Author’s Note:

The Canadian Investment Regulatory Organization (CIRO) reports that a little more than 1 in 5 Canadians use and trust finfluencers (or financial influencers) on social media for financial advice. A great deal of these individuals have no formal training and lack any financial planning credentials. As a result, many, albeit not all, statements put forth by these individuals tend to be misleading or downright false. Over the next few articles of Tax MYTHtakes, I look forward to providing the truth to combat several myths commonly perpetuated by such finfluencers.

Yours,

Ken Lee, PFA

Good morning, Toronto! Many finfluencers on social media claim, to varying degrees of truth, that Canadians coming of age NEED to immediately open several tax-advantaged accounts, including a Tax Free Savings Account (TFSA), Registered Retirement Savings Plan (RRSP), and First Home Savings Account (FHSA). One such short-form video on Instagram suggests that new adults should open an FHSA account ahead of a TFSA. In today’s article, we will discuss the basic design of these three plans, in addition to discussing several considerations that are often missed by these finfluencers.

An individual must be a Canadian resident and above the age of majority in their province (18 in Ontario) to open a TFSA or FHSA account. These registered accounts can hold a variety of different common investments in accordance with the investor’s risk tolerance and goals.

A TFSA allows individuals to shield their contributions and investment growth on a tax-free basis for perpetuity. Funds can be withdrawn on a totally tax-exempt basis at any time, for any reason, without affecting any income-tested government benefits (i.e. Old Age Security). For this reason, a TFSA can be a valuable tool to both supplement retirement income and also for everyday goals.

An RRSP, in contrast, operates on a tax-deferred (delayed) basis. Contributions to an RRSP are deductible against taxable income, which allows taxpayers to reduce their present tax liability. Taxpayers may elect to defer the deduction and claim it in a future tax year. Deductions are of more value when a taxpayer’s taxable income and marginal income tax are higher. RRSPs can be an advantageous tax planning tool where there is a significant difference between a taxpayer’s marginal tax rate during their working years and their retirement years. Where ideally used, the taxpayer receives a deduction at a higher tax rate and withdraws at a lower rate.

Finally, FHSAs combine the best attributes of both TFSA and RRSPs. FHSAs allow taxpayers to deduct from their income any contributions made towards the account, like RRSPs. Deductions can be carried forward indefinitely, even after the account is closed. As with TFSAs, investments can grow on a tax-free basis. However, the funds have a specified purpose: they are to be withdrawn only to buy a first home. If the funds are not used for this purpose, the account will be closed by 31 December of the year following the 15th anniversary of opening the account. At such time, the entire value of the FHSA can be rolled over into an RRSP. An unused and closed FHSA is functionally the same as an RRSP from a tax perspective.

The differences between these three accounts can be summarized by the following table:

Figure 1: TFSA/RRSP/FHSA Comparison Table (Credit: iA Financial Group)

Teenagers may have some RRSP contribution room as a result of having a part-time job. However, this room may be eroded by pensions and retirement savings plans that employers may offer. Generally, funds permitting, new adults tend to feel faced with the choice of contributing EITHER to a TFSA and/or FHSA. While many videos and even professionals strive to rank either one above the other, in reality, I argue that this choice is much more nuanced. Such a determination is dependent on the investment goals of each individual — an individual who does not foresee buying a house within 15 years should not open a FHSA.

Dangerously, many finfluencers fail to inform their viewers of situations in which tax-advantaged accounts may be subject to immediate tax. For example, while a TFSA is indeed exempt from Canadian tax, certain foreign taxes can and do apply to investments held. Many Canadians invest in US securities, and it is not unusual for a TFSA portfolio to comprise shares of American companies on American stock exchanges. When a US-based corporation pays dividends to a Canadian resident investor, Article X of the Canada–United States Income Tax Convention (the ‘Treaty) provides that 15% of the dividend is withheld as tax. Such withholding is reduced to 0% if the stocks were instad held in an RRSP, due to an exception within the Treaty. While out of the scope of this article, differing tax treatments across securities naturally lead to another area of tax planning: asset location.

Many Canadians are similarly uninformed of the ramifications of ceasing to be a Canadian resident on their tax-advantaged accounts. While many seem to believe that their accounts retain their tax-advantaged status worldwide, this is untrue. The new jurisdiction will generally apply its own rules to worldwide income and foreign accounts, which can be treated as fully taxable accounts.

No better example can be seen than with Canadians who become US residents, or are already US residents (such as by virtue of being a US citizen). The Internal Revenue Code (IRC) and Treaty do NOT recognize the tax-exempt status of TFSAs, although RRSPs retain their tax-deferred status. As such, should dividends or a capital gains event occur within a TFSA, the US will fully tax the gains, even if Canada does not impose any tax.

In addition, due to the onerous compliance regime characteristic of the US tax system, the taxpayer would likely have to include their TFSAs and RRSPs on their annual Report of Foreign Bank and Financial Accounts (FBAR) filings. In addition, Mutual Funds (MFs) and exchange-traded funds (ETFs) are popular means of diversifying investments in Canada. MFs and ETFs generally meet the Passive Foreign Investment Company (PFIC) tests of IRC §1297. Canadians holding investments that are classified as PFICs are required to file Form 8621. Worse, the US imposes the highest marginal tax bracket on PFIC gains.

In conclusion, while it is indeed important for young Canadians to open tax-advantaged accounts, it is equally important to consider investment objectives and future goals when choosing where to allocate funds. Financial professionals have an obligation to perform thorough due diligence on a client’s financial background to best inform their recommendations. Finfluencers have no such obligation — it is impossible to offer perfectly personalized advice to mass audiences. Unfortunately, people can and do suffer adverse tax consequences as a result of overly relying on such individuals.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning, Toronto! Moving abroad often presents several challenges and opportunities from a tax perspective. Students who move abroad for schooling on a full-time basis often incur significant expenses associated with establishing a dwelling in a new country. In this article, we aim to explain and discuss the intricacies of the deductibility of moving expenses.

