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Law 660 – Estate Planning UNIT 1: AN OVERVIEW OF ESTATE PLANNING ................................................................................................ 1

OVERVIEW OF CANADIAN INCOME AND WEALTH ...................................................................................... 1 AN OVERVIEW OF THE ESTATE PLANNING PROCESS -‐ 4 STEPS ................................................................... 1 ESTATE PLANNING OVER A PERSON’S LIFETIME ......................................................................................... 1

UNIT 2: AN INTRODUCTION TO THE 2 TYPES OF ACCEPTABLE TAX PLANNING ................................................ 2

ACCEPTABLE TAX PLANNING ...................................................................................................................... 2

TAX AVOIDANCE .................................................................................................................................... 2 TAX DEFERRAL ........................................................................................................................................ 3

UNIT 3: AN INTRODUCTION TO THE 3 FORMS OF UNACCEPTABLE TAX PLANNING ......................................... 4

S.239 – TAX EVASION/FRAUD (CRIMINAL OFFENCE – MOST SEVERE) ......................................................... 4

ACTUS REUS ........................................................................................................................................... 4 MENS REA .............................................................................................................................................. 4

S 163(2) – GROSS NEG PENALTIES (CIVIL PENALTY) ..................................................................................... 5 S 163.2 – MISREP OF A TAX MATTER BY A THIRD PARTY (CIVIL PENALTY) ................................................... 5

Guindon v R – currently being considered by the SCC ....................................................................................... 7

UNIT 4: AN OVERVIEW OF THE GENERAL ANTI-‐AVOIDANCE RULE (GAAR) ...................................................... 8

4 STEP APPLICATION OF THE GAAR (CANADA TRUSTCO AND COPTHORNE) ................................................ 8

STEP 1: TAX BENEFITS ............................................................................................................................. 8 STEP 2: AVOIDANCE TRANSACTION ........................................................................................................ 8 STEP 3: MISUSE OF THE PROVISION OR ABUSE OF THE ACT AS A WHOLE ................................................ 9 STEP 4: CONSEQUENCES ......................................................................................................................... 9

UNIT 5: THE TAX IMPLICATIONS OF OWNING YOUR OWN HOME ................................................................. 10

IMPUTED INCOME FROM HOME OWNERSHIP .......................................................................................... 10 PRINCIPAL RESIDENCE EXEMPTION .......................................................................................................... 10

CHARACTERIZATION OF THE PROPERTY ................................................................................................ 10 PRINCIPAL RESIDENCE DEFINITION ....................................................................................................... 11 THE BASIC MECHANICS OF THE PRE ...................................................................................................... 12 WHAT CAN BE SHELTERED BY THE PRE? ................................................................................................ 12 EXAMPLES ............................................................................................................................................ 12 Scenario 1 ......................................................................................................................................... 12 Scenario 1A ...................................................................................................................................... 13 Scenario 2 ......................................................................................................................................... 13

Scenario 3 ......................................................................................................................................... 14

DEATH AND THE PRE ................................................................................................................................ 15

Scenario 4 ......................................................................................................................................... 15

CHANGE IN USE OF PROPERTY FROM PERSONAL TO BUSINESS ................................................................ 16 TAX PLANNING FOR THE ELDERLY WITH A PRINCIPAL RESIDENCE ............................................................ 16

UNIT 6: THE TAXATION OF SAVINGS ............................................................................................................ 17

NON-‐REGISTERED FULLY TAXABLE INVESTMENTS .................................................................................... 18

INTEREST INCOME ................................................................................................................................ 18 CAPITAL GAINS ..................................................................................................................................... 18 DIVIDENDS ........................................................................................................................................... 18 SUMMARY OF THE GENERAL TAX CONSEQS FOR NON-‐REGISTERED INVESTEMENTS ............................. 19

REGISTERED RETIREMENT SAVINGS PLAN AND REGISTERED PENSION PLAN ............................................ 20

SUMMARY OF TAX CONSEQUENCES ..................................................................................................... 20 IMPLICATIONS OF INVESTING IN AN RRSP/RPP .................................................................................... 20

REGISTERED PENSION PLANS – SECTIONS 147.1-‐147.4 ............................................................................. 21 REGISTERED EDUCATION SAVINGS PLAN – SECTION 146.1 ....................................................................... 21

THE BASIC OPERATION OF AN RESP ...................................................................................................... 22 WITHDRAWALS FROM AN RESP ........................................................................................................... 22 What is named beneficiary doesn’t attend post secondary? ............................................................. 23

SUMMARY OF TAX CONSEQUENCES ..................................................................................................... 23

TAX FREE SAVINGS ACCOUNT (TFSA) – S 146.2 ......................................................................................... 23 SUMMARY: PICKING THE RIGHT INVESTMENT ......................................................................................... 24

UNIT 7: REGISTERED RETIREMENT SAVINGS PLAN ........................................................................................ 24

CALCULATION OF CONTRIBUTION ROOM ............................................................................................. 24 CONTRIBUTION PERIOD ....................................................................................................................... 25 RRSP FEES ............................................................................................................................................ 25 BORROWING TO CONTRIBUTE TO AN RRSP .......................................................................................... 25 RRSP AND CREDITORS .......................................................................................................................... 25 OVERCONTRIBUTIONS AND UNUSED DEDUCTIONS .............................................................................. 26 Contributing to RRSP ........................................................................................................................ 26 Deducting Contribution Room .......................................................................................................... 26

SPOUSAL RRSP ..................................................................................................................................... 26

TERMINATION OF RRSP ............................................................................................................................ 26

OPTION 1: ALL FUNDS W/DRAWN ........................................................................................................ 26 OPTION 2: PURCHASING AN ANNUITY .................................................................................................. 27

OPTION 3: PURCHASE A REG’D RETIREMENT INCOME FUND (RRIF) ...................................................... 27 HOW DO YOU CHOOSE? ....................................................................................................................... 27

HOME BUYER’S PLAN (S 146.01) AND LIFELONG LEARNING PLAN (146.02) ............................................... 28

HOME BUYER’S PLAN (146.01) .............................................................................................................. 28 LIFELONG LEARNING PLAN (S 146.02) ................................................................................................... 29 ADVANTAGES/DISADVANTGES OF HBP AND LLP .................................................................................. 29

TFSA VS RRSP ........................................................................................................................................... 30

UNIT 8: INTRA-‐FAMILY TRANSFERS .............................................................................................................. 30

TAXATION OF THE FAMILY UNIT – INTRODUCTION .................................................................................. 30 INCOME SPLITTING STRATEGY 1: REDIRECTING INCOME .......................................................................... 30

Section 56(4) .................................................................................................................................... 30 Section 56(2) .................................................................................................................................... 30

INCOME SPLITTING 2: HAVE SPOUSE AND CHILDREN WORK IN THE FAMILY BUS ..................................... 31

Deductibility of Remuneration to Family Members ........................................................................... 31 The Reasonableness of the Remuneration ........................................................................................ 31 Does the Family Member Have Control over the Remuneration? ...................................................... 31

Bradley v R (TC) ................................................................................................................................................ 31

Bruno v R (TC) ................................................................................................................................................... 32

INCOME SPLITTING 3: TRANSFERRING INC EARNING PROP TO SPOUSE/CHILD ......................................... 32

GENERAL RULES REGARDING THE TRANSFER OF PROP FOR INCOME TAX PURPS .................................. 32 Prop Sold bw Arm’s Length Parties ................................................................................................... 32 Prop Sold bw Non-‐Arm’s Length Parties ........................................................................................... 32 Gifts ............................................................................................................................................................ 33

Transfers of Prop bw Spouses/Partners ....................................................................................................... 33

Exceptions to the Attribution Rules ............................................................................................................. 34

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UNIT 1: AN OVERVIEW OF ESTATE PLANNING

What is estate planning? Prof’s def: lifetime & testamentary financial planning directed at the accumulation of wealth, its use a& its disposition for the benefit of succeeding generations & at all times its protection from unnecessary erosion.

OVERVIEW OF CANADIAN INCOME AND WEALTH

2 measures to determine how ind/family unit is doing financially: • 1. Income • 2. Net worth (FMV of assets less debts)

Imp to look at both measures: • Ind/family can be generating income but not adding to net worth • Conversely, ind/family might have low income but high net worth

According to the 2009 All Canadian Wealth Test: • 1. There are ppl with large amts of wealth but their number is small • 2. EP is not only for ppl w high incomes & wealth, but also must work w lower levels of wealth & income

AN OVERVIEW OF THE ESTATE PLANNING PROCESS -‐ 4 STEPS

Step 1: Information Gathering • Need to be good active listener; know a lot about client (critical step) • 4 main categories of info:

o 1. Ind’s needs current needs (short & long term) (ask ppl to monitor their expenditures) o 2. Their goals immediate, short term, long term o 3. Resources they have that can be used to satisfy needs & goals (may be w/in family unit or outside) o 4. Other considerations

Needs, goals & resources of anyone outside that has legit attachment or claim to their wealth Step 2: Developing the Plan

• Likely involves several diff options for client & you to consider (tax/non-‐tax implications of each option?) • One side of continuum client based counselling (interactive and collaborative approach w client) • Other side trad’l approach (advisor takes info, thinks about it and makes decision)

Step 3: Implementation of the Plan • Implementation usually done by the ind or other inds (ex: accountant) and not the estate planner • Imp stage much litig occurs here bc the plans the advisor came up w weren’t properly implemented

o Being a good estate planner involves checking w clients to see that the plans carried out properly o Antle v R “…not enough to have brilliant strategy, you must have brilliant execution.”

• Imp pt: should always consider whether your tax planning can be changed or undone if nec o The more inflexible the plan, the more caution you should exercise before implementing it.

Step 4: Review of the Plan • Ppl/sits change must check w client from time to time to see if it’s still the best plan (goals, needs, etc)

ESTATE PLANNING OVER A PERSON’S LIFETIME

To formulate effective plan, must take into acct person’s current (& future) needs, goal & resources (as well those of others where approp).

• 1. Young adult (20s) o Needs basics, money, transportation, education o Goals developing yourself as income producing asset (most imp), completing education o Resources loans, jobs, family, savings o Type of EP at this stage?

Acquiring debt to finance goals; managing debt; living on ltd means Retirement not big priority; use income to generate assets and capabilities

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• 2. Recently educated/working adult (30-‐45) o Needs basics, mortgage, children, etc o Goals paying off debt, acquiring home, stable family sit (most imp) o Resources salary, loans, investments o Type of EP? Est’ing investments, creating will, acquiring/managing debt, tax-‐motivated strategies

• 3. Maximum earning years (46-‐65) o Needs saving for retirement, paying off mortgage, life insurance (cheaper premiums if younger) o Goals paying off debt, retirement plan, income security (most imp) o Resources income, savings/investments, inheritances o Type of EP? Minimizing risk, reducing tax liability (tax deferral strategies), helping kids

• 4. Retirement (66? Onwards) o Needs steady income, low-‐risk investments, health & living costs, etc o Goals maintaining self-‐suff & financial/health/emotional well-‐being; helping kids (most imp) o Resources RRSP, investments, pension, savings, assets, life insurance, adult children, etc o Type fo EP at this stage? Accessing gov’t benefits, manage/pull out savings efficiently

UNIT 2: AN INTRODUCTION TO THE 2 TYPES OF ACCEPTABLE TAX PLANNING

-‐ Imp Q for any estate planner: is what I’m doing (1) legal [can I do this?] & (2) ethical [should I do this]? -‐ ITA is fairly definite about what types of tax planning are illegal:

• Criminal offence: Tax evasion – s.239 ITA anyone (including an advisor) who: o Makes, participates in, assents to or acquiesces in the making of a false or deceptive st (239(1)(a)), o Wilfully evades or attempts to evade compliance w the Act or payment of taxes imposed by the Act

(239(1)(d)), or o Conspires w any person in one or both of these regards (239(1)(e)) o Is guilty of a criminal off and may be subj monetary penalties and time in jail (up to 5 yrs)

• Civil offences (result in financial penalties, but not incarceration): o S.163(2) applies to a TP who “knowingly or in circs amounting to gross neg”, makes, participates

in, assents to or acquiesces in the making of a false st or omission o S.163.2 applies to non-TP advisors culpably involved w TPs engaged in offensive activities (gross

neg std) What about tax planning that is legal but defers/reduced TP’s tax liability? Is this ethical/acceptable?

• Like the crim & civ offences above, it’s also on a continuum • 1st view anything that is legal is acceptable

o Duke of Westminster case adopted by SCC in Stubart Investment Ltd v R Tax planning is good; an entitlement & rt; should be able to use leg to minimize tax liability Nothing sinister in arranging affairs to keep taxes as low as possible

o Possible issues: 1. Usually wealthy that engage in aggressive tax planning possible finan discrimination 2. Many abide by letter of law but violate spirit of law (purpose)

• 2nd view even though such planning is legal, it is unethical, immoral and socially inappropriate

ACCEPTABLE TAX PLANNING

2 types of acceptable tax planning: (1) Tax avoidance & (2) Tax deferral

TAX AVOIDANCE Tax avoidance the complete and absolute avoidance or savings of tax

• This is better than tax deferral bc you never have to pay the tax. • Ex: using principal residence exemption (PRE) to eliminate capital gains (CG) on sale of home

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TAX DEFERRAL Tax deferral when TP delays the imposition and payment of tax until sometime in the future

• Choosing not to pay tax when it’s req’d does not constitute a tax deferral strategy • Note: need to be careful about what constitutes a tax deferral and what does not • Ex: CG is triggered when TP actually or is deemed to dispose of a capital asset that has increased in value

o Rather than trigger disposition, TP may decide to put cap asset up as sec for a loan, which does not constitute a disposition Get the $ but haven’t disposed of CG so no taxes paid yet (deferred)

• Ex: no tax levied on RRSP contribution when it’s made when w/drawn in future taxable as “other inc” Benefits of tax deferral:

• 1. Defer tax to a pt in time where you can trigger the recog event when the tax liability is less o Converting tax deferral to tax avoidance (ex: w/drawing RRSP when in lower marginal bracket)

• 2. Takes advantage of ‘present value of money’ a dollar today is worth more than a dollar tmrw o Assess rel by: (current principle bal [amt of $ on hand]) * (1 + interest rate) = future principle amt o We’re interested in the after-‐tax, after-‐inflation return (inflation in Can right now is ~ 2%

So if you’re interest rate is 1%, you’re not better off bc inflation is at 2% o Ex: We have an asset that when we dispose of it will give us a $1000 tax liability. But what if we can

defer the triggering of the recognition event for a yr? (assuming the amt of income/gain & the associated tax liability will be $1000). How much will we save in today’s dollars if we defer?

