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Definitions And Terms

 

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Edited by:

Keith Anderson Chartered Accountant in association with the Edmonton based firm of Romanovsky & Associates Chartered Accountants

 

 

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A

 

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:

 

  1. any business income other than specified investment business income (defined HERE) or personal services business income (defined HERE) and includes an adventure or concern in the nature of trade. Specifically excluded is property (investment) income earned by the corporation. Investment income in this context excludes property or investment income incidental to the active business of the corporation or held principally for the purpose of gaining or producing income from an active business of the corporation.

  2. any incidental income of its active business.

  3. interest, rent, royalties from associated  companies where the amount in question was or may be deductible in computing Canadian Active Business Income of the payor associated company.

  4. Partnership income form an active business subject to certain allocation limits.

 

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:

 

  1. Property acquired from a related person or a person you do not deal with at arm's length. Generally, if you acquire the property for more than the Fair Market Value, you are deemed to have acquired it for a cost equal to Fair Market Value. The actual price paid becomes irrelevant. If you dispose of the property to a related person or a person you do not deal with at arm's length for proceeds less than Fair Market Value, you are deemed to have disposed of the property for proceeds at Fair Market Value. Special rules apply in cases of gifts, bequests, or sales to a spouse or common-law partner. Special rules also exist for transfers involving corporations, partnerships, or trusts. Also special rules exist in dispositions of shares of qualified small business corporation shares from a parent to a child where the parent claimed the capital gains exemption. Professional advice in these cases is needed.

  2. Where a taxpayer receives a dividend in kind (i.e. a dividend from a share owned in a corporation that is received in other property and not cash), the Fair Market Value of the property received at that time is deemed to be the ACB of the property.

  3. If a taxpayer immigrated to Canada after 1971, any capital property held at the time of immigration, except for Taxable Canadian Property, is deemed to have been acquired by the taxpayer at Fair Market Value at the date of immigration.

  4. If a taxpayer receives property under an Employees Profit Sharing Plan other than cash, the property is transferred to you at no immediate tax, but the ACB to the taxpayer is the Plan's acquisition cost of the property plus any income amounts attributed to the taxpayer (which the taxpayer has paid income tax on) for that property since acquisition by the Plan.

 

There are certain deductions in calculating ACB as follows:

 

  1. ACB of a partnership interest is reduced by a taxpayer's share of partnership losses and drawings.

  2. Where a portion of a property is disposed of, the ACB of the remaining part must be reduced.

  3. The cancellation or reduction of a debt instrument owned by a taxpayer may require the reduction in ACB of the debt instrument to the taxpayer.

  4. ACB of an interest in a trust (for example, mutual fund trusts) will be reduced by non-taxable capital distributions by the trust.

  5. Grants, subsidies, or other assistance received from government will reduce the ACB of the property acquired with the assistance.

  6. Other items which professional advice should be sought.

 

There are certain additions in calculating ACB as follows:

 

  1. Contributions of capital to a corporation, other than by way of loan, (for example contributed surplus) should be added to the ACB of the shares a taxpayer owns in the corporation.

  2. Superficial losses are added to the ACB of the property.

  3. Where a taxpayer acquires a debt instrument (for example a bond) for an amount less than the principal amount, the difference may have to be included in income.

  4. Interest and property taxes on land held for investment that cannot be deductible (for example if the land was vacant and did not generate incidental revenue) may under certain circumstances, be added to the ACB of the property.

  5. If reductions in ACB above result in negative ACB (except for cases of partnership interests), the negative amount is considered a capital gain subject to tax. The amount of the negative ACB is then added to the ACB for subsequent disposal purposes.

  6. Certain amounts with respect to partnership interests. Professional advice should be sought.

  7. Amount of loss which has been denied on a transfer of property to an affiliated corporation.

  8. Costs of surveying or valuing property incurred for the purpose of acquiring or disposing of the property.

  9. Certain designations from a mutual fund trust that create taxable income without a corresponding receipt of cash or property equal to the value designated.

  10. Other items which professional advice should be sought.

 

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:

 

  1. an individual and a spouse of the individual are affiliated.

  2. a corporation and a person by whom the corporation is controlled are affiliated.

  3. a corporation and each member of an affiliated group of persons by which the corporation is controlled are affiliated.