As a prerequisite, all of the concepts presented in this article are contingent on the student continuing to be a factual resident of Canada. As we discussed in Matriculating Abroad: Understanding Canadian Tax Residency, tax residents of Canada are eligible for most government benefits and are eligible to utilize tax-advantaged plans in exchange for being taxed on their worldwide income. Due to the specifics of how tax residency is determined in Canada, we concluded that most students would likely remain tax residents while abroad if they continued to maintain a dwelling for their exclusive use on a year-round and permanent basis — often satisfied by simply having a room in their parents’ house — and intend to return to Canada on the completion of their studies.

Students who move to be closer to their post-secondary institution (PSI) may be eligible to deduct moving expenses, provided that:

• The move is undertaken with the express purpose of permitting the student to take up full-time attendance in a program of study (i.e. degree) at a PSI; AND
• After the move, the student will ordinarily reside at a new dwelling; AND
• Such a new dwelling is at least 40km closer to the PSI than their old dwelling.

Examples of eligible moving expenses may include travel costs, amounts spent on meals/lodgings/transportation (to a maximum of 15 days), the cost of physically moving personal effects, and certain expenses associated with terminating/establishing residence at the old and new dwellings.

The determination of ordinary residence at a given location or dwelling does not have a ‘test’ or definition in the ITA. Rather, Canadian courts have come to assign several factors that help to answer the question of what constitutes ordinary residence:

Thomson v Minister of National Revenue, 1946 SCR 209 (Supreme Court of Canada)
“One is “ordinarily resident” in the place where in the settled routine of his life he regularly, normally or customarily lives. One “sojourns” at a place where he usually, casually, or intermittently visits or stays. In the former the element of permanence; in the latter that of the temporary predominates” — Rt. Hon. Justice Estey
“[Ordinary residence] is held to mean residence in the course of the customary mode of life of the person concerned, and it is contrasted with special or occasional or casual residence.” — Rt. Hon. Justice Rand

Furthermore:

Rennie v. Minister of National Revenue, [1990] 1 CTC 2141 (Tax Court of Canada)
“While […] for some pur­poses a person may have more than one residence (although only one domicile), I know of no authority that holds that a person can be ordinarily resident in two places at the same time.”

After an examination of previous court cases in this matter, I would conclude that there is a fair amount of nuance in arriving at a determination. In most cases, Canadian students often spend the Fall and Winter terms abroad (~8 months) and only return during their summer break (~4 months). On the one hand, per Thomson, most students will establish “a settled routine of life” in the foreign country during term months. This would support the conclusion that a student is ordinarily resident at that location during the academic term, and hence, eligible to deduct their moving expenses.

To rebut, Thomson also establishes that ordinary residence implies an element of permanence, while sojourning is of a more temporary nature. Many international students often live in student accommodation while abroad. Others may opt to rent a dwelling and sublet the lease in their usual summer absence. In this regard, the temporary nature of their foreign stays cannot be ignored. If a given student has most of their family/social ties in Canada, always returns home during breaks, and intends to return to Canada after the completion of their studies, it can be argued that their foreign residence is more akin to a temporary sojourn than a true ordinary residence.

In any event, part of this discussion is rendered moot by the fact that the ITA only allows students to deduct expenses against the taxable portion of scholarships, fellowships, and research grants that the students received in the year. Given that, for full-time students (a covered prerequisite), these types of income are almost always tax-exempt, it is practically assured that there will be no tax benefit.

However, in the case of a student moving to take up employment (i.e. summer employment), if such a student becomes ordinarily resident in their new dwelling AND this new dwelling is 40km closer to their job, then such eligible expenses incurred can be deducted against income that is earned at the new work location.

On the whole, there is much uncertainty and nuance in the ordinary residence test required to claim moving expenses. In the future, taxpayers and tax professionals alike would benefit, in my opinion, from a streamlined series of tests which could be applied to determine the matter for ordinary residence. Perhaps a future case will invite such tests to be created by the courts or by legislation.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning Toronto! While we do some things similarly to the United States, our neighbours to the south approach taxation quite differently regarding taxes! Today’s article aims to provide a comprehensive overview of the US tax system, residency status, and provisions of the Canada-US Tax Treaty, highlighting key considerations for Canadian residents that intend to study in the US.

The US tax system uses several distinct terms from the Canadian tax system, which are summarized below:

A significant variation between our tax systems lies in determining tax residency and liability. For example, if any Canadian resident maintained sufficient residential ties to Canada when absent (assuming they did not avail of any tie-breaker clause), they would be considered a factual resident and fully liable for all worldwide income. In other words, the Canadian tax system is blind to immigration status in considering tax liability. In contrast, citizenship or residence in the US determines tax liability. We shall consider the following statuses:

• US Citizens (USCs)
• Resident Aliens (RAs)
• Non-Resident Aliens (NRAs)

The US is one of two countries in the world that operate a citizenship-based taxation regime — the other being Eritrea. The effect of this regime is that US citizens are treated as US tax residents. A USC will NEVER be treated as a non-resident, barring renunciation of citizenship. US citizenship is conferred on a jus soli basis, meaning that any individual born in the US — regardless of the parents’ status — are USCs.

Under US law, an ‘alien‘ is anyone who is not a US citizen. An alien is a US resident if they meet either of the below tests:

• Green Card Test (GCT): Held Lawful Permanent Residence (LPR) status at any point during the year.
• Substantial Presence Test (SPT): Spent at least 31 days in the US in the current year AND a weighted total of 183 days over the current year and the two preceding years.

