Tax and Estate Planning Blog : Moodys LLP and SNC Law

With much fanfare, the “kiddie tax” was introduced into Canadian tax law effective January 1, 2000.  My, how time flies. It does not seem like it was 11.5 years ago that such a tax was introduced to prevent income splitting mischief.

The “kiddie tax” applies on certain types of income (“split income”) received by a child (under the age of 18 throughout the year – the “minor”) who has a parent that is resident in Canada at any time during the year. If applicable, the minor child will end up paying income tax at the highest personal tax rate that would otherwise be payable on the type of income received.   In addition, the parents generally have joint and several liability for the tax.

The most common type of income to which the “kiddie tax” applies is dividend income from a private corporation. It used to be routine planning to have a trust with a minor child as a beneficiary (or have the minor child own the shares directly in the private corporation to the extent that a lawyer would give a legal opinion that the minor child could hold such property) and ultimately pay dividends to the minor child. Prior to the introduction of the “kiddie tax,” such a simple plan was an effective income splitting tool since a child could use up their personal tax credits and in many cases pay no personal income tax up to certain levels of income. 

Another common plan prior to year 2000 was to have a partnership whereby the child (or a trust of which the child was a beneficiary) would be a partner and have the partnership receive income from a related entity. For example, the partnership could provide management or administrative type services to a corporation owned by “Mom” or “Dad” or both. Such income received by the partnership could then be easily allocated to the partners (of which a minor child would be a direct or indirect beneficiary of such partnership income) thus again providing for simple yet effective income splitting.

Both the dividend sprinkling plan and the partnership type plan described above are subject to the “kiddie tax” to the extent that the income is received by a minor child thus eliminating any income splitting advantage associated with such plans. 

One of the most common types of taxable income that is not split income and therefore not subject to the “kiddie tax” is capital gains. Accordingly, many plans involving related private corporations were put in place so as to recognize capital gains. The plan generally involved having certain shares of a private corporation being sold to a related company with the resulting capital gain being taxable in the minor child’s hands. Prior to the 2011 Federal Budget, such a plan was often used to the extent that the practitioner and their client believed that the general anti-avoidance rule (“GAAR”) would not apply. The Canada Revenue Agency, however, was not amused and would often times apply the GAAR to such a plan (with many cases still in the system). The 2011 Federal Budget has introduced a legislative fix to such a plan whereby after March 22, 2011 such capital gains will now be subject to the “kiddie tax.” However, other capital gains realized by a minor (for example, from a publically traded portfolio of assets or shares of a private corporation disposed of to an arm’s length person) will continue to not be subject to the “kiddie tax.” As such, capital gains realized and taxable in the hands of a minor either directly or indirectly is still a common and effective income splitting tool. 

Further, partnerships or trusts that provide services to arm’s length parties are also not subject to the “kiddie tax.”  For example, let us assume that Mom, Dad and a trust for their minor children are partners in a partnership. The partnership carries on the business of selling sandwiches to the public. To the extent that the partnership realizes profits, a reasonable allocation of partnership income can be made to the minor child (either directly or indirectly) without the incidence of the “kiddie tax.” (Section 103 must always be considered when dealing with partnership income allocations since unreasonable allocations might be reallocated by the CRA to a more reasonable allocation after all the factors are considered).

While the “kiddie tax” certainly provides a wrench for simple income splitting plans using minor children, effective planning can still be done today.   However, professional advice should always be sought before implementing any income splitting plan. The professionals at Moodys LLP Tax Advisors would be pleased to assist you in developing an effective plan.

• Email This
• Print
• Comments
• Trackbacks

In my many years of practice, it never fails to amaze me how many people rely on non-qualified persons for advice in one of the most complex topics there is – tax planning or, as Moodys LLP likes to call it, “tax optimization”. There is no shortage of “experts” who seem to think that they understand tax. In this day and age of instant information vis-à-vis the internet, such “experts” continue to flourish and continue to dispense tax advice to their colleagues and buddies. Unfortunately, many of those people end up in our offices seeking advice when things go wrong. In many cases, such advice has led to “planning” which is a ticking time bomb waiting for nasty results should their affairs ever be reviewed. 