  4. a corporation and a spouse of a person in each of 2 and 3 above are affiliated.

  5. two corporations are affiliated, if each corporation is controlled by a person, and the person by whom one corporation is controlled is affiliated with the person by whom the other corporation is controlled.

  6. two corporations are affiliated, if one corporation is controlled by a person, the other corporation is controlled by a group of persons, and each member of that group is affiliated with that person.

  7. two corporations are affiliated, if each corporation is controlled by a group of persons, and each member of each group is affiliated with at least one member of the other group.

  8. a corporation and a partnership are affiliated, if the corporation is controlled by a particular group of persons each member of which is affiliated with at least one member of a majority-interest group of partners of the partnership, and each member of that majority-interest group is affiliated with at least one member of the particular group.
    a partnership and a majority interest partner of the partnership.

  9. two partnerships are affiliated, if the same person is a majority-interest partner of both partnerships.

  10. two partnerships are affiliated, if a majority-interest partner of one partnership is affiliated with each member of a majority-interest group of partners of the other partnership.

  11. two partnerships are affiliated, if each member of a majority-interest group of partners of each partnership is affiliated with at least one member of a majority-interest group of partners of the other partnership.

  12. A trust is affiliated with a beneficiary who is entitled to a majority of the trust income or capital and any person affiliated with such beneficiary. If the trust is a discretionary trust, the affiliation rules apply where any beneficiary may potentially be the recipient of the majority of the trust income or capital. For these purposes, a contributor is affiliated with another contributor if connected by blood, marriage, common-law partnership, or adoption.

  13. Two trusts are affiliated with each other if a contributor to one of the trusts is affiliated with a contributor to the other trust and if a majority-interest beneficiary of one of the trusts is affiliated with a majority-interest beneficiary of the other trust. A contributor includes any person who has made a loan or transferred property, directly or indirectly but excludes situations where the loan was made at a reasonable rate of interest or if the property was transferred for fair market value consideration provided the contributor deals with the trust at arm's length and is not a majority-interest beneficiary of the trust.

 

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:

 

  1. related individuals and related corporations are deemed not to deal with each other at arm's length and

  2. a taxpayer and a personal trust are deemed not to deal with each other at arm's length if the taxpayer or any person not dealing at arm's length with the taxpayer, would have a beneficial interest in the Trust and

  3. where 1 or 2 do not apply, it is a question of fact whether persons (individuals or corporations) not related to each other are dealing with each other at arm's-length.

 

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:

 

  1. one of the corporations controlled the other (click HERE for the definition of Control).

  2. both of the corporations were controlled by the same person or group of persons (click HERE for the definition of Person).

  3. each of the corporations was controlled by one person and the person who controlled one of the corporations was related to the person who controlled the other, and one of those persons owned directly or indirectly in respect to each corporation, not less than 25% of the issued shares of any class of capital stock (other than a specified class). Click HERE for the definition of Related Corporations and HERE for the definition of Related Individuals. A specified class of shares means shares which have no voting or conversion to voting rights and have a fixed return.

  4. one of the corporations was controlled by one person and that person was related to each member of a group of persons that controlled the other corporation, and the one person owned directly or indirectly in respect to the other corporation, not less than 25% of the issued shares of any class of capital stock (other than a specified class). 

  5. each of the corporations was controlled by a related group and each of the members of one of the related groups was related to all of the members of the other related group, and one or more persons who were members of both of the related groups, either alone or together, owned directly or indirectly in respect to each corporation, not less than 25% of the issued shares of any class of capital stock (other than a specified class). 

  6. both of the corporations were associated with the same third linking corporation. However, for purposes of allocating the small business deduction only, corporations will not be associated with each other under this rule if the third linking corporation is not a CCPC (defined HERE) or the third linking corporation is a CCPC but elects not to be associated with either of the other corporations and does not claim any small business deduction for the year.