In the context of this article, any individual who holds a student visa (i.e. F-1 status) is considered an exempt individual for the SPT. Thus, students will be considered to be ‘Non-Resident Aliens (NRAs)‘, who are taxed only on US-source income.

USCs and Resident Aliens are taxed in the same manner, both being liable to tax on all worldwide income. In addition, USCs and RAs living abroad are subject to extensive reporting requirements. First, if the aggregate (combined) value of all bank accounts is over US$10k at any point during the year, the taxpayer must file a Report of Foreign Bank and Financial Accounts (FBAR). Furthermore, those holding financial assets that have an aggregated value of over US$50k must file an information return with the IRS under the Foreign Account Tax Compliance Act (FATCA). FATCA also compels foreign governments and foreign financial institutions to report accounts held by USCs and RAs to the IRS.

While Canada also requires its own tax residents to report foreign assets if their cost of acquiring the asset is over CA$100k under the T1135/T1134 regime, FATCA is significantly more far-reaching due to its arguable intrusion on the sovereignty of foreign jurisdictions. To that end, the powers of the US expand to its tax treaties. As discussed in Matriculating Abroad: Understanding Canadian Tax Residency, tax treaties have tie-breaker rules which aim to deem an individual who would be considered a tax resident in two jurisdictions to be resident of only one for taxation purposes. With respect to the Canada-US Tax Treaty (herein referred to as the ‘Treaty‘), Article XXIX(2) provides that:

Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing [the US] from taxing […] its citizens […] as if there were no convention between the United States and Canada with respect to taxes on income and on capital.

This ‘saving clause‘ of the Treaty specifically prevents USCs from claiming tie-breaker provisions which may assign residency to Canada. This means that a US citizen residing in Canada would, in effect, remain resident in both jurisdictions and be subject to tax on their worldwide income in both jurisdictions.

To reduce double taxation, both Canada and US allow for Foreign Tax Credits (FTCs), a dollar-for-dollar credit against income tax for ANY foreign income taxes paid.

Canadian students studying in the US will likely have three types of income:

• Employment income
• Scholarship/fellowship income
• Educational Assistance Payments (EAPs) from an RESP

Generally, NRAs have more recourse to claiming exemptions over USCs. Canadian employment income will only be taxed in Canada, as NRAs are only taxed on US-source income. US employment income is generally taxed at the usual federal graduated tax brackets in the US. However, if the taxpayer made less than US$10k in a year across all employers, then Article XV(2)(a) of the Treaty provides that this income will be totally exempt from US taxation. To avail of this provision, a taxpayer must file a 1040-NR return and also use Form 8833 to disclose the Treaty-based benefit. Such US employment income, regardless of meeting XV(2)(a), is taxable in Canada.

Unlike Canada, where scholarships are tax-exempt for full-time students, US law establishes that a scholarship’s tax liability depends on what portion of the scholarship is for qualified (education) or non-qualified (living) expenses. Only the non-qualified portion is taxed, at the usual graduated tax brackets.

Finally, given RESP EAP payments resolve from Canadian financial institutions, they are tax-exempt in the US for NRAs.

In contrast, a Canadian resident who is a US citizen studying in the US would not be able to avail of many Treaty provisions due to the savings clause. With respect to foreign scholarship income, Internal Revenue Manual 21.8.1.12.17 provides that if a scholarship’s terms are unclear AND it is used for tuition expenses, it shall be treated as tax-free. To that end, it is extremely advisable to keep a record of what the scholarship funds were spent on to ensure against a potential audit.

In all, the rules surrounding Canada-US taxation can be convoluted. In these cases, having professional advice can be crucial in fully understanding your rights and responsibilities in each country. In the next article, join us as we discuss the implications of Canada-UK taxation.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Author’s Note:

After a lot of excitement, I finally received my PFA designation this month. For many students in Toronto and around the country, January and the coming months will be for deciding where to study! While some will stay close to home, many others may study in another province — even abroad! On that note, it is fitting that the next series, Matriculating Abroad, focuses on exactly that! I look forward to providing a basic overview of our tax system’s treatment of cross-border situations. While I write this series with students in mind, many concepts apply equally to anyone with ties abroad.

On behalf of KLee Tax, happy reading! We hope you get into your dream schools! – Ken Lee, PFA

Good morning Toronto! When studying or residing abroad, it is possible for an individual to be considered a tax resident in both the foreign country and in Canada. How does Canada treat one of its tax residents abroad? What is a tax resident? In today’s article, we will explore the Act’s provisions pertaining to international taxation, deeming rules, and implications of these rules for Canadians studying abroad.

To begin, there are multiple definitions of what constitutes a ‘resident’ in Canadian law. For example, Canadian immigration law broadly recognizes 4 categories of immigration status: Canadian Citizens, Canadian Permanent Residents, Refugee/Asylum claimants, and Temporary Residents (those with visit/study/work permits). Your status under the immigration laws is fairly explicit. If you are a Canadian citizen, you can be assured that your immigration status is cemented — barring renunciation or revocation of your citizenship.

However, under the Income Tax Act, the concept of a Canadian tax resident is more nuanced. For reasons which will become clear, a Temporary Resident with a study permit can be considered a factual resident for tax purposes, while a Canadian citizen could also be considered a non-resident.

While the Act has other residency statutes, for relevance’s sake, this article will consider the implications of the following three:

• Factual Residents
• Factual Non-Residents
• Deemed Non-Residents

Non-Residents (NRs) — Factual or Deemed — are taxed in the same manner. The following table distinguishes the differences in taxation between Factual Residents and NRs.

*Former Factual Residents that are now NRs may retain their RRSPs and TFSAs after becoming a NR without immediate penalty, although they are not allowed to make new contributions. To be discussed in a future article.