One of the most common ticking time bombs that we run across is personal use property owned by a corporation. Routinely, we find cottage properties owned by corporations.  In some extreme cases, we discover situations where the shareholder’s or shareholders’ principal residence is owned by a corporation. Such “planning” is usually disastrous. Why is that? Well, there are a number of reasons. The biggest reason is that personal use property owned by a corporation will result in taxable benefits being applicable to the individual shareholder(s). The relevant provision under the Income Tax Act that requires a taxable benefit is subsection 15(1) which reads as follows:

15(1) Benefit conferred on shareholder -- Where at any time in a taxation year a benefit is conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by

(a) the reduction of the paid-up capital, the redemption, cancellation or acquisition by the corporation of shares of its capital stock or on the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 88 applies,

 (b) the payment of a dividend or a stock dividend,

 (c) conferring, on all owners of common shares of the capital stock of the corporation at that time, a right in respect of each common share, that is identical to every other right conferred at that time in respect of each other such share, to acquire additional shares of the capital stock of the corporation, and, for the purpose of this paragraph,

(i) where

(A) the voting rights attached to a particular class of common shares of the capital stock of a corporation differ from the voting rights attached to another class of common shares of the capital stock of the corporation, and

(B) there are no other differences between the terms and conditions of the classes of shares that could cause the fair market value of a share of the particular class to differ materially from the fair market value of a share of the other class,

the shares of the particular class shall be deemed to be property that is identical to the shares of the other class, and

 (ii) rights are not considered identical if the cost of acquiring the rights differs, or

 (d) an action described in paragraph 84(1)(c.1), (c.2) or (c.3),

the amount or value thereof shall, except to the extent that it is deemed by section 84 to be a dividend, be included in computing the income of the shareholder for the year. [emphasis added]

As you can see, subsection 15(1) is an extremely broad provision which can capture many fact patterns. The difficulty with the provision is that it does not set out detailed rules on how to quantify the taxable benefit. In the case of a cottage property, for example, many people feel that a comparable hotel rate is the appropriate taxable benefit that they need to capture into their personal taxable income or to pay to the corporation for the use of that cottage property. For example, if Mr and Mrs Apple each owned 50 percent of the shares of “OpCo” and OpCo owned a cottage property in Phoenix, Arizona, would the taxable benefit be say, $200 a night (a comparable hotel rate) multiplied by the number of days that they use the property (say five days per year) which equals $1,000? In short, the answer is no. Instead, the Tax Court of Canada has found in cases such as Youngman [1990] 2 CTC 10 (FCA), Donovan [1996] 1 CTC 264 (FCA), and Fingold[1997] 3 CTC 441 (FCA) that the taxable benefits applicable to the ownership of a cottage property by a corporation is not the hotel rate.  Instead, the taxable benefit is generally computed by reference to the cost of the property multiplied by an applicable rate of return. For example, if OpCo had paid $500,000 for the acquisition of the Phoenix, Arizona property and OpCo would normally receive a 15 percent rate of return on its invested capital then likely 15 percent of $500,000 (or $75,000) would be the appropriate amount to include in Mr and Mrs Apple’s personal taxable income annually. 

If you are not already awake or did not know about the risks of personal use assets owned by a corporation, then you should be aware that there is further damage. Firstly, there is no underlying “step-up” in the cost base of the personal use corporately owned assets for the taxable benefit received each year by Mr and Mrs Apple. This can lead to outright double taxation as a result of the corporation owning the personal use property. Secondly, when the property is sold, OpCo will realize a capital gain (assuming the property has increased in value) which may not be sheltered by any principal residence exemption (if the property could otherwise be treated as a principal residence by the individual shareholders). Finally, to the extent that the funds need to be extracted from the corporation, such extraction will normally be considered a taxable dividend (unless other tax free accounts are available such as a shareholder loan account or a capital dividend account). (I have purposely not discussed any GST or HST matters but such issues would also need to be reviewed).