Current principle bal = (future balance) / (1 + interest rate) 1000/1.05 (if the int rate was 5%) = 952 (current principle balance)

• So by deferring it a yr, we save $48 • 3. Allows for greater pre-‐tax investment returns

o Bc of tax deferral, possible to use income that would otherwise go to taxes to be used in the interim o Essentially getting a tax free loan from the gov’t o Ex: L has firm which earns 600K; L can live off 100K pre-‐tax income; L wants to invest last 500K

Option1 claim all as personal income • A. Net prof income = 600K; taxed at 40% 360K after tax income to L • B. If L only claimed the 100K; taxed at 40% 60K after tax income • C. L could take 500K to invest; taxed at 40% 300K after-‐tax income to invest

Option 2 Incorp the law firm and keep excess income in the prof corp • Calculation:

o Net prof income = 600,000 o Salary to lawyer = <100,000> o Active bus income (ABI) = 500,000 (earned by corp) o Tax (15%) = <75,000> o After tax corp income = 425,000

• s.18(1)(a): if expense incurred for purp of earning bus income, can also get deduction • This option gives L more money to invest into the corp (tax deferral strategy)

o Corp will eventually pay this out in form of dividend or e/ent income but may pay less tax (turns into tax avoidance strategy)

o W family who are e/ees/s/h’s, can pay dividends/incomes at lower rate Note: divs subj to attribution rules attribute income to appr person to report that income

• Attrib rules gen apply to property income (incl dividends) and not bus income. Note: a prof corp has tax benefits but does not provide ltd liability to person behind it

• Non-‐active members can also now be s/hs in the PC (income splitting possibilities) • Why some rich ppl don’t engage in tax deferral:

o Believe taxes will only go up (gov’t running deficits, etc). So if always in highest bracket pay now • Why some less wealthy ppl don’t engage in tax deferral:

o If always in lowest bracket (assuming rates stay constant), you’ll never turn deferral into avoidance o Lose some gov’t benefits if you pass an income threshold (quite low) putting money into an RRSP

and later taking it out may push person over this threshold; person then loses gov’t benefits

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UNIT 3: AN INTRODUCTION TO THE 3 FORMS OF UNACCEPTABLE TAX PLANNING

S.239 – TAX EVASION/FRAUD (CRIMINAL OFFENCE – MOST SEVERE)

-‐ Tax evasion (TE) TP knowingly (or through WB) does not comply w current income tax law • Usually involves failing to report/underreporting income/gains req’d to be incl’d in tax return • Also includes evading/attempting to evade compliance w the Act or payment of taxes imposed by Act

o Ex: destroying/altering/hiding financial records can be TE when combined w nec MR (239(1)(b)) S.239(1) – Tax Evasion/Fraud – every person who has:

(a) made, participated in, assented to or acquiesced in the making of a false or deceptive st (incls passive action) (b) to evade payment of a tax imposed by this Act, destroyed, altered, mutilated, secreted or otherwise disposed

of the records or books of acct of a TP, (c) made, or assented to or acquiesced in the making of, false or deceptive entries, or omitted, or assented to or

acquiesced in the omission, to enter a material particular, in records or books of account of a TP, (d) wilfully evaded or attempted to evade compliance w the Act or payment of taxes imposed by the Act, or (e) conspired w any person to commit an off described in paras 239(1)(a-‐d) (this includes tax advisors)

-‐ 239(d) is often used in combination w (a) - Crown must prove these 4 elements BRD:

• 1. That the Court has jur to hear the case (heard in crim court – usually a non-‐issue) o s.244(3): prov has jur re TE cases when A is a resident, carries on bus here, or is apprehended here

• 2. That it was the accused who committed TE • 3. That the accused’s actions constitute tax evasion (ie. the actus reus of the off) • 4. That the accused possessed the requisite men rea/intent • Note: Cr does not have to prove BRD amt of tax evaded (if above reqs are met, court will decide the amt)

ACTUS REUS

• Cr must prove “an act or course of conduct which has the effect of evading or attempting to evade payment of taxes actually owed under the Act”

o Thus, defence usually has 2 part defence: 1. Accused argues no TE bc no taxes owing 2. If Crown proves that it was TE, defence argues A’s actions were not TE

• Once Cr proves TP owed a tax liability (or did some other act that constitutes TE), AR satisfied (not hard) o R v Klundert So long as you’ve committed the action, the AR is satisfied. The act does not have to

be sinister/deceptive as anything regarding motive goes towards the MR.

MENS REA

• Crown must prove person had nec “intention” to commit TE, namely that: o 1. A knew or was WB that tax was owing under the Act; and o 2. A intended to avoid (or intended to attempt to avoid) payment of that tax o WB where person who has become aware of the need for some inquiry declines to make inquiry bc he

doesn’t wish to know the truth • S.239 requires “high level of culpability” beyond lesser forms of guilty knowledge such as “neg or reckless”

o If TP doesn’t know he must report an amt on return, or reports it incorrectly MR not met (but AR is) o If it looks like you’re trying to comply, then probably don’t have MR o R v Klundert “mistake or ignorance as to one’s liability to pay…may negate the fault req in the

provision, regardless of whether it is a factual mistake, a legal mistake or combination of both.” • If requisite intention or something tantamount to intention (ie. WB) is not present in facts of the case, then TP

will not be guilty of TE BUT, TP might be subj to gross neg penalty under s.163(2) [see below] -‐ General pts:

• As a crim off, all crim rules & CH protections apply usually run by crim lawyers (not tax lawyers) • S.239 is hybrid off can proceeds summarily or by indictment (s.239(2))

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o Summarily s.239(1)(g) and (h) set out penalties pay back tax evaded and: 1. Fine bw 50 -‐ 200% of tax evaded, or 2. Fine plus imprisonment not > 2 yrs

o Indictment s.239(2) pay back tax evaded and: 1. Fine bw 100-‐200%, or 2. Fine plus imprisonment not > 5 yrs

• No limitation period for TE by way of indictment (s.152(4)); 8 yr LP for TE via summary (s.244(4))

S 163(2) – GROSS NEG PENALTIES (CIVIL PENALTY)

-‐ Only applies to TPs and not 3Ps such as tax advisors. -‐ Most common of the civil penalties is gross neg penalty [s 163(2)]

• Lesser offence than TE req’ing less from the Minister, but Minister still has burden of proof [s.163(3)] • Only financial penalties; no jail time • Gross neg test in s.163(2) is higher than simple neg test: “high degree of neg tantamount to intentional

acting, or indifference as to whether the law is complied w or not” - Crown must prove on BOP that:

• 1. There was a false st or omission in TP’s tax return (aka a “misrep”), • 2. The misrep was made knowingly or under circs amounting to gross neg, and • 3. The misrep resulted in lesser tax liability or greater refundable tax credit than should have been the case

-‐ If successful, penalty is (1) $100; or (2) 50% of tax evaded whichever is higher -‐ No LP [s.152(4)] -‐ If CRA successfully convicts TP of TE cannot also use gross neg, BUT if unsuccessful, CRA can use gross neg

S 163.2 – MISREP OF A TAX MATTER BY A THIRD PARTY (CIVIL PENALTY)

-‐ Specifically directed at 3Ps Crown has burden of proof on BOP - s.163.2 – 2 types of 3P penalties:

• 1. Planner Penalty [s.163.2(2)] o Ppl who make false st’s that could be used by other ppl for tax purposes (doesn’t need to be used) o Don’t need a specific TP associated w the 3P for 3P to be liable

• 2. Preparer Penalty [s.163.2(4)] o Ppl who make (or participate in, assent to, or acquiesce in the making of) false st’s in re of a

“particular person” (ex: TP) for tax purposes So, tax preparers could be liable for this penality in sits where they do nothing, if they knew

or would be reasonably be expected to know that their client made a false st o For ppl who has actively involved w specific TPs ex: typical advisor relationship

• In both cases, this provision is triggered when: o 1. The 3P knowingly makes a false st; OR o 2. The 3P makes a false st that he would reasonably have been expected to have known was a false

st but for circs amounting to culpable conduct Circs…culpable conduct probably equivalent and uses same case law as gross neg

- Information Circular IC 01-1 • Examples of the Planner Penalty:

o 1. Tax shelter promoter holding seminar to provide info re a specific tax shelter that does not comply w the ITA or does not accomplish objectives represented

o 2. Appraiser/valuator preparing inaccurate report for scheme that could be used by unidentified investors

• Examples of the Preparer Penalty: o 1. Tax preparer preparing return for specific TP containing false st’s (ex: non-‐existent deduction) o 2. Person providing tax advice to a specific TP o 3. Appraiser/valuator preparing report for specific TP or # of persons who can be identified

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-‐ W accountants, their concern was that this 3P provision would turn them into unpaid CRA auditors – to ensure the tax returns they prepare don’t have false st. Is this appropriate?

• Yes as a professional, we should be aware of the possibility that clients may use us for nefarious purposes and should be turning them away

• No it damages rels, costs more money and clients won’t want to pay, how far does this go? -‐ W lawyers, in add’n to above, concern about violating solicitor-‐client privilege & client confidentiality in order to properly defend themselves against this penalty. Can lawyers ethically do this? Yes.

• AB Code of Conduct Rule 2.03(1) Ls must hold in confidence all info concerning bus/affairs of client unless: (a) auth by client; (b) req by law/court; (c) req to deliver info to Society; or (d)permitted by this rule

• Rule 2.03(4) if alleged that lawyer/associates/e/ees (a) have committed a crim off involving a client’s affairs; (b) are civilly liable w re to a matter involving client’s affairs; (c) committed acts of prof neg; or (d) engaged in acts of prof misconduct or conduct unbecoming a lawyer; the lawyer may disclose confidential info to defend against the allegations, but must not disclose more than is req

-‐ To provide some protection, gov’t took 2 further steps: • 1. Created 3P Penalty Review Committee (to try to prevent abuse of this provision by CRA auditors)

o Reviews all proposals and approves them so auditor can’t threaten a 3P w this provision o As of 2012, they’ve assessed 80 and rejected 7 o Prof: either the auditors are careful in which cases they send to committee or committee is rubber

stamping the proposals • 2. There is a “good faith defence” w/in the provision (s.163.2(6))

o s.163.2(6) 3P will not be found to have acted in circs amounting to “culpable conduct” where the advisor relied, in good faith, on info provided by or on behalf of the client and bc of such reliance, failed to verify, investigate, or correct the info

o “Good faith” not defined in Act and no case law BUT, IC 01-1 – Third Party Civil Penalties defines good faith honesty of intention and

freedom from knowledge of circs which ought to have put the holder on inquiry • This exception avail when the info used by the advisor is not, on its face, clearly

false, or obviously unreas to a prudent person or does not raise obvious Q’s o Also, there are some facts that could affect an advisor’s ability to claim the good faith defence:

1. Length of time advisor has known the client 2. Knowledge the advisor had of client’s particular circs 3. Amts involved (more money = more Q’s should be asked) 4. The expertise of the advisor (more expertise = easier for Minister to establish culpability)

o s.163.2(7) defence doesn’t apply w re to the planning or promoting arrangement [in 163.2(2)] -‐ Penalties:

• Planner Penalty [163.2(3)] at least $1,000 in re of each false st assessed o BUT, if false st made in course of a “planning” or “valuation” activity, may be > $1,000

Defs of “planning” and “valuation” activities in s.163.2(1) The penalty is the amt of the “gross st’s” in re of that activity (if > $1,000)

• Takes away any profit incentive for any ind to be involved in this type of activity So, even if you’re incidentally involved/didn’t receive anything, still fined $1,000

• Preparer Penalty [163.2(5)] min penalty of $1,000, and the lesser of: o 1. One of the ways to calc the amt is to see what the TP’s penalty would be under s.163(2) if he were

assessed and the Minister was successful in proving the off [163(2)(b)], or Penalty is 50% of the tax avoided doesn’t require Min to actually prove/charge the TP –

but says IF the Min was able to do so, what would the penalty be? o 2. Other way is $100,000 + whatever 3P advisor received in compensation from the off so can be

indefinite amt depending on circs

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Guindon v R – currently being considered by the SCC Facts

• Appellant (A) was a wills/estates lawyer (not tax L) and president of a charity. She was retained and prepared a legal opinion on a tax plan that purported to allow ppl to receive charitable tax receipts; Tax plan didn’t work – not implemented as described to her (she didn’t investigate and verify the facts).

• She engaged her charity in the plan and signed 135 donation receipts even though donations weren’t made. • After donation receipts issued, A learned that nothing that was supposed to be done, was done. Thus, she

told participants not to use the donation receipts until issues were resolved. But the promoter then issued a letter saying they could use the receipts (w/o A’s knowledge). A herself claimed the donation on her return.

• CRA audited plan & rejected it all donations were denied but no participants charged w gross neg or TE o But CRA later charged A under s.163.2(4) (preparer penalty) for $546,747 for false st’s made o This amt represented amt of tax participants would’ve owed had they been assessed under

s.163(2) and could be increased indefinitely under 163.2(5) • Practice pt: if beyond your expertise, don’t get involved

o Promoter may take opinion, even if negative, and use it in positive way (better to avoid altogether) Issues

• 1. Does 163.2 actually create a crim off, which would (1) engage the CH (particularly s.11); (2) raise the burden of proof to a crim std; and (3) require the hearing to occur in the appropriate prov court?

• 2. If 163.2 is a civil off, did A violate it? (ie. did A knowingly, or in circs amounting to culpable conduct, make false st’s that could be used by another person for tax purposes?)