 

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:

  1. an ambulance;
  2. clearly marked police or fire emergency-response vehicles;
  3. clearly marked emergency medical response vehicles that are used to carry emergency medical equipment and one or more emergency medical attendants or paramedics;
  4. a motor vehicle bought to use mainly as a taxi, a bus used in a business of transporting passengers, or a hearse in a funeral business;
  5. a motor vehicle you bought to sell, rent, or lease in a motor vehicle sales, rental, or leasing business, except for benefits arising from personal use of an automobile;
  6. a motor vehicle (except a hearse) you bought to use in a funeral business to transport passengers, except for benefits arising from personal use of an automobile;
  7. a van, pick-up truck, or similar vehicle that can seat no more than the driver and two passengers (excludes extended cab trucks) and in the year it is acquired or leased is used primarily (more than 50%) to transport goods or equipment in the course of business; or
  8. a van, pick-up truck, or similar vehicle with any seating capacity (includes extended cab trucks) and in the year it is acquired or leased, is used 90% or more of the time to transport goods, equipment, or passengers in the course of business.
  9. pick-up trucks that are acquired or leased in the tax year that are used primarily (more than 50%) to transport goods, equipment, or passengers in the course of earning or producing income and are used at a remote work location or a special work site that is at least 30 kilometres away from any community having a population of at least 40,000.

Notes

  1. CRA considers a Hummer a "similar vehicle" as discussed in points 7 and 8.

  2. If the back part or trunk of a van, pick-up truck or similar vehicle has been permanently altered and can no longer be used as a passenger vehicle it is no longer considered an automobile.
     

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:

  1. the date you first use it to earn income;

  2. the second taxation year after the year you acquire the property;

  3. the time immediately before the disposition of the property; and

    the time the property is delivered or made available to the taxpayer and is capable of producing a saleable product or service.

For a building, it usually becomes available for use on the earlier of:

 

  1. the date that you begin using 90 % or more of the building in your business;

  2. the second taxation year after the year you acquire the building; and

  3. the time immediately before the disposition of the property.

 

A building that you are constructing, renovating, or altering, it usually becomes available for use on the earlier of:

  1. the date you complete the construction, renovation, or alteration;

  2. the date you begin using 90 % or more of the building in your business;

  3. the second taxation year after the year you acquire the property; and the time immediately before the disposition of the property.

 

 

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B

 

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:

  1. the issuing corporation is insolvent in fact (not enough assets to cover liabilities).

  2. neither the corporation nor a corporation controlled (click HERE for a definition of control) by it carries on business. 

  3. the fair market value of the shares is nil.

  4. it is reasonable to expect that the issuing corporation will be dissolved or wound up and will not commence to carry on business.

 

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:

  1. The issuing corporation is insolvent in fact;

  2. Neither the corporation, nor a corporation controlled by it, carries on a business;

  3. The fair market value of the shares are nil;

  4. And, it is reasonable to expect that the issuing corporation will be dissolved or wound up and will not commence to carry on business.

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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C

 

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:

 

  1. a corporation controlled directly or indirectly by a public corporation (defined HERE), by non-residents, or any combination of the two. In this context, a corporation 50% controlled by non-residents or public corporations, or any combination is still a CCPC since control by this group is not necessarily achieved. Click HERE for a definition of Control.

  2. a corporation which would, if each share of the capital stock of any corporation that is owned by a non-resident or a public corporation were owned by a particular (notional) person, be controlled by that person. This is to defeat the argument that widely held corporations by non-residents, etc are CCPC's when the group does not act in concert to control the corporation.

  3. a corporation with one class of shares listed on a public stock exchange (Canadian or Foreign exchanges).

 

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:

  1. the purchase price (not including the cost of land, which is usually not depreciable;

  2. the part of your legal, accounting, engineering, installation, and other fees that relates to the purchase or construction of the property (not including the part that applies to land);

  3. the cost of any additions or improvements you made to the property after you acquired it, if you did not claim these costs as a current expense (such as modifications to accommodate disabled persons); and

  4. for a building, soft costs (such as interest, legal and accounting fees, and property taxes) related to the period you are constructing, renovating, or altering the building, if these expenses have not been deducted as current expenses.

 

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
(b) is a parent of a child of whom the taxpayer is a parent

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:

 

  1. one corporation controlled the other (click HERE for definition of Control).

  2. or one corporation owned more than 10% of the voting shares of the other and the shares owned had a fair market value of more than 10% of the fair market value of all shares of the other corporation.

 

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:

 

  1. A foreign affiliate of the particular corporation or

  2. a foreign affiliate of a person resident in Canada with which the particular corporation does not deal at arm's length.

 

Control - For purposes of the Income Tax Act, there are at least 3 meanings of control. 

