CGA Richmond/South Delta Chapter Corporate and Personal Tax Update January 19, 2013

1. CGA Richmond/South Delta ChapterCorporate and Personal Tax UpdateJanuary 19, 2013 Lori A. Mathison (604) 443-7118 Lori.Mathison@fmc-law.com

2. Agenda Corporate Personal Trusts Administration Director’s Liability International Issues CRA Audit Activity

3. Legislative Activity Announcements • BC Budget – February 2, 2012 • Federal Budget – March 29, 2012 • Bill C-45 – Jobs and Growth Act, 2012 • Introduced October 18, 2012 • Standing Committee on Finance October 30, 2012 • Budget 2012 • Bill C-48 – Technical Tax Amendments • First Reading on November 21, 2012 • December 31, 2012 Outstanding Federal Tax Legislation

4. Corporate

5. Combined Federal – BC Rates for CCPCs (January 1, 2012)

6. Personal Services Business (“PSB”) • Historical disincentives to being a PSB • Drop in corporate rates created planning opportunities around the use of PSBs • Amended subs. 123.4(1) – PSBs no longer eligible for general rate reduction effective October 31, 2011 • Effective 13% increase in tax rate • Review existing PSBs and restructure

7. PSB Pragma Services – Conseils Inc. v. Agence du Revenu du Québec, 2011 QCCA 12977 • Main element is whether employee can reasonably be regarded as an employee of the client • Look at degree of subordination • Look at ownership of tools, integration and attitude • Only obligation was to deliver product in budget • No subordination so no PSB

8. Deductions – Business Expenses • What is a Business Expense? • Paragraph 18(1)(a) of the Income Tax Act (the “ITA”) provides that no deduction shall be made for: • 18(1)(a) – an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property • What is the purpose of the expenditure? • Does the ITA have a specific restriction against the expense? • CRA Document 2012-0432621E5 • Business expenses incurred by real estate agent (including incentives paid to buyers) • Deducible if arm’s-length and all other deductibility criteria met

9. Deductions – Business Expenses • Para. 18(1)(b) prohibits a capital outlay or loss • except as expressly permitted • CRA Document 2012-0446521M4 • Capital improvements to a rental property not immediately deductible

10. Deductions – Business Expenses • Personal expenses not allowed – para. 18(1)(h) • CRA Audit Manual – watch for the following: • Purchases from suppliers that do not carry goods that would normally be used in the normal business activity • Purchase invoices made out to the taxpayer/registrant personally or to another family member • The delivery address is the taxpayer/registrant’s residence • Personal purchases may be paid by credit card. Scan the credit card statements to determine whether the purchases include personal items. Ensure that the taxpayer/registrant has not claimed personal travel as a business expense. • Where the business activity includes selling or purchasing products that are general household items – the risk of personal use of products increases.

11. Deductions – Business Expenses • Expense must be reasonable (s.67) 67 In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.

12. Deductions – Business Expenses • Evidence of expenses • The ITA provides no specific requirement to keep records • CRA Audit Manual states as follows: There are no specific statutory requirements as to the precise nature of the books and records that a taxpayer/registrant must keep. The auditor, together with the advice and assistance of the team leader, has to make this determination using professional judgment. • CRA Audit Manual: Where expenditures are not supported with the appropriate documentation, the expense should be disallowed unless there is other satisfactory evidence to support the amount claimed. Indirect audit techniques may be used to determine the reasonableness of expenses without supporting documentation…

13. Deductions – Business Expenses • Subsection 67.1 • 50% of amount paid for food or beverage or enjoyment of entertainment • Exceptions • Food, beverage or entertainment in ordinary course of business carried on by that person • Exception for restaurants, hotels and airlines that incur expenses for paying customers

14. Deduction – Business Expense • Subsection 67.1 • Stapley v. R., 2006 FCA 36 • Mr. Stapley gave vouchers for food, beverages, and entertainment to clients in hope of securing referral clientele. The taxpayer did not even attend with the clients when vouchers were used. The taxpayer claimed 100% of voucher cost as meals and entertainment expense deduction from business income. The FCA held that the vouchers were, on their face, intended for use as meals and entertainment. Subs. 67.1 clearly restricted deduction of meals and entertainment expenses to 50%.

