Tax and Estate Planning Blog : Moodys LLP and SNC Law

As mentioned in an earlier post, the Federal Budget is usually the place where most tax proposals arise. Accordingly, tax practitioners are keenly interested in the detailed Budget proposals that get released. However, as we have mentioned in earlier posts, there are also many income tax amendments / proposals and comfort letters released by the Department of Finance throughout the year. In addition, there are hundreds of cases released by the Courts every year in Canada that affect the practice of tax. Accordingly, while it has long been the tradition by many of our peers to race to release a Federal Budget summary, our approach at Moodys is purposefully different. We will, of course, release a Budget summary but we instead, strive for thoughtful analysis and the timely release of tax information throughout the year; not just once a year. 

At the moment, the exact date of the 2012 Federal Budget is not known. However, most speculation points to sometime toward the end of March 2012. As most readers know, the content of the Budget is a closely held secret. However, there always appear to be strategically timed "leaks" where one can safely bet that there will be a proposal that deals with the leaks. In addition, Finance Minister Flaherty has been busy in the last little while completing his “Budget consultations”. Whether such consultations will actually amount to any substantive proposals remains to be seen. 

With the above in mind, I will engage in a bit of sport fishing for tax practitioners. It is always fun to guess / speculate what will be in the Federal Budget from a tax perspective. A little caution though....the list below is mine only, is pure speculation and should not be relied upon. I have no inside knowledge whatsoever and, as stated, I am simply speculating.
 

1.        Scientific Research and Experimental Development ("SR&ED") Tax Credit Changes

This guess should be of no surprise to people who follow tax. With the release of the Jenkins Report in October 2011, this should be the impetus for the government to change the existing SR&ED tax credit regime which has long been criticized for being inefficient and overall not being effective. It will be interesting to see how the government intends to change / improve the existing system.

2.        Charitable Tax Credit Changes

Many of the recent Federal Budgets have contained targeted changes to the tax system for charities and donors. Most changes have been significant improvements. Some, however, have been anti-avoidance rules designed to stop certain abusive “strategies” or charitable tax shelters from being effective. There has been some speculation that that the Federal Budget might introduce a “stretch credit” for charitable donations much like what Alberta has done. A stretch credit is where the underlying tax credit granted for making the charitable donation is greater than the top rate of income tax for donors. For example, in Alberta, donors to charities of amounts greater than $200 per year will receive a combined Federal - Alberta tax credit of 50 percent notwithstanding that the highest personal tax rate on salary type income is 39 percent. Will the federal government follow suit? I am guessing a hedged maybe. There has also been speculation that the government might introduce proposals to exempt realized capital gains on private company shares or certain real property from taxation when donated directly to charity (similar to that for listed securities). While nice in theory, I am guessing that this will not happen in Budget 2012. Having said that, I think it is a safe bet that Budget 2012 will have some charitable tax proposals. 

3.        Depreciation Rates

This is almost a certainty. Every year the government reviews the current depreciation rates (the technical phrase being “capital cost allowance” or “CCA”) for various types of depreciable property and attempts to adjust such rates to reflect commercial realities. It is a pure guess as to what properties' CCA rates will be adjusted to this year, but wouldn't it be nice if the rate for computer equipment was finally (and permanently) adjusted to 100 percent? 

4.        Personal Tax Credits

In recent Budgets, there have been a flurry of new personal tax credits offered. Some of the more high profile credits introduced recently have been the Children's Fitness Credit, Children's Art Credit and the Transit Pass Credit. I am guessing there will be more of these types of credits proposed in the 2012 Budget, although I wish there were not. While these credits are high profile, they do not actually amount to a lot of dollars per person. It would shock me if the recent credits actually change behavioral patterns. For example, did the introduction of the Transit Pass Credit actually cause more people to take public transportation? I doubt it. Does the Children's Fitness Credit actually cause most families to enroll their children in fitness programs? Doubtful. As stated, the credits amount to a very low amount of tax savings per family, but unfortunately come with a tremendous amount of administration (keeping receipts, filing the receipts with the tax returns, causing tax preparers angst for such low dollar amounts, etc). Notwithstanding, the present government seems to like these high profile / low value tax credits and I am confident we will see more.

