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Definitions And Terms
Edited by: Keith Anderson Chartered Accountant in association with the Edmonton based firm of Romanovsky & Associates Chartered Accountants
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Accrual accounting – method of accounting for revenues and expenses are matched to the period in which they are earned or incurred, regardless of whether the cash has actually changed hands.
Active Business Income (ABI) - is important in calculating the amount of Small Business Deduction (defined HERE) of a corporation and, as defined by the Income Tax Act, includes the following:
Adjusted Cost Base (ACB) - is important for income tax as the ACB of a property is deducted from proceeds on a sale in order to calculate the gain or loss on the sale. The gain or loss may or may not be a taxable transaction. The starting point for the calculation of ACB is the actual cost to the taxpayer (the amount paid by the taxpayer) for the original acquisition of the property (for property acquired after 1971). There are exceptions to this rule as follows:
There are certain deductions in calculating ACB as follows:
There are certain additions in calculating ACB as follows:
Affiliated Persons - The Income Tax Act considers persons (includes individuals, corporations and partnerships and trusts after March 22, 2004) as affiliated in the following situations (list is not exhaustive). Individuals are affiliated with themselves, partnerships and the majority interest partner are affiliated, spouses including common law partners are affiliated, corporations and the person or spouse of the person who controls the corporation are affiliated, two corporations under common control (including circumstances where affiliated groups control the corporations) are affiliated, and other circumstances involving corporations and partnerships in various ownership structures can be affiliated. Excluded from affiliation are siblings, parents and children. The definition from the Income Tax Act is quite specific and defines affiliated persons in the following circumstances:
Allowable Business Investment Loss (ABIL) - is a certain percentage of a Business Investment Loss defined HERE. The percentage is the same as the capital gains/losses percentage HERE. ABIL's are treated differently from allowable capital losses in that it can be used to reduce all sources of income. An ABIL can be carried back 3 years and carried forward 10 years as a non-capital loss. If an ABIL remains unused after 10 years can then it can be treated as a net capital loss and carried forward indefinitely to be deducted against taxable capital gains.
Arm's-Length - Under the Income Tax Act:
See Non-Arm's Length HERE. See CRA discussion of Arm's Length HERE.
Associated Corporations - share the Small Business Deduction (defined HERE) and are defined by the Income Tax Act to include corporations if at any time in the year one of the following conditions existed:
Attribution - Click HERE for a discussion of Attribution.
Automobile - As defined by the Income Tax Act of Canada. Definition is important in determining if both a Standby Charge and Operating Cost taxable benefit is required. An automobile is a motor vehicle that is designed or adapted mainly to carry individuals on highways and streets, and has a seating capacity of not more than the driver and eight passengers. An automobile does not include:
Notes
Available For Use - The Income Tax Act allows taxpayers to deduct CCA on depreciable property used to earn income that is available for use. You can usually claim CCA on a property only when it becomes available for use. For property other than a building, it usually becomes available for use on the earlier of:
For a building, it usually becomes available for use on the earlier of:
A building that you are constructing, renovating, or altering, it usually becomes available for use on the earlier of:
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Bankrupt or Insolvent - for purposes of the Income Tax Act, a Bankrupt corporation is defined under the Bankruptcy Act or the Winding-Up Act and an Insolvent corporation is defined under the Insolvency Act There are specific conditions to be met and are part of a formal bankruptcy procedure. In addition to the formal Bankruptcy and Insolvency definitions, the Income Tax Act allows situations where the corporation is clearly defunct but not in formal bankruptcy proceedings. In these cases, the taxpayer may elect to have a disposition of shares at nil value occur if all of the following are true:
Business Investment Loss (BIL) - is a capital loss, defined HERE, which has special income tax treatment under the Income Tax Act. If a loss qualifies as a BIL, then the allowable portion of the business investment loss, defined HERE, is deductible against all other types of income. Normally, capital losses are only allowed to be deducted against capital gains. To qualify, the BIL must be shares or debt of a Small Business Corporation (defined HERE) which are disposed of to a person (defined HERE) whom you deal with at arm's length (click HERE for a definition of Non-Arms Length) or, in the case of shares, because the corporation has become formally bankrupt or effectively insolvent (click HERE for a definition of Bankrupt or Insolvent) or, in the case of debt, because the debt is deemed uncollectible and the deemed disposition rules (click HERE for a definition of Deemed Disposition) apply. A loss may not qualify as a business investment loss under certain circumstances, such as when a capital gains deduction has been claimed in prior years.
Shares of a bankrupt or insolvent corporation may be difficult to prove. If a corporation is bankrupt during the year (under the Bankruptcy Act or Winding-up Act), a taxpayer can elect to have a deemed disposition apply with nil proceeds and to have acquired the shares immediately afterwards for nil cost base thereby triggering the loss. However, if the shares are subsequently sold for more than nil proceeds, a taxable gain will be triggered. Additionally, there are some rules to aid in cases where the corporation is clearly defunct but not formally in bankruptcy proceedings. A taxpayer can elect to have a disposition (similar to the above description) where at the end of the taxpayer's taxation year all of the following apply:
Debt that is deemed uncollectible may be difficult to prove. Court cases have placed high weight on the taxpayer's subjective determination. Click HERE for more on Deemed Dispositions of Debt.