 

  1. De jure control refers to the right of control that rests in ownership of such a number of shares as to give the shareholder(s) a majority of the voting power of the corporation. De jure control is important in determining whether corporations are related, whether a corporation is a private (but not a Canadian-controlled private) corporation, whether there has been an acquisition of control triggering a deemed year end, whether a company is a controlled foreign affiliate, and other purposes. A person who has a right to acquire shares or to acquire the rights to acquire shares is considered to own shares for the purposes of this rule. As well, a person with a right to cause the redemption or cancellation of shares may be considered to have done so for the purpose of determining control.

  2. Extended De jure control refers to situations where a corporation is controlled if more than 50% of its voting shares are held by another corporation, persons with whom the other corporation does not deal at arm's length, or both.

  3. De facto control is part of the phrase, "controlled directly or indirectly in any manner whatever". Control in this sense occurs where the controlling party has any direct or indirect influence which, if exercised, would result in control in fact of the corporation. 

 

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):

  1. All positive investment income from property excluding carrying charges and capital gains.

  2. Positive real estate rental income (rental income) including recapture of CCA.

  3. Some other unusual items.

Investment Income Subtractions (not complete):

  1. All carrying charges excluding capital losses.

  2. Negative real estate rental income (rental losses)

  3. Some other unusual items.

 

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D

 

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:

 

  1. the forgiven amount requires the reduction of the following amounts in order: unapplied non-capital (business) losses of preceding years starting with the oldest losses, then farm losses of preceding years, then restricted farm losses of preceding years, then ABIL's of preceding years (click HERE for ABIL definition), then unapplied net capital losses of preceding years.

  2. Any forgiven amounts left over after 1. above, the taxpayer may elect to reduce in order: capital cost of depreciable property then the undepreciated capital cost of a prescribed class.

  3. Any forgiven amounts left over after 1. and 2. may be applied at the taxpayer's option to reduce in order: cumulative eligible capital, resource account balances, adjusted cost base (ACB) of non-depreciable capital property, ACB of shares or debt of unrelated companies, current year capital losses.

  4. any forgiven amounts left over after 1. 2. and 3. are included in income at the current capital gain rates (click HERE for current rates).

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:

 

  1.  a corporation from a taxable Canadian corporation or

  2.  from any other corporation resident in Canada (other than a non-resident owned investment corporation or corporation exempt from tax) and controlled by the recipient corporation

 

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:

 

  1. The issuing corporation is insolvent in fact;

  2. Neither the corporation, nor a corporation controlled by it, carries on a business;

  3. The fair market value of the shares are nil;

  4. And, it is reasonable to expect that the issuing corporation will be dissolved or wound up and will not commence to carry on business.

 

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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E

 

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:

  1. Add gross employment earnings and deduct union or professional dues and deduct employment expenses claimed as deductions.

  2. Add net self-employment business earnings or deduct net losses.

  3. Add net rental income or deduct net losses.

  4. Add royalties from work or invention.

  5. Add taxable support payments received.

  6. Add net research grants.

  7. Add employee profit sharing allocations.

  8. Add disability payments under CPP.

  9. Add supplementary EI payments (not regular EI payments).

  10. Deduct deductible support payments paid.

The following DO NOT qualify as earned income:

  1. Investment income.

  2. Taxable capital gains.

  3. Pension, RRSP, CPP, OAS, RRIF income.

  4. Retiring allowances.

  5. Death benefits.

  6. Scholarships or bursaries.

  7. Business income from a limited partnership.

 

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:

 

  1. Must relate to a business of the taxpayer.

  2. Must be Capital in nature. See HERE for definition of Capital Property.

  3. Must be incurred for the purpose of gaining or producing income from a business.

  4. The income gained must not be exempt from income tax, for example gambling income.

  5. Must not be deductible or depreciable under any other provision of the Income Tax Act. Examples include a 100% deduction for inventory sold or a partial deduction for CCA depreciation.

  6. Must be for the purchase of intangible property or tangible property not owned by the taxpayer.

  7. Must not be for an expense otherwise specifically disallowed under the Income Tax Act.

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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F

 

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:

 

  1. Cash denominated in a foreign currency if used for investment activity.

  2. Property, plant and equipment denominated in a foreign currency.

  3. Borrowed funds denominated in a foreign currency such as long-term and short-term debt if the funds would be considered to be used to offset an otherwise insufficient capitalization of the business and not used in the ordinary course of trading operations.

