is important to consider when making a final decision.”