If the ABIL exceeds income for the year, any excess will be considered a non-capital loss and can be carried back 3 taxation years or forward 7 taxation years to offset all types of income in those taxation years. If the loss cannot be fully utilized by the end of the 7 taxation years, it then becomes a normal capital loss which carries forward indefinitely.
Determining when a share is eligible for the loss because of insolvency is discussed HERE. A taxpayer should ensure that as soon as the conditions of insolvency are met, that a BIL claim is made. In cases of bankruptcy or insolvency, the taxpayer may elect to have disposed of the share for nil proceeds and then claim the capital loss. If the share subsequently is sold for more than nil proceeds, the gain must be reported as a capital gain.
Determining when a debt is uncollectible is more difficult as the Income Tax Act does not provide any conditions. The Courts have put some weight on the determination of when debt becomes uncollectible based on the taxpayer's subjective determination. However, all factors must be considered.
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Canadian Controlled Private Corporation (CCPC) - as defined by the Income Tax Act is firstly a Private Corporation defined HERE and which is incorporated in Canada. CCPC status is important in order to qualify for the Small Business Deduction defined HERE. There are three exclusions from this definition which are still considered Private Corporations, but are not CCPC's:
Capital Cost Allowance - Abbreviated as CCA, it is the tax deduction for depreciation on assets used to earn income. The Income Tax Act allows a specified deduction in taxation years for certain assets used to earn income. These assets are defined in the Income Tax Act. Any asset not listed in the Income Tax Act may be Non-Depreciable Capital Property. See also Recapture and Terminal Loss. Click HERE for more discussion on CCA.
Capital Cost - The Income Tax Act allows a taxpayer to deduct CCA on depreciable property used to earn income based on its capital cost. This is the amount on which you first claim CCA. The capital cost of a property is usually the total of:
Capital Gain - as defined in the Income Tax Act, is defined as the gain on the disposition of capital property (depreciable or non-depreciable) resulting from proceeds of disposition in excess of original cost. See also Gains or Losses. A Capital gain is different than a normal income gain in that only a specified percentage of the capital gain is taxable. Click HERE for the historical capital gains or losses inclusion rates.
Capital Property - as defined by the Income Tax Act includes any property the disposition of which creates a capital gain or loss. A Capital gain or loss is different than a normal income gain or loss in that only a specified percentage of the capital gain or loss is taxable. Click HERE for the historical capital gains or losses inclusion rates. Click HERE for a discussion of gains and losses in general and HERE for a definition of Capital Gain.
CCA - an abbreviation for Capital Cost Allowance and is the tax deduction for depreciation on assets used to earn income. The Income Tax Act allows a specified deduction in taxation years for certain assets used to earn income. These assets are defined in the Income Tax Act. Any asset not listed in the Income Tax Act may be Non-Depreciable Capital Property. See also Recapture and Terminal Loss. Click HERE for more discussion on CCA.
Common-Law Partnership - For purposes of the Income Tax Act, a common-law partner is a person of the same or opposite sex who cohabits at that time in a conjugal relationship with the taxpayer, and
(a) has cohabitated with the taxpayer for a continuous period of at least one year that ends at that time, or Where two people have been living common-law under the definition above, they are deemed to be common-law partners after that time unless they were not cohabitating at the particular time for a period of at least 90 days due to a breakdown in their conjugal relationship.
Common-law status is important for Canadian income tax as all common-law partners are considered "spouses" for income tax purposes (i.e. the status is NOT optional) and can enjoy the benefits of that status (or the detriments in some cases). The definition has two key words, "cohabitating" and "conjugal". These terms are not defined under the Income Tax Act and therefore taxpayers must rely on court decisions for guidance. Two people who live in a house, but have separate living and sleeping quarters may not be considered to be "cohabitating". Additionally, "conjugal" is based on several factors such as shared shelter, sexual behaviour, personal behaviour, shared services, shared social activities, societal perceptions of the couple, economic support, and children. No factor is more important than the other and a final determination of "conjugal" is based on the facts of each case.
Company (or Corporation) – a distinct legal entity separate from its owners. Rights and obligations of the company are subject to relevant statutes. Companies can be incorporated under federal or provincial statutes.
Connected Corporations - as defined by the Income Tax Act includes two corporations where either:
Connected Persons (Persons connected with shareholders) - as defined in the Income Tax Act, a person is connected with the shareholder of a corporation if that person does not deal at arm's length with the shareholder and if that person is a person other than:
Control - For purposes of the Income Tax Act, there are at least 3 meanings of control.
Corporate Attribution - Click HERE for a discussion of corporate attribution.
Cumulative Net Investment Loss - As defined in the Income Tax Act of Canada, is the cumulative amount of investment income less investment losses beginning in 1988. If the amount is negative, the balance is called cumulative net investment loss (CNIL). CNIL limits the capital gains exemption to the extent a taxpayer has deducted investment losses. To calculate, add up all investment income and subtract all investment losses since 1988.