5.        Anti-Avoidance Measures

The two last Budgets could be characterized as anti-avoidance Budgets. In 2011, we saw proposals that shut down deferrals for corporate partners of partnerships, measures to expand the “kiddie tax” and a restriction on the donation of flow-through shares to charity. In 2010, we saw proposals that would require certain aggressive tax strategies to be reported to the Canada Revenue Agency (these proposals have not yet been passed into law). Will there be more anti-avoidance rules introduced? I am guessing “yes”. The question is what will be targeted? Will certain income splitting strategies be targeted? Will the use of trusts to split income and capital gains be the subject of attack? Will Canada follow the lead of the US and force large companies to report their uncertain tax positions (“UTP”)? (In the US, certain companies must report their UTP to the IRS). Will charities be subject to even more reporting so as to ferret out the unsavory ones? Will ponzi scheme receipts be subject to tax to overturn the effect of a recent Tax Court decision? Not sure on any of this.

6.        Tax Rates

This seems to be the favorite subject of many people who write on the Budget....whether or not there will be any changes to income tax or GST rates. My educated guess is no. The government appears convinced (and I think they are right), that a low corporate tax rate is good for the economy and helps attract foreign investment. Accordingly, I do not envision any changes with corporate tax rates. For personal income tax rates, I simply think it would be the wrong time to play with rates and the corresponding brackets, so I am guessing there will be no change here as well. Same with the GST. Let's see if I am right!

7.        Registered Tax Preparers? 

As I wrote about in an earlier blog, I believe that Canada should follow the lead of the US and require paid income tax preparers to be registered. Up until recently, the government did not seem interested in such a proposal but their tone has changed. Will we see the introduction of a registration system for paid tax preparers? I doubt we will see it for Budget 2012 but stay tuned on this.

8.       Employees Profit Sharing Plan Trusts ("EPSPs")

The 2011 Budget announced the government was studying EPSPs and whether changes were needed. The Department of Finance sought public input and the time for such consultation has expired. Will we see proposed changes in Budget 2012 as a result of such a study / public consultation? I am guessing yes.

While I am probably missing a lot, the above highlights all that immediately comes to mind. Let's see how close I am when Budget 2012 is released.

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Roy A. Berg JD. LL.M. (US Tax) & Nicholas J. Dancey JD, LL.M. (US Tax)

On February 08, 2012 the IRS issued IR 2012-15, which contains proposed regulations that clarify the manner in which non-US financial institutions will find and report US persons to the IRS, which is required by the Foreign Account Tax Compliance Act (FATCA), enacted by the US Congress in 2010. The new regulations set forth: a) the type of information the financial institution will search for; and b) the manner in which it will search for that information.

Information the Financial Institution Will Search For
In order to determine whether an account holder is a US person, the financial institution is required to search for the following specific items:

1. Identification of the account holder as a US person;
2. Whether the account holder was born in the US;
3. Whether the account holder has a US address or US telephone number;
4. Whether there are instructions to transfer funds to an account maintained in the US; and
5. Whether power of attorney or signatory authority has been granted to a person with a US address or telephone number.  

If any of the foregoing are present, the institution must require the account holder to complete a US information report (form W-9) and that report will be submitted to the IRS.  If the report is not completed, or the account holder refuses to comply, then the institution will be required to withhold 30% of any distributions to the account holder and remit that amount to the IRS.

Manner in Which the Financial Institution Will Search For This Information

The manner in which the institution must search for indications that an account holder is a US person depends on the balance of the account, whether the account is new or existing, and whether the account holder is an individual or an entity.

Existing accounts held by individuals

1.     The financial institution is not required to conduct a search provided the account had a balance of less than $50,000. However, if the financial institution decides to make an inquiry, it must follow the methodology described below.

2.     If the account balance is at least $50,000 but less than $1,000,000, the financial institution must review its electronically searchable data for the information listed above.

3.     If the account balance is $1,000,000 or more the financial institution must review its electronically searchable data for the same indications listed above.  In addition, however, the institution is obligated to search all non-electronic files for the same information, including interviewing any relationship manager associated with the account.

New accounts held by individuals

When an individual opens a new account, the financial institution will be required to review all information provided when opening the account under appropriate know-your-customer and anti-money laundering rules.  Accordingly, the institution will generally not need to make significant changes to the information collected during the account opening process in order to identify US accounts, except to the extent that the above-referenced information is identified.

So what does this mean for the US citizen who is resident in Canada?  First, if the individual meets the thresholds under a preexisting account he may or may not be asked by the financial institution if he is a US citizen.  Second, when the individual opens a new financial account in the future he will most likely be asked for his place of birth, a copy of his passport, or asked about ties to the US.

As stated in our previous blogs on January 09, 2012 the IRS extended the Offshore Voluntary Disclosure programs indefinitely for US citizens who live abroad and who are not current on their US tax obligations.  The penalties for taxes and non-filing are draconian, and do not appear to be going away.  Those who have not brought their filings current should act quickly before FATCA compliance becomes effective. 