15. Deductions – Management Fees • CRA Document 2001-0114993 • Intercorporate management fees paid from Opco to Holdco • CRA reserves the right to challenge reasonableness

16. Deductions – Management Fees Les Enterprises Réjean Goyette Inc., 2009 DTC 1214 (T.C.C.) 124660 Canada Ltée Réjean $80,000 Management Fee 27442870 Québec Inc. Services Acquire and develop properties Construct residences

17. Deductions – Management Fees Les Enterprises Réjean Goyette Inc., 2009 DTC 1214 (T.C.C.) • $80,000 management fee disallowed • appeal dismissed • no legal obligation to pay as no formal management agreement

18. Deductions – Shareholder/Manager Remuneration • Bonusing down to SBD limit no longer standard planning • Consider paying GRIP dividends instead • Best way to proceed depends on each fact situation • e.g. when funds will be used by individual • Bonusing down creates an immediate taxable event in hands of recipients (which could be deferred if dividends paid later)

19. Shareholder/Manager Remuneration – Integration

20. Deductions – Shareholder/Manager Remuneration • Remuneration will not be challenged on reasonableness if paid: • To an active shareholder/manager • By a CCPC • To a resident of Canada • Acceptable if shares are held through a holding company • Section 67 concerns if payments made to non-active shareholders • Active shareholders can receive non-active business income

21. Deductions – Shareholder/Manager Remuneration • Policy will not apply in the following circumstances: • Earnings from unusual activities • Pre-CCPC earnings • Complex corporate structures • Technical Notes No. 30: • Income from a major sale of a business asset is not earned during the normal course of business operation and CRA may challenge reasonableness • Income derived from management fees or dividends is beyond the intent of the policy

22. Deductions – Salaries to Children Bruno v. R., 2012 TCC 316 • Deducts $18,000 + $7,000 during 2 taxation years as salaries (paid personal expenditures) • Court accepted that amounts reasonable • Deduction may be claimed if owed wages (even though expenses are for luxury items).

23. Scientific Research and Experimental Development (“SR&ED”) • Eligible Activity • Scientific or technological advancement • Scientific or technological uncertainty • Scientific and technical content • Eligible Expenditures • Salaries or wages directly engaged in SR&ED • Cost of materials consumed or transferred • Certain lease costs

24. SR&ED • Eligible current and capital expenditures are fully deductible when incurred in connection with SR&ED • Expenses incurred in Canada are eligible for an investment tax credit (“ITC”) of 20% (will be 15%) or 35% for a small Canadian-controlled private corporation (CCPC)

25. SR&ED • The 35% ITC is available on up to $3.0m of qualified expenditures incurred each year by a CCPC • ITCs are fully refundable on the first $3.0m of current expenditures by a CCPC

26. SR&ED Developments • Budget 2012 and Draft Legislation • Decrease in general rate for ITCs (20% → 15%) • Decrease in proxy rate for overhead expenses (65% → 60% → 55%) • Exclusion of capital expenses • Payments to arm’s length third parties • 80% inclusion rate • Third party capital expenses

27. SR&ED Developments • CCPC Planning • Need CCPC status to maximum SR&ED credits • TCC decision in Bagtech considered impact of provision in unanimous shareholders agreement (“USA”) that enabled Canadian residents to vote for the majority of the Board, even though non-residents owned majority of voting shares • TCC found CCPC status • Use of USA needs to be balanced against impact on control

28. SR&ED Developments • Federal Government Consultants on contingency fees • Public Consultations commenced August 2, 2012 • Why hire third-party tax preparers on a contingency fee basis • Why are contingency fee charged • How prevalent is the practice • What amounts are charged • Impact on the SR&ED program • Deadline to respond was October 1, 2012

29. SR&ED - CRA Service Standards • Refundable claims – 120 days from receipt of completed forms • Non-Refundable claim – 365 days from receipt of completed forms • Claimant – requests adjustments to non-refundable claim – 365 days

30. Red Flags – Change of Control • Deemed year end • Filing requirements • Unrealized losses (inventory, capital losses, terminal losses and eligible capital property) must be recognized • Restricted CCA on depreciable property acquired in preceding 12 months • Restrictions on losses, ITCs, SR&ED

31. Red Flags – Legally Effective Dividends • No specific form of resolution, but include • Effective date • Record date • Payment date • Amount of dividend and how it will be paid • Whether it is an eligible dividend or not • Must be signed by all directors

32. Red Flags – Dividend Effective Date • Cannot be backdated • Tip: if amount of dividend is unknown at the time, it needs to be declared, declare the amount based on a formula • Can also make dividend subject to certain steps occurring

33. Red Flags – Eligible Dividends • Definition of “eligible dividend” amended in subs. 89(1) and subs. 89(14) • Only a portion of a dividend can be designated as eligible • Although dividend can be split between eligible and ineligible, dividend cannot be segregated among shareholders • E.g. cannot pay eligible dividend only to certain shareholders • Need to follow usual corporate law requirements