Investment Income Additions (not complete):
Investment Income Subtractions (not complete):
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Debt Forgiveness Rules - under the Income Tax Act, a taxpayer that benefits under a forgiveness of debt situation will be subject to certain rules.
If the debt is personal or non-commercial in nature, nothing happens. In these cases, the debt is defined to include debt where the interest is not deductible for income tax purposes.
Commercial debt is debt where interest is deductible for income tax. To be deductible, it must have been incurred to earn income from a business or property. However, even in cases where the debt was non-interest bearing, the debt forgiveness rules apply where interest if paid or payable would have been deductible. Where commercial debt is forgiven, the forgiven amount is subject to certain tax treatment as follows:
The debtor has the ability to transfer the forgiven amounts to certain related corporations or partnerships. The transfer would be utilized where the debtor has used up all of the mechanisms available to reduce the forgiven amount and may therefore be required to include any remaining balance into income.
Click HERE for a more extended discussion.
Debt Parking Rules - the Income Tax Act has set forth some rules to counter situations where taxpayers set up structures to avoid the consequences of the Debt Forgiveness Rules (defined HERE).
In absence of the Debt Parking Rules, taxpayers who hold loans could sell, at a substantial discount, the loan to a non-arm's length person to the debtor instead of writing off the loan and collecting nothing from the debtor. Click HERE for a definition of non-arm's length and HERE for a definition of person. In these cases, the new creditor is non-arm's length to the debtor and would not claim any settlement or forgiveness of debt in perpetuity. The debtor would then not have to face the forgiveness of debt rules.
The Debt Parking Rules treat debt sold for less than 80% of its principal amount to a non-arm's length party of the debtor as having been settled for the amount of its cost to the non-arm's length party. Therefore, a discount of more than 20% will trigger a forgiven debt and the debt forgiveness rules will apply to the difference between the original principal and the amount of the proceeds. The remaining debt is now held by the new non-arm's length party. If the non-arm's length party tries to subsequently claim the debt as bad, the entire balance of the debt will be treated as if it was settled without payment and treated as a forgiveness of debt to the debtor.
Deductible Dividends - Under sections 112 and 113 of the Income Tax Act, dividends between corporations are deductible from recipient corporation's income under the following circumstances:
Under section 112, a taxable dividend received by:
may be deducted from the recipient corporation's income. A taxable dividend received from a corporation that is non-resident in Canada (other than a foreign affiliate) but has carried on business in Canada continuously since June 18, 1971, may be eligible for a deduction equal to the portion of the dividend determined by the ratio of the corporation's taxable income earned in Canada for the immediately preceding year to the total of the corporation's taxable income based on the assumption that it was resident in Canada throughout the immediately preceding year.
Under section 113,
a taxable dividend received by a corporation resident in Canada from a foreign affiliate is deductible from the recipient's income except to the extent it is paid out of active income earned in a non-prescribed country or passive income of the affiliate.
Deemed Disposition of Debt - for purposes of the Income Tax Act, it may be to your benefit to elect to have disposed of debt for nil proceeds, rather than trying to find an arm's length purchaser of the debt to realize your losses. To have the election be accepted by CRA, the debt has to be established by the taxpayer to be a bad debt (not merely doubtful or overdue on collection). The election is intended to allow a taxpayer to choose to create a loss and avoid the tax consequences of a forgiveness of debt (click HERE for a definition of Forgiveness of Debt Rules) in the debtor company. However, adverse tax consequences can occur to the debtor company under the debt parking rules (defined HERE).
There is no prescribed form to elect the disposition. A statement attached to the tax return is required with reference to subsection 50(1) of the Income Tax Act. If the election is accepted by CRA, any subsequent gain on the settlement of the debt (actual proceeds in excess of the nil cost base as a result of the election) will result in a capital gain to the taxpayer.
In cases where the debt is from a non-arm's length company, CRA will apply some strict conditions on the election. CRA will look at the debtor company's ability to repay the debt and other factors. Additionally, in non-arm's length situations, a capital loss can only be claimed where the debt was acquired for the purpose of gaining or producing income. In arm's length situations, the debt can also be considered capital property and a capital loss claimed under the discussion above.
Deemed Disposition of Shares - for purposes of the Income Tax Act, it may be to your benefit to elect to have disposed of shares for nil proceeds, rather than trying to find an arm's length purchaser of the shares to realize your losses. To have the election be accepted by CRA, the shares have to be established by the taxpayer to be shares of a bankrupt or insolvent corporation. Shares of a bankrupt or insolvent corporation may be difficult to prove. If a corporation is bankrupt during the year (under the Bankruptcy Act or Winding-up Act), a taxpayer can elect to have a deemed disposition apply with nil proceeds thereby triggering the loss. However, if the shares are subsequently sold for more than nil proceeds, a taxable gain will be triggered. Additionally, there are some rules to aid in cases where the corporation is clearly defunct but not formally in bankruptcy proceedings. A taxpayer can elect a disposition (similar to the above description) where at the end of the taxpayer's taxation year all of the following apply:
Depreciable Capital Property - Capital Property is defined HERE. Depreciable property includes property for which the Income Tax Act allows a deduction for business income at a certain percentage of the cost of the property on income earned by those assets. The deduction is CCA defined HERE.