  4. Investments like marketable securities denominated in a foreign currency .

 

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:

 

  1. Cash denominated in a foreign currency if used for receipts or payments on the account of normal business income.

  2. Inventory denominated in a foreign currency related to trade activities.

  3. Trade Accounts Receivable denominated in a foreign currency .

  4. Trade Accounts Payable denominated in a foreign currency .

  5. Operating line of credit denominated in a foreign currency used to finance inventory purchases.

 

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:

 

  1. the forgiven amount requires the reduction of the following amounts in order: unapplied non-capital (business) losses of preceding years starting with the oldest losses, then farm losses of preceding years, then restricted farm losses of preceding years, then ABIL's of preceding years (click HERE for ABIL definition), then unapplied net capital losses of preceding years.

  2. Any forgiven amounts left over after 1. above, the taxpayer may elect to reduce in order: capital cost of depreciable property then the undepreciated capital cost of a prescribed class.

  3. Any forgiven amounts left over after 1. and 2. may be applied at the taxpayer's option to reduce in order: cumulative eligible capital, resource account balances, adjusted cost base (ACB) of non-depreciable capital property, ACB of shares or debt of unrelated companies, current year capital losses.

  4. any forgiven amounts left over after 1. 2. and 3. are included in income at the current capital gain rates (click HERE for current rates).

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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G

 

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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H

 

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I

 

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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J

 

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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K

 

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L

 

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M

 

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:

  1. cash

  2. trade accounts receivable

  3. trade accounts payable

  4. debt financing, whether short or long-term

  5. future income tax liabilities and assets

  6. revenues and expenses related to monetary items such as normal business revenue (related to trade accounts receivable) and normal business expenses (related to trade accounts payable)

 

The following are generally considered non-monetary items:

  1. investments such as marketable securities carried at cost

  2. inventory carried at cost

  3. prepaid expenses

  4. property, plant, and equipment (fixed assets)

  5. patents, trademarks, licenses, and formulas

  6. goodwill

  7. other intangible assets such as deferred charges

  8. deferred or unearned income

  9. share capital

  10. revenues and expenses related to non-monetary items such as cost of goods sold (related to inventory), depreciation and amortization (related to fixed assets, etc.), and investment income (related to marketable securities carried at cost)

 

 

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:

  1. cash denominated in a foreign currency

  2. trade accounts receivable denominated in a foreign currency

  3. trade accounts payable denominated in a foreign currency

  4. debt financing, whether short or long-term denominated in a foreign currency

  5. future income tax liabilities and assets denominated in a foreign currency

  6. revenues and expenses related to monetary items such as normal business revenue (related to trade accounts receivable) and normal business expenses (related to trade accounts payable) denominated in a foreign currency

 

The following are generally considered non-monetary foreign currency items:

  1. investments such as marketable securities carried at cost denominated in a foreign currency

  2. inventory carried at cost denominated in a foreign currency

  3. prepaid expenses denominated in a foreign currency

  4. property, plant, and equipment (fixed assets) denominated in a foreign currency

  5. patents, trademarks, licenses, and formulas denominated in a foreign currency

  6. goodwill denominated in a foreign currency

  7. other intangible assets such as deferred charges denominated in a foreign currency

  8. deferred or unearned income denominated in a foreign currency

  9. share capital denominated in a foreign currency

  10. revenues and expenses related to non-monetary items such as cost of goods sold (related to inventory), depreciation and amortization (related to fixed assets, etc.), and investment income (related to marketable securities carried at cost) denominated in a foreign currency

 

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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N

 

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:

  1. cash

  2. trade accounts receivable

  3. trade accounts payable

  4. debt financing, whether short or long-term

  5. future income tax liabilities and assets

  6. revenues and expenses related to monetary items such as normal business revenue (related to trade accounts receivable) and normal business expenses (related to trade accounts payable)

 

The following are generally considered non-monetary items:

  1. investments such as marketable securities carried at cost

  2. inventory carried at cost

  3. prepaid expenses

  4. property, plant, and equipment (fixed assets)

