Advertising on social media – Deduction complication … and simplification

At issue

We are about two decades into the commercial internet age. Alongside the expanding list of never-before-seen online goods and services, traditional bricks-and-mortar businesses are simultaneously being transformed by this digital revolution. The lines have blurred in terms of physical production, as have geographic and regulatory borders.

When it comes to taxes, some may find it appealing (possibly amusing) to see our authorities playing catch-up, but that means uncertainty for entrepreneurs. To make viable financial plans, businesses need to know whether and how existing rules will map over into their digital activities, or if they have entirely new compliance requirements to contend with.

Early on much of the focus was simply on what is subject to tax, and as new offerings emerge those determinations continue. Equally important is the question of what may be deducted from that income, to which the Canada Revenue Agency has recently provided some clarity in the area of advertising on social media.

Income Tax Act (ITA) Canada – Deductions generally

The general ability to take a tax deduction is expressed first as a denial, followed an exception:

18 (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of (a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property [my emphasis obviously]

Of course, numerous provisions constrain the application of that general exception. Some of those are overarching such as the reasonableness requirement in s. 67. Others are more targeted, in particular for our purposes the sections dealing with advertising.

ITA – Limitation on advertising expense

The advertising limitations are expressed in s.19 for newspapers (including any “comics supplement”), s.19.01 for periodicals, and s.19.1 for a broadcasting undertaking.

Much of these rules address cross-border issues: from the citizenship of the publisher; to the degree to which editorial activity occurs in Canada; to the geographic location of typesetting or physical printing; to the proportion of editorial-to-advertising space, and more. Depending on the resolution of these issues, advertising may be fully deductible, half-deductible, or not at all – and in some cases a reference to the Department of Canadian Heritage may be called for.

It requires a great deal of interpretation to apply that language and those concepts in a dynamic new media industry, not to mention the due diligence burden placed upon the taxpayer to ascertain the necessary information to work with. In fact, it would not be unreasonable to characterize that traditional framework as antiquated, and in many ways unmanageable.

CRA letters 2017-0708891M4 (August 2017) and 2017-0719471E5 (September 2017)

In August 2017, the Minister of National Revenue Diane Lebouthillier personally responded to a taxpayer inquiry sent to a Member of Parliament. The question was whether foreign online advertising was deductible. The Minister acknowledged the general s.18 deductibility and the constraints of ss. 19, 19.01, and 19.1. She then advised, as head of the CRA, that those limiting rules would not be applied to the deductibility of advertising expenses on foreign Internet websites.

Another letter was issued by the CRA in September 2017, responding to a similar issue. The question was about the treatment of advertising on social media. The agency confirmed that the Canadian content and ownership rules would not apply to social media sites or networks, including foreign websites.

Practice points
  1. Expenses are generally deductible if an outlay is incurred to generate income from a business or from property, and it is reasonable in the circumstances.
  2. There are rules that limit deductibility of advertising expenses, contingent on whether certain Canadian content or Canadian ownership requirements have been met.
  3. The CRA has confirmed that Canadian content / foreign rules will not apply to advertising on social media networks or foreign websites.

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
  1. 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.
  2. There will be no negative tax consequences for the payment of investment fees for registered accounts from any source any earlier than 2019.
  3. 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

  1. 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.
  2. The corporation must be factually carrying on the business.
  3. 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.
  4. 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.