Tax Court • First issue: held it was crim offence Min went beyond scope of the provision

o Orig intention of provision was to defer inds from advising, participating in, etc, faulty tax plans by holding advisors accountable for participation

Most attention focused on possible magnitude of the penalties • Gross neg = 50% of tax avoided; TE = 50-‐200%; but 3P penalties can be indefinite

o If was civil, we’d expect gov’t to use civil off misconduct of “gross neg”; But used “culpable conduct”. Gov’t argued a finding of gross neg in a tax conduct may impact a tort action against advisor

by TP (court still unsure how to interpret word) o Sum: court held it was crim despite govt’s intentions to create civil off bc so far reaching that its

intent is to promote public order and protect public at large rather than deter specific behaviour. Also, potential unltd magnitude of the penalty was a “true penal consequence”

• A’s appeal allowed, on basis that A did not receive her s.11 CH protections, and the assessment vacated o S.11 CH says innocent until proven guilty, BUT s.163.2 allows CRA to assess binding penalty until

person convinces Tax Court (on BOP) of their innocence. • Second issue: TC identified donation tax receipts as false st’s (obiter)

o Re whether A had actual knowledge (or would be reas expected to know but for circs amounting to culpable conduct), court held that relevant time frame to apply this test was at time false st was made (as well as time leading up to it) this is when she signed donation receipts

Info/conduct after the fact not relevant (but could be aggravating or mitigating) o “Culpable conduct” similar to “gross neg” but not the same culpable conduct is strongest cases of gross neg and requires a finding of the nec MR of culpable conduct

o So, had this been civil, A acted in circs amt’ing to culpable conduct & would be subj to 163.2 penalties Federal Court of Appeal

• 1. Overturns TC’s finding that 163.2 is a crim off triggering all assoc CH protections on technical grounds o To bring CH challenge, notice of a CON Q must be served on fed/prov AG and none was given

• 2. Overturns TC’s finding that 163.2 is crim off that imposes true crim sanctions o Held it was directed at ensuring accuracy of info, honesty & integrity of the system and not to

redress a public wrong o 163.2 penalties, like other civil penalties, are mechanical & non-‐discretionary (TE sanctions are

discretionary) • 3. Declines to interpret 163.2 and instead simply upholds TC’s finding that it applied to A (penalty restored)

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UNIT 4: AN OVERVIEW OF THE GENERAL ANTI-‐AVOIDANCE RULE (GAAR)

-‐ There are trans’s/reporting positions that technically comply w all provision of the Act but are still “unacceptable”. • S.245 (GAAR) purpose is to catch planning that complies w the Act but constitutes an abuse/misuse • If triggered, no crime committed nor civil penalty imposed

o Instead, it allows CRA/court to: 1. Deny inappropriate tax benefits otherwise realized; and 2. Provide tax consequences considered reas in circs [s.245(2)]

• Gov’t’s defence of this can’t include all of the gov’t’s intentions; some planning may follow black letter of law but violate the spirit; want system to be fair to everyone (only wealthy can hire tax specialists)

• TP’s response this may lead to uncertainty and impede economic activity -‐ GAAR intended to prevent abusive tax avoidance transactions/arrangements, but at same time, not intended to interfere with legit commercial and family transactions. -‐ SCC’s first 2 judgments re GAAR: (1) Canada Trustco Mortgage Co v R and (2) Matthews v Canada (aka ‘Kaulius’)

• Recent SCC cases: Lipson v Canada and Copthorne Holding Ltd v R

4 STEP APPLICATION OF THE GAAR (CANADA TRUSTCO AND COPTHORNE)

1. Tax benefit: Did the TP receive a “tax benefit”? (s.245(1)) 2. Avoidance transaction: Did the tax benefit result from an “avoidance transaction”? (s.245(3)) 3. Misuse of the provision or abuse of the Act as a whole? (key step)

• 3 step analysis: o A. Interpret the object, spirit, and purpose of the provision o B. Determine if trans falls w/in or frustrates that purpose by looking at facts of case o C. Trial judge, as a Q of fact, determines if there has been abusive tax trans

4. Consequences: If first 3 steps satisfied, go to s.245(2) [in conjunction with 245(5)]

STEP 1: TAX BENEFITS Starting pt is s.245(1) Did TP receive a tax benefit as result of the trans?

• Very broad def & easy to trigger catches any sit where TP saves, avoids or defers tax • Canada Trustco (SCC) magnitude of tax benefit not relevant

o This is also a factual inquiry based on objective review of the facts by TJ Since it’s a factual inquiry, where Tax Court has made finding of fact re tax benefit, it can

only be overturned where the TC made a palpable and overriding error • In all cases heard by SCC, none overturned the finding of fact and all incl’d a tax benefit • Existence of tax benefit can be ID’d in isolation or est’d by comparing TP’s sit w an alternative arrangement

o W comparative approach, the alt arr must be one that might reasonably have been carried out but for the existence of the tax benefit if approach TP took resulted in less tax, there has been tax benefit

• Burden of proof on TP to show no tax benefit (TP usually concedes this pt)

STEP 2: AVOIDANCE TRANSACTION -‐ s.245(3) Did the tax benefit result from an avoidance trans or a series of trans’s that incls 1+ avoidance trans’s?

• Avoidance trans any trans that was undertaken primarily to obtain a tax benefit o If trans undertaken primarily for purpose other than a tax benefit, then GAAR does not apply

• Canada Trustco the fact that the trans could have occurred in an alternative way which would have resulted in more tax does not necessarily make TP’s plan a trans primarily designed to obtain a tax benefit

o Thus, the comparative approach used in step 1 is less relevant here (but they can still infer from this that you took the approach you did to get the tax benefit)

-‐ Thus, when dealing w one trans, key Q’s are: • 1. Did the trans result in the tax benefit ID’d in step 1? (Is there a conn bw the avoidance trans & tax benefit?) • 2. Was the primary purpose of that trans to obtain that tax benefit?

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-‐ Canada Trustco and Copthorne this is an objective test determined by TJ on the facts (not intention) • Thus Appellate courts should not overturn it absent palpable/overriding error (like step 1)

-‐ Burden of proof on TP to show: (1) that trans did not result in the tax benefit; or (2) it wasn’t the primary purp of the trans (but was secondary/ancillary conseq)

-‐ Very difficult for TP to win on this -‐ Note: TP usually makes non-‐tax arguments in trying to accomplish non-‐tax objectives, it resulted in lower tax

STEP 3: MISUSE OF THE PROVISION OR ABUSE OF THE ACT AS A WHOLE -‐ Most litigation and uncertainty at this step -‐s.245(4) GAAR won’t apply in sits where the trans doesn’t misuse any provisions of ITA or abuse ITA as a whole

• TP can take steps designed to obtain tax benefits if it doesn’t abuse a provision/Act (ex: RRSP contribution) o This step really about actions contrary to what Parliament intended when leg was enacted

-‐ SCC: this is not a 2 part test (misuse of provision or abuse of Act as a whole) this is single test that reqs court to do textual, contextual and purposive analysis of Act as a whole to determine if trans meets the def/req -‐ Burden of proof on Minister (unlike first 2 steps where Min can make assumptions & burden is on TP) -‐ 3 Step Analysis:

• 1. Ascertain what the object, spirit and purpose of the engaged provisions are o SCC the ‘o,s,p’ is the legislative rationale that underlies specific/interrelated provision of the Act o Using a textual, contextual and purposive analysis, if a plain reading of the leg is not suff, then Min

must prove what the underlying rationale of the leg is Collins & Aikman Products Co v R purpose of legislated scheme should be demonstrably

evident, w permissible extrinsic aids, and not abstract views/tax policy theories o Some uncertainty, but SCC has said where Parl has specified precisely what conds must be satisfied

to achieve a result, it’s reas to assume that Parl intended that TPs would rely on this o Birchcliff Energy Ltd v The Queen Min must set out in notice of assessment the tax policy (object,

spirit & purp) that the Min is relying upon in assessing the TP under GAAR • 2. Whether the trans falls within or frustrates the object, spirit or purpose

o Determine this through examination of the factual context of the case o Central inquiry: whether the trans was consistent w the purp of the provs of the Act relied upon by

the TP, when those provs are properly interpreted in light of their context. o Overall inquiry – mixed Q of fact and law reasonable and correctness o Abusive transactions will occur where: (Canada Trustco (SCC))

A. TP relies on specific provs of the Act to achieve an outcome that those provs seek to prevent; B. A trans defeats the underlying rationale of the provs that are relied upon; or C. An arrangement that circumvents the application of certain provs, such as specific AARs, in a

manner that frustrates/defeats the object, spirit or purp o SCC Min must clearly demonstrate the trans is an abuse of the Act (TP given benefit of the doubt)

• 3. Whether there has been an abusive tax transaction (TJ determines this as a Q of fact) o Bc it’s a Q of fact, the decision should not be overturned absent a palpable/overriding error o If any doubt, the doubt is to be resolved in favour of the TP o TP has had a fair degree of success at this part

STEP 4: CONSEQUENCES -‐ s.245(2) [in conjunction w s.245(5)] sets out the consequences of a trans being found subj to GAAR

• Gives CRA ability to tax TP accordingly (w interest) • This is not a criminal off as is the case for tax evasion under s.239 • Note: some uncertainty w what the proper consequence should be under s.245(2) Tax Court, Fed CA and

SCC had a diff outcome in the Lipson case when applying s.245(2)

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UNIT 5: THE TAX IMPLICATIONS OF OWNING YOUR OWN HOME

-‐ 70% of Canadian adults own their own home (30% in Europe) -‐ Advantages of owning home freedom re what you can do w space; building equity/making investment; more choice; potential to increase in value; use as security -‐ Disadvantages of owning home better investment returns than your home; concentrates wealth in one asset; no regular financial return; impair mobility; upkeep/mortgage costs; - s.18(1)(h) prohibits deduction of personal/living expenses (no deduction for buying house; paid w after tax $)

• Unless an expense is provided for in s.8 then no deduction against e/ent income (ltd exceptions) o Ex: may be certain deductions for a home office (working at home)

- s 20(1)(c) prohibits the deduction of interest unless the borrowed monies are used for the purp of earning income from a bus or prop (not satisfied when you take out mortgage for home to live in)

• Trace the borrowed funds if used for income earning purps (& it’s traceable) then you’ll get a deduction. • If you have rental suite or main floor is an office (you live upstairs), you can prorate and get a deduction • Note: in US, can use interest in home to get a deduction encourages ppl to own their own home but then

it’s better to have bigger mortgage (possible disadvantage) o Can approach values discourage ppl from getting bigger mortgages (more concern re debt lvls)

-‐ No obvious diff in tax treatment in purchasing home vs renting (both paid from after tax dollars) • But there are 2 benefits to owning:

o 1. Imputed income from living in own home is not taxable (bc it’s too hard to calculate imputed inc) o 2. Any gains arising from sale of principal residence are potentially tax free due to PRE (not in US)

IMPUTED INCOME FROM HOME OWNERSHIP

-‐ Imputed income the benefit & savings that is derived from the personal use of one’s own assets & from the performance of services for one’s own benefit Not actual, monetary income but we’ll deem it to be income -‐ Ex: our sidewalk/driveway needs to be shovelled

• Opt 1: shovel ourselves – costs time/effort but no financial cost; Opt 2: pay someone to shovel • What is the imputed value to us of shovelling ourselves?

o Amt we’d pay to hire someone else, grossed up by the amt of tax, since this is a personal expense o If it costs $20 then it costs you $20 after tax or $30 before tax imputed income of $30 o Imputed inc – the pre-tax value/savings or providing services for one’s self, or using one’s assets

Recall: Haig-‐Simons def of income was broad sum of what you consume + change in net worth • So, when ppl have imputed income (ex: shovel own walk) this is a change in net worth ($30 imputed inc) • We don’t, explicitly, impute income for tax purps (measurement issues and it’s not actual income)

o But we do it in various forms implicitly ex: couple where H earns everything and W earns nothing (bc W is cooking etc) should have to pay more tax than a couple who both work

Why is it that living in your house can be considered “imputed income”? • Don’t have to impute the income of living in your house so don’t’ have to pay tax on it • If you rent the house, you have to pay tax on the income but if you live in it, you don’t have to pay/no tax

o The imputed income is what you could’ve rented it out for

PRINCIPAL RESIDENCE EXEMPTION

CHARACTERIZATION OF THE PROPERTY For a gain to be eligible for PRE [s.40(2)(b)], the prop must constitute a PR as defined in s.54. Step 1: it must constitute a “capital property” as opposed to a “bus prop”

• This is bc defs of PR and PRE are found in Capital Gains and Losses Subdivision C of the ITA • How do we determine whether prop is capital prop or bus prop?

o Def of capital prop in s 54 (not very helpful), and o Application of primary and secondary intention tests

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When acquired, was primary intention to use or sell? • If sell, then it’s bus prop PRE doesn’t apply • If use, go to secondary intention did you have sec intention to sell it that

motivated you to purchase it? o Interpretation Bulletin 218R lists indicia:

1. # of similar trans’s 2. Nature of asset (raw land presumed as bus asset) 3. Return on investment (how can TP make reas return?) 4. Relation to TP’s bus activities 5. Degree of organization 6. Length of ownership

o These are based on Happy Valley Farms Ltd v Minister of National Revenue

Step 2: the prop must constitute personal use capital property • “PUCP” [s.54] prop used “primarily for the personal use & enjoyment of TP and anyone related” (ie. home) • This is also imp bc the stop loss rule [s.40(2)(g)(iii)] any losses on the disposition of personal use cap prop are deemed to be nil (bc gov’t sees the benefit you got from its use reflected in the decline in value)

o So if you sell your house for a loss, can’t use that for a deduction bc the Act deems it to be nil

PRINCIPAL RESIDENCE DEFINITION 1st req: must constitute a “housing unit” (not defined in the ITA)

• Incl: house, apt, duplex, cottage, mobile home, trailer, & houseboat (IT Folio S1-F3-C2 Principal Residence) 2nd req: TP must own the property, either solely or jointly w another person (could be a personal trust)

• 2 types of joint ownership: o 1. Joint Tenancy each person considered to own 100% of the legal & beneficial interest in prop

Right of survivorship if my wife dies, her interest disappears and I remain the sole owner BUT even though each of us owns 100%, my wife and I would each own 50% for tax purps

• E.g. my W and I buy house for 50,000 in 1985; she dies in 2014 and it’s worth 1 mill o 1985 I have ACB of 25,000; W has ACB of 25,000 even though we have JT o 2014/Wife when she dies she has proceeds of disp of 500,000 and ACB of

25,000 so a 475,000 capital gain (CG) o 2014/Me my ACB is 25,000 + 500,000 = 525,000

o 2. Tenancy in Common each person owns specified % of the prop • Types of Ownership Interests:

o 1. Legal Ownership Exists when title is transferred to, recorded in, reg’d in or otherwise carried in the name of a

person. Legal Os generally entitled to enforce their ownership rts against all other persons. o 2. Beneficial Ownership

The type of ownership of a person who is entitled to the use/benefit of the prop whether or not that person has concurrent legal ownership.

If person has benef, but not legal, they can enforce those rts against the holder of legal title. o Benef ownership will suffice for purps of claiming PRE

3rd req: beneficial owner must be an ind (cannot be a corp) [s40(2)(b)] • A personal trust is ok • Common for vacation props to be owned by indiv’s corp

o If corp is Canadian Controlled Private Corp and carrying on active bus, then first 500K subj to small bus deduction which reduced corp tax rate to ~15% (vs personal tax at 40%).