  5. patents, trademarks, licenses, and formulas

  6. goodwill

  7. other intangible assets such as deferred charges

  8. deferred or unearned income

  9. share capital

  10. revenues and expenses related to non-monetary items such as cost of goods sold (related to inventory), depreciation and amortization (related to fixed assets, etc.), and investment income (related to marketable securities carried at cost)

 

 

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:

  1. cash denominated in a foreign currency

  2. trade accounts receivable denominated in a foreign currency

  3. trade accounts payable denominated in a foreign currency

  4. debt financing, whether short or long-term denominated in a foreign currency

  5. future income tax liabilities and assets denominated in a foreign currency

  6. revenues and expenses related to monetary items such as normal business revenue (related to trade accounts receivable) and normal business expenses (related to trade accounts payable) denominated in a foreign currency

 

The following are generally considered Non-Monetary Foreign Currency items:

  1. investments such as marketable securities carried at cost denominated in a foreign currency

  2. inventory carried at cost denominated in a foreign currency

  3. prepaid expenses denominated in a foreign currency

  4. property, plant, and equipment (fixed assets) denominated in a foreign currency

  5. patents, trademarks, licenses, and formulas denominated in a foreign currency

  6. goodwill denominated in a foreign currency

  7. other intangible assets such as deferred charges denominated in a foreign currency

  8. deferred or unearned income denominated in a foreign currency

  9. share capital denominated in a foreign currency

  10. revenues and expenses related to non-monetary items such as cost of goods sold (related to inventory), depreciation and amortization (related to fixed assets, etc.), and investment income (related to marketable securities carried at cost) denominated in a foreign currency

 

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O

 

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P

 

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. The Income Tax Act defines Private Corporations if they were resident in Canada (regardless where incorporated) which is not a Public Corporation (defined HERE) or is not controlled directly or indirectly by one or more public corporations, by prescribed federal Crown corporations, or a combination of public and Crown corporations. Furthermore, a Private Corporation is a private corporation other than a Canadian Controlled Private Corporation (defined HERE).

 

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. The Income Tax Act defines Public Corporations if they are resident in Canada and if one the following is true:

 

  1. any class of shares of its capital stock are listed on a prescribed stock exchange in Canada.

  2. the company elects to be a public corporation on form T2073 on meeting prescribed conditions as to the number of shareholders, dispersal of ownership of shares, and size of the corporation.

  3. or, it has been designated by the Minister at a time when the conditions in 2. have been met.

 

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Q

 

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).

The “used in the course of carrying on a business of farming in Canada” has two rules, one of which must be true. The “general rule” applies regardless when the property was acquired and is a two part test that both parts must be met as follows:

1. the property must have been held for at least 24 months prior to the sale by the permitted users above and


2. in any two years of ownership by a family member or personal trust who is a permitted user described above, the gross revenue of the said user from the farming business in which the property was principally (>50%) used must have exceeded income from all other sources for the individual or where the owner of the real property is a family farm corporation or partnership, an individual who was a permitted user was for at least 24 months actively engaged on a regular and continuous basis in the farming business in which the property was used.

If a vendor fails to meet the above test may nevertheless qualify under a second rule if the real property was acquired before June 18, 1987 and if the property was used principally (>50%) in a farming business in Canada in the year of disposition or for at least five years during the time of ownership.
 

 

 

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: 

 

  1. The shares must be of a Canadian Controlled Private Corporation (defined HERE) which at the time of disposition, uses 90% or more of its assets either directly in an active business (defined HERE) carried on in Canada or as a holding company for such a corporation.

  2. The shares must be owned by the taxpayer, the taxpayer's spouse, or partnership related to the taxpayer (under the attribution rules HERE).

  3. The shares must not have been owned by anyone other than the taxpayer or a related person (Person defined HERE, Related Corporations defined HERE and Related Individuals defined HERE) during the 24 months preceding the disposition. Newly issued treasury shares (in the 24 month period) are disqualified but shares newly issued on incorporating a proprietorship or newly issued shares on a tax-deferred rollover to a holding company will not be disqualified.

  4. Throughout the 24 month holding period, at least 50% of the assets in the corporation must have been used principally (90% according to CRA) in an active business, or to finance a connected active business (click HERE for definition of Connected). 

