Ocean Mist

« Older Entries Subscribe to Latest Posts

27 Aug 2020

Why Incorporate?

Posted by Tax Consultants. Comments Off on Why Incorporate?

Incorporating your practice

Tax Deferral

The tax deferral advantage available to an incorporated person may be substantial. This is because Canadian Controlled Private Corporations (as are most professional corporations) may be able to access the small business deduction under the ITA. More specifically, in an incorporated practice, the first $500,0001 of annual “business related profit” – the amount remaining after deducting all eligible expenses – may be eligible for the small business tax rate of about 13%-18% (depending on the province), which is significantly lower than top marginal personal income tax rates. A person who would otherwise pay tax at the top marginal personal tax rate may be able to defer the payment of tax by leaving money within the professional corporation to be used for investment or corporate debt repayment. This deferral advantage is equivalent to a tax-free loan from the government. Retaining income in the corporation may also create savings for retirement. On retirement, these savings may be distributed, usually by way of dividends to shareholders, during a time when you are in a lower tax bracket.

Income Splitting

Income splitting, which can be achieved in some provinces through the establishment of a family trust or through the payment of dividends to shareholding family members, can be an effective way to reduce the total tax bill paid by your family. Although the “kiddie tax” rules negate the advantage of distributing dividends to minors, you may still be able to reduce your overall family taxes by making distributions to your spouse and/or adult children if they are in a lower marginal tax bracket than yourself.

Timing

All partnerships, sole proprietorships, and professional corporations that are members of partnerships are required to use the calendar year as their fiscal period. Professional corporations that are not members of a partnership can have an off-calendar year-end, which can provide an opportunity for certain tax deferrals at a personal level.

Secondary Advantages

In addition to the primary advantages of tax deferral and income splitting, there are numerous miscellaneous secondary benefits that may be available to incorporated physicians. These include:

  • Individual Pension Plans
  • Capital gains exemption
  • Affordable Benefits
  • Flexibility – Salary vs. Dividend
  • Corporate Owned Universal Life Insurance
  • Cash Flow Maintenance
  • Retiring Allowance and Death Benefits
  • Employee Profit Sharing Plan

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

2 Sep 2020

VDP

Posted by Tax Consultants. No Comments

Voluntary Disclosure / Tax Amnesty

If you have never filed all your income tax returns or have filed them incorrectly, this page is for you. And you don’t need a costly tax lawyer to assist you with this.

What is Voluntary Disclosure?

Revenue Canada Voluntary Disclosure program, commonly referred to as tax amnesty or tax pardon, is a fairness program that allows for taxpayers to voluntarily declare income and file returns that have never been filed or have been filed incorrectly.

This program waives civil penalties and avoids criminal prosecutions for those who are volunteering to act in accordance with their legal responsibilities, as under the Income Tax Act and Excise Tax Acts by reporting their affairs before the Canada Revenue Agency (CRA) begins any action or investigation.

Persons that use this program will pay the taxes owing and interest but penalties will be waived. As well, policies exist that acknowledge uncontrollable circumstances and can provide relief from interest in certain situations.

Non-residents are also accommodated and if they meet requirements, and can extend their submission of section 216 returns.

This program also allows for anonymous disclosure under the No-Name Policy, which protects the identities of the complying taxpayers.

No-Name Policy

If a taxpayer decides to keep his or her identify anonymous and confidential, he or she will be able to proceed with disclosure, free of prosecution for 90 days.

The 90 day period begins from the effective date of disclosure, which is determined by the date of a written voluntary disclosure submission or the receipt of a VDP Taxpayer Agreement Form as received by the CRA tax services office.

This period allows for the taxpayer to prepare and submit a complete disclosure without any CRA interference or prosecution. This anonymity is even applicable if the unreported income has been earned off-shore or through criminal activity.

Who Does this program apply to?

Tax amnesty can be applied in several scenarios including:

– Failure to report income
– Income with inaccurate or missing information
– Income earned off-shore or from criminal activity
– Not filed tax returns
– Improper expense claims
– Not remitted source deductions
– Neglecting to retain of a portion of a purchase price on the acquiring of assets from non-residents under section 116 of the Act.

Requirements for Voluntary Disclosure

Four conditions must exist for an individual to use Voluntary Disclosure:

1.The disclosure must be voluntary. If you are already being investigated, it is too late. You must initiate the disclosure and contact the Canada Revenue Agency before they contact you!

2.The disclosure must be complete and accurate. Previously pardoned penalties will be applied if a person reveals only partial information or provides information with material errors.

3.The disclosure needs to involve a penalty. If no penalty exists, declare and file as usual.

4.Disclosure must be information that is over one year old or, if less than one year, not simply employed as an attempt to use this program to file late and avoid penalty.

Legislative References for Voluntary Disclosure

The CRA has the legislative authority to waive or cancel penalties, in whole or in part, on a voluntary disclosure. The pertinent legislative provisions can be found in:

– subsection 220(3.1) of the Income Tax Act
– section 88 of the Excise Tax Act
– section 281.1 of the Excise Tax Act
– subsection 3.3(1) of the Customs Act
– subsection 126(1) of the Customs Tariff

2 Sep 2020

Voluntary Disclosure Program

Posted by Tax Consultants. No Comments

Voluntary Disclosure / Tax Amnesty

If you have never filed all your income tax returns or have filed them incorrectly, this page is for you. And you don’t need a costly tax lawyer to assist you with this.

What is Voluntary Disclosure?

Revenue Canada Voluntary Disclosure program, commonly referred to as tax amnesty or tax pardon, is a fairness program that allows for taxpayers to voluntarily declare income and file returns that have never been filed or have been filed incorrectly.

This program waives civil penalties and avoids criminal prosecutions for those who are volunteering to act in accordance with their legal responsibilities, as under the Income Tax Act and Excise Tax Acts by reporting their affairs before the Canada Revenue Agency (CRA) begins any action or investigation.

Persons that use this program will pay the taxes owing and interest but penalties will be waived. As well, policies exist that acknowledge uncontrollable circumstances and can provide relief from interest in certain situations.

Non-residents are also accommodated and if they meet requirements, and can extend their submission of section 216 returns.

This program also allows for anonymous disclosure under the No-Name Policy, which protects the identities of the complying taxpayers.

No-Name Policy

If a taxpayer decides to keep his or her identify anonymous and confidential, he or she will be able to proceed with disclosure, free of prosecution for 90 days.

The 90 day period begins from the effective date of disclosure, which is determined by the date of a written voluntary disclosure submission or the receipt of a VDP Taxpayer Agreement Form as received by the CRA tax services office.

This period allows for the taxpayer to prepare and submit a complete disclosure without any CRA interference or prosecution. This anonymity is even applicable if the unreported income has been earned off-shore or through criminal activity.

Who Does this program apply to?

Tax amnesty can be applied in several scenarios including:

– Failure to report income
– Income with inaccurate or missing information
– Income earned off-shore or from criminal activity
– Not filed tax returns
– Improper expense claims
– Not remitted source deductions
– Neglecting to retain of a portion of a purchase price on the acquiring of assets from non-residents under section 116 of the Act.

Requirements for Voluntary Disclosure

Four conditions must exist for an individual to use Voluntary Disclosure:

1.The disclosure must be voluntary. If you are already being investigated, it is too late. You must initiate the disclosure and contact the Canada Revenue Agency before they contact you!

2.The disclosure must be complete and accurate. Previously pardoned penalties will be applied if a person reveals only partial information or provides information with material errors.

3.The disclosure needs to involve a penalty. If no penalty exists, declare and file as usual.

4.Disclosure must be information that is over one year old or, if less than one year, not simply employed as an attempt to use this program to file late and avoid penalty.

Legislative References for Voluntary Disclosure

The CRA has the legislative authority to waive or cancel penalties, in whole or in part, on a voluntary disclosure. The pertinent legislative provisions can be found in:

– subsection 220(3.1) of the Income Tax Act
– section 88 of the Excise Tax Act
– section 281.1 of the Excise Tax Act
– subsection 3.3(1) of the Customs Act
– subsection 126(1) of the Customs Tariff

2 Sep 2020

10-year limitation period

Posted by Tax Consultants. No Comments

The Federal Court of Appeal recently released its decision in Bozzer v. The Queen, 2011 FCA 186. Since the introduction in 2004 of a 10-year limitation period for interest and penalty relief under subsection 220(3.1) of the Income Tax Act, the CRA has administered the provision as if the 10-year period for applying for relief expires on December 31st of the 10th year following the taxation year assessed (i.e., December 31, 2010 for taxation year 2000).

In a resounding victory for taxpayers, Justice Stratas rejected the Minister policy. In line with practitioners, who have argued that interest accrues continuously and that the CRA administrative practice has no fairness rationale, Justice Stratas accepted Mr. Bozzer position that the 10-year limitation period is the 10 years that end with the taxpayer application for relief, regardless of the taxation year of the principal tax debt.

However, CRA has not changed its administrative practice. The CRA has not yet expressed any official response to the decision and it remains to be seen if the Minister will appeal to the Supreme Court of Canada or ask the Department of Finance to legislate over the decision.

2 Sep 2020

Farm Losses Revisited by SCC

Posted by Tax Consultants. No Comments

On Friday March 23, 2012, The Queen v. John R. Craig was heard by the Supreme Court of Canada (SCC). This was the first opportunity for the SCC to revisit the issue of restricted farm losses since its decision in Moldowan v. The Queen, [1978] 1 SCR 480. In Moldowan, the SCC concluded that farm losses could only be deducted against other sources of income, without restriction, if farming or a combination of farming and some other source of income was a taxpayer chief source of income. This vague direction resulted in over 30 years of inconsistent decisions from the courts below.

2 Sep 2020

Time to Rework

Posted by Tax Consultants. No Comments

Companies that offer stock option plans to their employees may have to quickly re-evaluate these arrangements following significant changes to the tax treatment of stock options announced in the 2010 federal budget. Many of these changes are effective for stock options exercised after 4:00 pm (EST) on March 4, 2010.

These measures change the tax treatment of stock option cash-outs and eliminate the opportunity to defer tax on the employment benefit resulting from exercising qualifying stock options in public companies and private companies that are non-Canadian controlled private corporations (non-CCPCs). The budget measures also require employers to withhold tax on benefits from employee stock options exercised after 2010.

For employees with underwater stock options, the budget measures may provide some welcome tax relief. This relief may be available for stock option benefits going as far back as 2001.

Background Tax treatment of stock options

A stock option plan is an arrangement whereby a corporation gives an employee the right (an option) to purchase its shares at a given price. The price may be above or below the market price at the time the option is granted.

When the employee exercises the option to acquire the shares, the difference between the price the employee pays for the shares and their market value is treated as a taxable benefit to the employee.

If certain conditions are met, the employee can claim a deduction of one-half of the taxable benefit. The effect of this deduction is to tax the employment benefit at the same rate as a capital gain.

Generally, public company employees may qualify for the deduction if:

  • The shares are normal common shares (not preferred shares)
  • The exercise price is at least equal to the fair market value of the shares at the time the option was granted
  • The employee deals at arm length with the corporation.

Before the 2010 federal budget, public company and non-CCPC employees were allowed to postpone the taxation on the benefit on $100,000 per year of qualifying stock options to when the shares were sold instead of when the options were exercised.