If corp is both legal and benef owner unit not eligible for PRE If corp is only legal O (holds in trust for O/manager) PRE technically open

• Note: CRA is sceptical of this so need written trust doc 4th req: prop must be ordinarily inhabited by TP, TP’s spouse/CL partner (or former) or by child of TP [s.54(a)]

• “Ord inhabited” not def’d in ITA so we use case law has relied on ord meaning (to live in on a reg basis)

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o Common defs used: “usually or commonly occupied as an abode, more than a place where one would visit occasionally/use for certain purps other than ord habitation, normally occupy as home”

• This req is not a significant barrier to PRE Income Tax Folio S1-‐F3-‐C2: o Prop does not have to be continuously inhabited for long period of time during the yr to qualify

Ex: if buy house in Dec and move in before Christmas, deemed to have inhabited for that yr o Can be occupied seasonally (ex: cottage) & will typically be considered by CRA to be ord inhabited

BUT, if primary use of prop isn’t personal use, then ord inhabited req not satisfied (ie. rent) o Only time this is usually an issue is when prop is incapable of being ord inhabited in the yr

Ex: bought an empty lot & it’s a few yrs before house is built NOT ord inhab for those yrs 5th req: TP must designate the prop as his PR for the yr and the TP/spouse/minor unmarried children must not have designated any other qualifying props as his/her PR for that yr

• Exception: s.54(c) prior to 1982, each spouse could claim their own PR (still applies for pre-‐’82 props) 6th req: TP must be a Canadian resident for that yr (according to s.40(2)(b))

• NOT the yr you dispose of prop but the yrs you designate it as your PR • Note: prop does not have to be located in Canada to qualify as PR – the reqs just have to be met

THE BASIC MECHANICS OF THE PRE Step 1: as a PR is personal use cap prop, TP has to calculate capital gain upon disposition [s.40(1)]

• Recall: s.40(2) if we have loss, then it’s deemed to be nil • CG = proceeds of disp – ACB – associated selling expenses • Taxable CG = CG x 50% • Note: cap gains/losses formed part of tax base starting in 1972; To find ACB for Jan 1/’72 call accountant

Step 2: Calculate the PRE via s.40(2)(b) • Gen formula: PRE = [(# of yrs TP designates as the PR + 1)/(total # yrs owned)] x CG

Step 3: CG minus PRE • If this is negative amt, s.257 deems it to be nil (can’t use PRE to create a loss & use it to offset pos income)

-‐ To claim PRE, “Form T2091 Designation of a Prop as a PR by an Ind” must be completed w return in yr of sale • If PRE completely offsets the CG, don’t have to submit this form (but it’s a good practice to complete the

form and keep it for records; esp when dealing with joint ownership). (CRA can ask for it at any time)

WHAT CAN BE SHELTERED BY THE PRE? -‐ S.54(e) def of PR provides that in add’n to the house, TP can claim up to ½ hectares (1.24 acres) of land as part of his PR that may be regarded as contributing to TP’s use/enjoyment of housing use as a residence -‐ More than ½ hectare may be incl’d if able to satisfy “use and enjoyment test” based on subj factors such as lifestyle and zoning bylaws excess land must be nec to use/enjoyment of PR and not simply desirable

• Common ex is where prop cannot be subdivided into a smaller parcel [Cassidy v R]

EXAMPLES

Scenario 1

Assumptions: • TP is single adult female w no children; bought house (#1) in 2000 for $250,000 • April 2, 2009, bought another house (#2) for $500,000 • June 29, 2009, sold #1 for 410,000 with selling expenses of $10,000 thus net proceeds of $400,000 • TP is in highest bracket (40%) • TP has never owned other properties

Q: what are her tax implications arising from her housing transactions? • Answer on chronological basis

o 2000 bought #1 for 250,000 (ACB) Q’s to ask TP: want to know characterization of #1 – capital asset or bus asset?

primary/secondary intention test (was it income producing or pers use asset?)

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o Apr 2009 bought #2 for 500,000 o June 2009 sold #1 for 410,000 + 10,000 (selling expenses) (The disposition = recognition event)

• Step 1: calc CG (regardless of whether PRE shelters the whole gain) or the bus gain if it’s bus asset o CG proceeds of disp – ACB – selling expenses

CG 410,000 – 250,000 – 10,000 = 150,000 o Taxable CG 150,000 x 50% = 75,000 o 75,000 x 40% (highest bracket) = 30,000 tax (w/o PRE)

• Step 2: consider if PRE applies and if so, do the calculation o 1. Must be a housing unit Yes o 2. TP must own the prop Yes o 3. TP must be beneficial O Yes o 4. TP/spouse/children must ordinarily inhabit Yes o 5. Cannot have made other designations for PR for that time Yes (satisfied) o 6. Must bc Canadian resident for yrs claiming the PRE Yes o PRE [(# of yrs TP designates as the PR + 1)/(total # yrs owned)] x CG

TP bought in 2000 so that’s the yr she owned the prop owned for 10 yrs total We can designate #1 as PR from 2000-‐2008 (9 yrs) [(9+1)/10] x (150,000) = 150,000 PRE

• Recall: s.257 deems PRE to be 0 if PRE is higher than CG (neg number) • Step 3: CG – PRE

o 150,000 – 150,000 = 0 tax liability

Scenario 1A

Assume everything in scenario 1 except that: • TP bought vacant land in 2000 for $50,000; hired builder in 2001 to build house #1 on vacant land for

$200,00; took possession of completed home and moved in on Dec 23, 2002 Q: what are her tax implications arising from her housing transactions?

• Need to ask when they bought the house and why they bought the house? o When you build a house on the land, it becomes one asset

• Need to go through steps re whether the PRE applies here, we determine it’s a capital asset so… • Step 1: calc CG

o CG = 150,000 (same as scenario 1) separation in time bw buying land & building doesn’t matter • Step 2: calc PRE

o PRE [(# of yrs TP designates as the PR + 1)/(total # yrs owned)] x CG # yrs owned is 10 2000-‐2009 (bc land and house are seen as one) Ord inhabited? Only from 2002 onwards better that TP moved into house in Dec instead

of Jan (or else another 10% will be taxable [1 yr]) Thus PR for only 7 yrs [(7+1)/10] x 150K = 120,000 PRE

• Step 3: CG – PRE = net CG o 150,000 – 120,000 = 30,000 net CG o 30,000 x 50% = 15,000 net taxable CG o 15,000 x 40% (highest bracket) = 6,000 tax liability

Observation: PRE is based on a fraction of the CG; don’t care about the increase/decrease of house value over time

Scenario 2

H & W own 2 props. House purchased (& solely owned) by H in 1994 for 100,000. Cottage purchased (& solely owned) by W in 2004 for 25,000. They live in house from Sept-‐June but spend July and Aug at cottage. Decide to sell both props in 2013.

• It’s now Feb 2014 – they want to know: (1) how should they utilize PRE and (2) what each will have to pay on their tax return for 2013? (they sold the house for 610,000 with selling expenses of 10,000 and cottage for 425,000 with no selling expenses)

o Both are in 40% tax bracket and have decided not to designate either prop as PR for 2013

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• Assume reqs 1-‐6 are satisfied (both are cap props, PUCP, are ord inhabited, are Canadian residents etc) • Step 1: calc CG

o Note: where there are 2 props and only 1 disposed of, go through this same process o CG proceeds of disp – ACB – selling expenses

CG (house) 610,000 – 100,000 – 10,000 = 500,000 CG CG (cottage) 425,000 – 25,000 = 400,000 CG

• Step 2: calc PRE (w/ house from 1994-2003 and cottage from 2004-2012) o Family can only designate one of these as PR per yr o From 1994-‐2003, only 1 prop owned so we’ll designate the house as PR during this time o For the period where 2 props owned, pick the one that shelters the most amt of gain

Strategy calc gain per yr (# of yrs owned)/CG • House 25,000 gain per yr; Cottage 40,000 gain per yr • The cottage has greater gain/yr so, better use of PRE to designate the cottage

o PRE [(# of yrs TP designates as the PR + 1)/(total # yrs owned)] x CG PRE (house 1994-‐2003) [(10+1)/20] x 500,000 = 275,000 PRE PRE (cottage 2004-‐2012) [(9+1)]/10] x 400,000 = 400,000 PRE Note: TI 2004-0088031E5 says you can add ‘+1’ to both props disposed of in same yr

• But can only ‘+1’ if we designate at least 1 yr for PRE • Step 3: CG – PRE = net CG

o House 500,000 – 275,000 = 225,000 net CG Taxable CG 225,000 x 50% = 112, 500 Tax (40%) 45,000

o Cottage 400,000 – 400,000 = 0 net CG • Step 2: calc PRE (w/ house from 1994-2012 and no designation for cottage)

o PRE (house 1994-‐2012) [(19+1)/20] x 500,000 = 500,000 PRE o PRE (cottage) # yrs desig is 0 bc it’s all been used on house so can’t use ‘+1’ again

[(0)/10] x 400,000 = 0 PRE • Step 3: CG – PRE = net CG

o House 500,000 – 500,000 = 0 net CG o Cottage 400,000 – 0 = 400,000 net CG

Taxable CG 400,000 x 50% = 200,000 Tax (40%) 80,000 (vs 45,000 tax liability under strategy #1)

Scenario 3

Parents want to buy daughter a condo while she’s at University. Can parents sell it after and claim the PRE? • Possible concerns?

o Applying primary/secondary intention test, it’s possible that this is not cap prop but bus asset BUT the risk is v low likely a cap prop

o If it’s cap prop, it is “personal use cap prop”? Renting it out to others? (happens in practice a lot) o Ordinarily inhabited? (Recall: must be ord inhabited by TP/spouse/child)

As an adult, is the daughter a “child” for the purps of this req? Yes • s.252(1) “child” incls person who’s dependent on parents (v expansive def).

o PRE likely avail, but other tax concerns (If use PRE for this, can’t use it for own home in same per) • How could we alleviate these concerns?

o Give daughter the money and have her buy the unit She’s the O and can use PRE (it won’t tie up parent’ PRE for own home)

• Must be actual gift (attribution rules don’t apply when parents give $/prop to child) Concern: if daughter buys it, isn’t she still part of the family unit? No

• If a child is an adult and living on own or is a minor but married, then she is considered a TP sep and apart from parents. (IT Folio para 2.13)

Concern: giving an 18 yo 500,000 to buy a home • Can lend her $ instead. Dad can register SI on title and maintain level of control.

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• Likelihood of GAAR applying? o 1. Tax benefit? Yes, sheltering the gain on disposition o 2. Avoidance transaction?

Likely no avoidance trans trying to finance daughter’s education in efficient manner etc, not doing this primarily to get a tax benefit. Thus GAAR doesn’t apply.

Possible concern: if this looked like a gift but was not (parents gave daughter money to purchase but then all the money went back to the parents after sale & daughter used PRE).

• May look like it was done to duplicate the designations. o 3. Misuse/abuse of the Act?

Even if it was an avoidance trans, likely not a misuses/abuse. (just getting one designation) Note: on exam, prof could just write “please advise” need to go through all the above analysis (be thorough)

• ***Also be sure to mention the non-legal implications when advising a client • Also can say that there are some other issues the client may want to look into (ie. real estate market, etc)

DEATH AND THE PRE

What happens when someone w a PR dies? • When a person dies, he is deemed to dispose of his prop immediately before death at FMV [s.70(5)]

o Bc there is deemed disp, the beneficiary will get the house at FMV & tax free bc the deceased has taken the assoc tax conseqs

o If deceased unable to claim the PRE (has multiple props), the estate will have to pay the taxes before it can disperse the assets

o Note: life insurance proceeds go to beneficiaries tax free Ex: mom dies & house is to go to kid but mom can’t shelter the gain; use the life insurance

proceeds to pay the taxes & preserve the home so it can be transferred to child wo the taxes What if the B of the estate is a surviving spouse or CL partner? Exception to general exception above

• S.70(6) still a deemed disp of prop but it occurs at the deceased’s cost & not FMV (so no CG triggered) o Called a rollover the tax attributed to the deceased becomes the tax attributed to the spouse. Bc

there is a rollover, there is no CG triggered by the deemed disp. o If spouse is alive s.73; If spouse is dead s.70(6)

• S.40(4) transfers all the deceased’s tax entitlements to surviving spouse o As long as the deceased could’ve used the PRE, surviving spouse can use PRE for that same time per

Scenario 4

Mom purchased the couple’s current home in 2000 for 250,000. In 2009, mom died. The house was worth 450,000. Dad took full legal and beneficial ownership of the house. Dad died in 2013. The house was worth 400,000. Neither mom nor dad had any other props. Any incomes/gains taxable at 40% & they satisfy reqs for PRE. The house goes to the son after dad’s death. What are the tax implications to mom and dad?

• 2009 deemed disp when mom died o CG proceeds of disp – ACB o Under 70(6), deemed proceeds of disp is 250,000; her ACB is 250,000 CG of 0

So don’t have to worry about the exemption o The tax attributes to mom become the tax attributes to dad (as if dad bought the house in 2000)

Dad’s ACB is 250,000 • Dad gets the house and his ACB is 250,000 whereas FMV is 400,000 (if he sells right away, he has a CG)

o CG proceeds of disp -‐ ACB Bc the house is not going to surviving spouse after dad dies, the gen rule applies (s.70(5)) 400,000 – 250,000 = 150,000 CG

o PRE [(# of yrs TP designates as the PR + 1)/(total # yrs owned)] x CG [(13+1)/14] x 150,000 150,000 PRE Thus no taxes on PR bc we can offset the 150,000 CG w the 150,000 PRE

• Son would get the house at FMV & his ACB will be 400,000 (proc of disp of transferor = ACB of transferee)

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CHANGE IN USE OF PROPERTY FROM PERSONAL TO BUSINESS

What if the TP’s use of the asset changes? • We have another deemed disp [s.45(1)]

o If a personal use cap prop is turned into income earning prop (or vice versa), 45(1) deems a disp and reacquisition at FMV (so new ACB = FMV)

o PR converted into rental Go through CG calculation & if there is a gain, the ACB is bumped up Determine whether all the reqs are met for the PRE & if so, decide if you want to designate From that pt on, prop will be used for generating income & TP has new ACB (= to FMV)

• Also TP can claim any expenses (18(1)(a)) used for purps of generation income (prop taxes, maintenance, utilities, mortgage, etc)

o Rental converted to PR If prop suffered a loss, you can claim it as a net capital loss against any other income gains

• BUT, ss 45(2) and (3) allow you to defer the deemed disp on a change in use o TP must attach a letter to tax return in yr of deemed disp stating:

1. He wishes to make an election under these ss; and 2. Not claim any cap cost allowance (depreciating the prop for tax purps via 20(1)(a)) on

this now rental prop) (all other expenses you can deduct) o Then for up to 4 add’l yrs, the deemed disp will not be considered to occur & TP will be deemed to

still ord inhabit the prop (can still claim PRE during this time) o Caveat: if TP designates prop as PR, whatever prop TP is now living in can’t be the PR for those yrs o Note: if the reason you moved out of the orig house and are now renting it was due to e/ent, you

can get the benefit of this election indefinitely [s.54.1] Ex: work for Dentons in Edmonton and you buy a house; they relocate you to Toronto but

you want to come back to Edmonton eventually can use this election indefinitely Ex: I buy a house in 2000 for 200,000 and lived there until 2010. In 2010, I buy new house and convert old one to rental unit (FMV is 500,000).