 

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R

 

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:

 

  1. Canadian Controlled Private Corporations (CCPC's) pay a special refundable tax on investment income (passive interest, passive rents, capital gains, etc) 

  2. and other private corporations (which includes Canadian Controlled Private Corporations) pay a special refundable tax on certain taxable dividends (but not passive interest or passive rents) received in a year which are dividends from taxable Canadian corporations not connected with the corporation, dividends from taxable Canadian corporations connected with the corporation to the extent the payor corporation itself received a dividend refund, and dividends from foreign affiliates , other than connected foreign affiliates, to the extent of that portion of the dividend which is deductible under section 113 of the Income Tax Act. 

 

The refundable tax is:

 

  1. 26.67% on investment income except capital gains and dividends

  2. 13.33% on gross capital gains (or 26.67% on the taxable gain at 50% inclusion rate), 

  3. and 33.33% on dividends. 

 

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:

 

  1. they are controlled by the same person or group of persons (see definition of Control HERE and Person HERE)

  2. each of the corporations is controlled by one person and the person who controls one of the corporations is related to the person who controls the other corporation

  3. one of the corporations is controlled by one person and that person is related to any member of a related group that controls the other corporation

  4. one of the corporations is controlled by one person and that person is related to each member of an unrelated group that controls the other corporation

  5. any member of a related group that controls one of the corporations is related to each member of an unrelated group that controls the other corporation

  6. each member of an unrelated group that controls one of the corporations is related to a least one member of an unrelated group that controls the other corporation

 

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:

 

  1. one is the child or other descendant of the other

  2. they are siblings

  3. the are married to each other (includes common law)

  4. one is married to a person who is connected to the other as described in 1. and 2. (mother/father/brother/sister in laws)

  5. one has been adopted by the other, or by some person connected to the other as described in 1. above.

 

Remote Work Site - As defined in the Income Tax Act is a place you were required to work:

 

  1. where by the remoteness from any established community, you could not reasonably be expected to establish and maintain a self-contained domestic establishment and

  2. you were required by the terms of your employment to be away from your ordinary residence or to be at the location for a period of at least 36 hours.

 

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:

  1. used by the corporation or related corporation (defined HERE) primarily (more than 50% according to CRA) in Canada in carrying on an active business (defined HERE)

  2. or are shares or debt obligations of other SBC's which are connected (defined HERE) with the corporation. 

  3. or are a combination of assets all of which are described in either 1. or 2. above.

 

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:

 

  1. which was too far away from your ordinary residence to commute daily and

  2. you were required by the terms of your employment to be away from your ordinary residence or to be at the special location for a period of at least 36 hours.

 

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:

 

  1. the corporation employs in the business throughout the year more than 5 full-time employees

  2. or, in the course of carrying on an active business, any other corporation associated with it provides managerial, administrative, financial, maintenance, or similar services to the corporation and the corporation could reasonably be expected to require more than 5 full-time employees if those services had not been provided. 

 

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:

 

  1. a deemed disposition of a loan or deposit ceasing to be an eligible loan of an international banking centre business (paragraph 33.1(11)(a))

  2. a deemed disposition where a taxpayer acquires property for some purpose and later uses it for the purpose of gaining or producing income, or vice versa (subsection 45(1))

  3. a deemed disposition of a bad debt or a share, under the provisions of section 50

  4. a deemed disposition on the death of the taxpayer (section 70)

  5. a deemed disposition by a trust under subsection 104(4)

  6. a deemed disposition when a taxpayer becomes, or ceases to be, resident in Canada

  7. a disposition under the mutual fund reorganization rules of paragraph 132.2(1)(f)

  8. a deemed disposition where a life insurer changes the use of the property (subsection 138(11.3)

  9. certain dispositions under the mark-to-market rules applicable to financial institutions under subsection 142.5(2) and paragraph 142.6(1)(b)

  10. a deemed disposition of assets by an employee profit sharing plan under subsection 144(4.1) or 144(4.2)

  11. a deemed disposition where a corporation ceases to be exempt from Part 1 tax (subsection 149(10))

  12. the expiration of an option

  13. a disposition of a debt obligation where the loss was denied under paragraph 40(2)(e.1)

  14. a disposition by a corporation the control of which is acquired within 30 days after the disposition

  15. a disposition by a person that becomes or ceases to be exempt from tax under Part 1 within 30 days after the disposition

 

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: 