Distress Preferred Shares - As defined in the Income Tax Act are a special form of Term Preferred Shares. After exchanging debt for distress preferred shares, the corporate creditor is entitled to receive cumulative fixed dividends which are deductible when computing taxable income as opposed to receiving fully taxable interest income. The debtor and creditor negotiate a lower dividend rate on the distress preferred shares than the interest rate on the debt. The effect is that the debtor's financing costs and cash flow requirements are reduced and the creditor maintains at least the same after-tax rate of return on the funds provided to the debtor. The debtor's cash flow position is improved as its payment requirements are now at a lower rate. Although the lower dividends are not deductible by the debtor, as the interest was, this is not usually of consequence since the debtor is typically not in a taxable position.
There are specific requirements under the Income Tax Act for a Term Preferred Share to be considered a Distress Preferred Share.
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Earned Income for RRSP Purposes - RRSP contribution limits are subject to a maximum of a prescribed yearly amount or 18% of the previous year's earned income - whichever is lower. Earned income is calculated as the total of:
The following DO NOT qualify as earned income:
Eligible Capital Property (Eligible Capital Expenditures) - There are certain capital expenditures incurred in earning income which are neither 100% deductible nor subject to the CCA deduction as allowed by the Income Tax Act. Many of these type of expenditures will qualify for a partial deduction and are outlined in the Income Tax Act. To qualify, the expenditure must meet a number of conditions including:
Examples of Eligible Capital Expenditures include purchased goodwill, purchased customer lists, trademarks, patents, expenses of incorporation or reorganization. See also Recapture.
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Fair Market Value (FMV) - FMV is generally the highest dollar value that you can get for your property in an open and unrestricted market between an informed and willing buyer and an informed and willing seller who are dealing at arm’s length with each other.
Foreign Affiliate - under the Income Tax Act, a foreign affiliate is defined as a non-resident corporation in which the Canadian taxpayer's equity percentage is 10% or more.
Foreign Currency Capital Items - Under the Income Tax Act, the following are considered foreign currency capital items for calculation of foreign exchange for income tax purposes:
Foreign Currency Income Items - Under the Income Tax Act, the following would be considered foreign currency income items for the calculation of foreign exchange for income tax purposes:
Forgiveness of Debt Rules - under the Income Tax Act, a taxpayer that benefits under a forgiveness of debt situation will be subject to certain rules.
If the debt is personal or non-commercial in nature, nothing happens. In these cases, the debt is defined to include debt where the interest is not deductible for income tax purposes.
Commercial debt is debt where interest is deductible for income tax. To be deductible, it must have been incurred to earn income from a business or property. However, even in cases where the debt was non-interest bearing, the debt forgiveness rules apply where interest if paid or payable would have been deductible. Where commercial debt is forgiven, the forgiven amount is subject to certain tax treatment as follows:
The debtor has the ability to transfer the forgiven amounts to certain related corporations or partnerships. The transfer would be utilized where the debtor has used up all of the mechanisms available to reduce the forgiven amount and may therefore be required to include any remaining balance into income.
Click HERE for a more extended discussion.
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Gains Or Losses - The Income Tax Act taxes income gains or losses differently depending on whether the income or loss in capital in nature or whether the income or loss is a regular income gain or loss in nature. The distinction between what constitutes capital versus regular income gain/loss is not clearly outlined in the Income Tax Act. Consequently, the courts have had to make decisions setting precedence on this issue over the years. Factors the courts would look at include the period of ownership (the longer it is held the more likely the property is capital), the frequency of similar transactions (the more often a certain type of transaction takes place the less likely the income is capital), the extent of the improvement or development (when more effort is put in to a certain type of transaction, the less likely the income is capital), the reasons for holding the property and the nature of the sale (if the sale of property is the result of an active campaign to sell it rather that something that is unanticipated, the less likely the income is capital), the relationship of the transaction to the taxpayer's ordinary business (if the taxpayer is already in a business of a similar nature then it is less likely the income is capital), and the type of assets being disposed of (fixed capital items such as equity investments are more likely to result in capital income than floating capital items such as inventory).
Capital losses can only be applied against capital gains, whereas, normal income losses can be applied against any source of income gains (capital or normal income). Additionally, capital losses can be carried back 3 taxation years to offset capital gains in those years and also capital losses carry forward indefinitely. Normal income losses also can be carried back 3 taxation years, but only can be carried forward 7 taxation years. After 7 taxation years, normal income losses expire.
Generally Accepted Accounting Principles (GAAP) - In Canada, is the term used to describe the basis on which financial statements are normally prepared. GAAP encompasses not only specific rules, practices, and procedures but also broad principles and convention of general application. Specifically, GAAP comprise the Accounting Recommendations in the Canadian Handbook as prepared by the Institute of Chartered Accountants of Canada.