As can be seen, while Factual Residents are taxed on their worldwide income and are subject to both Canadian federal and provincial taxes, they also enjoy access to tax-privileged accounts, benefits, and tax credits. This is contrasted to NRs that, while only subject to federal taxes on their Canadian-source income, do NOT enjoy the aforementioned privileges that residents receive.

While the Income Tax Act does not define the term “resident,” the courts — most notably in Thomson v. Minister of National Revenue — have held that the question of residence, and thus liability for Canadian taxes, is reliant on the degree to which an individual has established and maintains their ordinary life in a given place.

Thus, the question of whether an individual is a Factual Resident, even after leaving Canada to live/study/work abroad, depends on the nature of their residential ties to Canada while abroad. Revenue Canada considers both significant and secondary ties in considering residency. No single combination of ties is, by itself, determinative.

Significant residential ties include:

• Dwelling place maintained for use in Canada;
• Spouse/common-law partner in Canada; and/or
• Dependents in Canada

Secondary residential ties MAY include:

• Personal property in Canada (i.e. furniture, cars, and clothing);
• Social ties with Canada;
• Economic ties with Canada (i.e. Canadian bank accounts, retirement savings plans, credit cards, and investments);
• Keeping provincial medical insurance coverage (i.e. OHIP);
• Retaining a Canadian Driver’s Licence;
• Having a registered vehicle in Canada;
• Retaining a valid Canadian passport;
• Retaining a valid Canadian phone number;
• Retaining membership in Canadian unions or professional organizations;
• AND MUCH MORE

Other factors that assist the CRA in determining an individual’s residency status MAY include:

• Intention to return to Canada;
• Frequently and the length of visits to Canada; and/or
• Residential ties in the foreign country

The CRA tends to scrutinize the residential ties of single individuals due to their lack of family ties, which are an extremely significant tie. Due to their life stage, high school students naturally tend to have less established ties, in spite of potentially having lived in Canada their whole lives. In addition, extended absences abroad (2+ years) tend to increase the likelihood of being treated as a non-resident, barring meaningful and substantive ties. Where an individual has failed to maintain sufficient residential ties to Canada, they are considered to be a Factual Non-Resident.

Particularly, most students tend not to be in a committed relationship, have dependents, or own/rent their own house. These lack of factors would, in theory, suggest a lack of significant ties to Canada. To that end, the CRA has also recognized (See ¶19 of GST/HST Memorandum 3.4) that a room in a parent’s house may potentially count as a residential tie, provided that the room is maintained and always available for the individual’s exclusive use upon any return to Canada.

Depending on an individual’s intentions to return to Canada after their absence, while most may strive to maintain being a Factual Resident, those who intend to permanently leave Canada should take steps to sever their ties. This can include closing all Canadian bank accounts and phone numbers, moving all personal effects abroad, establishing strong ties to the foreign country, and even informing Canadian institutions (such as banks) of Non-Resident status. There are several tax consequences of becoming a Non-Resident — to be explored in an upcoming article.

To assist in determining residency status, individuals should submit Form NR73 to the CRA for a NON-BINDING OPINION of their residency status. Processing time takes 2-3 months.

While most of this article has focused on determining if an individual remains a factual resident, it is also possible for an individual to be considered a resident under both Canada AND a foreign country’s tax laws. For example, it is common for individuals to be considered a tax resident of the other country if they spend a substantial portion of the year or have established residential ties in that country.

Canada has entered into tax treaties with many countries. These treaties generally contain ‘tie-breaking‘ rules that ‘deem’ a dual-resident individual to be a resident of only one country for tax purposes, applied in the following order:

• Permanent Home Test: In which country does an individual have a permanent home always available to them, in any hour of need?
• Center of vital interests Test: To which country is an individual’s social and economic ties closer?
• Habitual Abode Test: In which country does the individual regularly live?
• Citizenship Test: In which country does the individual hold citizenship of?

Should the first three tests tie AND the 4th test (Citizenship) fails (due to the individual holding none OR both of the Countries’ citizenships), the individual’s tax residence shall be mutually decided between the tax authorities of the two countries.

Per §250(5) of the Act, if an individual is a dual resident of both Canada and a foreign country, if the tax treaty breaks the tie in favour of the other country, the individual will be considered a Deemed Non-Resident for tax purposes in Canada.

In all, the rules surrounding residency status and international taxation can be extremely convoluted. Generally, where multiple jurisdictions are concerned, taxation can become extremely tricky, extremely quickly. In these cases, having professional advice can be crucial in fully understanding your rights and responsibilities in each country. In the next article, join us as we discuss the implications of Canada-US taxation.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning Toronto! Many Canadians may not want to wait till their deaths to make a gift to a charity. These same Canadians who want to make a life gift may not be willing to give up the income or control that the asset currently provides. In these cases, a charitable remainder trust can be an effective compromise. Today’s article will explain what the CRT is, as well as the CRA and the law’s position.

Unlike jurisdictions such as the United States, which provide a codified statutory definition of a charitable remainder trust (CRT) (see 26 C.F.R. § 1.664-1), Canada lacks such a definition. Instead, what constitutes a CRT in Canadian tax law has been construed through Revenue Canada’s administrative positions, technical interpretations, and some judicial precedent.

A CRT is still a normal trust where assets must be settled or transferred into the trust. However, the donor (or another beneficiary) typically retains the right to use the asset or to receive income from the asset for their lifespan — or fixed term (‘life interest’). After the term, a registered charity would become entitled to whatever remains of the asset (‘residual interest’). It is important to note that, as a part of this arrangement, the asset remains the property of the trust during the donor’s lifetime— the charity does not receive ownership until the donors’ life interest or term interest is fully satisfied (death).

In my previous article, The Price of Kindness: Charitable Contributions, I noted that one condition of a ‘gift’ existing for tax purposes was that the property in question had been voluntarily transferred by the donor. In a normal gift, this would imply that post-transfer, the donor has no right to any benefits of the property. By logic, property within a CRT would not qualify as a ‘gift’.

