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Ottawa has turned income-splitting rules into an absolute nightmare for small businesses

When the government replaced the income splitting rules for private corporations, they could have made it simple. Instead, the new package is complex and pages are filled with the new rules, lengthy definitions and exemptions to the rules. Basically what the new rules now require is that family members prove that their contributions to the family business are meaningful enough to get the dividends they receive. If they can’t, then the dividend income will be subject to punitive tax rates. If a company earns less than 90 percent of its income from a service business, the rules will not apply to certain family members. Since most of Canadian small businesses are service providers, they do not qualify for these exemptions.

Key Takeaways:

Income splitting involves diverting dividend income (and certain other types of income) from one family member to another member in a lower tax bracket.
Under the new rules, family members over age 24, who work less than 20 hours per week may have to prove that their contributions to the business are reasonable.
Some of the factors for work to be considered reasonable are: work performed, property contributed, risks assumed and any other “relevant factors,” in addition to this being compared with contributions made by their relatives.

“In short, it means that many family members — of all ages — now have to convince the tax authorities that their contributions to the family business are meaningful enough to justify the dividends they receive. Otherwise, they risk punitive tax rates on the dividend income.”

Coming clean to the CRA

A small-business owner, who has not kept up with their taxes, is concerned that their receipts and bookkeeping haven’t been recorded properly, and they want to know if a ballpark estimate can be made and submitted to the Canada Revenue Agency (CRA). Since the burden of proof is on the company, the best advice is for them to hire a bookkeeper or accountant to go through their business records and recreate the books. In the event of a review or audit, any company estimating could be subject to paying significantly more without proof.

Key Takeaways:

After not filing taxes for a couple years, a small business wants to know if they can file late taxes through estimation.
Business owners are required to keep accurate records each year, so hiring a good accountant to get caught up is imperative.
File late taxes as soon as possible to minimize penalties and interest.

“By not keeping records, you are inviting CRA to do the estimating for you—and they will estimate high.”

GST and HST basics – how to do right by the CRA and your business

Entrepreneurs and small business eventually grow to a level where they need to start charging a Goods and Service Tax (GST) and/or a Harmonized Sales Tax (HST). Some companies put off charging these taxes until their company reaches the threshold of $30,000 sales over the last four consecutive quarters. One reason a company may not sign up immediate is because some customers cannot claim the tax back. Taxes cannot be collected at a later date, so companies making over the minimum need to register with the CRA and start applying the tax according to the CRA’s guidelines.

Key Takeaways:

Proper collection of the GST and HST depends on such factors as the customer’s location, and the business’s annual revenue.
A business has to decide not only which tax to collect, but when to start collecting and how often to file.
Business owners who aren’t sure of their GST/HST responsibilities should call their accountant or the CRA.

“The CRA will wait for your return, but they don’t want to wait for your money.”

Borrowing to invest? Court ruling provides tax guidance

Breaking tax rules, even if you did so unintentionally, can be costly as a Canadian taxpayer recently found out after a Tax Court of Canada (TCC) decision. This case deals with interest deductions. The rules allow borrowers to deduct interest on their borrowed funds, but these funds must meet specific criteria. The money borrowed needs to be used for taxable purposes, such as mutual funds, or for earning other sorts of non-exempt income, such as the acquisition of rents. The borrower got it almost right. He did borrow to invest in mutual funds. But, then he got some of the capital back. Had he continued to put the money back into his investments, then this would have been all right. Unfortunately, the investor used the funds for personal expenditures, removing his ability to deduct interest. And, even though the percentage used for personal use was small, it was no longer possible to show a clear trail from borrowing to purpose. Understanding the fine print of tax law in this case would have saved this borrower a court trial and defeat.

Key Takeaways:

Knowing the rules of tax planning can save you a lot of money and help you avoid costly mistakes.
The rules around interest deductions can be complicated, but there are some general principles that apply here, namely the “purpose test” and “direct use” test.
If borrowing money, you cannot deduct interest charges if you are taking personal interest from the funds received from the borrow money.

“Earning income from business or property is important to deducting your interest costs. Be aware that capital gains don’t count as income from property.”

The surprising secret to funding a successful startup

When beginning a startup business, many entrepreneurs tend to ignore the significance of where their debt financing comes. This can be a costly mistake. Recent research has shown that using a personal loan, in contrast to a business loan, can make you less successful in future endeavors. The study didn’t examine why, but there are a number of possible reasons the type of funding makes a difference and can contribute to better and faster business growth.

Key Takeaways:

Even if they don’t need a loan to survive, startups might benefit from some debt from business loans.
Business loans can benefit startups by building credit ratings to enable them to apply for future loans and negotiatie better loan terms.
On the equity side, previous research indicates business loans help firms raise venture capital and receive higher IPO valuations of their shares when underwritten by their banks.