• There is a deemed disp/reacquisition under s.45(1) o CG (deemed) deemed proceeds of disp – ACB

500,000 – 200,000 = 300,000 deemed CG o PRE [(# of yrs TP designates as the PR + 1)/(total # yrs owned)] x CG

[(10+1)/11] x 300,000 = 300,000 PRE o Net CG 300,000 – 300,000 = 0

• Let’s assume I actually sell my house in 2012 for 600,000 o CG proceeds of disp – ACB

600,000 – 500,000 (app of change of use rules and deemed disp) = 100,000 CG o 100,000 x 50% = 50,000 50,000 x 40% = 20,000 tax liability

• BUT if you make the election under ss. 45(2) & (3), no deemed disp in 2010 o In 2012, when you actually dispose of the prop

CG proceeds of disp – ACB • 600,000 – 200,000 = 400,000 CG

o Thus, can use the PRE, which would incl the yrs it was rented out, to shelter this CG So long as you sell w/in the 4 yr period, you can still designate that prop as PR and get PRE

TAX PLANNING FOR THE ELDERLY WITH A PRINCIPAL RESIDENCE

Option 1: sell house and either rent or move in w family members/friends (or buy smaller place) • Tax implications disposition will trigger potential tax

o Need to calc CG & see if PRE is avail to shelter gain; if not, after tax proceeds will be reduced • Tax issues to be discussed w client if they have other props (this will affect the use of the PRE for certain

props); when they purchased; how long they’ve lived there; if they’ve used the designation etc o If bought before Dec 31, 1971 need to look to ITARs (need to determine value as of this date)

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• Non-‐tax issues to be discussed w client alternative living arrangements, emotional aspects, goals etc

Option 2: remain in house but take out home equity line of credit (LOC) • Home equity LOC borrowing money from bank & using home as security • Tax implications None. No disposition so don’t have to go through CG calc, etc. • Non-‐tax implications

o Must pay interest on loan, which is non-‐deductible S.20(1)(c) to deduct interest (only against prop or bus income), the borrowed funds must

have been borrowed to earn income from bus prop • Bronfman (SCC) must be able to directly trace borrowed funds into income

producing asset o Before a bank lends money, want to make sure (1) it’s covered in case D defaults and (2) D can

make monthly payments Concern if D has low cash flow, bank may increase interest rate to compensate, etc

o Some clients don’t like debt (need to explore their comfort with debt)

Option 3: enter into a reverse mortgage with financial institution (FI) • Reverse mortgage v similar to regular mortgage – you are pledging the value of the home as security for

a loan. Key diff is that: o In a conventional mortgage using the debt financing (ie the mortgage) to purchase the house – as

you repay the mortgage proceeds, you increase your ownership in the home o In a reverse mortgage you own the home and looking to access the equity therein by pledging

the home as security (through mortgage, you’re giving some of the value to the FI) As you draw on the reverse mortgage, you’re net value in your home starts to decline No tax implications as there is no disposition

• Age req: home O must be at least 55 o FI will not foreclose while you/spouse are still alive (hence the age req) – the debt can keep

increasing as no monthly payments req • Use req: must keep home as your home; can’t move out and make it a 100% rental prop (partial rental ok) • Limitation on mortgage amt: amt lent will be 10-‐40% the value of home (depends on homeO’s equity&age) • Repayment terms: repayment not req’d until you/spouse die or you sell the house to a 3P (diff bw HELOC) • Interest terms: int doesn’t have to be paid during the life of the rev mortgage (just tacked on to the principal) • Use of Funds: typically no reqs on how the monies are spent

o BUT, if there is a pre-‐existing charge on the prop (ie. initial mortgage or home equity loan), then this existing debt must first be paid off by the proceeds of the reverse mortgage

• If the amt of debt > than value of house when person dies, this is FI’s loss o If the amt of debt is less, FI takes part of proceeds to pay off loan and rest goes to estate

• Advantages no payments during life of mortgage; frees up savings; you know what you’ll lose; get to keep house

• Disadvantages higher interest rates and compounding interest; interest can significantly accrue; house may not be avail to estate

• Note: no tax benefit w this so GAAR doesn’t apply

UNIT 6: THE TAXATION OF SAVINGS

3 types of investments we’ll look at: • 1. Non-‐registered fully taxable investments • 2. Registered investments (RRSPs, RPPs & RESPs) • 3. Tax Free Savings Accounts also a reg’d vehicle but operates differently

To determine what type of investments a person should use, the person should ask himself: • 1. What is my tax sit at time of investing? • 2. Am I in high/low tax bracket relative to where I think I’ll be for remainder of my life? • 3. Will my income change sig from time I make the investment to time I may need/intend to use it?

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• 4. Do I have a specific purp/use for the investment? • 5. Is this intended use in the short or long term? • 6. Will I be using this invest. or someone else? If someone else, what’ll their likely tax sit be at time of use? • 7. What other investments/access to financing do I have?

NON-‐REGISTERED FULLY TAXABLE INVESTMENTS

-‐ Assumptions/background info: • Ind is in highest tax bracket (39%) and resident in AB • Ind wishes to make passive investments (as opposed to investing in/carrying on an active bus)

o Passive investments invest money & then not involved w income generating process o 2 types of pass inv: 1. Interest bearing securities (bonds, treasury bills)

2. Equity securities (stocks) return via dividends or increase in share value -‐ 3 types of investment income: Interest income, CGs, & Dividends

INTEREST INCOME -‐ Fully taxable under ITA & simplest to determine (Ex: $1K of int income pay $390 of tax w $610 of after tax inc) -‐ Interest income is part of prop income (no special treatment afforded to it) -‐ Interest income is the highest taxed of the 3 types of income

CAPITAL GAINS -‐ Only 50% taxable (Ex: if person has $1,000 CG, he will pay $195 of tax w $805 after tax income) -‐ Certain types of CGs eligible for lifetime CGs deduction

• If you realize a CG that can be attributed to a qualified small bus corp or qualified farm prop, then over your lifetime you can shelter up to $800,000 of CGs from those assets

DIVIDENDS -‐ Taxation of dividends is the most complicated of the 3 - Starting pt dividends (D) paid out of after-tax corp income (no deduction for corp to pay out Ds)

• Thus 2 TPs: (1) corp & (2) shareholder • Ex: corp has $1,000 of pre-‐tax income & policy of paying as much as it can to its lender/s/h (same person in

this case) [assume corp tax of 30%] o So after tax income is $700 amt is used to pay D to investor who has to report this $700 income o If corp is selling bonds, the pre-‐tax int rate will be higher than rate of return on shares bc the corp

can deduct the int expense (use pre-‐tax $ to finance) whereas it has to use after tax $ to financed Ds So interest can be paid out of pre tax dollars ($1,000) rather than after tax ($700)

o So if corp used bond strategy, it can give investor $1,000 in interest income who will then pay 39% tax and have after tax income of $610 (corp would have $0 taxable income and $0 tax)

-‐ To make up for the fact that Ds paid to ind has already been subj to corp tax, we have the “gross up and dividend tax credit regime” for the taxation of Ds in hands of the ind

• This tries to take into acct the corp tax already paid on corp income in determining the amt of further tax to be levied on the SHs re the D

• Principle of Integration: At least w/ “active bus income” earned by a CCPC, Canada has tried to design a regime so that the total tax (both corp & s/h) levied on corp income distributed to s/hs (Ds) approximates what a sole proprietor/p/ship would pay (in total) on such bus income earned personally

o PoI: We should have tax system that doesn’t influence behaviour (neutrality) o Overall taxes should be same regardless of whether ind carries on bus personally or through a corp

and then distribs after tax corp income to the SHs • Ex: (cont’d) ind gets $700 in D income; we take this & gross it up by a percentage to the pre-‐tax corp income

o $700 (D income) + $300 (gross up income) = $1,000 (taxable D) o Then assess the indiv tax (39%) $1,000 x 39% = $390

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o We didn’t receive $1,000, only $700, so then we give a D tax credit (DTC) to acknowledge that the corp has paid corp tax DTC = $300 (the amt of corp tax paid)

o Net effect of these 2 amts ($390 and $300) is the ind has tax liability of $90 • Calculations recap:

o Debt investment: Corporation

• Pre tax income = $1,000 • Interest expense = <$1,000> • Taxable income = 0 • Corp tax (30%) = 0 • After tax corp income = 0

Indiv investor: • Interest income = $1,000 • Tax (39%) = $390 • After tax ind income = $610

o Equity Investment Corporation

• Pre tax income = $1,000 • Interest expense = 0 • Taxable income = $1,000 • Corp tax (30%) = $300 • After tax corp income = $700

Indiv investor • Dividend income = $700 • Gross up = $300 (nominal calc) • Taxable dividend = $1,000 • Tax (39%) = $390 • Dividend tax credit = $300 (credit for amt of corp tax paid) • After tax ind income = $610 (700 [D income] – 90 [tax liability: 390 – 300])

o Ind carrying on bus personally (vs through a corp) Pre tax income = $1,000 Tax (39%) = $390 After tax income = $610

• For ind investors, there is always greater pre-‐tax rate of return if the investment is in the form of debt than it is for equity But the assoc tax rate on Ds will also be less than the tax rate on interest investments

o Thus, you need to consider the after tax income in both cases -‐ The D tax credit (DTC) an ind can claim on Ds received depends what tax rate the corp paid before paying the D

• If the Ds were subj to “high rate corp tax”, then they will likely constitute “eligible Ds” and subj to higher gross up and DTC (and hence a lower effective ind s/h tax rate) most public corps

o The corp must designate a D as an “eligible D” otherwise it’s treated as an ord D and taxed as such o On eligible Ds, the AB combined rate for inds is 19.29% o E.g. with eligible Ds of $1,000, the amt of tax is $192.90 with $807.10 left over after tax

• If Ds were subj to “low rate corp tax” (due to small bus deduction), they will be “ordinary Ds” (non-‐eligible) and subj to std DTC (and hence higher effective ind s/h tax rate)

o On ord Ds, the AB combined rate for indivs is 27.71% o Ex: w ord Ds of $1,000, the amt of tax is $277.10, with $722.90 remaining as after tax income

SUMMARY OF THE GENERAL TAX CONSEQS FOR NON-‐REGISTERED INVESTEMENTS -‐ Non-‐registered investments are made w after-tax income no tax deduction at time investment is made -‐ Any income on the investments is subj to tax in yr of recognition (albeit at diff rates)

• Recog for interest & D income (“prop inc”) when there is legal entitlement to the interest & D income

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• Recog event for CG/losses when cap asset is disposed of (actual or deemed) -‐ Remaining after-‐tax income fully avail for use/further investment (some exceptions) -‐ Assuming the same pre-‐tax income/gain, the order of preference would be:

• 1st – 1,000 eligible D (807.10 after tax) – is the 1,000 the amt after the corp has paid tax on it? • 2nd – 1,000 pre tax CG (805 after tax) • 3rd – 1,000 pre tax ord D (722.90 after tax) • 4th – 1,000 pre tax interest income (610 after tax)

REGISTERED RETIREMENT SAVINGS PLAN AND REGISTERED PENSION PLAN

-‐ “Registered” under the ITA special recognition and tax treatment under ITA -‐ Purpose of RRSPs/RPPs to encourage Canadians to save for retirement -‐ 3 potential tax benefits of using RRSPs/RPPs:

• 1. Being able to invest using pre-‐tax dollars o If you make a contrib, you’ll get a deduction (using pre tax dollars to put into RRSP) o If you’ve paid the tax, then you’ll get a refund

• 2. While investment is in RRSP/RPP, no taxes levied on any income generated by those investments o As a result, it grows faster (if non-‐reg’d investment, must pay tax every yr)

• 3. Possible to have lower tax rate apply to income than would be incurred if it has to be reported every yr Stage 1: when person makes contrib to RRSP/RPP, ITA provides that such a contrib will not be subj to tax

• For RRSPs, ss. 60(i) & 146(5) gives TP deduction for contribs • For RPPs, s.6(1)(a)(i) pension contribs are non-‐taxable benefit

Stage 2: as long as contrib stays in reg’d retirement vehicle, no tax is levied on contrib nor income earned thereon Stage 3: when retirement assets pulled out of RRSP/RPP, w/drawal is considered “other income” pursuant to ss.56(1)(a), 56(1)(h) & 146(8)

• The entire w/drawal/pension payment is taxed (not just the income on the investments) • RRSPs represent a consumption approach to taxation trigger pt for tax is when you use/spend

-‐ Investments made in RRSPs/RPPs must be “qualified investments” (Reg 4900); if not, it’ll be subj to penalty taxes • Most investments are qualified (generally, the same types discussed in non-‐reg’d fully taxable investments) • Major exception shares in your private corp are not qualified

SUMMARY OF TAX CONSEQUENCES 1. Contributions to these plans will constitute a deduction or will otherwise not be taxable

• So, a taxable income will be reduced, which will result in a reduction in tax liability & maybe a refund • This may result in TP making larger investment or having more money (from refund) for other purps

2. While in the reg’d plan, no taxation on any of the income (interest or Ds) or CGs realized • Thus, don’t have to report the income/disposition on return as long as they remain in the plan • Also don’t have to keep track of initial inves price like you would for unreg’d inves (to calc your CG on disp) • This means there is 39% more interest income, 19.5% more CGs and 19-‐28% more income for

reinvestment and compounding while in the plan than if it was in fully taxable investment 3. When w/drawal made (or when plan must be wound up), the full amt is treated as “other income” and fully taxable at the marginal rate in that yr

IMPLICATIONS OF INVESTING IN AN RRSP/RPP -‐ Diff opinions/strategies:

• Some suggest holding investments eligible for Ds and CGs outside your RRSP o Withdrawal from RRSP is taxed at 39% (assuming highest bracket) thus you lose the preferential

treatment for Ds & the 50% inclusion rate for CGs if these are in your RRSP • Others think when you take into acct other consids (ex: taking out at lower rate), it doesn’t really hurt you

o Longer you have it in RRSP, less you should worry about losing things like the 50% CG inclusion rate -‐ W RRSP, once money is withdrawn, that’s it can’t put it back in (subj to 2 exceptions)

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REGISTERED PENSION PLANS – SECTIONS 147.1-‐147.4

-‐ Gov’t set out some max amts that ppl can contribute/save for their retirement & get the tax benefit for retirement • If they’re not part of an RPP, they have full access to the maximum • If they are part of an RPP, it reduces the e/ees ability to contribute to an RRSP

o There is little if any ability for an e/ee who is part of an RPP to contribute to an RRSP (this is to give everyone the same entitlement)