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The study and practice of tax is tough. I have said it before and I'll say it again, I believe that tax is one of the most difficult areas of practice in existence.

In my many years of being a tax specialist, there have been no shortages of "tax myths" that I have run across and dealt with in practice.  Here are my answers / rebuttals to some of the more popular ones:

1.      Yes, the imposition of income tax in Canada IS legal in Canada and anyone who states otherwise is leading you down the wrong path.

2.    No, the Canada Revenue Agency (the "CRA") has not accepted your filing positions simply because you received a notice of assessment. The CRA generally has three years, with many exceptions that can extend this time, from the date of the notice of assessment to review and make changes to your return. We talk generally about this topic in one of our recent blogs Filing On The Basis Of Proposed Tax Legislation.

3.    No, the CRA does not "allow" say $10,000 of salaries to be paid to minor family members. The law provides that only reasonable salaries in the circumstances with a business purpose are deductible to the business.

4.    No, you can't avoid tax on death by simply gifting property to the next generation. There are taxes that can arise, such as capital gains taxes, by virtue of such property being deemed to have disposed of at fair market value. If you're a US citizen, then US gift tax might apply.

5.    So, someone is saying that if you buy a charitable tax shelter that you will be able to save more in taxes than the actual cost of the "investment" that will be "donated"?  Dream on.....if it's too good to be true it likely is. The CRA has been successfully attacking charitable tax shelters for years. The CRA has written on this often.

6.    So you're buying a vacation property and someone has told you that you can save a lot of tax by purchasing it through a corporation? Get some advice on this.....such a "plan" is usually ripe for disaster. Read what we've written on this.

7.    So you're a US citizen resident in Canada and you're not compliant with your US tax filings? "How will they find me?" or "The US has bigger fish to fry than me!" are your mantras? Well, your mantras are about to become very challenged. The US is aggressively trying to find you and there's a good chance they will....especially when FATCA comes into force.

8.     So someone has told you that you don't pay Canadian tax on investment earnings on offshore bank accounts? Wrong...dead wrong. As a Canadian resident, you must pay income tax on your world-wide income. You may also have reporting obligations on your foreign assets as discussed below.

9.    So you think the disclosure of foreign assets does not include US securities like Microsoft, Apple, Cisco, etc.....right? Wrong. It does. The definition of "specified foreign property" in subsection 233.3(1) of the Income Tax Act (the “Act”) (which is the section that requires foreign property disclosure by virtue of the requirement to file prescribed form T1135) specifically includes a share of the capital stock of a non-resident corporation. We have previously written about this.

10. So you've lived in a house that you just constructed or otherwise acquired for just one day since someone has told you that if you live it in for a day that it will be considered your principal residence and thus any gain realized on a sale will be tax free.....right? If it was only that simple. The definition of "principal residence" in section 54 of the Act is very lengthy and requires very detailed conditions to be met.   One of the requirements is that the housing unit must have been "ordinarily inhabited" in the year by the taxpayer, the taxpayer's spouse or common law partner or by a child of the taxpayer. Will one day occupancy meet the test of being "ordinarily inhabited"? Each situation will need to be reviewed for the facts and circumstances but it would be highly unlikely that one day occupancy would meet the test of being ordinarily inhabited.

The CRA is also aware of tax myths and has recently published a good Tax Alert . The US Internal Revenue Service also has a tax myth publication.

The bottom line is this.....tax is tough. Be very wary of accepting tax advice from someone who does not practice in the area.

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RRSPs are an extremely popular investment vehicle for Canadians. With the mild weather, it may be easy to forget it is February and the RRSP deadline is February 29^th. (The deadline is usually March 1, but with 2012 being a leap year it will be the last day of February.) This RRSP season, taxpayers and their advisors should be aware of a change in the RRSP rules enacted as a result of the 2011 Federal Budget. These new “advantage rules” target tax avoidance schemes and other structures that most taxpayers would not be involved in, but these rules also set a trap for the unwary. If the advantage rules apply, the Canada Revenue Agency (“CRA”) may impose a penalty tax of 100%. In general terms, this 100% tax is on the amount of the “advantage”, which may be the entire value of the investment. .

The advantage rules are complex and their intended policy may be subject to debate. But in very broad strokes, these rules target schemes including economic benefits resulting from trading RRSP room between taxpayers, transactions that artificially inflate RRSP room, conversion of taxable employment income or business income into tax-sheltered RRSP investments, and a variety of other tax-avoidance concoctions yet to be conceived that take advantage of the RRSP rules in an inappropriate manner. 