Notwithstanding this apparent contradiction, while the CRA does not treat the donor as giving the underlying property to the charity immediately—as with a traditional gift—they consider the donor to be giving the charity a present interest in the future value of the property. For tax purposes, it is therefore critical that the charity’s right to receive the remainder of the asset is ironclad. Thus, the CRA will consider a residual interest to have been gifted if ALL of the following requirements are met:

• There must be a transfer of property from the donor to a trust; AND
• The property in the trust vests with the charity at the time of the transfer (there may NOT be a vesting period); AND
• The transfer is irrevocable (the donor cannot ‘change’ their mind)

Where the above conditions are met, the charity is empowered to issue a donation tax receipt. However, it would be improper to issue a donation receipt for the full value of the transferred property. Given the donor’s life interest, the tax-deductible amount is actually limited to the present value of the charity’s remainder interest.

This is easier said than done — determining the present value of the charity’s interest is not straightforward. Generally, depending on the asset type, an actuarial report will be required for valuation purposes. This report considers, amongst other factors, the donor’s life expectancy, long-term expected investment returns, and a discount rate. As a function of the Time Value of Money, the longer the donor’s life expectancy, the smaller the present value and resulting donation receipt.

Normally, property transferred into a CRT is treated as a deemed disposition of the entire property at FMV, which would trigger any latent capital losses/gains on the full value of the property, in spite of only part of the property actually being ‘donated’. Taxpayers can make a subsection 118.1(6) election, which would allow the capital gains to be calculated based on the difference between the ACB and the FMV of purely the life interest. The remainder interest would still be treated as a gift.

Income that is generated from the life interest, as with other trusts, must be distributed to the beneficiaries to avoid the trust being taxed at the highest marginal brackets. Similarly, the distributed income is taxable in the beneficiary’s hands, with the character of the income (i.e. dividends or interest) being fully retained.

In conclusion, a charitable remainder trust is an excellent way for certain individuals to make a gift to a charity, enjoy the tax benefits now, and still enjoy the benefit of the money. However, care must be taken to assess a CRT’s suitability for younger donors, given the uncertainties of the current calculation method. In all, the CRT regime in Canada would benefit from an amendment to the Act that organizes all of the CRA’s guidance into easily accessible law.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning Toronto! As discussed in previous articles, the death of a taxpayer generally triggers capital gains, while registered assets (like RRSPs and RRIFs) are fully taxable as income, unless a rollover applies. Even so, these rollovers only delay the realization of the tax liability. Generally, death triggers significant tax liability at the highest marginal rates. Thus, estate planning equally balances managing the tax consequences of death, as well as distributing the assets in accordance with the decedent’s wishes. This article aims to discuss the role of charitable giving in estate planning and the tax mechanisms of making charitable gifts on death.

It is common for many wills to include a donation to a registered charity that is paid out of the taxpayer’s estate after their death. While the intention is established by the deceased, the actual donation is executed by the estate trustee during the administration of the will. The estate will be permitted to allocate the resulting donation tax credit to the deceased’s terminal tax return or the immediately preceding tax year. Generally, due to the discussed tax implications, it is more beneficial to allocate the credit to the terminal return. Unlike charitable donations made during life, which are limited to 75% of net income, testamentary donations benefit from an increased limit of 100% of net income.

These donations tend to be particularly effective in estates with significant unrealized capital gains or substantial RRSP/RRIF balances, especially where there is no surviving spouse to defer taxation and appeal to individuals who seek to retain full control over their property during their lifetime. However, the donation is contingent on the estate having sufficient liquidity to satisfy other liabilities (i.e. debt) before the charitable gift. An estate trustee owes a charity the same fiduciary duty (to act in a party’s best interest) as any other beneficiary. Charities are known to litigate to defend the bequest in the event of trustee misconduct or will challenges by other beneficiaries.

To avoid ambiguity, it is important to specify what type of bequest is being made. In Ontario, testamentary gifts can be classified into three categories:

• Specific bequests gift a clearly identified asset or fixed amount of money from a specific source to a named beneficiary. However, they are vulnerable to failure if the asset no longer exists.
• Residual bequests gift a part of/all of whatever remains (the “residue”) after all liabilities and specific bequests of an estate are paid out
• Contingent bequests come into effect only if the primary intention of the original bequest cannot be met, often survival.

In addition, a particularly powerful form of charitable giving includes the in-kind donation of publicly traded securities (i.e. stocks traded on an exchange, mutual funds, and ETFs). When directly bequeathed to a registered charity, the resulting capital gain is fully exempt from tax. At the same time, the charity issues a donation receipt for the FMV of the securities at the time of the transfer, which generates donation tax credits that can be applied to other income. In this sense, an in-kind donation is ‘double-dipping’ as you get both an exemption on capital gains, but also a tax credit. By contrast, if the estate were to sell the security and donate the cash proceeds, while they would still get the donation receipt, they would be fully liable for the accrued capital gains tax. Given that the TFSA and RRSP/RRIF are preferentially taxed, for those taxpayers considering making a gift, it is ideal to, where possible, leave securities in non-registered accounts to charities.

In conclusion, making charitable gifts at death provides a meaningful way to support the community while also defraying the tax consequences of death. The next article will explore strategies for charitable giving during one’s lifetime.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning, Toronto! It is no secret that many Canadians are generous. As the year draws to a close, many people may be considering donating to their local food bank, nonprofit, or charitable organization. Today, we kick off a new series that will examine the treatment of charity within the Canadian tax system. Today’s article will address charitable giving within the personal tax system, with the following articles discussing how charitable giving is incentivized and how charity is used as an effective tool to eliminate taxes.

