Insurance Journal – Page 3

Investment fees paid from outside RRSP, RRIF or TFSA – CRA position deferred to 2019

At issue

A common feature among RRSPs, RRIFs and TFSAs is that investments accumulate on a tax-sheltered basis. In principle, any reduction in the amount in the respective account reduces the benefit of that tax sheltering. Where investment management fees are paid from an external source, more money remains invested in the particular account.

However, whether an investor is inevitably better-off should take into consideration the source of those external funds. Whereas RRSP and RRIF accounts are pre-tax, a TFSA is after-tax. Arguably, using after-tax money from a cash account for a pre-tax RRSP/RRIF fees may not be the best result for an investor. The benefit is clearer with TFSAs, as both it and a cash account hold after-tax funds. Investors should consider their own tax position before coming to a conclusion.

Apart from the investor’s decision, the Canada Revenue Agency (CRA) has been mulling over the issue. According to its most recent communication, their updated and more stringent position will not apply until 2019, and hopefully we’ll have more clarity on that position early in the coming new year.

Income Tax Act s. 207.01(1) (b)(i)

These “advantage rules” were enacted in 2007 with the introduction of TFSAs, and were extended to RRSPs and RRIFs in 2011.

The definition of “advantage” applies to an increase in the value of a registered plan because of an action or transaction of a non-arm’s length party to the plan. If someone at arm’s length party would not have taken the action, and if the purpose is to benefit from the plan’s tax-exempt status, then a 100% tax applies to the amount of the determined advantage.

2016-0670801C6 – 2016 CTF Q5. Investment management fees for RRSPs, RRIFs and TFSAs

The CRA has a long-standing administrative policy that it does not consider it to be an over-contribution if a planholder uses outside funds to pay registered plan expenses. At the 2006 Canadian Tax Foundation Conference, the CRA was asked whether it holds a similar deferential view on the application of the (relatively new) advantage rules.

In response, CRA stated that an increase in value of the registered plan indirectly results from investment fees being paid by a party outside of the plan. This would likely be an advantage, and the planholder could personally be subject to advantage tax of 100% of the amount of fees paid.

The agency then advised that it was continuing its review of fees and fee rebates and would share the results in an Income Tax Folio expected to be published in early 2017. Its revised position would apply to fee payments after January 1, 2018.

2017-0722391E5 – Investment management fees

In September 2017, the CRA announced that it was considering a number of submissions from various stakeholders, and would be deferring the proposed implementation date by one year to January 1, 2019.

It made no mention of an updated target date for publication of the relevant Tax Folio, nor did it give any indication that it might be reconsidering its position.

Practice points

Expect publication of the Income Tax Folio on the advantage rules in 2018. As the CRA’s original advisory acknowledged that time would be needed for the investment industry to make applicable system changes, presumably CRA is still targeting for a date early in the year.
There will be no negative tax consequences for the payment of investment fees for registered accounts from any source any earlier than 2019.
Apart from the CRA/tax rules, individual investors should consider their own tax situation before deciding the appropriate source for the payment of investment fees.

Securities commissions may be earned through a corporation, but it still depends on facts

At issue

Being able to earn income through a corporation has historically allowed for more flexibility as to how and when tax will apply to the income.

I say “historically” because we are in the midst of proposals from the current federal government that would significantly affect private corporation taxation. The focus there is not on whether the corporation can be used to earn the income, but on what happens to the assets of a corporation after it has legitimately earned it.

For advisors in the business of trading in securities, the first issue to resolve is whether commission income can be earned through a corporation at all. The CRA commented on this in a letter released in the summer of 2017, tying together its past commentaries in an effort to clarify its position on the issue.

IT-189R2 Corporations used by practicing members of professions

Last updated in 1991, this Interpretation Bulletin outlines the conditions under which professional practices may be incorporated. As a first condition, it will be allowed “unless provincial law or the regulatory body for the particular profession provides that only individuals may practice the profession.” Paraphrasing the second condition, it must be factually true that the corporation carries on the business.

The IT refers to professions “such as law, medicine, engineering, architecture or accounting.” Though it’s a short list, it does not rule out other professions qualifying.

Income Tax Technical News 22 (January 11, 2002)

This ITTN dealt with the more nuanced issue of whether commissioned income earned by an individual could be transferred to a corporation. CRA’s comments were prompted by the case of Wallsten v. R. 2001 DTC 215 that ruled in favour of the taxpayer, despite that Mr. Wallsten’s contract with Sun Life prohibited him from assigning his commissions to any third party, in this case his corporation. The case proceeded under the informal court procedure, and therefore had no binding precedent value.