As mentioned, the advantage rules are unlikely to effect the transactions or investments of most taxpayers. However, the pitfall lies in “swap transactions”, which are probably completed by a number of taxpayers fairly regularly.

It is well known that a withdrawal from an RRSP is generally included in a taxpayer’s income, subject to certain exceptions.[1] In certain cases, a deduction is available where an amount is withdrawn from an RRSP, but these exceptions are narrow. These exceptions are where a taxpayer recontributes or transfers an amount to a pension plan,[2] a retirement compensation plan,[3] or a retiring allowance.[4] There is also an exception involving the death of an RRSP annuitant.[5] That said, many advisors had believed it to be permissible to “swap” investments to or from an RRSP. For example, before the enactment of the advantage rules, taxpayers might withdraw cash from their RRSP but contribute other investments to the RRSP, and provided that the investments contributed were of at least the same value as the amount withdrawn, it was believed that the withdrawal would not be a taxable amount. Prior to the advantage rules, we understand the CRA generally took no issue with this practice.

The advantage rules, however, impose the penalty tax on a “swap transaction”, which is defined as follows

“swap transaction”, in respect of a registered plan, means a transfer of property between the registered plan and its controlling individual or a person with whom the controlling individual does not deal at arm's length, but does not include

(a) a payment out of or under the registered plan in satisfaction of all or part of the controlling individual's interest in the registered plan;

(b) a payment into the registered plan that is a contribution, a premium, or an amount transferred in accordance with paragraph 146.3(2)(f);

(c) a transfer of a prohibited investment or a non-qualified investment from the registered plan, in circumstances where the controlling individual is entitled to a refund under subsection 207.04(4) on the transfer; or

(d) a transfer of property from one registered plan of a controlling individual to another registered plan of the controlling individual if

(i) both registered plans are RRIFs or RRSPs, or
(ii) both registered plans are TFSAs.

These broad provisions contemplate a variety of transfers in and out registered plans as well as transfers between “registered plans” (which is defined to include RRSPs, RRIFs, and TFSAs).[6] Indeed, the seemingly innocuous practice of replacing cash inside an RRSP with other investments of the same value held outside an RRSP, or vice versa, seems to be caught.

The CRA has confirmed this is the case in a recent technical interpretation.[7] The CRA noted that fair market value transactions are not excluded from the “swap transaction” definition. There are limited exceptions to the “swap transaction” definition set out in paragraphs (a) through (d) reproduced above. Otherwise, in the CRA’s view, the advantage rules effectively create a wholesale prohibition on swap transactions.

As a result, taxpayers and investment advisors should avoid moving assets in and out of RRSPs unless they are prepared to suffer an income inclusion, as they would under most RRSP withdrawals – or, even more unfavourably, pay the 100% penalty tax.

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This is not a new topic. However, it is one that we deal with time and time again....especially in recent years.

Tax policy and the implementation of tax legislation in Canada is under the purview of The Department of Finance. Much of Canada's new tax legislation arises from the annual Federal Budget. However, there are also technical amendments released in draft form (often for public comment) throughout the year. Such draft or proposed legislation may be further amended to correct for errors, provide clarification and address public submissions before it is finally released into a Bill. The Bill is then put before Canada's House of Commons and the Senate for debate and eventually receives Royal Assent and becomes law (unless for some reason the Bill fails to pass). The proposed legislation will often contain detailed “coming into force” provisions that establish the date from which a specific proposed provision will have legal application. Often, but not always, the application of the proposed legislation will be effective from a date earlier (i.e. retroactive effect) than the date that the provision is actually passed into law. The process to convert draft legislation to law can often take a long time.

The Department of Finance may also release “comfort letters” in response to parties' concerns with the technical accuracy of certain existing provisions of the Income Tax Act (the “Act”). Such comfort letters often state that The Department of Finance is prepared to correct the perceived problem and further undertake to recommend to the Minister of Finance to release proposals that will achieve such objective. However, the comfort letters are appropriately hedged and state that there is no guarantee that such proposed amendments will become law.

In recent years, there has been a tremendous amount of draft legislation and comfort letters that have been released and have not yet been proclaimed as law. The Office of the Auditor General of Canada pointed out this problem in its 2009 Fall Report.