Generally, an RPP is a mandatory plan for e/ees whose e/er has set up an RPP • Contribs typically made by both the e/er and the e/ee • For very good plans, it’s fully covered by the e/er; in some cases, the plan is fully funded by e/ee contribs

2 main kinds of RPPs: • 1. Defined benefit plan upon retirement, the e/ee is paid a certain amt of pension which can be

calculated based on the earnings and length of participation in the plan by the e/ee o Focus on the benefit

Once you establish what the benefit is, work backwards to determine what contribs must be made by the e/ees & e/er in order to have the assets ready to provide these benefits

Benefit is determined up front o Calc (# of yrs of pensionable service) x (2%) x (avg of 5 highest salaray yrs)

E.g. (30) x (2%) x (100K) = 60,000 per yr (if you retired with full pension) o If the contribs generate a larger than forecasted return, the PP may have a surplus o Risk: contrib amt may become v costly when the workforce becomes top heavy (e/ees pay more for

the same pension) • 2. Defined contrib or money purchase pension plan the annual contributions by the e/er & e/ee are

set out and each makes the contribs each yr (and gets a tax deduction) o The assets in the plan earn income tax free and, whatever is in the plan on the person’s retirement

for that person, is simply paid out in some fashion (and become taxable to that person at that time). o Risk: investments may do well or poorly & if economy is bad, your portion may be smaller

• 3. Pooled Registered Pension Plan (PRPP) o Focused on e/ees as opposed to orgs o E/ers can, if they don’t want to have their own PP, sign up for a PRPP o If the e/ee leaves the org that doesn’t have its own organizational PP, they can continue to

participate in this PRPP w no e/er o Used primarily for small orgs who don’t have suff # of e/ees to create their own PP

REGISTERED EDUCATION SAVINGS PLAN – SECTION 146.1

-‐ RESP special savings plan under the Act designed/intended to allow inds to provide for their children’s, grandchildren’s, etc post-‐secondary education (it’s a trust) -‐ 3 participants:

• 1. Subscriber person who opens and contributes to RESP • 2. Promoter person who manages the RESP in accordance w the Act (usually a FI) • 3. Beneficiary(s) person who receives the money from the RESP to finance education

3 types of plans: • 1. Individual plan only one beneficiary, • 2. A family plan can have more than one beneficiary (B) (all must be blood related to the subscriber),

o Reqs: A. Must all be related, and B. The subscriber must be the parent of the B’s (or the primary caregiver)

• 3. A group plan group of ind plans -‐ There are also “specified plans” for disabled beneficiaries -‐ W ind and group plans, the subscriber does not have to be related to the B by blood or adoption

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THE BASIC OPERATION OF AN RESP -‐ The B must be a Can resident w a SIN at the time the RESP is created (promoter needs it to open the RESP)

• Subscriber can then start making contribs to the RESP -‐ There are (now) no contrib limits to an RESP

• But, the max contribs for each B cannot exceed $50,000 in total (excluding gov’t grants) o Excess contribs subj to 1% tax per month

• Contribs can only be made in re of a B who is under 31 in the yr of contrib -‐ The govt, through the Canada Education Savings Grant (CESG), makes contribs to RESP:

• 20% of the contribs made up to an annual amt of $500 (based on max contributions of $2,500) o Any excess room is carried forward (but can’t prepay/over contribute to get more benefits earlier) o Maximum CESG of $7,200 for each B (must make $36K in contribs to get the full $7,200)

• Don’t have to open the RESP right when child is born child starts accruing entitlement from birth o E.g. if child is 4yo, the child would have $2,000 of accumulated entitlement (500/yr)

• Can’t prepay but can ‘catch up’ by making greater payments if you haven’t maxed out the yearly entitlement o Ex: can pay 5,000 for the past 2 yrs and get $1,000 CESG o BUT, the largest CESG you can get in 1 yr is $1,000 (so a $5,000 payment) o CESG stops contribs when child is 17; to get payments when the B is 16 or 17, you must have had

contribs before child was 15 • Add’l amts for low income families based on income levels • AB grant of $500 to RESP of every child born to AB res’s + $100 grants at 8, 11, & 14yo in AB schools

-‐ The promoter (the FI) can invest the contribs/grants in same investments as for RRSPs (ie. qualified investments) • If income is generated, like in RRSP, it will not be subj to tax while in the RES • But, contribs to RESP are NOT tax deductible (so using after-‐tax income)

-‐ When B attends post-‐sec, he can access the RESP to assist w education costs • Unlike RRSPs, only certain amts are taxable (specifically, the Education Assistance Payments [EAP])

WITHDRAWALS FROM AN RESP -‐ An RESP has 3 categories of funds:

• 1. Contribs (by the subscriber) • 2. Gov’t grants (ie CESG & CLB) • 3. Income generated on both the contribs and gov’t grants • 2 and 3 are referred to as Education Assistance Payments (EAPs)

-‐ Recall: for RRSPs, no need to determine what is being w/drawn from the RRSP (all taxable as Other Income) • W RESPs, nec to determine exactly what is being w/drawn imp for tax conseqs (part of the job of FI)

o Contrib amts not taxable (same as if parent made gift of money) o Grants and/or income generated on grants or contribs taxable to the B (EAPs) o Similar to an RRSP in some re tax deferral strategy (tax free while in RESP);

- So why participate? • B can receive as much of the subscriber’s contribs w/o triggering any tax • EAPs are income & thus taxable but at B’s tax rates & after factoring applicable tax credits (likely low rate)

o Bc B will be going to school, entitled to tuition tax credit and basic personal credit Thus, w re to to first 20K of EAPs paid out each yr, that income will be tax free bc of the

basic personal credit and tuition credit (totalling 20,000) -‐ In first yr of studies, there are limitations on how much EAPs the B can receive 5,000 limit

• After this, as long as B continues in full time education, no gen restriction on amt of EAPs paid out o But must be reas and related to education

• CRA TI won’t Q anything under 20,000 (in EAPs) as being unreas -‐ Best to max out the EAPs paid out each yr to fully utilize the tax credits avail (may be tax free) -‐ There’s no req for tax purps that the EAPs distributed on a yearly basis actually go to educational costs

• But must be reas & bear a rel to educational costs (so, if kid gets scholarship, can use EAPs for a car) -‐ Subscriber has fair bit of control over how much is paid out

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What is named beneficiary doesn’t attend post secondary?

-‐ It’s possible to replace the named B w/ a bro or sis (who are part of the same family plan) -‐ It’s also possible to transfer from one RESP to another (if each child has their own ind plan)

• If the transfer is bw related ppl, you don’t have to worry about exceeding the 50K max w the transfers • But if it’s bw 2 unrelated ppl, then you’ll be penalized for exceeding the 50,000 max

-‐ If no one to transfer money to then subscriber’s contribs can be returned w/o any tax implications • Subscriber can take back contribs any time (don’t have to wait until 35th yr), but:

o 1. The govt grants are repaid to the gov’t; and o 2. Any income on the contribs & grants (Accumulated Income Payments) are returned to subscriber

In add’n to this amt being taxed at subscriber’s tax rate, there’s also a 20% penalty tax BUT, both these taxes can be avoided if these funds transferred directly into the sub’s RRSP

-‐ RESP must be terminated by B’s 35th birthday (& no contribs can be made once B has turned 31yo)

SUMMARY OF TAX CONSEQUENCES RESPs are somewhat of a hybrid bw RRSPs/RPPs & non-‐reg’d fully taxable investments

• Similar to non-‐reg’d investments bc contribs to RESP made w after-‐tax funds (no deduction) o Thus when the contribs are paid out to the B, they are not taxable since tax has already been paid

• Similar to RRSP/RPP bc no tax on any income on the contribs and grants while in the RESP o Benefit: the total pool grows at a faster rate bc not losing a portion of the income to tax

-‐ When the B receives the income from the plan as well as the grants to fund his post-‐secondary (EAPs), such income and grants are taxable to the B in the year of receipt [s.56(1)(q)] -‐ If the B does not get the contribs and EAP out of the RESP, then:

• All remaining grants have to be repaid; • Remaining contribs can be returned to the subscriber tax free • All remaining inc generated by RESP are taxable to the sub at his applicable tax rate plus a 20% penalty tax • If the sub has the contrib rm & contributes the AIP to his RRSP, he avoids both the normal and penalty taxes

-‐ Note: attribution rules prevent parents from transferring money to minor children & then using them to invest it • But, once the child is 18, the attribution rules no longer apply • The RESP is an exception to the gen attribution rule

-‐ Advantages 20% return w no risk; tax deferral; idea that money is now the child’s; non-‐app of attribution rules -‐ Disadvantages potential fees (less w bigger banks); need to use after-‐tax money; tax when money w/drawn

TAX FREE SAVINGS ACCOUNT (TFSA) – S 146.2

• Started in 2009 for Canadians 18 and older • 2009-‐2012, TP can contribute 5,000/yr w excess room carried forward 2013+, contrib room is 5,500/yr

o So Canadians who were 18 in ‘09 who haven’t contributed yet can contribute up to 31,000 in 2014 • A trust where the contributor is also the beneficiary (B)

-‐ Similar to RESPs bc initial contrib made w after-tax income (no deduction for contrib) -‐ Similar to RRSP/RRPs bc any income/CGs not taxable while in the plan -‐ Distinctions:

• When amts w/drawn from TFSA, amts don’t constitute income for tax purps o Whereas w RRSPs/RPPs &RESPs, at least some of the w/drawl will constitute income for tax purps o Imp benefit for low income ppl when you retire, there are many gov’t benefits w income thresholds

The more income you have (ex; from RRSPs), the less benefits you get (but TFSAs aren’t inc) So TFSAs have no bearing on your gov’t benefits Ex: Canada Child Tax Benefit, GST Tax Credit, Old Age Security Benefits, Guaranteed Income

Supplement and Employment Insurance Benefits • W/drawals from a TFSA can be returned to the TFSA in a subsequent yr

o Most reg’d plans (RRSP/RESP) don’t allow w/drawals to be re-‐deposited Ex: RESPs Sub can take contribs out any time but promoter must pay back the assoc grants

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• Can’t repay the amt I’ve taken out in RRSPs o Ex: sub has contributed 20,000, then pulls out 1,000 (grant also given back),

the next 1,000 put in is the 21,000 amt (used up more contrib room) o The sub also has to use new eligibility for govt grant and the old grant given

back is lost forever max amt of grants received is now 7,000 (not 7,200) o This is accomplished by adding current yr’s w/drawals to TP’s contrib limit for subseq yrs

Ex: open up acct in 2009 w annual entitlement of 5,000; assume contribution of 5,000 • You buy Apple w that 5000 & at end of 2009, the value in that acct is 20,001 • In 2010, get annual entitlement of 5,000 and you don’t make any contrib; decide to

w/draw all 20,000 (1 dollar left in account); end of year valuation is $1 • In 2011, get annual entitlement of 5,000 + 5,000 (2010 entitlement you didn’t use) +

20,000 (2010 w/drawal) in 2011 you can contribute 30,000 Ex: In 2009 I have a new entitlement of 5,000; in May I actually contribute 5,000; In Aug, I

withdraw 1,000; then in Oct I contribute another 1,000 • I’ve contributed 6000 in 2009 so I’m over the limit by 1000 penalty is 1%/month • In 2010, I have total contrib room of 6000 (5000 new + 1000 from 2009 w/drawal)

Ex: In 2009, I have new entit of 5000; actual contribution of 5000; invest it in Google and by Dec 23, it’s worth 100,000; on Dec 30 I w/draw 95,000; balance at end of 2009 is 5000

• In 2010, new entit of 5,000 + 95,000 w/drawal = avail contrib room of 100,000; I contribute 100,000 and invest in RIM; end of yr value is $1 (RIM sinks)

• In 2011, no contrib room carried forward; new entit of 5K + 1 remaining = 5001 entit Imp pt amt of contrib room depends on success of your investments

• If you make bad investment and the value of TFSA sinks, you lose that contrib room o Note: if making more on your investment, may be worth it to over contribute and pay the penalty

Problem: may be subj to GAAR • Tax benefit? Yes. Tax avoidance? Yes (could’ve made investment outside TFSA).

Misuse? Probably (policy is TP shouldn’t over-‐contribute; there’s even a fine) • Generally, if H gives W money & she invests it, the attribution rules will attribute the income/CG to H

(s.74.1) and tax it accordingly o W TFSA, only the B can contribute (no spousal TFSAs) BUT H can give W 5,000 to put in her TFSA

and none of it will be attributed to him (exception to attribution rules) -‐ What happens when B of TFSA dies and there is a balance?

• Gen rule money in TFSA is tax free to B’s estate and can be transferred to anybody w/o tax (no gift tax) • If deceased transfers TFSA to a B (who is not spouse/CL partner) then the acct is tax free but any

income/CGs earned subsequent to orig owner’s death is taxable IOW, no longer a TFSA from that pt on o Exception if B of deceased is spouse/CL, both the acct & subsequent income/CGs are tax free

There is a rollover spouse steps into shoes of deceased Restriction: no new entitlement to the spouse

SUMMARY: PICKING THE RIGHT INVESTMENT

Q: given the various investments, how might a TP decide (and a professional advise) how to invest their savings? • What do you want to do with the money? Save for child’s education? Retirement? • When do you think you’ll use the money? • Who will be using the money? You? Your spouse? • All the Q’s we raised at the beginning of this unit are relevant.