In the ITTN CRA maintained its position that it was not bound by Wallsten. However, it accepted that if a given professional is “not otherwise precluded” from assigning income to a corporation, and if “the corporation is carrying on the business, then the commission income would be reported by the corporation.”

CRA 2017-0693761E5 (July 11, 2017)

The principal issue in this CRA letter is “whether an individual in the business of trading in securities can earn commission income through a corporation.” I’ve added the underline here to emphasize what is being asked, so you can compare against how it is answered.

The author reproduces the key extracts from IT-89R2 and ITTN-22, then ties them together in the concluding sentence:

“Whether a corporation is factually carrying on that business is a question of fact that must be determined on a case-by-case basis and in our view, requires more than a mere assignment of income.” [emphasis added]

Thus, the CRA will not give a blanket approval, harkening back to the factual foundation. At the same time, it does not say that assignment of income to the corporation is not possible, but rather that it is not sufficient on its own to enable the corporation to report it.

Practice points

Securities commissions cannot be earned by a corporation if that is forbidden by a provincial regulation, a governing professional body or a private business contract.
The corporation must be factually carrying on the business.
Assignment of commissions from an individual to a corporation may be acceptable, but that action alone will not suffice to allow the corporation to report the income.
Keep an eye on the current federal proposals regarding private corporation taxation, as this could affect longer term usefulness of a corporation, and thereby influence the decision to use a corporation in the first place.

Is a mortgage incentive taxable to a borrower financing a real estate purchase?

At issue

Real estate values have been rising at rates beyond historical norms over the last few years, especially in some major urban centres. Whether purchasers are seeking home ownership or investment opportunity, the usual need for mortgage financing is accentuated when property values rise so rapidly.

This is generally good news for financiers, but obviously the competition for borrowers can be stiff. The marketing minds at these institutions have come up with some innovative ways to attract the attention of purchasers, along with novel product features.

No doubt borrowers are appreciative of the competition that keeps interest rates in check, and for the perks they appear to be receiving. Appearance, however, is not necessarily reality, and a closer look at the tax implications of mortgage incentives will allow borrowers to better evaluate a given proposition.

Income Tax Act (ITA) sections

A few ITA sections have bearing on the discussion here, beginning with the basic rule of income in s.9, followed by some broad categories of income inclusions in s.12:

9. (1) Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.

…

12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable …

Among the forty or so categories in s.12, two paragraphs are of particular note: (c) interest, and (x) inducements and reimbursements.

2016-0681271E5 – Cash back amounts on renewed mortgages – March 21, 2017

In the situation brought before the CRA, a corporation receives cashback amounts from a bank at the time it renews mortgages relating to its rental properties. The cashbacks are subject to payback if certain events occur within 3 to 5 years. The questions posed are whether the cashback is taxable to the borrower, and whether any payback can be claimed as a deduction.

The CRA writer begins by ruling out the possibility of the cashback being an interest payment to the borrower. She then touches on the general rule under s.9(1), which may alone suffice, but rests the determination mainly on being an inducement pursuant to para.12(1)(x). The amount of the inducement would be treated as income for the tax year in which it is received.

As to any payback, if an inducement is included in income pursuant to para.12(1)(x), a related payback in a later tax year would entitle the taxpayer to claim a deduction under para.20(1)(hh) in that later time.

CRA Views 2015-0609071E5: Mortgage incentive – February 22, 2017

A credit union offered its members a bonus on deposits to a particular type of savings account, conditional on the funds being used as a down payment for a property purchase, with the mortgage being placed with the credit union. The credit union’s position is that, as there is already a flat interest rate on the account, the bonus should not be considered interest to the borrower.

As above, the CRA writer here also addresses whether the bonus may be interest, but does not come to a conclusion, and instead states that if the bonus does not meet that requirement then it may still be taxable under another ITA provision.

Both s.9(1) and s.12(1)(x) are dependent upon the taxpayer having income from “a business or property.” That is a question of fact, and “without a detailed review of the relevant facts and documentation, we are unable to provide a definitive response.”

Practice points

The upfront rate on a mortgage is usually the main cost to a borrower, but other fees or concessions could increase or decrease that. An inducement in the form of an incentive is one such amount that can reduce the effective cost.
Where an incentive is received by a borrower/taxpayer in the course of earning income from a business or property, such as a rental unit, the amount is likely a taxable amount.
Where the borrower is not trying to earn income from the property, for example a family home, it is not clear whether the amount is taxable. While this leaves such individuals uncertain, at the same time it is conceivable that such amounts could be received non-taxable if the incentive program is carefully designed.