  1. a subsequent disposition of the substituted property so that neither the transferor nor an affiliated person owns the property; provided that during the 30-day period afterwards neither the transferor nor an affiliated person owns the substituted property, or another property identical to the substituted property that was acquired within the 30 days before the subsequent disposition of the substituted property;

  2. when the substituted property is no longer eligible capital property in respect of a business carried on by the transferor or an affiliated person;

  3. when the transferor becomes or ceases to be resident in Canada, if the eligible capital property would have been subject to the deemed disposition rules if it were still owned by the transferor;

  4.  if the transferor is a corporation, when it becomes or ceases to be exempt from Part 1 tax;

  5. if the transferor is a corporation, an acquisition of control of the corporation by a person or group of persons;

  6. if the transferor is a corporation, when a winding-up of the transferor begins, other than a winding-up into a parent corporation subject to the rollover provisions of the Income Tax Act.

 

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:

 

  1. a deemed disposition of a loan or deposit ceasing to be an eligible loan of an international banking centre business (paragraph 33.1(11)(a))

  2. a deemed disposition where a taxpayer acquires property for some purpose and later uses it for the purpose of gaining or producing income, or vice versa (subsection 45(1))

  3. a deemed disposition of a bad debt or a share, under the provisions of section 50

  4. a deemed disposition on the death of the taxpayer (section 70)

  5. a deemed disposition by a trust under subsection 104(4)

  6. a deemed disposition when a taxpayer becomes, or ceases to be, resident in Canada

  7. a disposition under the mutual fund reorganization rules of paragraph 132.2(1)(f)

  8. a deemed disposition where a life insurer changes the use of the property (subsection 138(11.3)

  9. certain dispositions under the mark-to-market rules applicable to financial institutions under subsection 142.5(2) and paragraph 142.6(1)(b)

  10. a deemed disposition of assets by an employee profit sharing plan under subsection 144(4.1) or 144(4.2)

  11. a deemed disposition where a corporation ceases to be exempt from Part 1 tax (subsection 149(10))

  12. the expiration of an option

  13. a disposition of a debt obligation where the loss was denied under paragraph 40(2)(e.1)

  14. a disposition by a corporation the control of which is acquired within 30 days after the disposition

  15. a disposition by a person that becomes or ceases to be exempt from tax under Part 1 within 30 days after the disposition

 

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:

 

  1. Real property situated in Canada (land and buildings). This excludes mortgage investments.

  2. All property used or held in a business carried on in Canada that is eligible capital property or inventory (with some exceptions).

  3. Shares of a corporation resident in Canada, other than a mutual fund corporation, in which the shares of that particular class are not traded on a prescribed stock exchange.

  4. Shares of a non-resident corporation which are not traded on a prescribed stock exchange if at any time during the 60 month period preceding the time at which taxable Canadian property status must be determined (usually the time of disposition) more than 50% of the fair market value of all the property of the non-resident corporation was made up of other taxable Canadian property and more than 50% of the fair market value of the shares disposed of is derived from any combination of other taxable Canadian property.

  5. An interest in a partnership if at any time during the 60 month period preceding the time at which taxable Canadian property status must be determined (usually the time of disposition) 50% or more of the value of the partnership interest was taxable Canadian property.

  6. Capital interest in a trust resident in Canada (other than a unit trust).

  7. A unit of a unit trust resident in Canada (other than a mutual fund trust).

  8. A unit of a mutual fund trust if at any time during the 60 month period preceding the time at which taxable Canadian property status must be determined (usually at the time of disposition) the non-resident and persons with whom the non-resident does not deal with at arms-length own 25% or more of the issued units of the trust.

  9. Other properties where professional advice should be sought.

 

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:

 

  1. Canadian resource properties.

  2. Timber resource properties.

  3. Income interest in a trust resident in Canada.

  4. Life insurance policy in Canada.

 

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:

 

  1. certainty of intention. It must be clear that it is the intention of the settlor to create a trust relationship.

  2. certainty of trust property. The property in question must be clearly identified or identifiable. The property must exist at the time with no contingencies to be satisfied.

  3. certainty of beneficiaries. The beneficiaries must be clearly identified or identifiable. 

 

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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Keith Anderson, BComm, CA-IT Copyright September 9, 1999 Last Modified :10/17/13 12:22 PM