Stock options in Canadian controlled private corporations (CCPCs) are treated differently. As long as the employees deal at arm length with the corporation, the taxable benefit is reported when the employees sell the stock option shares, rather than when they exercise their options and acquire the shares. The 2010 federal budget does not affect these rules for CCPCs and their employees.

Stock option cash-outs

Some stock option plans have a stock appreciation right attached to them. Such plans allow the employee to receive a cash payment equal to the value of the options instead of purchasing the shares. In other words, the employee can cash out the options.

Before March 4, 2010, the same tax consequences for the employee resulted from the cash payment as from the issuance of shares — the employment benefit was included in income and the related one-half deduction was available if the required conditions were met. The employer could claim a deduction for the full amount of the cash payment.

The 2010 federal budget proposes to change these rules such that employees who receive a stock option cash-out can only claim the deduction of one-half of the employment benefit if the employer elects to forgo the deduction for the cash payment. If the employer does not make this election, it will be entitled to a corporate tax deduction for the payment but the employees must pay tax on the full value of the employment benefit. This change is effective for all stock options that are cashed out after 4:00 pm (EST) on March 4, 2010, regardless of when the options were issued.

The Department of Finance has not provided any grandfathering relief for stock option cash-out arrangements that were in place before the proposed changes to the rules in the 2010 federal budget. As such, employers and employees will need to reconsider the implications of any cash-out arrangements in place prior to March 4, 2010 before completing the transactions.

Finance has confirmed that an employer election to forgo the deduction for the cash payment when an employee cashes out his or her stock option rights can be made separately for each employee. In other words, it does not necessarily have to apply to all the employees in the stock option plan.

Finance has also indicated that the policy reason for not allowing employers to claim a deduction for a stock option cash-out payment is to preserve symmetry in the tax treatment of stock-based compensation. (When an employee exercises stock options and acquires shares, the employer does not get a deduction because it does not pay out cash.) This policy change also achieves more consistency with the U.S. tax treatment of stock options.

Example of new tax treatment of stock option cash-out
The following analysis illustrates the effect of the change by comparing the after-tax cost of stock option cash-outs to employees and employers under the old pre-budget rules and the new post-budget rules.

As the table shows, the employee after-tax proceeds of a $100 cash-out payment can remain the same pre- and post-budget at $77 (columns 1 and 2). However, the pre-budget regime caused the CRA to effectively lose a total of $7 in tax revenue per $100 of benefit, rather than receiving $23 in tax revenue from the employee. The reason for this tax revenue difference is the employer tax savings of $30 from claiming a deduction for the $100 cash payment to the employee.

Post-budget, the elimination of the employer tax deduction results in the CRA receiving $23 per $100 of benefit (when the employer elects to forgo the deduction (column 2)). If the employer does not elect to forgo the deduction (column 3), the CRA receives $16 in tax (compared to $23) but the net after-tax proceeds to the employee fall to $54 because the employee cannot claim the stock option deduction.

Tax Results of Pre- and Post-Budget Employee Cash-Outs
Pre-Budget Post-Budget
Cash-Out Cash-Out
with Election1
Cash-Out
No Election
Employer Cash Paid $100 $100 $100
Tax Savings @ 30% (C)2 30 30
Net After-Tax Cost to Employer $70  $100 $ 70
Employee Cash Received $100 $100  $100
Less Stock Option Deduction 50 50
Taxable Income 50 50 Â100
Tax thereon @ 46% (P)3 (23)  (23) (46)
Net After-Tax Proceeds to Employee $ 77 $77  $54
CRA perspective: Net tax
revenue lost (received) (C –
P)
$ 7 $(23) $(16)
1)The employee and employer will get the same tax result as the cash-out with election if
the employee acquires the shares instead of taking the cash-out.

2)Assuming a 30% corporate tax rate, $100 deduction equals $30 in tax savings.

3)Assuming a combined federal/provincial top marginal personal tax rate of 46%.

The table illustrates that the cash-out without the employer election to forgo the deduction may be the least appealing, even though less tax is paid initially, because the employee is significantly worse off.

If the employer did not elect to forgo the deduction (column 3), the employee would get a better result (from a tax point of view) by acquiring the shares instead of taking the cash-out option. The employee could then sell the shares to achieve the same cash position as the cash-out option with the employer election to forgo the deduction.

Accounting implications of tax changes
In situations where employees holding options to acquire shares under an employee stock option plan are entitled or can choose to receive cash in lieu of shares and they elect to receive those cash payments, these cash-settled grants were generally classified in the financial statements as a liability.

For Canadian GAAP purposes, transactions settled in equity instruments are generally classified as equity-settled awards and other transactions are classified as liability (cash-settled awards).

For these cash-settled awards, the company may have recorded a future tax asset on the basis that it will receive a deduction when the employee ultimately elects to receive cash payments and the cash payment is made. The proposed budget changes may require the company to review its accounting treatment of its future tax asset.

In addition, as a result of the proposed budget changes, companies may choose to modify the terms of their existing stock option agreements such that their existing liability classified stock option awards are reclassified as equity-settled awards. In these cases, they need to carefully consider the accounting treatment for the change in terms and conditions.

Deferral of stock option taxable benefit

Before the 2010 federal budget, public company employees who exercised stock options could generally defer tax on the related taxable benefit on up to $100,000 of annual qualifying employee stock options until the shares were actually sold. The budget proposes to eliminate this deferral, effective for stock options exercised after 4:00 pm (EST) on March 4, 2010.

As such, employees who exercise stock options after 4:00 pm (EST) on March 4, 2010 will not be able to defer tax on any of their employment benefit.

Employer withholding tax requirements

The budget states that, for benefits arising on the issuance of securities after 2010, employers must withhold tax on a stock option employment benefit from the employee pay. The amount of the withholding can be reduced for the 50 percent stock option deduction if the employee qualifies for the deduction.

As a result, employees who exercise stock options after 2010 will effectively have to pay the tax right away, rather than when they file their tax return for the year.

This tax withholding measure does not apply to options granted before 2011 under a written agreement entered before 4:00pm (EST) on March 4, 2010, if the agreement includes restrictions on the optioned shares disposition.

Background

Before the budget, employers were technically required to withhold tax on the employment benefit at the time of exercise. However, if the employee was not paid any cash, the CRA administratively waived the tax withholding requirement on the benefit for Canadian resident employees.

The budget does not provide details on how the employer will, as a practical matter, withhold the appropriate tax on the employment benefit when the employee does not receive any cash compensation on the exercise of the stock option.

Presumably, the employee will have to provide cash to the employer so that the employer can remit the required employee withholding tax to the CRA. Non-CCPC private companies will unfortunately place their employees in a difficult position where no market in which to sell the shares is available to the employee. Amendments to such plans will likely be necessary.

Employees who exercise stock options will need to keep in mind when considering whether to sell any of the shares that they will effectively need to have funds to pay a tax liability as soon as they exercise their options.

Underwater stock options

Shares purchased through a stock option plan are usually expected to increase in value. However, some employees who exercised stock options and did not sell the shares right away may have seen the shares value fall since the day they exercised their options.

Depending on how much the shares value has fallen, employees with these underwater stock option shares who deferred the taxable benefit when they exercised their options (as described above) could end up with a deferred tax liability greater than the value of the shares. The budget proposes a special election that the employee can make to ensure that any tax liability on the deferred stock option benefit, when realized, does not exceed the proceeds from the shares disposition.

Effectively, the election mechanism converts the taxable employment benefit from the employee income into a deemed taxable capital gain. In exchange, the employee pays a special tax equal to the actual proceeds received on the sale of the shares. By making the election, the employee applies the capital loss realized on the disposition of the shares to the deemed taxable capital gain, thereby using allowable capital losses that otherwise must be applied to taxable capital gains.

As such, employees who deferred the taxable benefit on a stock option exercise and who dispose of the shares for proceeds less than the taxable benefit can elect to pay tax equal to the proceeds of disposition instead of paying tax on the taxable benefit. To take advantage of the election, the employee must make the disposition before 2015.

In assessing whether they should take advantage of the special relief, employees should keep in mind that the election reduces the potential for tax relief from using the capital losses otherwise available on the underwater shares against capital gains realized from disposing of other property.

Relief available as far back as 2001
The budget proposes to allow these elections for the previous 10 years (which goes beyond the normal three-year assessment period). Thus, it may be possible for employees to go back as far as 2001 to obtain relief for a deferred employment benefit that was realized on shares that were sold before the March 4, 2010 budget announcement.

To take advantage of this tax relief, employees must make the special election on or before their tax return filing due date for 2010 (generally April 30, 2011). For dispositions after 2010 but before 2015, the deadline for making the election will be the tax filing due date for the year the disposition occurs.

Example of underwater stock option election
The following example illustrates the tax consequences of making the underwater stock option election.

Assume that Mr. X is granted a stock option by his public company employer (Pubco) in 2008, when the fair market value of the Pubco shares equals the exercise price of $1,000. Mr. X exercises the option in 2009, when the fair market value of the shares has increased to $10,000. Thus, Mr. X has a taxable employment benefit of $9,000 in 2009 ($10,000 fair market value minus $1,000 exercise price). Mr. X chooses to defer the $9,000 employment benefit until he disposes of the shares. However, by 2010, the fair market value of the shares has declined to $1,000. Mr. X chooses to dispose of the shares in July 2010.

The following table illustrates the results of Mr. X making the underwater stock option election. This analysis assumes that Mr. X is subject to a combined federal/provincial top marginal tax rate of 46%.

Tax Consequences of Underwater Stock Option Election
No Election Election
Employment Benefit 2010 $9,000 $9,000
Stock Option Deduction (4,500)  (9,000)
Deemed Taxable Capital Gain1  4,500
Allowable Capital Loss2 (4,500)
Taxable Income $4,500 $
Tax @ 46% 2,070
Special Tax (Proceeds of Disposition)  N/A $1,000
Total Tax $2,070  $1,000
1)Deemed capital gain equals ½ of the lesser of the employment benefit
and the capital loss (both $9,000 in this example).2)Allowable capital loss realized offsets deemed capital gain.

As the table shows, by making the election, Mr. X will reduce his normal $2,070 tax liability to $1,000. With the election, he claims a $9,000 deduction to remove the entire employment benefit from his income but instead he has to include in his income a deemed taxable capital gain of $4,500 ($9,000 benefit — 50% capital gain inclusion rate). He is then able to use his allowable capital loss of $4,500 ($10,000 cost base of the shares $1,000 proceeds = $9,000 — 50%) to offset the deemed capital gain of $4,500. Thus, no capital loss remains for carryover.

Making this election completely eliminates Mr. X regular tax liability for the employment benefit/capital gain and uses up his capital loss. He is then left with paying the special tax equal to his proceeds of disposition of $1,000. This results in a current tax savings of $1,070 ($2,070 -$1,000).

However, if Mr. X expects to realize capital gains that he could use his allowable capital loss of $4,500 to offset, he may be better off not making the special relief election. In this situation, he would carry over the $4,500 capital loss and apply it against $4,500 in taxable capital gains to realize tax savings of $2,070 ($4,500 — 50%). Doing this would completely offset the $2,070 tax cost of the employment benefit while allowing him to keep the $1,000 proceeds from disposing of his underwater shares.

Generally, to make the special relief election worthwhile, an employee would have to see a significant drop in the value of the stock option shares (e.g., a loss of at least 80 percent of the stock value in our example) and not be able to use the related capital losses to reduce tax on other gains.