At this point, it may be prudent to let the reader know that the Canada Revenue Agency used to have an administrative position which enabled a corporation (often referred to as “sole purpose/single purpose” corporations) to acquire US personal property without subsection 15(1) applying. However, this administrative position ended for acquisitions of US property after 2004 with some limited grandfathering. Accordingly, people need to be very aware of the dangers of acquiring US personal use property through a corporation. However, such a caution extends to all types of personal use property. For example, we have often seen timeshare properties, personal furniture, recreational vehicles, etc., owned by corporations. It appears that people think that significant tax savings can be achieved by owning such properties through a corporation. Unfortunately, nothing could be further from the truth. 

So what do you do if you have personal use property owned by a corporation and you are one of the shareholders? Unfortunately, there are not many solutions to this difficult issue. Instead, you should be looking to extract the personal use property from the corporation using available tax free accounts. However, if tax free accounts are not available then simply paying the personal income tax on an extraction may be far cheaper in the short and long term to avoid nasty surprises.  

For those of you who would like to see a video on this topic in Moodys’ YouTube channel, click here.

• Email This
• Print
• Comments
• Trackbacks

Before we proceed the reader needs to know that the views expressed below are mine only and do not necessarily represent the views of all the accounting professionals in our firm.

For those of you who have not heard, the Canadian Institute of Chartered Accountants (“CA”) and the Society of Management Accountants of Canada (“CMA”) are currently exploring the environment to see whether merger talks should be held, with the ultimate goal being one designation for the merged body (currently proposed to be “Chartered Professional Accountant” or “CPA”). Seven years ago, the same two bodies brought a proposed merger deal to the table of members, but the proposal was withdrawn before it was brought to a vote by members. This time, however, there is no current proposal agreement but rather the two bodies are simply putting their toe in the water to see whether the current landscape is ripe for a merger. To this end, both professions are engaging their members in a series of dialogues and discussions - both online and in person - to see if there is interest in moving forward with such merger talks. 

I have been closely monitoring the online and in-person discussions. For the people that are not interested in the merger, the reasons given tend to be something like this:

1.   “My designation is better than yours and a merged CPA designation will water down the ultimate accounting profession.”

2.   “I worked very hard to attain my designation and enabling a lesser designation to merge with my higher quality designation is offensive.”

3.   “CA’s and CMA’s do different things and the marketplace recognizes such differences. Why, then, the need for a merged designation when the marketplace clearly differentiates and demands such designations?”

4.   “CPA? That will make us look like American CPA’s!”

As I stated, I have listened very closely to both sides of the debate and, try as I may, the persons who are negative to exploring a possible merger always seem to fall in one of the above categories.

However, good leadership often means taking on controversy for the betterment of all. Instead of resting on ones’ laurels and saying “I’m better than you,” self improvement often requires a good long hard look in the mirror. In this case, the leaders of the CA’s and CMA’s deserve high praise for taking a good long hard look in the mirror to see whether change is necessary for the better good. Perhaps it might not be. But more importantly, perhaps it WILL be. Seven years ago, the world was a different place. The internet and emerging technologies have made the world a much smaller place with people and professions becoming irrelevant very quickly.

While I certainly understand the frustration and defensiveness of a practitioner who worked very hard in their studies to attain a professional status, one would hope that such a practitioner can put their personal interests aside and study both sides of the debate to see whether a merged body would help out the profession as a whole as opposed to them personally. One might ask why should a person pursue such an exercise to set aside their personal interests in order to study the common good? The answer to that is simple … while their personal interests at the moment may be well taken care of given their existing professional status, the profession cannot exist with members who think only of their personal interests as opposed to the common good. It should be common sense that if the profession is improved both in the short term and the long term, the personal interests of the average member will also improve. In my humble opinion, it is simply selfish to only worry about one’s personal interests as opposed to the greater interests of the profession as a whole. 

