Insurance Journal – Doug Carroll

Whether interest on T-series distributions is deductible

At issue

Borrowing money for investment is a way to leverage up the amount of capital on which you can generate income. Of course that can also work against you by magnifying losses, but whichever way the performance goes, the interest on that borrowed money is usually tax-deductible.

For a straight buy’n’hold investor, deductibility is in turn straightforward. But when the borrowed money is repositioned in some way – whether by the investor’s actions or by the operation of the investment itself – deductibility can be brought into question.

Mutual funds – return of capital

In Van Steenis v. The Queen, the taxpayer borrowed $300,000 in 2007 to invest in units of a mutual fund. The fund had the capacity to return capital to investors, a feature often called ‘tax-efficient’ or t-series funds. In this case, the fund returned capital each year up to 2015, to a total of $196,850. Mr. Van Steenis used some of that money to pay down his loan, but the majority was used for personal expenses.

The Canada Revenue Agency reassessed Mr. Van Steenis for his interest expense deductions from 2013 to 2015, denying the portion related to his personal expenses.

Requirements for interest deductibility

As background, there are four requirements for interest deductibility:

interest must be paid or payable in the year.
it must be pursuant to a legal obligation on the borrower to make the payment,
the money must have been borrowed for purpose of earning income from a business or property, and
the amount of interest must be reasonable.

Importantly on the third point, it is the current use of borrowed money that is relevant in determining the income-earning purpose. On appeal, Mr. Van Steenis’ position was that he borrowed the money in 2007 to purchase mutual fund units, and that he continued to own those same fund units in the years in question, so therefore he should be entitled to continuing interest deductions.

Furthermore, he had no control over how the fund company characterized the distributions. He argued that though the fund was returning capital from its perspective, that does not necessarily correlate with each unitholder’s actual invested capital, and therefore he should not be bound by that characterization.

Ruling on continuing purpose

The judge did not accept Mr. Van Steenis’ arguments. Almost two-thirds of his capital was returned to him over the years, and more than half of that was used for personal purposes. Returning to that third deductibility requirement, there was no longer a direct link between the borrowed money and investment in the fund units.

In support of this finding, the judge points to the fact that a mutual fund trust is by its nature a flow-through structure. Income that it distributes to unitholders is included in their income and deducted from the fund’s income. By contrast, capital distributions result in a dollar-for-dollar reduction in the unitholder’s adjusted cost base, according to specific provisions of the Income Tax Act.

In sum, a return of capital reduces the amount of the investor’s own money that is in fact invested. If the entire returned capital had been used to reduce the borrowed principal, all ongoing interest charges would have been deductible because all remaining outstanding indebtedness would still be directly connected to the fund units.

As it was, more than half of that money was spent on personal expenses, and you don’t get a deduction for personal spending.

Minister of Revenue confirms the CRA is not going after retail employee discounts

At issue

In the house where I grew up, we bought almost all of our clothing, housewares and other durable goods from one retailer. That’s because it was the company where my dad worked, and part of the employment deal was a discount on purchases.

That’s a common practice for retail employees and restaurant workers, and one that garnered some front page media attention recently. It’s not because of any public uproar as if it was some kind of scandalous abuse. On the contrary, it was prompted by what appeared to be a reversal of the Canada Revenue Agency’s longstanding practice of acknowledging these as non-taxable items.

Is the CRA really intending to begin requiring employers to track the savings each employee receives, and report that as a taxable benefit each year?

Income Tax Act (ITA) Canada

Per paragraph. 6 (1)(a), income from employment includes “benefits of any kind whatever received or enjoyed by the taxpayer …in the course of, or by virtue of the taxpayer’s office or employment”. Some exceptions are allowed in the following subparagraphs, with no mention of discounts.

Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment

The CRA has an ongoing multi-year project migrating and consolidating its tax practice guidance from a variety of older formats into the online Folio format. This particular Folio was published in October 2016, but the story hit the headlines in October, 2017.

The Folio states that a discount is generally to be included as an employee benefit under para. 6(1)(a). With the exception of discounts made available to the general public, “the value of the benefit is equal to the fair market value of the merchandise purchased, less the amount paid by the employee.” Responsibility is placed on the employer to “determine the value of the benefit to include in an employee’s income.”