34. Red Flags – Eligible Dividends • Previously no late designations permitted • New subs. 89(4.1) allows a late dividend designation • Must be made within 3 year period following date on which designation was required to be made; and • MNR must view late designation as “just and equitable”

35. Red Flags – Deemed Dividends • CRA Document 2012-0435381E5 • Repurchase of Xco’s P/S is a disposition of properties to an unrelated person • 55(2) could apply to the extent deemed dividend exceeds safe income (55(3)(a) not available) • Repurchase of Yco’s P/S – 55(3)(a) will apply Yco Xco 51% P/S 49% P/S Opco

36. Red Flags – Capital Dividends • Amount of dividend cannot exceed CDA • Note CDA dividends paid • Capital losses in previous year will reduce the CDA • Trap – addition to CDA on disposition of eligible capital property only at end of taxation year • Subs 83(2) requirements (elect in prescribed form at or before time when dividend is paid)

37. Personal

38. Combined Top Marginal Tax Rates(Federal & BC)

39. Employment Income Caruso v. H.M.T.Q., 2012 TCC 233 • Issue if Caruso could deduct fees paid to agent for services in negotiating contract with Florida Panthers • Caruso loses • Must be “legal expenses” to “collect or establish a right to salary”

40. Samipal Dhaliwal v. The Queen, 2012 TCC 84 Facts: • Taxpayer had lent money to his employer, which became a bad debt during 2007. • Taxpayer claimed an ABIL upon e-filing his 2007 tax return but there was no means of indicating that he was “electing” to have s. 50 apply. • ABIL was rejected on initial assessment. Taxpayer submitted a T-1 Adjustment request, but this was denied.

41. Samipal Dhaliwal v. The Queen, 2012 TCC 84 Issue: • Whether Taxpayer elected in his 2007 e-filed tax return to have s.50(1) apply to a debt which became bad during the 2007 taxation year. Decision of Boyle J: • [34] The text of subsection 50(1) does not describe a form or otherwise dictate how the taxpayer makes his or her election and chooses in his or her tax return to have the subsection 50(1) apply… I agree with the sensible reasoning of Beaubier J. in Anderson [92 DTC 2296] and Tardif J. in Roy [[2004] 2 CTC 2519] that, upon a proper interpretation of section 50, it is sufficient to communicate the taxpayer’s election by clearly communicating in his or her tax return that he or she wants to be allowed an ABIL in respect of particular debt or shares disposed of in that year. This same analysis applies equally to electronic and paper format tax return.

42. RRSPs – Prohibited Investments • Before 2011 Federal Budget (and 2012 Budget for RCAs) • Private company shares could be qualified investment if at time of acquisition held less than 10% of shares • Even if held more than 10%, still qualified investment if no control and below $25,000 exemption

43. RRSPs – Prohibited Investments Changes • Eliminate $25,000 exemption • Prohibited from investing in entities in which has a significant interest (10%) • Prohibited from investing in entities that do not deal at arm’s length

44. RRSPs – Prohibited Investments • Special tax of 50% of FMV if prohibited investments • Tax can be refunded if RRSP disposes of prohibited investment by the end of the following year in which tax applies • Unless annuitant knew or ought to have known that prohibited investment

45. RRSPs – Advantage Tax • New RRSP anti-avoidance rules are designed to disallow certain “advantages” that are intended to exploit the tax-free nature of an RRSP. • The advantage tax will generally apply to: • Income attributable to prohibited investments. • Increases in the fair market value of the RRSP’s assets derived from transactions that would “not have occurred in an open market” and that were primarily undertaken to benefit from the RRSP’s income tax exemption. • Payments for services from the RRSP holder or a non-arm’s length person or returns on investments from property owned by the RRSP holder. • Increases or decreases in the RRSP’s value due to “swap” or “strip” transactions.

46. RRSPs – Advantage Tax • Advantages subject to a 100% tax equal to FMV • Annuitant personally liable for tax • Any income earned could trigger further advantage tax liability

47. Trusts

48. Trusts Residence of Trust – Garron Family Trust Case • Supreme Court of Canada held that the central management and control test shall be used to establish the residency of a trust. • Against the rationale developed in Thibodeau case – the residency of trustee determine the residency of the trust. • Same test as for corporations. • Promote consistency, predictability and fairness in the application of tax law.

49. Trusts Emigrating Trusts – Withholding Tax • Income allocated to non-resident beneficiary is subject to withholding tax when paid or credited. • Where the trust becomes non-resident before its income is paid or credited, withholding tax may be difficult to levy. • Amendment deems income of the trust to have been paid or credited to its non-resident beneficiary immediately before the emigration of the trust, although the income is only payable.

50. Administration