“These financing details are noteworthy because recent research shows a connection between debt use and venture success. Compared to equity-only firms, startups initially using business loans have higher average revenues and survival rates three years later.”

Here’s what taxes can do to your savings if you’re not careful

Over 65 percent of Canadians are aware of and contribute to a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA). Both of these options are ways Canadians can protect their savings from being taxed. But, if you are looking to save some money outside a TFSA or RRSP account, then you need to know your options to minimize taxation on those savings. Investment of income outside of these two accounts typically fall into three taxation categories: capital gains, interest income and eligible dividends income. Each is taxed differently if you choose to invest and save, you should choose which works best for you.

Key Takeaways:

Interest income earned from deposits in savings accounts, guaranteed investment certificates (GICs), or bonds is treated like your regular income from a tax perspective.
Capital gains are incurred when you transfer or sell an investment like a stock, and is taxed at your marginal rate, but only half of the capital gain would be subjected to tax.
Eligible dividends income is paid to shareholders, and the tax rate applied is often lower than that for interest income and higher than that for capital gains.

“If you have any savings sitting outside an RRSP and TFSA, you should be aware of the tax bite. Different types of investments are taxed differently, and this can make a significant difference to your actual investment returns.”

What you need to know about the tax consequences of earning and spending loyalty points

In Canada, there can be tax requirements involving bonus points if the points are a result of business travel, or you purchase business items and get reimbursed for them. If you get cash from the points or the points are a form of employee payments, they are subject to tax. How do you know how much is taxable? The taxable benefit is equivalent to the fair market value of the annual rewards. If an employer controls the points, the employee is obligated to report this on his/her T4 slip.

Key Takeaways:

One must be aware of the tax consequences when using travel points.
The CRA has made many changes over the years regarding the use of points as it relates to taxes.
The use of travel points for business and personal may differ with regards to tax consequences.

“But be sure to consider the tax consequences before redeeming those points, especially if you’ve accumulated some of the points through work.”

Selling your home tax-free may be more complex than you think

The Principle Residence Exemption (PRE) has been used as a tax-free way for Canadians to sell their homes, as long as it’s not for business profits. Properties included in this exemption can range from condominiums to house boats. It can even be outside of Canada, but you have to prove that you live there, even part-time, and are not using it as rental income. If you flip houses, even living in them as you’re doing so, you might not qualify for the PRE.

Key Takeaways:

If you buy or sell residences on a regular basis, the principle residence exemption is not available to you.
The property must be a residence that is not primarily owned for earning income.
The property must be inhabited to qualify for the PRE; though there is no exact definition on how long one must live in the residence.

“Canadian residents can often sell a principal residence free of tax, thanks to the principal residence exemption.”

Can you get survivor benefits from an ex-spouse?

A question arises if you split your pension credits with your ex-spouse and then if that person dies, what happens to the credits? For federal employee pensions, the living spouse is entitled to survivor benefits if you were only legally separated, and so in this case, he would receive 50% of her pension. If you are divorced, you won’t see that money unless you were named by that person’s estate as a beneficiary. If the marriage produced children, then they are likely to receive the credits. Regular pensions are subject to similar rules.

Key Takeaways:

Upon a marriage breakdown when you split pension credits with an ex-spouse, those credits and entitlement are literally transferred, and the transfer is generally irrevocable.
Children from a marriage are entitled to 20% of an ex-spouse’s pension benefit until age 25. Kids over 25, receive a supplementary death benefit with certain conditions.
If an ex-spouse passes away with no will, the assets would be distributed based on the intestacy laws of the province.

“Is it possible to apply to be given back lost, but earned, pension entitlements as neither my ex-wife, (nor any surviving spouse/partner) will now be drawing on these benefits?”

Avoid tax traps when opening a joint investment account

Depending on the reason for changing an investment account from an individual to a joint account, the change can have unintended implications due to spousal attribution. This won’t happen when opening a new joint account. But if you transfer capital assets to your spouse inside a joint account, then attribution will generally apply, and the income or capital gains will be taxed back to the contributing spouse. If the reason for changing an account type is for estate planning, then a better way to accomplish this may be to add each other onto existing individual accounts as joint with rights of survivorship. Before you make a change, it’s good to know the tax implications that comes with each type of scenario.

Key Takeaways:

Combining accounts or transferring funds may result in spousal attribution, whereby the contributing spouse is taxed.
If your goal is to have the resulting investment income go to your spouse, then consider a spousal loan at the CRA prescribed rate of interest.
A trust may be considered (instead of a spousal loan) if there are significant non-registered assets and there are other family members for whom they want to use or allocate the trust income.

“It’s not uncommon for a point to come where spouses wish to make individual accounts into joint ones, often for estate planning and administration. It’s important to be aware of the implications to ensure it’s what you want and nothing adverse results.”