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Inter Vivos Trusts - Trusts are defined HERE. An inter vivos trust is defined to include all trusts other than testamentary trusts. This means that the settlor of the trust is still living. The most common example is a Family Trust created by a settlor for the benefit of family members, usually minors.
Investment Income - Generally includes items which a taxpayer would think is property or passive income as opposed to income from employment or business. It includes dividend income, interest income, and limited partnership income less any expenses incurred to earn that income like interest expense for money borrowed to purchase the investments, investment council fees, and other carrying charges. Technically rental income and capital gains are not "investment" income but are still generally a "passive" source of income. If the income received is dependent on the performance of some service by the taxpayer, the income is not investment income
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Joint venture - a bringing together of resources for a specific purpose with a limited life. The joint venturers retain ownership of each party’s contributed resources
Joint Tenants (Joint tenancy) with Rights of Survivorship. Under Joint Tenancy, two or more individuals have ownership on an undivided basis. In other words, each joint tenant owns 100% of the same assets. Upon the death of one of the owners, the remaining owners will own the entire account equally. The right of survivorship means that when one owner dies, the surviving owners take full title and possession of the jointly held property. Such ownership is common among married couples since property is left to the survivor without the need for a will, thereby avoiding probate.
Joint Tenants-in-Common. When two or more people own property as tenants-in-common, they each own fractional interests in that property. Under tenants-in-common, there are no automatic right of survivorship as with Joint Tenants with Rights of Survivorship. At death, the interest of the deceased tenant will pass to the estate, making it potentially subject to the probate process, and not to the surviving tenants. Assets held in Joint Tenants-In-Common can be in any percentage for example individual A may hold 25% and individual B may hold 75%.
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Monetary Items - As defined by GAAP in Canada, monetary items are money and claims to money the value of which is fixed by contract or otherwise. If an item does not fit the definition of Monetary, then by definition the item is Non-monetary.
The following are generally considered monetary items:
The following are generally considered non-monetary items:
Monetary Foreign Currency Items - As defined by GAAP in Canada, monetary items are money and claims to money the value of which is fixed by contract or otherwise. Monetary Foreign Currency Items are therefore monetary items which are denominated in a foreign currency - for example a US dollar bank account or accounts receivable in US dollars.. If an item does not fit the definition of Monetary, then by definition the item is Non-monetary.
The following are generally considered monetary foreign currency items:
The following are generally considered non-monetary foreign currency items:
Motor Vehicle - As defined in the Income Tax Act. This is an automotive vehicle designed or adapted for use on highways and streets. Motor vehicles do not include a trolley bus or a vehicle designed or adapted to be operated exclusively on rails.
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Non-Arm's Length - See Related Corporations and Related Individuals below. The Income Tax Act defines Arm's Length HERE. See CRA discussion of Arm's Length HERE.
If not arm's-length, by definition you are non-arm's length. When transactions occur among non-arms length parties, agreed prices may be adjusted to provide tax results that would have occurred if the transaction has occurred at fair value between unrelated parties. As well, there are a number of tax rules that prescribe tax adjustments to non-arm's length transactions see Superficial Losses and Stop Losses. Transactions with non-arms length non-residents can give rise to special reporting requirements as well as pricing adjustments.
Non-Capital Loss - as defined by the Income Tax Act loss includes unused losses from office, employment, business or property, and unused allowable business investment losses (ABIL). The following is a schedule outlining when such losses can be used:
Non-Depreciable Capital Property - as defined by the Income Tax Act would include any capital property the disposition of which would create a capital gain or loss and which the Income Tax Act disallows any CCA deduction. The definition of Capital Property is HERE and the definition of CCA is HERE.
Non-Monetary Items - As defined by GAAP in Canada, monetary items are money and claims to money the value of which is fixed by contract or otherwise. If an item does not fit the definition of Monetary, then by definition the item is Non-monetary.
The following are generally considered monetary items:
The following are generally considered non-monetary items:
Non-Monetary Foreign Currency Items - As defined by GAAP in Canada, monetary items are money and claims to money the value of which is fixed by contract or otherwise. Monetary Foreign Currency Items are therefore monetary items which are denominated in a foreign currency - for example a US dollar bank account or accounts receivable in US dollars.. If an item does not fit the definition of Monetary, then by definition the item is Non-monetary.
The following are generally considered Monetary Foreign Currency items:
The following are generally considered Non-Monetary Foreign Currency items:
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Partnership - an agreement in which two or more entities such as individuals or corporations combine their resources in a business with a view to making a profit. Partners share in the profits according to the terms of the agreement.
Permanent Establishment - The Income Tax Act and various Provincial Tax Acts require business income (incorporated or not) to be allocated between provinces in which the business has a permanent establishment. Generally, a permanent establishment exists in a province that has an office, branch, farm, timberland, mine, oil well, factory, or workshop or warehouse. Additionally, if a business carries on business through an employee or agent, established in a particular place, who has general authority to contract for his employer or principal, or who has a stock of merchandise owned by his employer or principal from which he regularly fills orders which he receives, the corporation is deemed to have a permanent establishment in that place. There are other numerous other factors which affect whether or not a permanent establishment in another province exists.