UNIT 7: REGISTERED RETIREMENT SAVINGS PLAN

CALCULATION OF CONTRIBUTION ROOM -‐ Basic pt unlike TFSA/RESPs, TPs must acquire the contribution room

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Calculation of Deduction Limit [146(1)]: -‐ Deduction limit for current yr = “Unused deduction rm from prev yrs + {[lesser of (i) RRSP Dollar Limit for current yr or (ii) 18% of earned inc for prev yr] – pension adjustment for prev yr} – PSPA +PAR”

• 1st component Unused RRSP Deduction Room (not utilized from prev yrs) carried forward • 2nd component {everything in the brackets} RRSP Deduction Limit (current/new entitlement)

o (i) “RRSP Dollar Limit “ [s.146(1)] the Money Purchase Limit of the preceding yr “Money Purchase Limit” (s.147.1(1)) for 2013 $24,270 (adjusted for inflation every yr)

• Thus the max contribution in 2014 (based on 2013) is $24,270 to gain this contribution room, you needed an income of $134,833 in 2013 (18% x 134, 833)

o (ii) Earned Income [s.146(1)] The net income from e/ent, bus, real estate rentals and royalties from work/invention where

TP is the inventor (does not include investment income or CG) • Also includes spousal support, research grants and disability pension

o Thus, RRSP entitlement for 2014 (assuming no carry forward and pension plan) is lesser of: (1) $24, 270 (the Money Purchase Limit for 2013); or (2) 18% of TP’s earned inc for 2013 Note: the bottom of Notice of Assessment will state your contribution room

o Pension Adjustment for prev yr amt rep’ing TP’s (and e/er’s) participation in RPP (on T4 slip) • 3rd component Net Past Service Pension Adjustment (PSPA) + Pension Adjustment Reversal (PAR)

o PSPA deduc relating to pension adjs for prior yr’s service that have been acquired in current yr Ex: buying past yrs pensionable service Provided on T4 Note: if involved in e/er PP, you’ll have little opp to contribute to RRSP bc this will wipe out

the RRSP Dollar Limit or 18% of Earned Income o PAR had pension entitlements but then you lost it

-‐ Even if you don’t owe any taxes (income < deduction/credits), good idea to still file bc the income you’ve earned still constitutes Earned Income that will give you contrib room in RRSP

CONTRIBUTION PERIOD -‐ s.146(5) to be deductible for a partic yr, must make RRSP contrib during the yr or w/in 60 days of following yr

• If end of 60 days is on weekend, have until end of first bus day following • During the 60 days, can choose to use for prev yr or following yr (use in the yr where inc will be higher)

RRSP FEES -‐ s.18(1)(u) any fees assoc w RRSP will not be deductible for tax purps

• Good idea to have fees paid outside of RRSP only finite amt you can contribute to RRSP so want all of that to be earning return (and not being taken for fees)

BORROWING TO CONTRIBUTE TO AN RRSP -‐ s.20(1)(c)int is deductible in calc bus/prop inc if the borrowed funds can be traced into the inc earning activity

• BUT if you borrow to invest in RRSP, the interest on it will not be deductible for tax purps [s.18(11)(b)] o The same applies to RESP, RPP or TFSA contributions

• Gov’t has this rule bc it wants ppl to save – if borrowing, you’re not really saving o However, bank have RRSP loans good idea if you can make a large return (return > interest) bc

the investment is generating money right away (rather than waiting to save money to invest)

RRSP AND CREDITORS If you make beneficiary (B) designation w/in RRSP, then upon death it will go to B & not form part of estate & hence eligible for attachment by creditors [Amherst Crane Rentals Ltd v Perring (ONCA)]

• If you only designate in will (and not RRSP docs), then it’s uncertain (lower courts say it goes to B)

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OVERCONTRIBUTIONS AND UNUSED DEDUCTIONS While interrelated, there are 2 distinct components to adding to RRSP:

• (1) Contributing to RRSP & (2) Deducting contribution room for IT purps

Contributing to RRSP

s.204.2(1.1) may contribute up to 2K over the RRSP Ded Limit wo incurring penalty but this won’t be deductible • Any amt over 2K is subj to 1%/month penalty of the excess contribs [s.204.1(2.1)] • Thus, the only reason to make this excess contrib is to get it in the RRSP sooner to invest • This 2,000 excess contrib amt is a lifetime amt (not per yr); Also note that TP is taxed twice on this amt • GAAR potential If you over-‐contribute & pay the penalty bc you’ll be making more on the investment

Deducting Contribution Room

-‐ TP doesn’t have to claim full amt of contrib as a deduc for that yr can claim it in a subseq yr (when inc higher)

SPOUSAL RRSP -‐ Spousal RRSP [s.146(1)] the TP’s spouse/CL partner is the B (not the TP) – must include w/drawals in her inc

• TP still makes the contribs (not spouse) • Spouse can structure the investments in spousal RRSP and can continue to contribute to her own RRSP • For purps of calc deductions from TP’s RRSP contrib room, any payment made to a spousal RRSP treated

the same as if TP made to his own RRSP (subj to same rules as contribs to TPs own plan) o So contrib will give TP a ded & reduce his RRSP Deduct Limit, but will not affect spouse’s inc/taxes

- Benefits to contributing to spousal RRSP: (besides the tax deferral & potential tax avoidance benefit) • 1. Promotes income splitting • 2. RRSP must be wound up when TP turns 71 – if spouse is younger, can keep contributing • 3. If spouse younger, the money can stay in RRSP longer and earn more • 4. The $ belongs to spouse so my creditors can’t access it (unlike RESP where $ belongs to the promoter) • 5. If both inds have RRSP’s, both can utilize Home Buyer’s Plan and Lifelong Learning Plan • 6. Reps an actual shift/equalization in wealth bw the inds (unlike pension splitting that is notional only)

-‐ Re income splitting: • Transfer wealth from higher paying TP to lower TP better to have 2 w/draw 50K than 1 w/draw 100K • Pension splitting [s.60.03] higher inc TP [65yo+] can allocate some inc to be reported on spouse’s return

o Can transfer up to 50% of certain retirement income (e/er sponsored PP inc, RRSP annuities, RIF) o Notional wealth is not actually shifted; redistributed only for tax purps o Cannot split OAS, guaranteed income supplement, CPP

- Concern re spousal RRSP if contrib is w/drawn too early by spouse (w/in 2 yrs after last contrib made), the amt is attributed back to contributing spouse [s.146(8.3)]

• Other than this, attrib rules gen don’t apply to spousal RRSPs [s.74.5(12)]

TERMINATION OF RRSP

-‐ Ind can contribute to RRSP until end of calendar yr that you turn 71 after this, something must be done w it • 3 options: 1. Collapse it & w/draw the funds

2. Purchase an annuity 3. Purchase a Registered Retirement Income Fund (RRIF)

OPTION 1: ALL FUNDS W/DRAWN -‐ s.146(8) w this option, the TP/B will be taxable on full amt of the RRSP in yr it collapsed (not the best option)

• Note: when you w/draw (other than w HBP & LLP), bank req to make w/holdings as a pre-‐payment of tax o You can credit this amt when you file return (& get credit back if there’s leftover)

-‐ Those who claim pension payments early are subj to penalty

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• Thus, don’t claim CPP/e/er pension early but use $ in RRSP first helps keep income stable & low so you can qualify for other govt benefits; also helps limit the amt being w/drawn when you turn 71 (so less tax)

OPTION 2: PURCHASING AN ANNUITY -‐ Better option than the first -‐ Annuity give lump sum to financial institution (FI) and they give you recurring payments

• FI takes the funds & invests it then estimates how much they will get back • Whoever receives the payment includes it in their return when they get it (part of “other inc”)

o No tax paid when annuity purchased, only when it’s received (a “rollover” & “tax def” [s.56(1)(d)]) - 2 types:

• 1. Fixed term pays a particular amt for a fixed period of time (ex: 25 yrs) o Longer the annuity the smaller the monthly payments o More certainty for the bank (only uncertainty is what rate of return they get on the investment) o If anything left when primary B dies, it goes to the named subseq B

• 2. Life annuity guarantees a certain payment for the life of the annuitant (or in some cases his spouse) & may guarantee a min payout (ex: 10 yrs)

o More risk for ind & FI If ind lives longer, he “wins”; if indiv doesn’t, FI gets to keep remaining amt

OPTION 3: PURCHASE A REG’D RETIREMENT INCOME FUND (RRIF) -‐ RRIF [s.146.3] similar to RRSP

• Similarities: o B can still make investment decisions w/ money in the RRIF o Incomes continues to accrue on tax-‐free basis & all of the payments made out of it are fully taxable

• Differences: o 1. Once you’ve transferred from RRSP to a RRIF, can no longer make yearly contribs to it

There are no tax conseqs in transferring RRSP to RRIF o 2. Each yr the B is req’d to w/draw a certain percentage w this percentage increasing each yr

Based on the FMV of the RRIF assets & age of B B can take out more than min payment if desired

• Advantages o Flexibility retains control over investments and amt w/drawn (vs annuity) o When primary B dies, possible for spouse/CL to continue receiving payments from RRIF if spouse is

the B w/in either the RRIF or the will If no desig, upon testator’s death, total amt included in the testator’s terminal return

• Disadvantage Once funds exhausted, B has no access to further regular payments (unlike annuity) • Can be est’d anytime before end of yr in which ind turns 71

HOW DO YOU CHOOSE? How do you choose bw a RRIF and annuity?

• RRIF – more flexibility o Retain more control can continue to make investment decisions o More potential for greater returns (& may be able to recover some inves losses you’ve incurred) o W annuity, once decision is made, the payments are fixed

• Annuity o Could provide more security (esp if you have no B’s or have health ailments) o W RRIF, if you exhaust funds then no more $; w annuity it gives you an amt for certain per of time o On death: -‐ Annuity if you name a B, that B only has to incl the amt they receive each yr on return

-‐ RRIF If B is spouse/CL treated same as deceased; min amt paid out each yr & taxed If not spouse/CL amt in RRIF deemed to be w/drawn and incl’d in B’s return

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HOME BUYER’S PLAN (S 146.01) AND LIFELONG LEARNING PLAN (146.02)

Recall: when you w/draw funds from RRSP you’re subj to w/holdings (initially) and income taxes (ultimately) • 2 exceptions: 1. Home Buyer’s Plan [s.146.01]

2. Lifelong Learning Plan [s.146.02]

HOME BUYER’S PLAN (146.01) HBP B “borrows” money from his RRSP to purchase a house in Canada

• Can borrow up to 25K to buy house for himself or a related person w a disability (where house is more suitable for that person)

• H & W (CL) can each w/draw 25K from own RRSPs total of 50K (house must be put in both their names) • Bc this is an “excluded w/drawal” [s.146.01(1)], it’s not subject to w/holdings • If T1036 form (HBP’s Request to w/draw Funds from an RRSP) is filled out not incl’d as income (no tax)

Main conds for participating: • 1. Must enter written agreement to buy/build a qualifying home before making a w/drawal

o Must have an offer that was accepted; if it falls through (see #7) • 2. Must intend to occupy the qualifying home as a principal residence (PR)

o Can’t use this to house flip, but nothing in Act/CRA that imposes a min time for living there • 3. Must be considered first time home buyer (this does not apply where B is a disabled person)

o Cannot have O’d a PR home for at least 4 full calendar yrs prior to yr you want to participate in HBP o If married, possible that both or only one will qualify

For both to qualify neither party must have O’d a home as PR for 4 calendar yrs prior • 4. Must not have a pos HBP balance from prior participation in the plan

o Have 15 yrs to pay money back into RRSP from previous use of the plan • 5. Must be a Canadian res both at time of w/drawal & when HBP is outstanding

o If after you take money out you cease to be a res, must: 1. Include the outstanding bal in your income immediately prior to being a non-‐res; or 2. Pay off the existing bal in full to avoid an income inclusion at the earlier of:

• (a) when you file your return for the yr, & (b) w/in 60 days after ceasing to be Can res o Same applies if person dies spouse can take over obl to pay to avoid income inclusion

• 6. Must complete T1036 for every eligible w/drawal & generally have to receive all w/drawals w/in same calendar yr (some exceptions)

• 7. Must buy/build the qualifying home before Oct 1 of yr after the yr of w/drawal (some exceptions) o If not, must claim w/drawal or put it back in RRSP w no tax conseqs by Dec 31 of that following yr

• 8. Must have made your last contrib to the RRSP from which you intend to make the w/drawal at least 90 days before the w/drawal If w/in 90 days, may not get a deduction for earlier contrib

Repayment: • To avoid an income inclusion, borrowed funds must be repaid (w/o interest) to RRSP over 15 yr period

o Annual instalments begin in 2nd yr following the yr of the w/drawal o Can make repayments either in calendar yr or in following 60 days of following yr (like RRSP)

• No deduction given for putting money back in (already received the deduction) • Repayment does not affect contrib rm (can cont to make contribs while using HBP if so you have contrib rm • If you pay less than min amt diff is an income inclusion for that yr

o You also don’t get to repay this amt ever (you’ve claimed it forever) • If you pay more min payment for remaining yrs is reduced (don’t get to take time off from repaying) • Must repay money to RRSP acct you took it from • Formula Annual payment = [outstanding balance]/[# yrs left to pay off to avoid income inclusion]

o E.g. outstanding balance = 15,000 1st repayment 15,000/15 = 1,000 Balance now 14,000 2nd repayment 14,000/14 = 1,000

• Assume actual repayment is 7,500 so outstanding balance is 6,500 3rd repayment 6,500/13 = 500

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LIFELONG LEARNING PLAN (S 146.02) LLP borrowing from RRSP to finance post-‐secondary education (PSE)

• Can w/draw up to 10,000/yr (annual limit) & 20,000 (total limit) for full-‐time training/education for himself or spouse (but not kids) w/o triggering any tax

o Can w/draw over max 4 yr period o Each partner can w/draw from own RRSP to finance one spouse’s PSE 40,000 total

• If you w/draw > 10,000 in one yr, the add’l amt is incl’d as income inclusion (fully taxable) • Can take out more than what your tuition is (ITA will not ask you to account or explain the use of the $) • Can be used again so long as previous amt has been paid back to RRSP • Form RC96 must be filled out each time w/drawal is made, then it won’t be taxed and no w/holdings by FI

Main conds for participating: • 1. Must be Can res when you receive funds from RRSP & until loan is repaid

o If w/drawing money for spouse, both must be Can res o If one becomes non-‐res outstanding bal all reported as income immediately prior to being a non-‐

res OR person can repay w/in 60 days of being non-‐res to avoid the income inclusion (s.146.02(5)) o Same applies upon death (s.146.02(6))

• 2. Must be enrolled/committed to enrol as full time student in: o a) Qualifying educ program of at least 3 mos in duration (at least 10 hrs/wk of instruction/work) o b) At an eligible educ institution (does not have to be in Can) o c) Usually on a full-‐time basis (educ instit decides what constitutes “full time”)

Exception for disabled students using the LLP, but not enrolled full-‐time • 3. Must enrol in yr of the w/drawal or before Mar 1 of following yr • 4. Must file income tax return every yr

Repayment: • Funds must be returned over 10 yr period to avoid income inclusion • LLP continues (no repayment req) while student meets all criteria below (unless disabled)

o w/drawals must begin to be repaid in equal instalments at the earlier of: 1. The yr following the last yr the student was enrolled on full time basis; and 2. 60 days following the 5th yr after the yr in which w/drawal first made under LLP

• Formula annual payment = [outstanding balance]/[# yrs in which it has to be repaid] o Same reqs/rules as HBP o Can continue to make deduc contribs to RRSP while making repayments to LLP (not deductible) o E.g. outstanding balance = 15,000

1st repayment 15,000/10 = 1,500 Note: if you only repay 1,000 then 500 is reported as income BUT the balance at the end of

1st repayment period is still 13,500 (you’ve repaid that 500 amt by taking it as income) • Unlike the HBP, no limitations on how many times you can participate in LPP • Can participate in LPP as long as reqs satisfied and no outstanding balance from prev use of LLP • Also possible to participate in HBP and LLP at same time