Two obvious examples of proposed legislation not yet being passed into law come to mind. The first is the non-resident trust and foreign investment entity proposals. These proposals were first introduced in the 1999 Federal Budget and the resulting draft legislation has been revised at least six times over the last 13 years and still remains “proposed” (i.e. not law). The most recent revision resulted in the virtual scrapping of the foreign investment entity proposals but retained the non-resident trust proposals. If passed, much of the effect of these proposals will have retroactive effect to 2007 (with the date of the proposed application being changed many times over the years). The second are the restrictive covenant proposals that were first announced by the Department of Finance on October 7, 2003. Such proposals are extremely complex and we have written extensively on this subject. The restrictive covenant proposals have been amended many times with the most recent being July 2010. Such proposals also have not been passed into law but if passed will generally have retroactive effect to October 7, 2003 (with some exceptions to this general date).

Canada's tax system provides, under section 152, that an individual's tax return for a particular taxation year is generally "statute-barred" from a reassessment on the 3rd anniversary date of the date that the particular taxation year was assessed. For example, if Mr. Apple's 2006 personal tax return was filed in April 2007 and was assessed by the Canada Revenue Agency ("CRA") say May 15, 2007, then Mr. Apple's 2006 tax return would be prevented from any amendment (either by the CRA or by Mr. Apple) on May 15, 2010.

There are some exceptions to the general rule. For example, if Mr. Apple or the person filing the return made any misrepresentation on the 2006 tax return that was attributable to neglect, carelessness, willful default or committed a fraud then the CRA may reassess beyond the May 15, 2010 date (see subsection 152(4) of the Act). Also, there are some circumstances where Mr. Apple may want to file a waiver, also provided for under subsection 152(4), to the CRA that keeps all or parts of the 2006 return open for reassessment. Mr. Apple may also be able to rely on the “taxpayer relief provisions” of subsection 152(4.2) to extend the statute-barred date if he makes an application no later than the day that is 10 calendar years after the end of the particular taxation year in question if he was entitled to a refund or a reduction of taxes payable for that particular year. Corporations or inter vivos trusts are not entitled to benefit from the “taxpayer relief provisions” unlike Mr. Apple as earlier described. Corporations, other than Canadian-controlled private corporations, have similar rules regarding statute-barred dates but generally the date is four years from the date of notice of assessment.

Accordingly, what is a taxpayer to do when they are dealing with a tax matter that might be the subject of proposed legislation? For example, if a taxpayer granted a restrictive covenant in 2011, should he file his tax return on the basis of existing law or under the basis of the proposed legislation (which will generally be very complicated to deal with and may not have favorable tax results in comparison to existing law)? Good question and quite a quandary. When analyzing the issue, one should consider statute barred issues as discussed above and also whether the proposed legislation contains specific provisions that might override the normal rules of subsection 152(4) if a person wanted to ignore the proposed legislation and file on the basis of existing law.

The CRA has a long standing policy that encourages taxpayers to file their tax returns on the basis of proposed legislation. In CRA Income Tax Technical News No. 44, the CRA had the following to say on the topic:

It is the CRA’s longstanding practice to ask taxpayers to file on the basis of proposed legislation. This practice eases both the compliance burden on taxpayers and the administrative burden on the CRA. However, where proposed legislation results in an increase in benefits (for example, Canada child tax benefit) to the taxpayer, or if a significant rebate or refund is at stake, the CRA’s past practice has generally been to wait until the measure has been enacted.

A comfort letter is not considered proposed legislation and usually only reflects the Department of Finance’s views on a particular issue affecting a specific taxpayer. Given that our tax system is on the basis of self?assessment, taxpayers may decide to file on the basis of a comfort letter. Generally, the CRA will not reassess taxpayers who filed on the basis of a comfort letter, provided that they did so in conformity with the comfort letter.

Generally speaking, the CRA will not reassess if the initial assessment was correct in law. As a result, a taxpayer’s request to amend their tax records to reflect proposed legislation will be denied. It is recommended that taxpayers file a waiver in respect of the normal reassessment period to protect their interests.

In the event that the government announces that it will not proceed with a particular amendment, any taxpayers who have filed on the basis of the proposed amendment are expected to take immediate steps to put their affairs in order and, if applicable, pay any taxes owing. Where taxpayers acted reasonably in the circumstances, took immediate steps to put their affairs in order, and paid any taxes owing, the CRA will waive penalties and/or interest as appropriate.

In my opinion, the CRA's guidance usually, but not always, makes sense. From a practical perspective it is also sound. However, everyone's facts are different and, of course, one would need to carefully consider what is appropriate in their circumstances. People should heed professional tax advice on this difficult area of tax law.
 

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