Person - The Income Tax Act has an extended meaning of "person" which includes both individuals, corporations, partnerships and trusts.
Personal Services Business (PSB) - As defined by the Income Tax Act includes a corporation where an individual renders services through a corporation and who is a specified shareholder or related person is a specified shareholder of the corporation and it can reasonably be regarded that the individual is an officer or employee of the entity for which the services are provided unless throughout the year unless there are more than 5 full-time employees in the PSB corporation. A specified shareholder is defined as a person who owns directly or indirectly at any time of the year 10% or more of the issued shares of any class of the corporation or related corporation. The PSB rules are to prevent employees from incorporating their income but also catches management companies serving professionals especially if the professional's spouse is an employee.
Principal Residence Exemption - As defined by the Income Tax Act is a calculation allowing the capital gain on a principal residence to be reduced or eliminated completely. The following formula calculates the exempt portion of the gain which is subtracted from the total gain to arrive at the taxable portion of the gain:
1 plus the number of tax years ending after the acquisition date (but only after 1971) for which the property was your principal residence and during which you were resident of Canada ___________________________________ X (Multiplied by) The Capital Gain on Sale (Divided by)
the number of tax years ending after the acquisition date (but only after 1971) during which you owned the property
Private Company (or Corporation) - a non-publicly traded company formed by 50 or fewer shareholders.
Property Income - generally includes all investment income, rental income, and capital gains.
Proprietorship (or Sole Proprietorship) - a business established but not necessarily registered by an individual who personally assumes all responsibility for its financing, operations, taxes and profits or losses
Public Company (or Corporation) – a company which can raise capital by selling shares to the public
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Qualified Farm Property (QFP) - is important in calculating the amount of capital gain exemption available on the disposition of that property. Individuals have a lifetime tax-free exemption of $750,000 ($500,000 for 2006 and previous years) in gains on sales of QFP combined with Qualified Small Business Corporation shares. Qualified Farm Property is defined as real property, shares in a family farm corporation which owns real property, or an interest in a family farm partnership which owns real property which the real property or shares of a family farm corporation which owns real property, is owned by an individual, his spouse, or family farm partnership in which the taxpayer or spouse has an interest which has been used by the taxpayer, his spouse, any of the taxpayer's children or parents, or by a family farm corporation or family farm partnership in which the taxpayer, his spouse, any of the taxpayer's children or parents has a share or interest in the course of carrying on a business of farming in Canada (note that the property need not actually be used in carrying on a farming business at the time of disposition).
Qualified Small Business Corporation (QSBC) - is important in calculating the amount of capital gain exemption available on disposition of QSBC shares. Individuals have a lifetime tax-free exemption of $750,000 ($500,000 for 2006 and previous years) in gains on sales of QSBC shares combined with Qualified Farm Property. The major criteria for QSBC status are:
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Real Property - Real Property is a legal term for land and anything permanently affixed to the land such as buildings.
Recapture - The Income Tax Act allows a business to deduct a certain percentage of the cost of Depreciable Property and Eligible Capital Property in calculating business income. This is referred to as tax depreciation or amortization. Depreciable Property is contained in certain classes depending on the asset's characteristics and the Income Tax Act varies the percentage deduction on each class. Eligible Capital Property is in a class all to itself and has a set percentage deduction. When Depreciable or Eligible Capital Property is disposed of, the lesser of the original cost of the asset or proceeds on sale is deducted from each class. If at the end of a taxation year any class has a negative balance (because the deduction on sale exceeds the balance in the class) then the negative balance is included in business income as "recapture" of excess previous years depreciation.
Refundable Dividend Tax On Hand (RDTOH) - For purposes of corporate income tax:
The refundable tax is:
The tax is refundable to the company when the company pays a taxable dividend to the shareholder(s). The tax is refundable at $1 for every $3 of taxable dividends. The purpose of the RDTOH is to put a mechanism in place so that investment income is taxed at the same rate no matter if earned in a corporation or by an individual. The system is not perfect and certain tax advantages or disadvantages result which is discussed HERE.
Related Corporations - For purposes of the Income Tax Act, two corporations are related and are therefore not dealing at arm's length if any the following is true:
Related Individuals - For purposes of the Income Tax Act, two or more individuals are related and are therefore not dealing at arm's length if any of the following is true:
Remote Work Site - As defined in the Income Tax Act is a place you were required to work:
As a general rule, remoteness occurs when the nearest established community with a population of 1,000 or more is no closer than 80 kilometres by the most direct route normally travelled.
See also Special Work Site.
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Self-Contained Domestic Establishment - As defined in the Income Tax Act, is a dwelling house, apartment, or other similar place of residence in which a person, as a general rule, sleeps and eats. An establishment where a person sleeps (hotel or boarding house) bust does not eat or which is not self-contained (for example a room in a boarding house) will not qualify.
Small Business Corporation (SBC) - as defined by the Income Tax Act, includes a Canadian Controlled Private Corporation (CCPC) defined HERE, where all or substantially all (90% or more according to CRA, although this is subject to interpretation) of its assets (measured at fair value, not cost) are either:
Small Business Deduction (SBD) - Corporations which are Canadian Controlled Private Corporations (defined HERE) throughout the taxation year are eligible for the SBD on the first certain amount (click HERE for this amount) of Active Business Income (defined HERE). The SBD amount is shared among Associated Corporations (defined HERE).