Within Canada, the terms ‘non-profit organization’ and charity are often used interchangeably to describe a charitable organization that serves the community. However, Canadian law recognizes that there is a distinct difference between the two. A non-profit organization (NPO) is an organization that operates for purposes other than generating a profit. Generally, NPOs operate for social welfare, civic improvement, pleasure, and/or recreation purposes. On the other hand, a charity is an NPO that is registered with the CRA’s Charities Directorate. All charities are NPOs, but not all NPOs are charities.

While the Act does not define the definition of a ‘gift’, extensive litigation has prompted the courts to clarify its meaning. In Queen v. Friedberg, before the Federal Court of Appeals, it was clarified that a gift must meet all of the following:

• Be made with donative intent (given voluntarily without the expectation of material benefit); AND
• The property is voluntarily transferred by the donor; AND
• The transferred property was owned by the donor at the time of gifting; AND
• There is no benefit or consideration given to the donor for the property.

Further, many Canadian’s assume that a gift made to either an NPO or a charity entitles them to a donation receipt. In actuality, a donation is only receiptable if it is made to a qualified donee (organizations that are empowered to issue donation receipts), as defined in ITA §149.1(1). Common examples of qualified donees include all charities, Canadian amateur athletic associations, and the United Nations (and associated agencies). Political organizations (such as parties) are not qualified donees and are treatly seperately for taxation purposes. While some NPOs are qualified donees, the vast majority are not. Thus, gifts that are made to an NPO that is NOT a qualified donee will NOT qualify for an official donation receipt.

A donation receipt is only issued for the eligible amount of the gift. The Act defines this to be the FMV of the property on the day it was donated, LESS any ‘advantage’ (value of goods or services provided for the donation) given to the donor.

The federal charitable donation is a non-refundable tax credit that is calculated in two tiers. The first $200 of eligible donations receives a federal tax credit equivalent to the lowest tax bracket (currently 14.5%), while amounts above $200 receive a 29% credit. For taxpayers whose taxable income is in the top federal bracket (above $253,414), the tax credit on donations above $200 increases to 33% for the lesser of:

• The amount of income taxed at the top bracket; OR
• The amount of the donation.

Any eligible amounts that do not qualify for the 33% rate are simply credited at 29%. In Ontario, the process is simplified: a tax credit of 5.05% on the first $200 of eligible donations and 11.16% on the balance.

Despite these calculations, donations do not need to be claimed in the year that they are made. Donations can be carried forward for up to five years. This may be useful when large donations are made, as, for example, donations claimed cannot exceed 75% of net income in a given tax year. Finally, spouses can choose to share donations and allocate the credit between themselves accordingly.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning Toronto. From our past articles, you will have gained the impression that corporations tend to receive much more favourable tax treatment compared to individuals. In the past, this has led many individuals to incorporate and provide services that are no different from an employee working for an employer in an attempt to capture corporate tax benefits (such as lower tax rates) from work that is functionally employment.

To address this, the Act includes a specific category of corporations: Personal Services Businesses (PSBs). If a corporation is determined to be a PSB, there are significant income tax implications.

Federally, the base corporate tax rate (Part I) is 38%. After a 10% federal abatement that all corporations qualify for, the federal tax rate is actually 28%. For almost all corporations, the federal government permits a general tax reduction of 13%, making the effective federal corporate tax rate 15%. As discussed in Profit and Policy: Unpacking the Small Business Deduction, income that qualifies for the SBD is taxed at 9% federally. In Ontario, this system is simplified: 3.2% on income that qualifies for the SBD, and 11.5% on all other income.

A PSB is defined in subsection 125(7) of the Act to exist where:

• There is an individual (‘incorporated employee’) who performs services on behalf of the corporation; AND
• The individual is a specified shareholder (owns more than 10% of all voting shares by any means); AND
• If the corporation did not exist, the individual would be reasonably regarded as an employee of the payor (corporation’s clients); AND
• The amounts paid to the corporation for services rendered were from an arms-length corporation (not related); AND
• The corporation employed fewer than 5 full-time employees throughout the year.

Historically, the CRA and Tax Court have looked at several factors to determine if an employee/employer relationship exists. This determination is case-specific – there are no set factors which immediately ‘condemn’ a corporation as a PSB. I can distill these questions to:

• Who has the right to determine how, when, and where work is performed?
• Who provides the tools, equipment, and resources required to carry out the work?
• Does the incorporated employee bear any real chance of making profit or suffering loss?
• How integrated is the incorporated employee in the payor’s business structure?

As a PSB, many of the usual tax benefits afforded to corporations are denied. PSBs cannot claim the Small Business Deduction. PSBs do not receive the 13% general tax reduction, and are subject to an additional 5% federal surtax. For a PSB with a Permanent Establishment in Ontario, its tax rate would be 44.5% (28% federal + 5% surtax + 11.5% Ontario), which is still lower than the 53.53% top marginal tax rate (for Ontarians making over ~$253k) from 2024. The PSB taxation rate is roughly equivalent to the marginal tax bracket of an Ontarian making between ~$150k-$178k (44.97%), so if the corporation’s expected income was above this threshold, it may be advantageous to be a PSB. However, if the corporation pays all of this money as a salary/dividend to the incorporated employee, this may erode the perceived tax benefit.

A PSB is also severely limited in its ability to deduct expenses. In an effort to mirror the deductions that would be permitted to employees under the tax system for individuals, PSBs are not allowed to deduct advertising, rents, travel, CCA for equipment, and other deductions that corporations are generally entitled to. As per paragraph 18(1)(p) of the Act, PSBs are limited to deducting wages paid, benefits provided (such as the employer portion of CPP/EI), and some legal expenses (related to recovering payment for unpaid work performed).