Also, depending on the exercise price, even if the shares significantly decline in value, an election may not be beneficial if the proceeds of disposition of the stock option shares are high in relation to the taxable employment benefit.

If the shares sale proceeds exceed the tax on the deferred taxable benefit, the election is not helpful.

Non-arm length employees stock options

The 2010 federal budget proposes to amend the income tax rules to clarify that the disposition of rights under a stock option agreement to a non-arm length person results in an employment benefit at the time of disposition (including cash out). Although the government considered that these benefits were taxable in these circumstances under existing tax rules, it also believed that clarification of these rules was warranted.

2 Sep 2020

Trust Residence

Posted by Tax Consultants. No Comments

On April 12, 2012, the Supreme Court of Canada (SCC) released its decision in Fundy Settlement v. Canada (2012 SCC 14). This case was the SCC first opportunity to consider the appropriate test for determining the residence of a trust for tax purposes.

Prior to this case, it was widely believed that the residence of a trust was determined by reference to the residence of its trustee. This conventional wisdom had been challenged by the Minister of National Revenue in its assessment of the Fundy Settlement.

The lower courts agreed with the Minister that the appropriate test was not the residence of the trustee, but the corporate central management and control test (CMC test). In a terse 19 paragraph decision, the SCC agreed with the courts below.

The case was about a trust that had a Barbados-resident trust company as its trustee and Canadian-resident individuals as the beneficiaries. When the trust disposed of shares of an Ontario corporation, it remitted withholding tax to the Minister of National Revenue on account of the capital gain realized by the trust. The trust then sought to obtain a refund of the Canadian withholding tax on the grounds that the trust was resident in Barbados and, thus, exempt from Canadian capital gains tax under the Canada-Barbados Tax Treaty.

The Minister challenged this position, asserting that the trust was resident in Canada because the role of the trustee was limited and the Canadian-resident beneficiaries were actually managing the trust.

The SCC concluded that, as with corporations, the residence of a trust should be determined by the principle that a trust resides where its real business is carried on, that is, where the central management and control of the trust actually takes place. In reaching its decision, the SCC concluded that corporations and trusts are similar because the function of both is the management of property, and that the application of the CMC test to trusts would promote consistency, predictability and fairness.

The SCC did not reject the possibility that the residence of a trust could coincide with the residence of its trustee, but only when the trustee carries out the function of centrally managing and controlling the trust in the trustee place of residence. In the case of the Fundy Settlement, it was found that the Canadian-resident beneficiaries were managing the trust with the result that the trust was resident in Canada.

2 Sep 2020

Attribution Case

Posted by Tax Consultants. No Comments

On July 13th, 2012, the Federal Court of Appeal dismissed the Crown appeal in The Queen v Peter Sommerer (2012 FCA 207)

In 1996, Peter Sommerer father, Herbert Sommerer, created an Austrian private foundation of which Peter, his wife and children were beneficiaries. Peter then entered into an agreement with the foundation to sell it certain shares at fair market value. The foundation used part of its endowment money to pay Peter for the shares. The foundation later sold the shares and realized a capital gain.

The main issue in the case was whether subsection 75(2) of the Income Tax Act (Canada) should be interpreted to apply in the context of the fair market value sale of shares, such that the capital gain realized by the foundation could be attributed back to Peter.

The Crown argued that the capital gains realized by the foundation should be attributed to Peter because it was possible that the shares or property substituted for the shares (including the proceeds of their sale) might be distributed to him as a beneficiary. In other words, the Crown argued that subsection 75(2), which generally applies in respect of the settlement of a trust where the settlor is also a beneficiary, should also apply in respect of property that has been purchased by a trust from a beneficiary at fair market value.

The Tax Court of Canada found in favour of the taxpayer on the basis that subsection 75(2) could not apply to a beneficiary in respect of property sold to a trust at fair market value. The Court main conclusion was that once properly unraveled and viewed grammatically and logically, the only interpretation is that only a settlor, or a subsequent contributor who could be seen as a settlor, can be the the person for purposes of subsection 75(2) of the Act.

A unanimous Federal Court of Appeal upheld the Tax Court decision. Since Peter was neither the settlor not a subsequent contributor (because the property was sold at fair market value), the Court held that subsection 75(2) did not apply to attribute the capital gains realized by the foundation to him.

2 Sep 2020

Carrying on business in Canada

Posted by Tax Consultants. No Comments

In the past 15 years, direct investment in Canada has more than tripled in value; more than 65% of that investment has come from the U.S. It is anticipated that this figure will continue to grow as U.S. corporations seek to expand their markets. This item discusses the basic Canadian tax issues facing U.S. corporations seeking to expand their businesses into Canada and the use of limited liability companies (LLCs) and unlimited liability companies (ULCs).

Taxation of Nonresident Corporations

Under Canadian law, nonresident corporations are subject to income taxes in Canada when they carry on a business there or dispose of taxable Canadian property (generally real estate, property used in a Canadian business and private company shares). These corporations will be subject to tax at ordinary rates, which range from 31% to 39% depending on the province to which the income is allocated.

In addition to income taxes, nonresident corporations are subject to a branch tax of 25% of the profits deemed to have been repatriated to the U.S. The amount is determined by formula and is designed to replicate the withholding tax that would have been imposed had those corporations carried on their Canadian business indirectly through a Canadian corporation that distributed its after-tax business earnings via dividends

Defining “Carrying on Business”

A question often asked is, “what level of Canadian business activity can a nonresident corporation engage in before being deemed to be carrying on business in Canada?” The term “carrying on business” is not specifically defined in the Canadian Income Tax Act (Act); rather, a common-law definition has evolved from the U.K. and Canadian courts. In addition, Act Section 253 provides an extended meaning of the term that deems a nonresident to be carrying on business in Canada if it:

1. Produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs anything in Canada;

2. Solicits orders or offers anything for sale there through an agent or servant, whether the contract or transaction is completed inside or outside of Canada; or

3. Disposes of certain resource properties or Canadian real estate.

Accordingly, the level of Canadian activity required to be deemed to be carrying on business there is very low. U.S. resident corporations can usually find relief in the Convention between the United States of America and Canada with respect to Taxes on Income and on Capital, signed September 26, 1980 (Treaty).

Treaty Provisions

The Treaty generally provides relief for U.S. residents via Article VII, Business Profits. This Article states that a U.S. resident will not be taxable in Canada on business profits unless it carries on a business there via a permanent establishment (PE) situated in Canada. When there is a Canadian PE, all business profits allocable to it may be taxed there.

Article V, Permanent Establishment, defines a PE to include:

1. Place of management, a branch, an office, a factory, a workshop and a mine or oil and gas well;

2. Building site or construction or installation project that lasts more than 12 months;

3. Person acting in Canada on behalf of a U.S. resident if that person has, and habitually exercises in Canada, the authority to conclude contracts.

A PE is deemed not to include a fixed place of business used solely for storage, display or delivery of goods or for the purchase of goods. In addition, the fact that a U.S. corporation has a Canadian subsidiary that carries on business there via a PE will not result in the U.S. parent having a PE in Canada.

Accordingly, when treaty protection is available, it is possible to carry on business in Canada, within these limits, without being subject to Canadian income taxes. Note: Canada requires a nonresident carrying on business in Canada, but exempt from Canadian tax because of Treaty provisions, to file an annual information return; see Act Section 150(1)(a).

Article 10, Dividends, also reduces (and in some case eliminates) various withholding taxes and exempts the first C$500,000 of branch profits from Canadian branch tax.

The LLC Trap

The popularity of U.S. LLCs in the last few years has led these entities to establish Canadian branches or subsidiaries. While an LLC may be disregarded or treated as a partnership for U.S. tax purposes, it will be treated as a corporation for Canadian tax purposes. This differing treatment generally does not cause any problems in inbound-to-Canada planning, and can provide some significant opportunities in the area of cross-border financing structures.

The LLC trap is caused by the fact that Canada does not consider a disregarded LLC, or an LLC treated as a partnership, to be a U.S. resident for Treaty purposes; thus, it does not afford treaty benefits to such an LLC. This is became Article IV, Residence, defines a resident of a contracting state as a person that is subject to tax in that state. Because a disregarded LLC or an LLC treated as a partnership is not subject to tax in the U.S., it is not deemed to be a U.S. resident. Thus, an LLC carrying on business in Canada:

* Will be taxable in Canada, whether or not it is operating through a PE;

* Will be subject to 25% withholding tax, if it receives interest, dividends and royalties from a Canadian resident;

* Will not be eligible for the C$500,000 branch tax exemption; further, the branch tax will be imposed at 25%, rather than the 5% Treaty rate.

There are also negative consequences for an LLC that forms a Canadian subsidiary. While the subsidiary will still be taxed at regular Canadian rates, the withholding tax on dividend distributions will be 25%.

It is widely anticipated that the next protocol to the Treaty will resolve the LLC trap; however, it is not known when it will be completed. Accordingly, if an LLC is considering expansion into the Canadian market, it is vital that a Canadian tax adviser be consulted before commencing operations there.

ULCs

A special type of Canadian corporation, the ULC, has become very popular with cross-border planners over the last few years, due to the opportunities presented by its hybrid classification. It is treated as a corporation for Canadian tax purposes and may be treated as a disregarded or flowthrough entity for U.S. tax purposes. In the past, this type of corporation could only be formed in the province of Nova Scotia; very recently, the province of Alberta passed legislation allowing ULC formation there, too; compare the Nova Scotia Companies Act to the Alberta Business Corporations Amendment Act (Bill 16, 5/17/05). Some of the advantages “of using a Canadian ULC include:

1. When an S corporation carries on business in Canada through a PE, the use of a ULC can reduce the effective tax rate, by allowing the S shareholders access to foreign tax credits that would not be available if the S corporation had used a regular Canadian corporation. A qualified subchapter S subsidiary is often used to shield the parent S corporation from liabilities arising from the Canadian operations, as a ULC does not provide liability protection.

2. The use of a ULC allows losses to flow through to the U.S. parent.

3. When a ULC is disregarded for U.S. purposes, transfer pricing issues are simplified; only the Canadian authorities must be satisfied, as the transfer price does not affect U.S. taxation.

4. A ULC instead of a Canadian branch also simplifies Canadian transfer pricing issues, as there is more guidance available on establishing transfer prices between two corporations than on determining the profits that should be allocated to a PE under the Treaty.

5. The use of a ULC instead of a regular Canadian corporation avoids the complexities of the U.S. controlled foreign corporation and passive foreign investment company rules.

6. The ULC can be very useful in developing cross-border financing structures that can significantly reduce the effective cost of capital.

7. In an acquisition, it may be possible to step up the basis of the assets of a Canadian target corporation by “converting” it to a ULC.

The cost of incorporating and maintaining a ULC has risen over the past several years, due to increased fees being charged by Nova Scotia; however, with the competition provided by Alberta’s ULC legislation, it is anticipated that these costs will now decrease.