Special Work Site - As defined in the Income Tax Act is a place that you were required to work temporarily:
Note that to fulfill the requirements of 1. above, the taxpayer must have a self-contained domestic establishment available for use and not rented out to anyone else that is beyond commuting distance from the special work site.
See also Remote Work Site.
Specified Investment Business (SIB) - as defined by the Income Tax Act is a business the principal purpose of which is to derive income from property (including interest, dividends, rents, or royalties) but does not include a business where:
In essence, income from a business which exists primarily to earn income from property is treated as property income (not eligible for the small business deduction) unless the business has achieved a certain minimum size.
Specified Shareholder - as defined by the Income Tax Act is a shareholder of a corporation who owns directly or indirectly, at any time of the year, 10% or more of the issued shares of any class of the capital stock of the corporation or any other corporation that is related to the corporation and a taxpayer is deemed to own each share of the capital stock of a corporation owned at that time by a person with whom the taxpayer does not deal at arm's length. This definition is used in the definition of Personal Services Business and Attribution.
Stop Loss Rules - The Income Tax Act contains several sections to disallow tax losses on transfers to affiliated persons. The meaning of Affiliated can be found HERE, the meaning of Person can be found HERE and the meaning of Transfer can be found HERE.
The Superficial Loss Rules are part of the Stop Loss Rules. The purpose of these rules are to prevent taxpayers from realizing deductible losses without any real intention to dispose of the property in question. However, taxpayers are motivated to obtain some tax benefit from their poor performing assets without permanently disposing of them.
There are exceptions to the Stop Loss Rules and the Superficial Loss Rules as follows:
The Stop Loss Rules In Detail
Non-Depreciable Capital Property in Section 40(3.3)(a) of the Income Tax Act
Non-Depreciable Capital Property is defined HERE.
Losses are disallowed on dispositions of non-depreciable capital property from a corporation, partnership, or trust (the "Transferor") where the Superficial Loss Rules would not otherwise apply and, during a period that begins 30 days before and ends 30 days after the disposition, the transferor or a person affiliated with the transferor acquires the same or an identical property and the transferor or affiliated person owns such property at the end of that period. In this case, the denied capital loss is preserved and allowed at a later point in time to the transferor when the property is no longer owned by the transferor or an affiliated person. Unlike the Superficial Loss Rules, the denied loss is not added to the transferee's adjusted cost base of the property substituted nor is the loss added to the transferor's cost base in any shares it owns in the transferee if the transferee is a corporation unless number 2. below applies. It requires that the Transferor keep track of when the Transferee sells the property to an unaffiliated person, and then the Transferor can claim the loss at that time.
Shares in Section 40(3.6) and 112(3) to 112(4.1) of the Income Tax Act
There is another specific stop loss rule where a taxpayer, including an individual, disposes of a share in the capital stock of a corporation to that corporation, and the taxpayer is affiliated with the corporation immediately after the disposition. The provision may apply, for example, to a redemption, acquisition or purchase for cancellation of the taxpayer's share by the corporation. It does not apply to a disposition of a distress preferred share. The taxpayer's capital loss, if any, is deemed to be nil. The amount of the denied loss is added to the cost base of the shares in the corporation owned by the taxpayer immediately after the disposition. However in the case of corporations disposing of shares in other corporations, the loss is reduced by certain dividends received on those shares unless the shares have been owned for one year or more at the time of the transaction and the holding was not more than 5% of the issued shares of any class at the date the dividend was received. If the taxpayer owns no shares in the corporation immediately after the disposition but is nonetheless affiliated with the corporation, it appears that the loss is denied with no relief in the form of an increased cost base.
Depreciable Property in Section 13 (21.2) of the Income Tax Act
Depreciable Property is defined HERE.
There is another stop loss rule which denies the deduction of a terminal loss on the disposition of a depreciable property of a prescribed class by a corporation, trust or partnership (transferor), where either the transferor or a person affiliated with the transferor owns the property or a right to acquire the property 30 days after the disposition. Any denied terminal loss is in effect “frozen”, and is subsequently allowed to the transferor upon the earliest of certain triggering events, such as where the property is again disposed of and is no longer owned by the transferor or an affiliated person. Until the triggering event occurs, the transferor may claim capital cost allowance (CCA) as if the transferor continued to own the property with a capital cost equal to the amount of the denied terminal loss. If there is no terminal loss on the disposition of the depreciable property, this stop loss rule still applies in the circumstances described above if the amount that would otherwise be the proceeds of disposition of the depreciable property is less than the lesser of the transferor's capital cost of the property, and the proportion of the undepreciated capital cost (UCC) of the class to which the property belongs that the value of the property is of the value of all properties in the class. In such case, the transferor is deemed to have disposed of the property at the lesser of these two amounts (the deemed proceeds), and the amount by which the deemed proceeds exceeds the amount that would otherwise be the proceeds of disposition is added back as a capital cost of a notional depreciable property of the same class owned by the transferor.