As with any corporation paying an employee, PSBs are subject to the usual payroll obligations: to register for a payroll account, withhold and remit Income Taxes/CPP/EI, and issue T4 slips.

To conclude, these punitive measures (as well as the usual significant compliance, regulatory, and paperwork burden associated with having a corporation) are efforts to discourage employees from forming their own corporations. However, as discussed, there may exist some situations (corporation’s gross income is >$250k) where there may be potential tax benefits to a PSB, provided that all of the corporation’s income is NOT flowed down to the employee.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning Toronto! The Small Business Deduction (SBD) is one of the most powerful tools that small Canadian corporations can use to reduce their tax burden. In today’s article, we will discuss how the owner-manager can apply the SBD, as well as some limitations they should be aware of.

The Canadian corporate tax system, similar to personal taxes, is made up of both federal and provincial components. However, corporate taxes diverge from personal taxes by applying one uniform tax rate, in comparison to the graduated rate scheme seen for individuals. For an Ontario-based CCPC, the combined general corporate tax rate, after all applicable reductions, is currently 26.5% – 15% federal and 11.5% Ontario. Most corporations pay income tax at this rate.

A corporation must be a CCPC to claim the SBD, which provides for preferential tax treatment on up to the first $500k of active business income (passive income does not qualify) earned in Canada. This $500k is referred to as the Business Limit (BL) and is the maximum income eligible for the SBD. The BL itself can be lowered by several situations, which are discussed below. As the name implies, the SBD takes the form of deduction. In the event that the CCPC’s tax year was under 51 weeks, then the SBD is prorated by dividing the BL by 365 days and multiplying by days in the tax year. A Personal Services Business (PSB) is NOT eligible for the SBD on any portion of its income, with a few exceptions. These exceptions, along with a discussion of the tax implications of PSBs, will follow in the next article.

All provinces/territories have concepts similar to the federal SBD, offering a lower tax rate on income that qualifies for the SBD. Ontario, as with most jurisdictions, aligns its phase-out rules (discussed below) with the federal system. Most provinces allow the small-business rates on income up to $500k, mirroring the federal government. However, some provinces choose to enact different thresholds, such as Saskatchewan, where the small-business rate is 1% of taxable income, up to $600k.

From time to time, a CCPC may carry on business in more than one province/territory, rendering it liable for tax in each jurisdiction. For tax purposes, §400(2) of the Regulations determines what qualifies as a Permanent Establishment (PE). A PE is deemed to exist if a corporation has a fixed place of business (i.e. office, branch, factory, etc.) or has an agent with the authority to contract on behalf of the corporation. PEs determine income tax liability in a province or territory.

If a corporation only has one PE, it follows that 100% of its taxable income will be taxed in that province. However, if a corporation has multiple PEs, the corporation’s taxable income and SBD must be allocated between the provinces. ITR §402(3)(a) provides that both of these allocations are made by averaging the percentages of wages paid and gross revenue earned in each PE.

As its name suggests, the SBD is intended for small businesses. To prevent abuse, the government provides that the SBD may be shared between corporations or reduced under certain circumstances.

First, the BL is shared by related (a.k.a associated) corporations. This is to be mutually decided between the related corporations. Paragraph 256 of the Act defines that corporations are related if one controls the other (such as with holding corporations), or if both are controlled by the same person or group of persons. In this case, ‘control’ means to own more than 50% of the voting shares in the corporation.

The same paragraph contains further situations where a corporation may be related to each other. ITA §256(1)(c) provides that two corporations can be associated if:

• Each corporation is controlled, in any manner, by a person, AND
• The persons controlling the corporations in question are related to each other¹, AND
• Either of the persons owns at least 25% of any share class (generally, voting shares) in both corporations. (The cross-ownership test)

¹§251(2) ITA defines related persons to be individuals connected by blood, marriage/common-law partnership, or adoption. Blood relationship means ascendants, descendants, siblings, their spouses (brother/sister in-laws), or siblings of your spouse. As a result of this provision, aunts, uncles, nephews, nieces, and/or cousins would NOT be connected by blood relationship under the Act, and hence, are not related persons.

By ITA §256(2), corporations can also be considered related if they are each related to a common corporation.

If a corporation’s shares are owned through another corporation (i.e holding corporation), the Act deems that the aforementioned shares are considered to be owned by the shareholder of the other corporation as an anti-avoidance measure. While there are many more situations where corporations may be considered to be related, these are beyond the scope of the article – only the more common situations were covered.

A corporation may also be subject to a partial or full phase-out of the SBDs if the combined Taxable Capital Employed in Canada (TCEC) of the CCPC and all associated corporations are over $10m. Generally, this is the sum of the shareholders’ equity, surpluses, debt, and reserves, less investments/debts held in related corporations. The BL is also reduced, where the combined Adjusted Aggregate Investment Income (AAII) of the CCPC and its associated corporations are over $50k in the tax year concerned. AAII is defined as the sum of all passive income (interest, dividends, capital gains, etc.), reduced by certain allowable deductions under the Act

The calculation for the reduction to the BL is seen below. Neither calculation can exceed the BL. Note that if a CCPC exceeds both provisions (above), the greater of the two calculations applies:

TCEC Reduction = (BL/$500k) x (Portion of CTCEC over $10m/$40m)

AII Reduction = (BL/$500k) x 5(AAII-$50k)

A CCPC will be ineligible for the SBD if it and all its associated corporations’ combined TCEC is over $50m OR if combined AAII is over $150k. This is to ensure that the SBD only goes to small to medium businesses that are principally engaged in active business.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!

Good morning Toronto! For many small business owners in Canada, the Lifetime Capital Gains Exemption (LCGE) is a powerful tax benefit that can significantly reduce the amount of capital gains tax owed on the sale of qualifying property. In today’s article, we will discuss how the LCGE works and the requirements to claim it.