Conclusion

While this item has discussed some of the basics of Canadian taxation of nonresidents and some issues surrounding the use of LLCs and ULCs, there are many more considerations for a U.S. corporation seeking to expand into the Canadian marketplace; it will be vital for U.S. and Canadian tax planners to work together to find the most effective structure for both sides of the border

2 Sep 2020

GST/HST to Independent Medical Evaluations

Posted by Tax Consultants. No Comments

Please call us today for a free consultation: 604-642-6157

 Supplies of health care services

DRAFT FOR DISCUSSION PURPOSES ONLY

Introduction

In a Tax Court of Canada decision concerning

The Court concluded that the individuals were “patients” of the Riverfront facility because they attended the facility to be examined by a physician. The Court concluded that because Riverfront provided the examination rooms and other equipment necessary for the examinations and remunerated the physicians for the examinations and reports, Riverfront supplies of IMEs and reports fell within the exemption provided in section 2 of Part II of Schedule V to the ETA. This provision exempts a supply made by the operator of a health care facility of an institutional health care service rendered to a patient of the facility. Thus, for an IME to be an exempt supply, the activities that comprise the IME must fall in one of the exemptions in the ETA.

In view of the Court comments regarding the physicians examinations, we reviewed our position on the tax status of supplies made directly by physicians of IME reports, as well as evaluations supplied by other health care professionals. Our position is noted below.

Riverfront Medical Evaluations Ltd. v. Canada (“Riverfront”), the issue was whether a corporation supplies of independent medical evaluation (“IME”) reports to insurance companies and lawyers were “institutional health care services” supplied by the operator of a health care facility and rendered to patients of the facility. Essentially, the Court found that an IME consisted of medical care because it consisted of a physical examination of an individual by a physician. In addition, the Court found that Riverfront was a “health care facility” for purposes of the Excise Tax Act (the “ETA”) because the physical examinations were provided at Riverfront facility.

Under the Excise Tax Act (the Act), exemptions from the GST/HST for supplies of medical and certain other health care services are generally limited to those made by suppliers who are engaged in the practice of a particular profession and who are licensed or certified under the laws of a province to practice the particular profession. These suppliers are defined in the Act.

For instance, a supply of a consultative, treatment, diagnostic or other health care service rendered to an individual is exempt for GST/HST purposes when a medical practitioner makes the supply. A medical practitioner is defined as a person who is licensed under the laws of a province to practice the profession of medicine or dentistry

In addition, a supply of an optometric, chiropractic, physiotherapy, podiatric, osteopathic, audiological, speech-language pathology, occupational therapy, or psychological service rendered to an individual is exempt when a practitioner supplies the service. A practitioner is defined in the Act as a person who practices the profession relevant to one of these services and who is licensed or otherwise certified to practice that profession (if required in the province where the service is supplied) or has the qualifications equivalent to those necessary to be so licensed or certified in another province (if not required in the province where the service is supplied). Please note that it is possible for a corporation to qualify as a medical practitioner or practitioner.

2 Sep 2020

International Taxation

Posted by Tax Consultants. No Comments

Non-residents who conduct business in Canada, earn Canadian income or own taxable Canadian property are required to report and file Canadian income tax returns. Failure to file the required withholding taxes and remittances to CRA can result in severe tax penalties, significant amounts of interest on back taxes, increased accounting and legal costs, and could even tie up proceeds from the sale of Canadian property for extended periods of time.

We have experience in preparing and filing NR4, NR6 and Section 216 tax returns with Canadian tax authorities for non-residents and obtaining Clearance Certificates from CRA.

We have also helped many non-residents obtain favourable results under Voluntary Disclosure rules for waiving CRA penalties.

2 Sep 2020

Recent case

Posted by Tax Consultants. No Comments

Are Management fees deductible?

Tax planning to use tax losses in a corporate group structure may be allowed by the Canada Revenue Agency , using management fees as a tool for that planning may not be. As the recent case, Les Entreprises Rejean Goyette Inc. v. Her Majesty the Queen (2009 CCI 351), in which the Tax Court of Canada (TCC) denied the taxpayer’s deduction of inter-corporate management fees because there was no formal management agreement and, therefore, no legal obligation to pay them.

2 Sep 2020

Stock option

Posted by Tax Consultants. No Comments

Stock option plans are quite often an integral part of an employee compensation package to create long term capital use in retirement. Companies implement these plans to attract, reward and retain highly skilled employees.

What is a stock option?

A stock option allows the employee to purchase a certain number of shares at a specified price (The option price) for a specified period of time. Often there is a holding period during which the employee cannot exercise the option. Once this holding period is over, the option is considered vested and the employee can exercise the option any time thereafter until the expiry date, if any.

This article will review the different tax rules associated with option plans for Canadian-controlled private corporations (CCPCs) and non-CCPCs i.e. Canadian public corporations.

Taxation of stock options from Canadian public companies

While there are no tax consequences when such stock options are granted, at the time the employee exercises the option they trigger an ‘option benefit. This benefit is equal to the difference between the market value of the stock and the ‘option price. This benefit must be included in the employees income from employment in the year in which the option is exercised. The employee can claim a tax deduction equal to one-half of the option benefit if the shares are common shares and the exercise price, at the time the options were granted, was equal to the fair market value of the shares.

For example:

  • You have options to acquire 3000 common shares of ABC
    Company at $30 per share (equal to the fair market value of the shares on the date the options were granted).
  • Current market value of ABC common shares is $75.
  • All options are vested.
  • If all 3000 shares are exercised, the taxable option benefit is $67,500 ($75-$30 = $45 x 3000 shares x 50%).

Taxation of stock options from Canadian controlled private corporations

Employees of CCPCs do not need to include the ‘option benefit in income until the year in which the employee disposes the shares. As with non-CCPC shares, the option benefit may be reduced by one-half as long as the exercise price at the time the options were granted was equal to the fair market value of the shares. If it does not meet these criteria, an employee may be able to access another one-half deduction as long as the shares have been held for at least two years at the date of sale.

Deferring the ‘Option Benefit’

The 2000 Federal budget introduced a deferral of the ‘option benefit for non-CCPCs until the employee sells the shares, or is deemed to have disposed of the shares on death or on becoming a non-resident of Canada. This deferral applies to options exercised after February 27, 2000, regardless of when the options were issued.

The amount that may be deferred is limited to the benefit arising on $100,000 worth of stock options vested in a particular year. While the $100,000 amount is based on the fair market value of the shares at the time the option is granted, the actual benefit that can be deferred can be much greater.

This can best be illustrated by example:

In January 2000, an employee received 10,000 qualifying shares at an option price of $25 per share equal to the fair market value at the time of grant.

Of the 10,000 options, 5,000 vested in January 2001 and the
remaining 5,000 in January 2002.

On December 1, 2002, all options were exercised. The fair
market value of the shares on that date was $60.

In 2004, the employee sells all 10,000 shares at a fair market value of $65 per share.

2002 Tax Calculation:

Step One – Calculate the number of shares that can be deferred.

The $100,000 maximum deferral is based on the $25 fair market value. Therefore the income benefit that the employee can defer in our example is based on 4,000 shares per vested year ($100,000 / $25).

Step Two – Calculate the income deferral.

(Number of shares * benefit per share)

2001 deferral = $140,0000, (4,000 shares * $35 ($60-$25))

2002 deferral = $140,0000, (4,000 shares * $35 ($60-$25))

Total deferral – $280,000

Step Three – Calculate the income benefit.

2001 income inclusion = $175,000, (5,000 x ($60-$25 = $35))

2002 income inclusion = $175,000, (5,000 x $60-$25=$35))

Total income before deferral – $350,000, less deferral (from Step Two) = $280,000

Total income reported in 2002 = $70,000

Of this $70,000 only 50% is taxable at the employees marginal tax rate.

2004 Tax Calculation

The employee now pays the tax on the $280,000 option benefit that was deferred and the gain on the shares from 2002 to 2004 ($65-$60 x 10,000 shares = $50,000). The total
income reported when the shares are sold is $215,000 ($330,000 x 50%)

Note: If the value of the shares have declined when you eventually sell, you will realize a capital loss but still be liable for the tax on the option benefit.

An employee who receives stock options for a public company and elects to defer the taxable benefit of up to $100,000 per annum (under subsection 7(8) of the Canadian Income Tax Act) until the shares are disposed of must report the taxable benefit (receipt of the stock option) at the time of disposition (on form T1212) and must pay Canadian income tax at that time.

Note: The above article is for information purposes only and should not be construed as offering tax advice. Individuals should consult with their personal tax advisors before taking any action based upon the information in this article.

2 Sep 2020

Luxembourg

Posted by Tax Consultants. No Comments

Luxembourg Foreign Investment

The Luxembourg government actively encourages foreign investment. There are no formalised legal regimes aimed at foreign investment as such (other than the tax-exempt holding companies and collective investment funds ) but on an ad hoc basis the government offers a variety of types of assistance including guarantees, cash, tax incentives, subsidised loans, assistance with development and construction projects etc.

Luxembourg has a wide range of customised investment incentives specifically for new ventures to the principality. This includes the offer of land with favourable conditions at one of the country municipal business parks or national industrial parks which are equipped with the infrastructure necessary to support a successful business.

In addition, there are incentives for investment available to Luxembourg and foreign investors alike under the laws of 28th July 1923 and 27th July 1972.

Luxembourg Tax Treatment of Offshore Operations.

Offshore companies are taxed as follows :

  • Holding companies formed under the law of 31st July 1929 are exempt from income taxes (the IRC and the Municipal Business Tax on Profits) and from the Fortune Tax. No tax is levied on the transfer of shares, and there are no taxes due on the liquidation of a 1929 Holding Company. No withholding tax is due on dividends payable to a 1929 Holding Company. (NB 1929 holding companies can no longer be formed.)
  • 1929 Holding Companies are subject instead to the capital contribution tax  of 1% of subscribed capital, either on formation or on a later capital increase, and to the subscription duty (taxe dabonnement) which amounts to 0.20% of the value of the shares issued by the Holding Company, payable annually in four equal instalments. If shares are quoted, the value is the current market value; if there is no quotation, the paid-in value is used. There are adjustments if dividends are paid out during the year, if profits are written to reserves, or if losses are incurred. Under legislation which came into effect in 2004, in order to satisfy the EU˜harmful tax practices initiative:

A 1929 holding company loses its tax-exempt status if at least 5% of its dividends received relate to foreign participations that are not subject to tax at a rate comparable to the Luxembourg corporate income tax rate. An effective tax rate is considered to be comparable if it is at least 11%, equating to approximately one-half of the current corporate income tax rate that applies to regular resident taxpayers and is in line with the tax rate generally applicable to dividends received from participations that do not qualify for a full exemption.

Further, the taxable base needs to be determined under a method similar to the methods used in Luxembourg. An auditor or accountant is required to certify annually that the eligibility requirements have been met. A 1929 holding company that loses its tax-exempt status is subject to the normal corporate income tax regime.

For newly incorporated 1929 holding companies, the amendment applied as from 1 January 2004. For existing 1929 holding companies (i.e. those incorporated under the law applicable before 1 January 2004), the new rules will not apply before they are terminated in 2010.