ADVANTAGES/DISADVANTGES OF HBP AND LLP -‐ Adv: Can make down payments/pay for PSE tax free contribs made w tax free $ so have more cash avail -‐ Disadvantages:

• Losing investment returns in RRSP must compare the rate of return you are making in RRSP vs the interest you would pay to borrow the money to finance house/PSE

o Ex: if taking the money out allows you to make a larger down payment thereby lowering your mort rate (and this is more financially beneficial than the return you’re losing) it might be worth it

• Ppl may just take the money out and not repay it (purp of RRSP is to save)

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TFSA VS RRSP

Strength of TFSA: • Pull money & non-‐taxable • Don’t have to repay it (and don’t have to repay over period of time) lots of flexibility • Don’t lose ability to repay it

But one advantage of using RRSP’s is that you get a deduction for contribution • So everything else the same, you will have more dollars in RRSP to use bc of the deduction

-‐ For lower inc ppl, pay tax & put $ into TFSA; then contribute to RRSP when able to make larger contibs

UNIT 8: INTRA-‐FAMILY TRANSFERS

TAXATION OF THE FAMILY UNIT – INTRODUCTION

-‐ Recall: basic principle of Can tax law that each ind treated as sep & distinct TP w own inc & prop regardless of rel status each files own return w/ full access to tax marginal tax brackets & credits -‐ One strategy: equalize incomes bw spouses/children to use low tax brackets aka “income splitting”

• Benefits (1) less tax & (2) potentially multiple access to enhanced CG’s deductions • Not impossible to income split but many rules to consider Always be aware of GAAR

-‐ 3 ways: 1. Redirecting income 2. Have spouse/children work in family’s bus 3. Transfer income-‐earning prop to a lower income spouse/child

INCOME SPLITTING STRATEGY 1: REDIRECTING INCOME

Cannot have income redirected from an e/er to a spouse bc of 2 statutory provisions: 56(4) & 56(2)

Section 56(4)

- s.56(4) applies when a TP who has a right to an amt which would be taxable as income, transfers/assigns it to a Can res who is not at arm’s length This imputes the income back to the TP • Conseq: potential double tax CRA can tax the orig TP but then also tax the person assigned the money

o 440R2 if was deliber attempt to avoid tax tax both ppl; it not it will only tax the entitled TP o Practice pt if you make a big fuss about the double tax, CRA will back down and won’t tax spouse

-‐ This applies to any type of income (most anti-‐income splitting rules only apply to prop inc) - Arm’s length [s.251]

• Related persons do not deal at arm’s length [s.251(1)(a)] • Related persons include:

o 1. Blood rel parent/child (or grandchild/grandparent) and siblings [s.251(6)(a)] o 2. Marriage married to or connected [s.251(6)b)] o 3. CL partner person who cohabits w the TP in conjugal rel & either

(a) has so cohabited for 12 mo period; or (b) is the parent of a child w the TP [s.248(1)] o 4. Adoption includes legal adoption and adoption in fact [s.251(6)(c)]

- s.56(4) does not apply: • 1. When TP assigns pension rts (CPP or equivalent prov plans) to spouse/CL • 2. To transfers of the rt to prop inc where underlying prop also transferred (may be caught by other rule)

Section 56(2)

-‐ Far more commonly used anti-‐income splitting provision (aka the “constructive receipt” provision) -‐ Triggered when following conds present:

• 1. There is a payment/transfer of prop by one person to another (who is not the TP) o No req this has to be to non-‐arm’s length

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o “Prop” is def’d v broadly in s.248(1) prop of any kind whatever whether real or personal, immovable or movable, tangible or intangible, or corporeal or incorporeal” (Incl transfers of $/inc)

• 2. The payment/transfer is made pursuant to the direction of or w the concurrence of the TP o CRA likes to assert this to overturn income splitting but inconsistent results in this case law o Ex: common strategy: H is the key s/h e/ee (owns bus); then W & kids acq diff class of shares in co

These non-‐active ppl then given dividends from the co SCC said this strategy is ok • 3. The payment/transfer is for the benefit of either the TP or some other person the TP wished to benefit

o Ex: A TP has a co and it uses the corp pay ex spouse for child support in tax effective manner o CRA has been successful by arguing in these cases that person receiving income has no entit to it

• 4. The payment/transfer would’ve been incl’d in TP’s inc if it had been received by TP rather than the other -‐ CRA will tax the payment/transfer to TP as if he had received it (Act is silent on whether there can be double tax) -‐ s.56(2) does not apply when TP assigns pension rights (CPP or equivalent prov plans) to spouse/CL

INCOME SPLITTING 2: HAVE SPOUSE AND CHILDREN WORK IN THE FAMILY BUS

-‐ Very common and generally works -‐ Tax deferral benefits w using family corp if earning active bus inc as CCPC, 1st 500K taxed at 14% (Sm Bus Ded) -‐ But there are potential issues: 1. Deductibility of remuneration to family members

2. The reasonableness of the remuneration 3. Does the family member have control over the remuneration?

Deductibility of Remuneration to Family Members

-‐ To get a deduc for an expense, it must be legit if paying someone salary (& claiming a deduc for it), person must’ve done something of value (actual services) to justify payment -‐ Potential consequences in add’n to repaying amt:

• 1. For 1st time off, CRA will usually assess gross neg penalties (not TE penalties, which can be up to 200% of tax evaded) & will also monitor you closely after this

• 2. May use 56(2) & 56(4) to tax the amt to the key family member carrying on the bus -‐ If corp is paying dividends to s/hs, that’s okay (but can’t pay dividends if fam members not s/hs)

The Reasonableness of the Remuneration

-‐ s.67 only the reas portion of any expense is deductible for tax purps • Always have to be concerned w/ this section, esp w/ family bus’s

-‐ “Reasonableness” factual determination; courts may look at magnitude of expense in relation to its FMV -‐ For salaries paid to a key ind, as long as the salary is paid out of active bus inc, any amt will be reas

• But, if the salary is paid out of investment income: o Test what an arm’s-length professional advisor would make on the services being provided

-‐ Same test is applied to non-key family members what would an arm’s length stranger reas get as compensation? • This is applied w spouses/children providing services • CRA can tax this amt 3 times and add on gross neg penalties (corp tax, wrong TP inc, & attr back to entit TP)

Does the Family Member Have Control over the Remuneration?

-‐ Particularly imp when looking at children receiving money -‐ Main idea: person must be receiving the value of services they’re providing

Bradley v R (TC) • The parent paid small salaries to 2 children; monies paid into bank and mutual fund accts in trust for the

children but no monies could be w/drawn by anyone other than the parent (sole legal control) • Parent & 1 son testified the $ was used for the benefit of the children – Court bothered by fact that the parent

had sole control over the funds and upheld Reassessment that disallowed the salary deduction for the 2 kids • Prof: court prob had other facts to believe this was really a way to avoid tax w/ no actual transfer of wealth

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o So if money doesn’t flow to the children directly, the CRA will reassess o If you set up accts for kids and you’re trustee then need to keep receipts re where money is spent o Gen rule if parents take $ to provide basic necessities, this will be not be seen as the child’s benefit

Basic family law says this is parent’s oblig, not child’s

Bruno v R (TC) • TP operated bus & deducted salaries for 2 kids (13/15yo); bought kids “luxury goods” they wanted = to salary • TP stated the kids chose what they wanted, but that she could veto any purchases she deemed inappropriate • Min denied expenses on basis that (1) the kids did not have suff control over the monies and (2) that these

were personal/living expenses prohibited by s.18(1)(h) o Re (1) TC disagreed w Bradley & held that it was not bound by it bc it was an informal procedure case o Re (2) TC relied upon Symes v The Queen for the principle that s.18(1)(h) does not apply to an

expenditure that was incurred for the purp of earning income (a “mixed purpose” expense) Instead of giving cash, mom bought Xbox etc (child still provided expense to bus)

INCOME SPLITTING 3: TRANSFERRING INC EARNING PROP TO SPOUSE/CHILD

-‐ Seems to make sense that higher inc TP can transfer prop that generates income to lower income fam member • But ITA disregards this and has special rules • To analyze this, useful to break it into 2 parts: 1. Transfer of prop

2. Taxation of the income generated by the prop

GENERAL RULES REGARDING THE TRANSFER OF PROP FOR INCOME TAX PURPS Starting pt taxation follows the gen law

• ITA respects the legal/equitable O/ship interests (and transfer of interests) as set out by prop/trust law • But, where this leads to an inapporp tax result, the ITA sets out diff outcome for tax purps 2 scenarios

o 1. When prop sold bw arm’s length parties o 2. When prop sold bw non-‐arm’s length parties

Prop Sold bw Arm’s Length Parties

-‐ When prop sold bw 2 arm’s length parties, Act assumes that whatever price the parties have chosen reps the FMV • Bc at arm’s length & only self interest in mind, we assume bargaining and best exchange possible

-‐ Ex: Vendor has house & FMV is 500,000 & ACB is 200,000; no selling expenses and both at 40% tax rate • Increase in value of prop only taxed once to V, P gets benefit of higher cost base (symmetry in the ITA)

-‐ FMV not defined in the Act • Has been held to be a Q of fact by the courts • Black’s Law Dict amt at which prop would exchange hands bw a willing buyer/seller, neither being

under any compulsion to buy/sell & both having reas knowledge of relevant facts (accepted by courts)

Prop Sold bw Non-‐Arm’s Length Parties

Where prop is sold bw non-‐AL parties, there’s a risk that they may agree to a price that does not reflect prop’s FMV • Imp bc transfer price gen determines the proceeds of disp to the V (which affects CG/loss) & ACB to the P • Parties may decide to overstate the price to increase the CG to V (who likely has cap or other losses w/

which to shelter the addit gain) as well as the ACB to the P o E.g. I’m the V & my sister is P; I can fully shelter the gain on my house w PRE (gain is irrelevant for

me) but my sis has multiple props & is buying my house to use as a rental and to sell later for a gain Price is imp to sis can claim cap cost allowance & also sell it down the road (want to keep

the CG as small as poss) FMV is 500,000 but we do the trans at 600K gives her higher ACB so she can claim more

depreciation while using it as rental & higher ACB when she sells (so CG will be smaller) o Me (as V) proc of disp = 600K; ACB = 200K; CG = 400K; PRE = 400K 0 tax owed o Sister (as P) ACB = 600,000 (better off)

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• Parties may decide to understate the price to reduce the CG to the V o Ex (same as above): FMV of house is 500,000 but sell at 400,000

Me (as V) proc of disp = 400K; ACB = 200K; CG = 200K (rather than 300K) Sister (as P) ACB = 400K (when she sells it, she’ll have higher tax liab bc of lower ACB)

To counter this ss.69(1)(a) & (b) give CRA the ability to adjust one side of the trans for IT purps • If overstated s.69(1)(a) can reduce the purchaser’s ACB to the prop’s FMV at the time of transfer (while

leaving the overstated proceeds of disp to the V “as is”) o So… (1) V “wastes” some of his losses (w the PRE) w/o a corresponding benefit to the P; OR o (2) if V does not have any tax shelter, effectively taxing the excess amt both to the V (immediately)

& to P (when the P disposes of the asset)) • If understated s.69(1)(b) can increase V’s procs of disp to the prop’s FMV (while leaving the

understated ACB to the P “as is”) o This also results in double taxation of the understated amt (to both the V and P) o In above ex I have to pay tax on the extra 100K of CG’s (so 300K total) & sis has to pay the extra

tax on the add’l 100K when she sells it -‐ Given these punitive provs (aka “one-‐sided adjustments”), non-‐arm’s length parties should take special care to ensure trans’s occur at FMV

• Typically involves: o 1. Getting an arm’s length valuation of the prop (when the FMV isn’t readily avail); and o 2. Including a “price adjustment” clause in the transfer docs

Parties jointly agree that they’ll retroactively change the values on both sides to what the CRA/courts determine is the FMV

• This is very relevant when ind transfers prop to a corp he starts o I start as proprietor, then take assets I own personally and transfer to corp in exchange for shares o Transfer must be at FMV bc this ind is not acting at arm’s length

Gifts -‐ Where prop is gifted from one person to another:

• By def, there are nil proceeds of disp (trans is a transfer for no consideration) • But for tax purps, ss.69(1)(b) & (c) deem:

o 1. The donor to have received proceeds of disp equal to the FMV of the prop at time of the gift; and Therefore have to report FMV proceeds & pay the associated tax Always a concern when donor is gifting non-‐monetary prop w no consideration

o 2. The recipient to have acquired ACB in the prop equal to FMV So if you turn around and sell it at FMV then no CG & thus no tax has to be paid

• If this wasn’t the case, families could continue to pass on prop w/o ever paying any tax -‐ Cash neither appreciates/depreciates so if giving cash, the proceeds of disp & ACB will be the same (so no CG & thus no tax assoc w transfer)

Transfers of Prop bw Spouses/Partners -‐ s.73 where a transfer of cap prop occurs bw spouses/CL, s.73 will auto apply to override the gen tax treatments described above (esp s.69) unless steps are taken to elect out of its application (can elect out of s.73 under s.74.5)

• This will deem the trans to occur for tax purps at the Transferring Spouse’s ACB (no tax implication) • Note: if alive s.73; upon death s.70(6)

-‐ s.73 will apply to spousal transfers: • 1. While the spouses are married, but also • 2. Where the marriage has dissolved BUT the transfer is part of “a settlement of rights arising out of their

marriage” [s.73(1.01)(b)] o As long as transfer was done before formal diss of marriage, you can do this (so no tax triggered)

-‐ s.73 does not apply to transfers bw parents and children • Exception parents can transfer farm prop to kids at their ACB so no tax

-‐ Both spouses have to be Can res’s at the time of the prop transfer.

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• If the recipient spouse is not, s.73 will not apply & the default rule under s.69 will deem the trans for tax purps to occur at FMV (triggering gains/losses)

Exceptions to the Attribution Rules -‐ s.74.5(1) gen exception concerning bona fide FMV transfers

• If the transferor sells the prop to his spouse/CL or non-‐arm’s length minor at FMV & elects out of s.73, then any inc and/or gains realized by the transferee after the sale will not be attributed back to transferor

o Thus possible to elect out of s.73 & the associated attribution rules re transfer bw spouses • 2 reqs to be able to elect out of s.73 treatment:

o 1. The trans is reported at FMV bw the spouses (both must report), and o 2. The recipient spouse must pay to transferring spouse FMV consideration

-‐ If it’s not a bona fide trans then 74.5(1) will not apply • Ex: use a debt instr as consid & recipient spouse doesn’t actually pay out that debt 74.5(1) won’t apply • E.g. if recipient spouse provides FMV consid in form of cash or other prop, that cash/prop must be hers

o IOW, the transferring spouse can’t transfer the prop then give the money to pay

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