Eligible Capital Property in Section 14(12) of the Income Tax Act
Eligible Capital Property is defined HERE.
There is a stop loss rule to prevent the loss on the disposition of eligible capital property. In particular, the provision applies where a corporation, trust or partnership (transferor) disposes of a particular eligible capital property in respect of a business and would otherwise be eligible for the deduction for example if the company ceases to carry on business and during the period that begins 30 days before the disposition and ends 30 days after the disposition, either the transferor or a person affiliated with the transferor acquires the property or an identical property (called the “substituted property”) and such person owns the substituted property at the end of the period. When this happens, the transferor is deemed to continue to own eligible capital property in respect of the business and not to have ceased to carry on the business, until immediately before the earliest of one of the triggering events. Until the triggering event, the transferor can continue to deduct amounts in respect of the taxpayer's cumulative eligible capital pool and the deduction for the loss on disposition is deferred until the triggering event. For these purposes, where the transferor is a partnership which otherwise ceases to exist after the disposition of the property but before the triggering event, the partnership is deemed to continue to exist, and its members are deemed to remain members, until immediately after the first triggering event. The triggering events are:
Inventory in Section 18(14) and 18(15) of the Income Tax Act
Finally, there is a stop loss rule to deny losses where a person (the Transferor) disposes of inventory of a business that is an adventure or concern in the nature of trade and, during a period that begins 30 days before and ends 30 days after the disposition, the transferor or a person affiliated with the transferor acquires the same or identical property and at the end of the period the transferor or a person affiliated with the transferor owns the same or identical property. The loss is denied and the amount of the loss is deemed to be the loss of the transferor after certain triggering events such as the transferee selling the property.
There are some tax planning ideas to avoid Stop Loss and Superficial Loss problems HERE.
Superficial Loss Rules - These rules are outlined in Section 54 of the Income Tax Act. This rule applies where a person or affiliated person acquires or had the right to acquire the same or identical property within 30 days after the disposition or 30 days before the disposition of the property in question. The disposition could have been made to anyone. In these cases, the loss on the disposition is denied and the amount of the loss is added to the cost of the substituted property.
There are some exceptions to this rule which are exempt from the Superficial Loss Rules and the Stop Loss Rules including:
Click HERE for some tax planning ideas to avoid Stop Loss and Superficial Loss problems.
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Taxable Canadian Property (TCP) - As defined by the Income Tax Act of Canada, have two branches.
First branch - Property when disposed of by a Canadian non-resident which gives rise to a capital gain or loss:
Second Branch - Property when disposed of by a Canadian non-resident or deemed dispositions by emigrants or deemed acquisition by immigrants which gives rise to normal income not capital gains or losses:
Term Preferred Shares - As defined in the Income Tax Act are shares with characteristics that mimic debt obligations. If not for these rules, lending institutions could obtain tax free payments by replacing their loans with investments in term preferred shares with repayment terms that are essentially the same as if debt payments were made. Dividends on shares between certain corporations are tax free whereas interest income on debt is taxable.
The technical definition of Term Preferred Share is very complex and beyond the scope of this site. The Income Tax Act removes the tax free inter-corporate dividend and replaces it with a fully taxable dividend. Distress Preferred Shares are an exception to this situation.
Terminal Loss - The Income Tax Act allows a business to deduct a certain percentage of the cost of Depreciable Property and Eligible Capital Property in calculating business income. This is referred to as tax depreciation or amortization. Depreciable Property is contained in certain classes depending on the asset's characteristics and the Income Tax Act varies the percentage deduction on each class. When Depreciable Property is disposed of, the lesser of the original cost of the asset or proceeds on sale is deducted from each class. If at the end of a taxation year there are no assets left in a particular class, the balance of the class may be written off as a terminal loss.
Testamentary Trust - Trusts are defined HERE. A testamentary trust are trusts which arise on someone's death. They are usually created out of the deceased person's will. Testamentary Trusts include Spousal Trusts. A Spousal Trust is one in which the spouse is entitled to receive all of the income of the Trust and no other person other than the spouse may receive or benefit from the use of the income or capital of the Trust during the spouse's lifetime. There is a tax-deferred rollover of the deceased's property into a Spousal Trust if the property transferred vests indefeasibly with the trust within 36 months (period extendable by CRA).
Transfer - The Income Tax Act contemplates a "transfer" by whatever means such as a gift, sale or other type of disposition.
Trusts - a Trust is a binding obligation, undertaken voluntarily, which is enforceable by law. It may be created by a person (verbally or written), a court order, or by statute. There are three elements:
Types of Trusts include Testamentary and Inter Vivos Trusts.
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Undepreciated Capital Cost (UCC) - The Income Tax Act allows taxpayers to deduct CCA on depreciable assets used in a business. The UCC is the amount remaining after you deduct CCA from the capital cost of a depreciable property. Each year, the CCA you claim reduces the UCC of the property.
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Working capital – liquid funds available to pay obligations as they come due. Often described as a ratio of current assets in relation to current liabilities.
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