What are some of the arguments for a merged CA-CMA body? Consider the following:

1.   A combined CA-CMA body will be a very large group and, in fact, one of the largest accounting bodies in the world.
 

2.   The merged body will have the opportunity to take a serious look at new education requirements for new entrants into the CPA profession. Assuming that the entrance levels are as high or higher than the highest current standard for either the CA or CMA then presumably such arguments for a weaker long term designation will disappear.
 

3.   The merged body may have a greater voice at the relevant tables (such as accounting standards, tax legislators and administrators), in order to influence change. Let’s be serious. Canada is a small player in the world scene, but with a merged body we may be able to influence greater change.
 

4.   Efficiencies will likely improve. Currently, each province in Canada has its own provincial office in order to administer the accounting profession. Is this really necessary? Under current law it likely is, but perhaps with a merged body and government involvement efficiencies may ultimately arise.

5.   Let’s be honest. Does the average consumer of accounting services know the difference between the designations? Truthfully! I would respectfully suggest that the answer is no. While there are always exceptions to this rule, on the whole I would suggest that no one really knows the detailed differences between a CA and a CMA unless research is done in order to investigate such. This leads to significant brand confusion amongst consumers of accounting professionals’ services. Any elimination of brand confusion should be welcome both for the short and the long term. 

In addition, to the extent that merger discussions are ultimately entered into, I am hopeful that the merged body takes a sober second look at the need for specializations within the profession. Currently, both CA’s and CMA’s are guilty of publicly stating to the world that they can do many things (such as audit, tax, general accounting, information technology and business valuation). The truth is, the average member cannot do all those services and any statement to the contrary is simply false. While the CA’s have recognized the need to specialize in certain areas such as business valuation (which has a recognized sub-designation of CA.CBV), information technology (with a recognized sub-designation of CA.IT) and others, the obvious missing sub-designations are audit and tax. To suggest that the average CA or CMA knows audit and/or tax at a level appropriate to practice professionally is again incorrect. Quite simply, both audit and tax are specialties on their own that require rigorous training and experience. Any dabbling by a practitioner in these areas is a recipe for disaster. Wouldn’t it be better, to serve the public, to allow users of professional services to know which sub-specialty the particular CPA possesses? Of course it is. Unfortunately the introduction of sub-designations for tax and audit has been very controversial. Witness, for example, a proposal to introduce CA.Tax as a sub-designation earlier in the 2000’s. At the last moment, the CA.Tax proposal was dismissed for reasons that were never publicly made available but, reading between the lines, it is pretty obvious that a certain influential sector of the CA membership would not support it.   It is my hope, for the betterment of the profession as a whole and in the interests of serving the public better, that the tax sub-specialty idea be revisited with the idea of being re-introduced.

While we are on the topic of a “wish list”, wouldn’t it also be a great idea if the merged body had some ability to influence the government regulators who have the power to introduce legislation that would restrict the use of the label “accountant”? Currently, anyone can call themselves an accountant whether or not they are professionally designated. However, other professions are not similar. For example, in both medicine and law people cannot call themselves “doctors” or “lawyers” unless it is true. If they do so without the proper authorization, enforcement action can be taken.

Many more arguments exist on both sides of the merger equation. However, this brief overview is not intended to be an exhaustive treatise on the case for or against a merger. Instead, this overview is intended to provoke thought and, hopefully, some controversy on the discussion that the leaders of the CA’s and CMA’s have raised with members. 

From the tone of this blog, it should be no secret on which side of the fence I am excited about. Having said that, the current discussions are simply that … discussions only. As the old saying goes, “the devil is in the details” and I look forward to reviewing details of a proposed merger and making my mind up about such a proposal at that time. However, perhaps the leaders and the profession will decide that further discussions on this matter should not be done. From my point of view, that would be a huge disappointment. Any time that one has to make progress, it is my opinion, that one should grasp that opportunity and run with it. 

• Email This
• Print
• Comments
• Trackbacks