  • Milliardaire Holding Companies are taxed on the basis of various percentage rates applied to interest paid out and dividends distributed by the company, and on the remuneration and fees paid to directors, auditors and liquidators residing less than six months of the year in Luxembourg. The minimum annual tax liability of a Milliardaire Holding Company is much less than an equivalent 1929 Holding Company would pay. (NB Milliardaire holding companies can no longer be formed.)
  • Financial Holding Companies are taxed on the same basis as 1929 Holding Companies. (NB Financial Holding Companies can no longer be formed.)
  • The replacement for the 1929 holding company, the Family Private Assets Management Company, or SPF is intended to be exempt from corporate income tax, municipal business tax and net-worth tax, and from withholding tax on distributions. These new vehicles are prohibited from commercial activity, and will be limited to private wealth management activity, for example the holding of financial instruments such as shares, bonds and other debt instruments, in addition to cash and other types of bankable asset. If the SPF is used to hold voting rights in other companies, it must ensure that it does not involve itself in the running of those companies, and it is prohibited from providing any kind of service. The SPF exemptions can be affected by participation in non-resident, non-listed companies, if those companies are located in a country not subject to a roughly equivalent corporate tax regime.
    A subscription tax at a rate of 0.25% is payable on share capital.
  • SOPARFI companies, which were created under the law of 24th December 1990, are subject to the normal regime of income taxes etc but do receive the benefit of Double Taxation Treaties, and in many circumstances are exempt from taxation on dividends received from or paid to resident and non-resident companies in which they have a significant participation. The EU Parent-Subsidiary Directive also provides some withholding tax exemptions (improved as from 2004), but the SOPARFI benefits are more extensive. The rules are complex; there are conditions; and there are limitations on the deductibility of expenses.
  • The various forms of UCI are all exempt from all Luxembourg taxation, and pay only a small capital duty on start-up, plus an annual tax on net assets which (at the time of writing) varies between 0.01% and 0.06% depending on the type of fund. In June, 2004, the Luxembourg government announced that pension funds would be exempt from the 0.01% subscription tax, in order to encourage the transnational pooling of pensions assets.
  • In 2004, Luxembourg introduced the SICAR, which may take one of a number of corporate forms, including that of a limited partnership. A fixed capital duty of Euro 1,250 applies to equity capital injections upon incorporation or thereafter. SICARs that are in corporate form are fully taxable and should in principle, unlike 1929 holding companies, be eligible for benefits under Luxembourg tax treaties as well as benefits under EC directives. Investment income and realized gains are not considered taxable income, and realized losses and write-downs are not deductible. All other income and expenses are taxable in the normal way. Distributions are exempt from withholding tax, as are redemptions by nonresident investors, regardless of the amount or holding period. SICARs are exempt from wealth tax, and there is an exemption from VAT for management charges. SICARs are excluded from the benefits of fiscal consolidation. Investors seeking tax transparency will opt for a SICAR in the form of a limited partnership (SeCS). An SeCS is not liable to corporate income tax or net wealth tax, and is exempt from the municipal business tax. Income from the partnership and capital gains realized on units by nonresident partners will not be taxed in Luxembourg.


Luxembourg The EU Parent/Subsidiary Directive

Changes to the parent/subsidiary directive in 2004 have reduced the holding requirement to 20% for 2005-06; to 15% for 2007-08; and to 10% for 2009 onward. Under the EU Directive on Interest and Royalties, which also came into effect in 2004, both types of payment will be exempt from withholding tax if they are between associated companies (rules as for the participation exemption).

Luxembourg has actually gone even further, meaning that there is no withholding tax on royalties paid to non-resident companies, and Luxembourg holding companies incorporated according to the terms of the law of 1929 are not subject to such withholding tax either. In line with the directive, the laws came into force retrospectively, with effect from January 1st 2004.

Luxembourg Taxation of Foreign and Non-Resident Employees In Luxembourg the taxation of individuals is based entirely on the concept of residence, regardless of nationality. Generally, individuals are considered to be resident when they maintain a residence in Luxembourg with the intention of remaining other than temporarily. A stay of six months is deemed to be residence. Most types of compensation and benefit paid to employees are taxable; there are no special privileges or exemptions for expatriate workers.Non-residents are liable to pay Luxembourg taxes only on certain types of income arising in Luxembourg or from Luxembourg sources. These types of income are very precisely defined in Luxembourg legislation. Nationals of countries with which Luxembourg has double taxation treaty also need to be aware that the relevant treaty may well affect their tax treatment. The main types of taxable income for non-residents are:

  1. income from trade or business carried on in Luxembourg or arising there;
  2. income from dependent services (ie employment income) performed or arising in Luxembourg;
  3. pension income resulting from former activity in Luxembourg;
  4. investment income arising or paid from Luxembourg;
  5. income from leasing of goods etc situated in Luxembourg or exploited by a Luxembourg entity;
  6. capital gains on the sale of property or substantial participations in Luxembourg companies.

Each of these categories is further defined in considerable detail in the legislation.

Luxembourg eventually signed up to the compromise on the European Savings Tax Directive reached in January, 2003, and has imposing a withholding tax on non-residents investment returns, like Switzerland, as from July, 2005 (initially at a rate of 15%, rising to 20% in 2008, and 35% in 2011).

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

2 Sep 2020

US structures

Posted by Tax Consultants. No Comments

US structures

US entities doing business overseas can use a variety of structures. Some of the most important are listed below with notes about their taxation characteristics:

Controlled Foreign Corporation

The foreign subsidiary of a US corporation or a foreign company owned by US shareholders is typically a Controlled Foreign Corporation (CFC).

A CFC means any foreign corporation if on any day during the foreign corporation taxable year US shareholders own more than 50% of:

  • The total combined voting power of all voting stock, or
  • The total value of all the stock.

A foreign corporation is any corporation not created or organized in the United States. A US shareholder is a US person that owns 10% or more of the voting power of all classes of stock entitled to vote of the foreign corporation. A US person is a citizen or resident of the United States, a domestic partnership or corporation, or any estate or trust unless its income from sources outside the US (other than income that is effectively connected with a US trade or business) is not includable in gross income under US tax law.

In determining whether a US person is a US shareholder, the US person will be considered to own stock that it owns:

  • Directly;
  • Indirectly through foreign entities; or
  • Constructively under certain rules that attribute stock ownership from one entity to another.

A US shareholder includes actual distributions from a CFC in taxable income, plus under Subpart F of the Tax Code certain types of undistributed income of a CFC, including:

  • Passive investment income;
  • Income from the purchase of goods from, or sale to, certain related entities;
  • Income from the performance of services for or on behalf of certain related entities;
  • Certain types of shipping and oil-related income;
  • Insurance income from insuring risk located outside the CFC country of incorporation;
  • Income from bad conduct activities, such as participation in an international boycott, payment of illegal bribes and kickbacks, and income from a foreign country during any period that country is retainted under IRC 901(j); and
  • In addition, the US shareholders of a CFC are required to include in income their share of the CFC increase in earnings invested in US property.

The Subpart F rules are extremely complex, and professional advice is absolutely necessary in interpreting them.

Foreign Sales Corporation

Under legislation dating from 1984, which was eventually declared unacceptable by the World Trade Organization after a complaint from the European Union, the US Internal Revenue Code authorized the establishment of foreign sales corporations (FSCs), being corporate entities in foreign jurisdictions through which US manufacturing companies could channel exports. 15% of the revenue concerned was exempted from corporation tax, meaning (at 35% tax) that companies kept 5.25% more of their revenue.

The FSC rules generally replaced the domestic international sales corporation (DISC) rules. IC-DISCs exist, however, for small domestic taxpayers.

Possessions Corporations

Possessions corporations may operate to obtain the benefits of section 936 in all US possessions including the US Virgin Islands. However, the overwhelming majority of possessions corporations are operating in Puerto Rico.

Possessions corporations must have:

  • Filed a valid Form 5712, Election To Be Treated as a Possessions Corporation Under Section 936 (an election cannot normally be revoked for the first ten years);
  • Derived 80% or more of their gross income from sources in a US possession during the applicable period immediately before the tax year ended, and
  • Derived 75% or more of their gross income from the active conduct of a trade or business in a US possession during the applicable period immediately before the tax year ended. In 1976 the amount was 50%. This amount increased over the years to 75%.

The applicable period is generally the shorter of 36 months or the period when the corporation actively conducted a trade or business in the US possession.

A domestic international sales corporation (DISC) or a former DISC, or a corporation that owns stock in a DISC, former DISC, foreign sales corporation (FSC), or a former FSC is ineligible for Section 936 relief.

A possessions corporation is allowed a credit against its US tax liability equal to the portion of its tax that is attributable to:

  • The taxable income from non-US sources from the active conduct of a US trade or business within a US possession, and
  • The qualified possession source investment income.

The credit is not allowed against environmental tax, tax on accumulated earnings, personal holding company tax, additional tax for recovery of foreign expropriation losses, tax increase on early disposition of investment credit property, tax on certain capital gains of S corporations or recapture of low income housing credit.

A possessions corporation may elect either the cost sharing or profit split method of computing taxable income with respect to a certain possession product

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

31 Aug 2020

Tax Forecast

Posted by Tax Consultants. No Comments

Corporate Income Tax Forecast Methodology

The corporate income tax forecast is produced by:

  • Forecasting total annual corporate tax liability.
  • Forecasting annual liability by payment type advance payments, final payments, delinquent payments and refunds.
  • Convert the annual tax liability forecast by payment types into a quarterly collections forecast.

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

Corporate Liability Model

The corporate income tax model is similar in nature to the personal models. However, the transition from collections to liability is far more complex. A specific corporate tax year may start any time during the same calendar year. Many corporations use calendar year or fiscal year as their tax year, but not all. As a result, collections and refunds for a given tax year are spread over several years The differing tax years also means that payments are received on multiple tax years simultaneously. For example, an average of 72 percent of advanced payments received during a calendar year belongs to that tax year. The remaining 28 percent belong to the prior tax year.. In essence collections are split by tax year and then shifted back in time to create a liability data set.

This produces a monthly liability variable for each payment type. The monthly data are then converted to annual data prior to forecasting each payment type. The main driver behind the total liability model is corporate profits.

Collections Model

The spreading equations take the annual liability forecasts by payment type and convert them into monthly collections forecasts. The steps involved in this process are laid out below:

  • Annual forecasted liability by payment type is spread equally over the months of the year.
  • The liability series for all payment types except refunds is split into two pieces based on when collections for a given tax year’s liability occur. (The reverse of the process used to convert collections to liability).
  • The forecasts are then shifted forward in time to account for the time between when the liability is incurred and collections occur.
  • Historical seasonally patterns are applied to the forecasts using X-11 determined seasonal factors.
  • Monthly forecasts are summed to get quarterly collections forecasts.

Forecaster Judgement

The raw collections forecasts must be adjusted to account for tax law changes that are not included in the liability models. This includes recent legislation and policy actions such as adding more tax auditors at the Department of Revenue. Kicker credits that have yet to be taken are also reflected in this manner.

In addition, recent collections trends must be taken into consideration. If there is reason to believe that collections patterns will vary from historical patterns, then the forecast can be adjusted accordingly outside of the forecasting models. Both of these items can have significant impacts on the final revenue forecast.

31 Aug 2020

Nova Scotia Unlimited Liability Company

Posted by Tax Consultants. No Comments

U.S. Residents Should Consider Using A Nova Scotia Unlimited Liability Company For Canadian Investment (An Update)
Certain jurisdictions allow, under their corporate laws, the incorporation of companies where the shareholders are liable, on liquidation, to the obligations of the companies in excess of their assets. In Canada, the province of Nova Scotia allows for the incorporation of such a company. Section 9 of the Nova Scotia Companies Act permits the formation of unlimited liability companies. The companies are referred to as Nova Scotia Unlimited Liability Companies (NSULC).The shareholders of such a company have unlimited joint and several liability for the obligations of the company. However, unlike the partners of a partnership, the shareholders of an NSULC have no current liability to creditors; their liability only occurs when the company is liquidated with insufficient assets to satisfy its debts. Shareholders of an NSULC should consider interposing some sort of limited liability entity to reduce their exposure.