CRA letters 2017-0726641M4 & 2017-0729161M4 – Taxability of employee discounts

An immediate firestorm erupted for the Minister of Revenue Diane Lebouthillier, and within a day she clarified that this was the action of CRA bureaucrats, not the government’s policy intention. One day later, Folio S2-F3-C2 had been taken down from the CRA website, replaced by as a statement that it was “currently under review.”

We now have written affirmation that employee discounts are not on the CRA’s radar. Two letters were published in the last couple of months, from the Minister of Revenue herself. The letters are almost verbatim one another, with one providing a bit of additional reassurance to restaurant employees. The Minister states that the “longstanding administrative policy that employee discounts on merchandise are generally not taxed … is still in place and is explained in Guide T4130.”

T4130 Employers’ Guide – Taxable Benefits and Allowances

This Guide advises an employer that if it sells “merchandise to your employee at a discount, the benefit he or she gets from this is not usually considered a taxable benefit.” If the discount is below the employer’s cost, there would be a taxable benefit for the difference between fair market value and the price paid.

Practice points

Generally, benefits received by an employee from an employer are taxable.
Discounts for an employer’s merchandise and meal discounts for restaurant employees continue to be non-taxable, per the CRA’s longstanding policy.
If a discount is below employer cost then a taxable benefit may still arise.

Does a trustee have to disclose the existence of a trust to a beneficiary?

At issue

A trust is an arrangement where someone holds property for another who is entitled to the income and/or eventual receipt of that property. Though things can get quite complex, for present purposes this simple definition suffices to distinguish the two key parties: the former being trustee and the latter being beneficiary.

A trustee is a fiduciary, which at its core imposes an obligation to hold the property solely for the beneficiary’s benefit. If and when called upon, the trustee must account to the beneficiary who is entitled to know that the trustee is fulfilling that obligation. But what if a beneficiary is unaware that there is even a trust in place?

A recent decision of the Supreme Court of Canada (SCC) sheds light on a trustee’s obligations in such a circumstance. While the case deals with a large scale commercial dispute, the principles laid down should be carefully considered by all trustees, including those involved in personal and family trusts.

Valard Construction Ltd. v. Bird Construction Co., 2018 SCC 8

This is a commercial construction case where there was a series of subcontracting relationships. Shortforming the names, BCC subcontracted work to LEL, which in turn subcontracted to VCL, and the events unfolded as follows:

BCC obtained a surety bond allowing a “beneficiary” who is unpaid for labour or materials to claim from the bonding company, as long as a claim is lodged within a defined 120 day period.
LEL became insolvent, leaving VCL with unpaid invoices. VCL was initially unaware of the bond (which was uncommon in projects of this nature), only becoming aware after the claim period.
VCL sued BCC for failing to inform of the bond and its requirements.

Good recordkeeping is a must, in large part to distinguish business from The Court accepted that BCC was in the position of trustee, then quoting from Waters’ Law of Trusts it held that wherever “it could be said to be to the unreasonable disadvantage of the beneficiary not to be informed” of the trust’s existence, the trustee was obliged to disclose.

The Court ordered that BCC was liable to pay to VCL the amount that it could have obtained from the bonding company, had VCL been sufficiently informed to make a timely claim.

Application to personal trusts?

It is important to note that a beneficiary’s right to be informed of a trust is not absolute. Before reaching its conclusion in Valard, the SCC points out that where the interest of a beneficiary is remote, “it would be rare to find that the beneficiary could be said to suffer unreasonable disadvantage if uninformed of the trust’s existence.”

An example of when this remoteness might be considered would be where someone only becomes entitled if trust property remains after the death of a current beneficiary. Or perhaps a trust requires someone to reach a certain age before becoming entitled. Even more remotely, suppose a trustee has discretion whether or how much of the trust property to distribute to beneficiaries, or even to add or remove beneficiaries.

Trustees would be advised to check with their legal counsel where beneficiaries may be in the dark as to their status, particularly in light of the Supreme Court’s ruling in the Valard case.

Practice points

A trust is a separation of legal title to property from beneficial entitlement.
As the legal title holder, a trustee has an obligation to manage the trust property in the best interests of the beneficiary and to account for actions taken.
Where a beneficiary is unaware of the trust, the trustee may be obliged to inform the beneficiary of its existence. Whether and when the trustee must do so is a matter best discussed with a legal advisor.