The Lifetime Capital Gains Exemption (LCGE) is an exemption on the sale of Qualifying Farm/Fishing Property (QFFP) and Qualified Small Business Corporation Shares (QSBCS). It allows individuals to shelter from tax, up to a certain lifetime amount. Currently, this amount is set as $1.25m. In practice, as capital gains are included as income at a rate of 50%, the LCGE takes the form of an up to $625k deduction. For many owner-managers, their business is their largest asset. Selling the business often triggers significant capital gains liability. By sheltering a portion of the mentioned capital gain from taxation, the LCGE allows entrepreneurs to support their retirement, transfer wealth to the next generation, or even reinvest proceeds into another venture.

The LCGE is claimed when filing the T1 Personal return for the tax year in which the disposition occured. The sale is reported on Schedule 3: Capital Gains or Losses of the T1 return. The LCGE is then applied by completed Form T657: Calculation of Capital Gains Deduction – it is not an automatic deduction. The CRA often requests proof after filing the return to ensure that the deduction meets all eligibility criteria (discussed below).

QFFP is defined in ITA §110.6(1) as property owned by the individual, their spouse, or a partnership where an interest in the partnership is an interest in a farm/fishing operation of the taxpayer or their spouse. Eligible farm/fishing property is defined as land, buildings, quotas, an interest in a farm/fishing partnership, or a share of the capital stock of a family farm/fishing corporation. In addition, the property must have:

• Been owned by the individual, their spouse, or the partnership for at least 24 months before deposition; AND
• More than 50% of the FMV of the property was used in the course of carrying the concerned farming/fishing business.

More relevant in today’s article, QSBCS are defined in ITA §110.6(1) to be shares of a Small Business Corporation (SBC) that meet certain conditions and tests at the time of disposition (sale). Specifically, immediately before disposition:

• The shares must have been owned by the individual or a related person (See ITA §251(2) for definition) for at least 24 months; AND
• During the 24 months preceding the sale, the corporation must have always been a CCPC; AND
• During the 24 months preceding the sale, at least 50% of the FMV of the CCPC’s assets were active business assets (the 50% test); AND
• Immediately before disposition, at least 90% of the FMV of the CCPC’s assets were active business assets (the 90% test).

Shares that are issued within 24 months of the acquisition may not automatically meet the 24-month holding period requirement. ITA §110.6(14)(f) deems such shares to be owned by an unrelated person before the issuance of the shares. However, if the shares were issued as consideration for other shares (such as in a share-for-share exchange, estate freeze transaction, corporate reorganization, amalgamation, etc) or as dividends, then the newly issued shares will be deemed to have been for the same period as the original shares. In the event the 24-month test is not met, the LCGE will be denied with respect to the ineligible shares that failed the test. All other shares that meet the 24-month holding period will continue to remain eligible for the LCGE, contingent on meeting all other eligibility requirements.

Furthermore, to satisfy the 50% and 90% tests, at least 50% and 90% of the CCPC’s assets must be active business assets during the 24 months before, and immediately before, the disposition, respectively. Active business assets are defined as assets used principally¹ in generating income from active operations of the business. Typical examples of active assets include inventory, equipment, goodwill, and property used in daily operations. Conversely, assets like excess cash, investment portfolios, and real estate (for rental) are considered non-active (passive) assets because they are not directly tied to the company’s line of business.

¹For the purposes of the Act, ‘principally’ means that the asset was used at least 50% of the time/value in the active business.

In the event the corporation has too many passive assets, it will negatively impact the owner’s ability to claim the LCGE. Typically, to meet these tests, corporations often undergo ‘purification‘, a process that aims to remove and reduce passive assets before the sale. This can be done by:

• Paying out excess each as dividends/salaries/bonuses
• Transferring passive assets to a holding company (HolCo)²
• Reinvesting idle funds in active operations

²The HolCo must not be a related corporation (controlled by the same shareholder) to the owner, as the assets of all related corporations are included for the calculations of the 50% and 90% test.

The definition of an active business asset has been tested repeatedly in the courts. In Ensite Ltd. v. The Queen, the Supreme Court of Canada was tasked with considering whether cash can be treated as an active business asset. This case eventually produced the ‘Ensite test‘, which deems that an asset is only considered active if the withdrawal of the property would have ‘have a decidedly destabilizing effect on the corporate operations themselves.’

In all cases, Ensite and related rulings have repeatedly emphasized the importance of maintaining comprehensive and well-documented records that justify the classification of assets as active business assets. Cases that lack this documentation tend to be looked on unfavourably by the courts.

In Gervais v. Canada (originally argued in French at the Federal Court of Appeals), the taxpayer attempted to split the capital gain from the sale of shares between himself and his spouse to multiply the LCGE. The court found that the transaction was primarily structured to avoid taxes. As a result, General Anti-Avoidance Rules were applied to reverse and deny the tax benefit. In all, owners should take care to ensure that all transactions undertaken for purification purposes are genuine, well-documented, and have a clear business rationale.

Finally, it should be noted that since the LCGE is an exemption, a taxpayer can claim a portion of it today and, if they start a new qualifying venture in the future, claim the remaining portion of the LCGE again, subject to the overall lifetime limit at that point in time.

In all, the LCGE is a powerful tax planning tool for owners of qualifying small business corporations and/or farm/fishing properties. Successfully claiming the LCGE requires careful attention to meeting the tests and maintaining proper documentation. With careful planning, taxpayers can easily maximize the LCGE while remaining compliant with the Act and Regulations.

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Too complicated? No worries! We file tax returns and offer tax planning services to individuals and not-for-profit organizations. Whether you are working your first job or an NPO looking to make a difference, you can be sure that KLee Tax will be there for your tax needs, when and where you need us.

Contact us below for a consultation or to discuss the contents of this article!