Formation of an NSULC

An NSULC is incorporated pursuant to the Nova Scotia Companies Act. A memorandum of association, a solicitors declaration and a list of officers and directors must be filed with the Registrar of Joint Stock Companies. The memorandum of association records the name of the company, any restrictions on its objects and details regarding share capital. The amount of share capital must be specified. There is no restriction on the number of shareholders. A shareholder must be a legal entity.

The corporation must maintain a registered office in Nova Scotia and have a registered agent for service in Nova Scotia. There is a requirement for an annual corporate statement to be filed and a fee of $85 to be paid. There is no requirement for Canadian directors.

Tax Treatment

In Canada, an NSULC is considered to be a corporation under the Income Tax Act and, therefore, an NSULC is treated like any other Canadian corporation for Canadian tax purposes.

In the U.S., an NSULC is not treated as a corporation under the Internal Revenue Code. Any business entity that is not required to be treated as a corporation is eligible, under the “check the box” rules, to choose its classification for U.S. federal tax purposes. Therefore, an NSULC is eligible to choose a classification that allows for flow-through treatment of corporate income to the shareholders and it would be taxed in their personal hands. Any Canadian taxes paid by an NSULC would be considered to have been paid by its shareholders for U.S. tax purposes and the Canadian taxes would, therefore, be eligible for U.S. foreign tax credit claims. Any losses realized by an NSULC would be considered to have been realized by its shareholders for U.S. federal tax purposes.

An NSULC controlled by non-residents of Canada will not be eligible for the small business deduction or refundable dividend tax on hand and will pay tax at a rate of approximately 44%. An NSULC will be subject to provincial tax in the provinces in which it has a permanent establishment or employees. Canadian corporate taxes will be available to U.S. shareholders as a foreign tax credit, within prescribed limits, against U.S. taxes.

Certain U.S. states still rely on the “four factors” test and this may require the alteration of Standard Memorandum and Articles of Association for an NSULC in order to obtain flow-through treatment for tax purposes in those states.

Under the Canada-U.S. Tax Treaty, an NSULC is a “company” for Canadian purposes of applying the treaty and is a “resident” of Canada under Article IV of the treaty. Therefore, unlike a U.S. limited liability company, an NSULC benefits from the treaty. A subsequent sale of an NSULC by a U.S. shareholder is treaty exempt unless the shares derive their value primarily from Canadian real estate.

A U.S. Corporation owning an NSULC would be able to deduct losses against its U.S. profits (subject to the U.S. dual consolidated-loss rules) without suffering branch tax in Canada. A U.S. corporate shareholder that owns more than 10% of the shares of the NSULC can benefit from the reduced 5% dividend withholding rate under the treaty. A U.S. S Corporation can acquire shares of an NSULC, although it cannot acquire the shares of an ordinary Canadian corporation. Interposing a U.S. S Corporation or limited partnership between U.S. shareholders and an NSULC will protect them from the joint and several liability obligations of NSULC shareholders.

Tax Planning Strategies

Acquisition of a Canadian Rental Property

U.S. residents who wish to purchase Canadian rental property may find that using an NSULC is a tax effective strategy.

An NSULC will be a Canadian resident and, therefore, rent payments made to an NSULC will not be subject to the 25% withholding requirements imposed by the Canadian Income Tax Act. Under the Act, a Canadian resident who pays rent to a non-resident must withhold tax from the rent payment at a rate of 25%. Although it is possible for the withholding to be based on the net rent instead of the gross rent (providing that the non-resident arranges for a Canadian agent to collect the rent and to remit the withholding tax), there would still be Canadian tax filing requirements in respect of the rental activity.

In many cases, taxable income is not expected for several years with a rental property, due to various costs such as interest. U.S. shareholders of an NSULC would benefit from this as they would be able to deduct their proportionate share of the losses in calculating their taxable income in the U.S.

When the NSULC has taxable income, it will be subject to Canadian tax at a rate of approximately 44%. A foreign tax credit will be available to U.S. shareholders of the NSULC.

Purchase of a Canadian Business

U.S. residents or corporations who are interested in buying the assets of a Canadian business from Canadian shareholders, who want to sell their shares in order to access the $500,000 capital gains exemption, should consider using an NSULC.

If the company (Targetco) were an Ontario company, it could be converted into an NSULC and the Canadian shareholder could treat the sale as a sale of shares and the U.S. purchaser could treat the sale as a purchase of assets. The Ontario company would be continued in Nova Scotia as an ordinary Nova Scotia company. This would require the consent of the Ontario Minister of Finance (this takes about a week) and authorization under the Ontario Business Corporations Act, supported by a special shareholders resolution (this takes a day or two). An NSULC (Purchaseco) would then be incorporated by the U.S. resident and used to purchase the shares of Targetco. Purchaseco and Targetco would then be amalgamated to continue as an NSULC (Amalgco). The amalgamation would require the approval of a Nova Scotia Supreme Court Judge in Chambers and the approval of major creditors with an affidavit that trade creditors would be paid in the ordinary course of business (this takes about two weeks). The U.S. shareholders of Amalgco would then benefit from flow-through treatment of the income or losses of Amalgco.

Another option would be to use two NSULC in order to allow the U.S. purchaser to deduct purchase price interest. First, Targetco would be continued in Nova Scotia as an ordinary Nova Scotia company. Then the owners of Targetco would incorporate an NSULC and Targetco and the NSULC would be amalgamated to continue as an NSULC (Amalgco). The U.S. purchaser would then incorporate an NSULC (Purchaseco) which could be owned by a U.S. S Corporation. Purchaseco would be financed so that the acquisition of Amalgco is structured as 25% equity and 75% interest-bearing debt of Purchaseco to avoid the thin capitalization rules. Purchaseco would then purchase the shares of Amalgco and Purchaseco and Amalgco would then be amalgamated to continue as an NSULC. The interest on the debt could be deducted in calculating the Canadian taxable income of the target business. The purchaser would have a stepped-up basis in the assets for U.S. tax purposes since the target company is treated as a flow-through entity.

Conclusion

An NSULC can be an effective strategy for U.S. residents who desire to hold investments in Canada. In some situations, the use of an NSULC would not be tax effective and may, in fact, be detrimental.

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

31 Aug 2020

Regulation 105

Posted by Tax Consultants. No Comments

Paragraph 153(1)(g) of the Act makes provision for withholding from a payment of fees paid for services on account of the payees potential liability for tax under the Act.

Section 105 of the Income Tax Regulations gives effect to paragraph 153(1)(g) in the context of payments to non-residents.  The purpose of paragraph 153(1)(g) is to ensure that if the non resident recipient of a payment is liable to pay income tax in Canada, then there will be funds available in the form of a percentage withheld and remitted, to satisfy the obligation. R105 withholding is not the final tax amount. It is only a tax instalment, contrary to Part XIII (Tax on Income from Canada of Non-Resident Persons).

Subsection 164(2) allows for this instalment to be applied against any income tax owed by the taxpayer

31 Aug 2020

What is Permanent establishment (PE)?

Posted by Tax Consultants. No Comments

Definition of PE may vary from different jurisdictions, since each jurisdiction have different provincial, state and/or federal laws therefore permanent establishment treatment for Domestic Law various from the international laws. However the objective may be the same, which is to allow the taxation authorities to exercise their power by relying on a guide to determine which authority may have the legal right to tax the produced income. These rules determine, when and how much another province/state or country may tax an enterprise which carries out a business on their soil. Canada and USA have negotiated tax treaties with each other and other countries (some reasons) in order to resolve conflict and elimination of double taxation when taxpayers are operating in two countries.

Most of the time in order to determine if a PE exists it is required to understand the nature of the business – what functions, operations and activities are carried out, and what individual employees are doing on behalf of their employer.

A permanent establishment should not be confused with a subsidiary. A subsidiary is a separate legal entity. A permanent establishment is not, it is merely a branch and as such an extension of the head office

Tax law, tax treaties, jurisprudence and administrative practices have has been evolving over time. The concept of the PE has been adapted to incorporate new ways of doing business and more in particular internet sales.

Furthermore, filing requirements may result from having a permanent establishment in Canada or in another country.

Domestic law

  • ITA 2(1)  Canadian residents are subject to Canadian tax on world-wide income
  • ITA 124(1) and ITR 400-402 Permanent establishment concept applicable in the allocation of provincial income
  • IT-177R2 – Permanent Establishment means a fixed place of business

The principal place at which business is conducted

The place where a business is carried on through an employee or agent with general authority to contract or who has a stock of merchandise from which orders are filled

Corporation which otherwise has a permanent establishment in Canada owns land in a province the land is the permanent establishment

Place where a corporation uses substantial machinery or equipment

  • ITA 2(3) covers non-residents

Where a person is not subject to income tax under subsection 2(1) (not resident in Canada) subsection 2(3) provides that if that person

Was employed in Canada;

Carried on a business in Canada, or

Disposed of a taxable Canadian property

Any income tax will be payable upon taxable income determined under division D (sec 115 and 116)

Note that the words business is defined in subsection 248(1) and extended meaning of carrying on business in Canada in Section 253.

Tax treaties

Once it has been established that a business is being carried on in Canada by a resident of the US, it is necessary to refer to the treaty to determine if its provisions override the Canadian law, as it otherwise applies. The treaty would only be invoked to provide relief.  A tax treaty will not create an obligation if the obligation does not exist under domestic law.

The main use of the concept of a PE is to determine the right of a Contracting State to tax the profits of an enterprise of the other Contracting state.

The provisions of Article 5 (of OECD Model Tax Convention) also apply in determining whether any person has a PE in any State. These provisions would determine whether a person other than a resident of Canada or the US has a PE in Canada or the US, and whether a person resident in Canada or the US has a PE in a third state. The key determinants of a PE is defined in Article V (1) must be a place of business (2) the place of business must be fixed; and (3) the carrying on of the business of the enterprise through this fixed place of business

Under Article 7 of the Canada-US Tax treaty, a contracting state cannot tax the profits of an enterprise of the other contracting state unless the profits are attributable to the PE situated therein.

Article V of the Canada US tax treaty is for a great part similar to Article 5 of the OECD model tax convention.

Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.

31 Aug 2020

Medical Clinic Contracting with Associates

Posted by Tax Consultants. No Comments

This policy clarifies the application of the GST/HST to payments made between parties within a medical practice organization with respect to the organization operating expenses.

Sample Ruling 7: Medical Clinic Contracting with Associates Statement of Facts

1. Practitioner A is a sole proprietor operating a medical practice under the name Clinic XYZ. The sole proprietor owns the practice and all related assets of the practice.

2. Practitioner A contracts with independent contractor associates whereby the associates will render health care services to individuals at Clinic XYZ and agree to pay Clinic XYZ for the use of the facility, medical equipment, and supplies of administrative services.

3. Clinic XYZ does not invoice the associates specifically for the use of the clinic, medical equipment, or administrative services. Rather, the associates and Practitioner A enter into an arrangement whereby the associates will assign to Clinic XYZ the fees payable to them by the provincial health insurance plan. Pursuant to this arrangement, Clinic XYZ will forward the associates billings to the provincial health insurance plan for the health care services the associates rendered using their billing numbers for this purpose. Clinic XYZ will collect these fees, remit 60% of the fees to the associates and withhold the remaining 40% in exchange for providing the use of the clinic, medical supplies, and administrative services.

Ruling Requested

The 40% of the associates fees that Clinic XYZ withholds is not consideration for a taxable supply and accordingly, no GST/HST applies to this portion of the associates fees not remitted to the associates.

Ruling Given

Based on the facts set out above, we rule that the 40% portion of the associates fees that Clinic XYZ does not remit to the associates is consideration paid by the associates for a taxable supply consisting of the use of the facility and medical equipment and administrative services. This supply by Clinic XYZ is a commercial activity and if Clinic XYZ is registered or is required to be registered (i.e., is not a small supplier), the GST/HST applies to the consideration paid by the associates for this supply (i.e., the portion of the associates fees withheld by Clinic XYZ).

While Clinic XYZ collected the fees payable by the provincial health insurance plan, it did not provide health care services to patients. Clinic XYZ is collecting the amount from the provincial health insurance plan on behalf of the associates. The associates and Practitioner A have an agreement that the associates will pay Clinic XYZ for the use of its facilities. Therefore, the amount of the associates fees withheld by Clinic XYZ is not consideration for a supply of health care services; rather the amount withheld is consideration for a taxable supply made by Clinic XYZ to the associates.

Definitions and Interpretations

EXEMPT SUPPLIES OF HEALTH CARE SERVICES

1. Under Part II of Schedule V to the Act, supplies of many health care services are exempt. In general terms, health care services have to promote physical and mental health, and the protection against disease. These services must be performed by health care professionals who are entitled to provide the health care services listed below.

Services Provided by Medical Practitioners and Practitioners

2. A supply of a prescribed diagnostic, treatment or other health care service (e.g., a laboratory testing service) when made on the order of a medical practitioner or practitioner is exempt.

3. A supply made by a medical practitioner of a consultative, diagnostic, treatment or other health care service rendered to an individual (other than a surgical or dental service that is performed for cosmetic purposes and not for medical or reconstructive purposes) is exempt.

4. A supply of any of the following services when rendered to an individual, where the supply is made by a practitioner of the service, is exempt:

(a) optometric services;
(b) chiropractic services;
(c) physiotherapy services;
(d) chiropodic services;
(e) podiatric services;
(f) osteopathic services;
(g) audiological services;
(h) speech-therapy services;
(i) occupational therapy services; and
(j) psychological services when provided by a practitioner who is registered in the Canadian Register of Health Service Providers in Psychology.

5. Only health care services that promote physical and mental health and protection against disease are exempt; other professional services provided by medical practitioners and practitioners (e.g., witness fees for court appearances) are taxable unless exempted by some other provision of the Act. For example, when such supplies are made by hospital authorities that are also charities, the supplies are likely to be exempted by virtue of section 2 of Part VI of Schedule V.

Institutional Health Care Services

6. Institutional health care services made by the operator of a health care facility to a patient or resident of the facility are exempt. [When a medical or prosthesis is installed in a health care facility in conjunction with an exempt institutional health care service, the supply of the prosthesis is also exempt. For example, when medical treatment in a hospital involves the installation of a prosthesis such as an artificial hip, the supply of the prosthesis by the hospital is exempt.] Exempt institutional health care services do not include medical or dental services performed for purely cosmetic purposes.

7. A supply of food and beverages, including the services of a caterer, made to an operator of a health care facility under a contract to provide, on a regular basis, meals for the patients or residents of the facility is exempt.

8. Fees charged by health care facilities to their patients or residents to cover accommodation and other institutional health care services are exempt. However, separate charges for other services, provided on a commercial basis by these facilities, that are not health related (e.g., parking and meals served in a cafeteria to visitors), are taxable.

9. The definition of “health care facility” under Part II (Health Care Services) of Schedule V to the Act includes a facility operated for the purpose of providing residents of the facility who have limited physical or mental capacity for self-supervision and self-care with:

(a) nursing and personal care under the direction or supervision of qualified medical and nursing care staff or other personal and supervisory care (other than domestic services of an ordinary household nature);

(b) assistance with the activities of daily living and social, recreational and other related services to meet the psycho-social needs of residents; and

(c) meals and accommodation.

Cosmetic Surgery for Medical or Reconstructive Purposes

10. Surgical and dental procedures that alter or enhance a patient’s appearance but have no medical or reconstructive purpose, are considered to be cosmetic surgery and, generally, are taxable. Refer to paragraph 6 of this memorandum for more information on this subject.

11. However, cosmetic surgery that is performed for medical or reconstructive reasons is exempt. An example of this type of surgery is skin grafting performed on a burn victim.

12. In certain circumstances, provincial and territorial health insurance plans consider cosmetic surgery to be medically necessary and therefore an insured service. In these cases, the service is exempt. Such surgery is usually evaluated on a case-by-case basis. The criteria for finding cosmetic surgery to be medically necessary include:

(a) the surgery is to alter a significant defect in appearance caused by disease, trauma, or congenital deformity; and
(b) it is recommended by a mental health facility, or
(c) the patient is less than eighteen years of age and the defect is in an area of the body which normally and usually would not be clothed.

Nursing Services

13. A supply of a nursing service provided by a registered nurse, a registered nursing assistant or a licensed practical nurse is exempt where:

(a) the service is provided to an individual in a health care facility or in the individual’s place of residence;
(b) the service is a private-duty nursing service; or
(c) the supply is made to a public sector body (for example, a school authority, a hospital authority or a municipality).

14. Nurses may provide their services directly to patients or they may be hired by employment agencies who specialize in the provision of health care providers. In either case, the charge for their services is exempt.

Dental Hygienist Services

15. A supply of a dental hygienist service is exempt regardless of whether the hygienist is self-employed or is an employee of a management corporation or a medical practitioner.

27 Aug 2020

GST HST basics

Posted by Tax Consultants. No Comments

A good understanding of Canada’s complicated tax rules is essential to maximizing reducing tax risk, profit, and maintaining compliance.

Most transactions involve indirect taxes, including GST/HST and PST. These taxes can easily increase the cost of doing business – especially if refund and tax minimization opportunities are overlooked.

HST basics: five things you must know

Here are five fundamentals that businesses in Ontario and B.C. need to know about the new tax:

  1. HST combines the federal Goods and Services Tax (GST) with the provincial sales tax (PST) into a single tax.
  2. Ontario businesses will charge 13 per cent.
  3. B.C. businesses will charge 12 per cent (the lowest HST rate in Canada).
  4. HST applies to both goods and services, adding the provincial sales tax to services that would previously only have had GST applied.
  5. As of May 1, 2010 businesses that sell goods or services to be delivered, installed or performed on or after July 1, 2010 are required charge HST.

Which businesses will need to charge HST?

HST will apply to goods, services, real property and intangible property, such as contractual rights and patents. (We’ve included two charts below to show how the tax status of many goods and services will change.)

You will need to charge HST if:

  • you have sales over $30,000 in the calendar year or any four consecutive quarters;
  • your business is registered for the GST already.

Current GST registrants won’t need to apply for a new number. The business number (BN) you use for your GST account number will be the same number you will use for your HST account and your filing frequency stays the same.

Why harmonize?

In both Ontario and British Columbia, the HST is being introduced to help businesses cut red tape and save money. The purpose of harmonization is to make businesses more competitive and to stimulate the economy.

Here’s how this works.

Under the current tax system, you can claim back the GST you’ve paid on all of your business expenses, but you can’t do the same for PST. As a result, goods have a tax history that has PST added at every step of the supply chain. These hidden PST costs are included in the final price, with consumers paying tax on the embedded tax.

As a value-added tax, GST is different. There is no hidden tax, because businesses can use the GST they pay out as an input tax credit. The business only remits the difference between the GST it has collected and the GST it has paid.

Harmonization brings the same system and advantages to the collection of the retail sales tax portion. Every business expense that includes HST, from phone services to office supplies, will help reduce the total amount of tax remitted to the government.

Claiming input tax credits

Not all businesses will be able to claim input tax credits on the PST portion of the HST right away.

Small and medium-sized companies with annual taxable sales under $10 million will be able to claim input tax credits for the sales tax paid out after July 1, 2010. However, financial institutions and large businesses with annual taxable sales of more than $10 million will have to wait five years to claim input tax credits paid on the provincial portion of the HST for certain expenses. Then, full input tax credits will be phased in over a three-year period.

Once the HST is fully phased in, the estimated savings for business are substantial.

In B.C., its estimated that businesses will save $1.9 billion in input costs. In Ontario, the HST will slash about $4.5 billion annually in hidden sales taxes once its fully phased in.

Lessons learned from other provinces

The HST is not new to Canada. Already, Quebec and the Atlantic provinces have tax harmonization. And around the world, more than 130 countries have adopted value-added taxes.

Interestingly, prices actually dropped slightly in the eastern provinces after the HST was introduced. According to the C.D. Howe Institute, lessons from the implementation of HST in the eastern provinces suggest that harmonization in Ontario and B.C. will not lead to higher consumer prices.

In Ontario, businesses can expect to save more than $500 million annually in compliance costs while B.C. businesses can expect to save $150 million a year.

Sales tax harmonization will simplify tax compliance for businesses since they will only have to manage one sales tax system, says Ted Wigdor, vice-president, government and corporate affairs, with Certified General Accountants of Ontario. That means one harmonized tax base, one set of sales tax returns and one consistent reporting period, all of which will benefit small- and medium-sized enterprises.

HST implementation checklist

The following checklist will help you identify the systems you will need to change to be ready for the introduction of the HST on July 1, 2010.

  • Do you need to modify your cash registers or point-of-sale systems?
  • Do you need to update automatic payments to include HST?
  • Do you need to update your e-commerce website to add the HST? (Remember, your business might be closed for the July 1 holiday, but your website is not!)
  • Do you need to update your accounting software to accommodate the new tax?
  • Do you need to update your accounts receivable / accounts payable / invoicing software?
  • Do you need to make adjustments to the way you do your input tax/taxable benefits calculations?
  • Are there any other aspects of your business that will be affected by the new tax?

Sample HST remittance calculation

To better understand how value-added tax works, let’s take a British Columbia accounting firm as an example.

Scenario: The firm hires an independent contractor to work on an accounting project. The contractor bills the accounting firm $1,000 and the accounting firm, after reviewing the work and managing the project, bills its client $2,000.

As of July 1, 2010: calculating the “value-added”

Contractor’s fee to accounting firm $ 1,000
+ 12% HST $ 120
Total invoice $ 1,120
Accounting firm’s fee to client $ 2,000
+ 12% HST $ 240
Total invoice $ 2,240

Â

Total HST remitted to government: $240.

Even though $360 of HST is collected between the two companies, only $240 is remitted to the government. That’s because while the accounting firm collected $240 in HST, it keeps $120 of the funds collected to cover the money paid out to the contractor and only remits the remaining $120 to the government.

In reality, each business will likely have other qualifying HST deductions as well from the tax paid on other business expenses, so the amount paid to the government would likely be reduced even further.

Special rules for transactions that staddle the implementation date

Service businesses that have not charged provincial sales tax may need to charge both taxes on work that overlaps the July 1 implementation date.

If over 90 per cent of the work is done before July 1, the business will charge GST only. However: If more than 10 per cent of the work is done after July 1, the business will need to charge GST on the pre-transition portion of their work and charge HST on the remaining portion. These rules apply to the taxable supplies of personal property and services made in Ontario or B.C.

Consider a design firm that creates a brochure a client. Work begins in May and the brochure is completed at the end of July. Seventy per cent of the work is performed in May and June, while the remaining 30 per cent is performed in the month of July.

Since more than 10 per cent of the work overlaps the HST implentation date, the firm must charge both GST and HST. Here is an example of how the company would invoice both taxes:

Invoice for services rendered

Brochure design (pre-July1) $ 7000
GST (5% of $7000) $ 350
Brochure design (post-July1) $ 3000
HST (12% of $3000 using the BC rate) $ 360
Total amount owing $ 10,710

Â

How goods & services will be taxed as of July 1, 2010

Wondering which products and services will see a change in their tax status as of July 1? Here’s a run-down of some of the key ones:

Goods & services that will have the HST added in both provinces

Â

Affected goods & services Up to June 30 After July 1
Advertising services GST only HST
Cleaning services GST only HST
Commissions GST only HST
Custom software* GST only HST
Electricity GST only HST
Gasoline GST only HST
Goods for resale and raw materials GST only HST
Heating fuels GST only HST
Magazines* GST only HST
Manufacturing equipment* GST only HST
Membership fees (fitness, golf) GST only HST
Office rent GST only HST
Personal services (manicures, hair cutting, etc.) GST only HST
Professional services (accounting, legal, graphic design, etc.) GST only HST
Real property contracts (home improvements, office renovations) GST only HST
Safety clothing* GST only HST
Taxi and limousine fares GST only HST
Trade show admissions and conferences GST only HST
Training seminars GST only HST
* These items may be subject to certain conditions or, as in the case of safety clothing, be defined by the province.

Â

Goods and services with variable PST/HST status in Ontario and B.C.

Â

Goods/services Current PST tax status Current PST tax status Tax status with HST
 Ontario British Columbia Â
Legal services Non-taxable Taxable Taxable
Admissions under $4 Exempt Non-taxable Taxable
Footwear under $30 Exempt Taxable Taxable
Basic groceries Exempt Exempt Zero-rated
Restaurant and catered meals Taxable (under $4, exempt) Exempt Taxable in B.C.; In ON over $4 is taxable, under $4 has a point-of-sale rebate on the provincial portion*.
Snack foods and soft drinks Taxable Exempt Taxable
Internet access fees Non-taxable Taxable Taxable
Newspapers Exempt Exempt Taxable in B.C.; in Ontario, there is a point-of-sale rebate on the provincial portion of HST
Software services (subject to certain conditions) Taxable Exempt Taxable
Adult-sized clothing for children under 15 Taxable Exempt Taxable

Â

* While the Ontario tax rate for prepared foods and beverages under $4 is often said to be tax exempt, that is not correct. According to a GST/HST bulletin GI-064, businesses will get an instant point-of-sale rebate on the 8 per cent provincial portion of the HST. There are strict guidelines for qualifying products as well as how the HST must be shown on the sales receipt.

Consumers will normally receive the rebate by being paid by the retailer at the point of sale. The consumer can file a rebate claim with CRA using Form GST189 within four years of the purchase if the vendor does not pay or credit the rebate amount at the point of sale. Be sure to visit the link in the further reading section below to learn more about which products qualify for this instant rebate.

Further reading

For more on how transitional rules for the HST may affect your business, go to http://www.cra-arc.gc.ca/tx/pstr/trnstnl/menu-eng.html.

For more information on the HST and how to get registered, go to “Demystifying the GST / HST” at http://www.canadaone.com/ezine/oct03/gst.html.

For more information on qualifying products for Ontario’s Point-of-Sale rebate on Prepared Foods and Beverages http://www.crfa.ca/pdf/cra_pos_rebates.pdf.

For more information on point-of-sale rebates for Ontario newspapers visit http://www.cra-arc.gc.ca/E/pub/gi/gi-060/gi-060-e.pdf.

For more information on transition rules for services and personal property, visit http://www.cra-arc.gc.ca/E/pub/gi/notice247/notice247-e.html#P1.2

Most Visited Articles

  1. Accounting 101: Balance Sheet Basics
  2. Choosing a Business Name
  3. All You Need to Know about Importing from the USA to Canada
  4. The Ins and Outs of Vacation Time & Vacation Pay
  5. Writing an Effective Business Plan: Page 1 – Introduction

Related Articles

  1. Accounting 101: Balance Sheet Basics
  2. Financial Ratios Revisited
  3. Help! What Taxes Must I Pay?
  4. Updating the GST Rate in Quickbooks & Simply Accounting
  5. Equity Financing: Understanding Venture Capital

Health care professionals

Â

Â

On July 1, 2010, the provincial sales tax (PST) will be harmonized with the federal goods and service tax (GST), resulting in a federally administered single sales tax imposed at 12%. The proposed harmonization will impose significant additional costs on the health care industry.

Now is the time for medical and health care professionals to consider the implications of harmonization on their costs, compliance systems and customers. Medical and health care professionals are persons licensed or otherwise certified to provide such services and include doctors, dentists, nurses, and other health care providers (e.g., chiropractors, orthopedists, optometrists, physiotherapists, podiatrists, chiropodists, osteopaths, audiologists, pathologists, occupational therapists, psychologists and midwives).

Most services provided by medical and health care professionals are not currently subject to either the GST or the PST. Under B.C.’s proposed harmonization with the GST, these services should remain exempt from B.C. HST with no direct impact to the consumer. However, where supplies made by a medical or health care professional are taxable (e.g., therapeutic massages, cosmetic surgery, sales of certain goods such as toothbrushes, etc.) these supplies will be subject to the B.C. HST. This represents a significant increase to the price of these supplies to consumers, and it is recommended that the tax status of these items be reviewed in detail prior to the introduction of the B.C. HST.

Impact on purchases made by medical and health care professionals

Currently, the PST applies to a relatively narrow base of goods and services used by medical and health care professionals in their practices. The B.C. HST will apply to a much broader base of goods and services. As a result, medical and health care professionals will be required to pay additional non-recoverable tax on the purchase of goods and services that are not currently subject to the PST. Consequently, their overhead costs will likely increase, and these professionals may be forced to pass on the additional costs to their customers.

The following table highlights a number of typical expenses that are currently subject to the GST but not the PST. Acquiring these items under the B.C. HST will become more expensive than under the current regime.

Other issues to consider

With the implementation of the B.C. HST fast approaching, medical and health care professionals should  consider a number of strategic planning activities:

  • Timing of purchases – stocking up on purchases of goods that do not currently attract the PST but that will attract the B.C. HST on July 1, 2010, will assist in reducing overall costs.
  • Real estate issues – consider purchasing real property prior to the implementation of the B.C. HST to minimize the taxes due on the purchase (i.e., 5% GST instead of 12% B.C. HST on the purchase of real property).
  • Corporate structure – consider reviewing the structure to determine the optimal treatment for income tax and B.C. HST purposes.
  • Current contracts – discussing the impact of the B.C. HST on suppliers will assist in determining whether a supplier’s costs will be positively affected by the implementation the B.C. HST and, as such, allow the medical or health care professional to purchase these products at a lower price.

Farmers in BC

Currently, farmers are exempt from paying PST on the cost of many items purchased for use in the farming business.  If a farmer is registered to collect GST/HST, any HST paid on costs for the farming business are recoverable as input tax credits. As most agricultural products are zero-rated (they are considered taxable, but the HST rate is zero), very little or no HST would be collected.  Many farmers are small suppliers, so registering to collect GST/HST is not mandatory, but would probably be to their advantage.  See Who has to register to collect GST/HST?

 Proposed General Transitional Rules for BC HST

Transitional rules are required to determine which tax – the existing PST (Social Services Tax) or the BC component of the HST – would apply to transactions that straddle the July 1, 2010 implementation date.

November 18, 2009 – New home sales – Grandparenting

Where written agreements of purchase and sale are entered into on or before November 18, 2009, and both ownership and possession of the homes are transferred under the agreement after June 2010, the sales will be subject to the federal component of the HST, but not the provincial component.  This would apply to sales of newly constructed or substantially renovated single-unit homes to individuals, and to sales of residential condominiums to all persons including individuals.

Sales of these grandparented homes would not be eligible for the new housing rebate or new rental housing rebate.

October 14, 2009

Certain purchasers that are non-consumers may have to self-assess the BC component of the HST on consideration that becomes due, or is paid, after October 14, 2009 and before May 1, 2010 for goods and services provided on or after July 1, 2010.  This would not apply if the non-consumer is a GST registrant and would therefore be entitled to an input tax credit.

Note:  Consumer means an individual who acquires goods or services for the individual’s personal consumption or use or for the personal consumption or use of another individual.  See the detailed information in Canada Revenue Agency’s Notice 247 regarding this topic.

A GST registrant in BC or Ontario should not be collecting the provincial portion of the HST prior to May 1, 2010, for goods or services provided in BC or Ontario, even if the goods or services are to be provided on or after July 1, 2010.  Prior to May 1, only the 5% GST should be collected for these goods or services.

May 1, 2010

The HST would generally apply to consideration that becomes due or is paid on or after this date, for property and services provided on or after July 1, 2010.

Some items addressed in the proposed HST transitional rules:
Â
Â
Â
Â
Â
Â

Â

 Â

bullet Â

Funeral services – HST will not apply to funeral services where the contract is entered into before July 1, 2010.   Â
Â
Â

Â

bullet Â

Transitional PST inventory rebate for residential real property contracts – A rebate will be available for PST embedded in construction materials purchased before July 1, 2010, but used in residential property contracts on or after July 1, 2010.   Â
Â
Â

Â

bullet Â

Subscriptions to newspapers, magazines and other periodical publications – HST will not apply to subscriptions paid before July 1, 2010.   Â
Â
Â

Â

bullet Â

Passenger transportation services – HST will generally not apply to the cost of continuous journeys that commence before July 1, 2010.   Â
Â
Â

Â

bullet Â

Freight transportation services – HST will generally not apply to the cost of a freight transportation service performed on or after July 1, 2010 if the service is part of a continuous freight movement of goods that begins before July 2010.    Â
Â
Â

Â

Â

For further information on the BC HST and the proposed transitional rules, see the following on the BC Ministry of Finance website

 Â

bullet Â

News Release   Â
Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

Â

Canada Revenue Agency information:
Â
Â
Â
Â
Â
Â

Â

 Â

bullet Â

Notice247 Harmonized Sales Tax for Ontario and BC – Questions and Answers on General Transitional Rules for Personal Property and Services   Â
Â
Â

Â

bullet Â

Notice246  Harmonized Sales Tax for BC – Questions and Answers on Housing Rebates and Transitional Rules for Housing and Other Real Property Situated in BC.   Â
Â
Â

Â

bullet Â

GST/HST Information Sheets:  Transition to the Harmonized Sales Tax
Â

Â

 Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

GI-056 Services   Â
Â
Â

Â

bullet Â

GI-057 Memberships   Â
Â
Â

Â

bullet Â

GI-058 Admissions   Â
Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

GI-070 Goods   Â
Â
Â

Â

  bullet

  Â

GST/HST Information Sheets:  Harmonized Sales Tax:
Â

 Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

bullet Â

Â
Â

Â

  Due to the general nature of the bulletin, it should not be relied upon as legal or tax advice.Â