Deductibility of professional’s run-off insurance post-practice

At issue

In order for someone to claim a tax deduction, our tax system requires that there be an income source to which an expense relates, and that the purpose of the expense is to produce such income.

For a professional who ceases practice, it would thus seem unlikely that deductibility would be available for an amount expended after the business has ceased to exist.  However, where that expense relates back to the pre-retirement period when professional services were being rendered, deductibility comes back into the picture.

Income Tax Act (ITA) Canada 

ITA subsection 9(2) makes reference to calculation of a taxpayer’s loss from a “business or property” for a taxation year.  It requires that a taxpayer’s loss, if any, from that source be determined by applying the ITA provisions for income computation.  Put another way, if there is no business or property income for that taxation year, in principle there can be no deduction.

Furthermore, an expense must fulfill the purpose requirement under ITA paragraph 18(1)(a) dealing with business or property, whereby:

18. (1) “… 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”

A.G. (Canada) v. Poulin, 1996 DTC 6477 (FCA)

Poulin was a real estate broker who had ceased carrying on business in 1984.  In 1987, he was found liable to a past client in relation to a transaction from 1976.  Poulin sought to deduct the $385,802 adjudged award as a business loss in 1987, and to carry the remaining loss to other years.

The court held that the fact that Poulin was not carrying on the business in 1987 did not preclude him from seeking to claim under paragraph 18(1)(a), “as long as he was engaged in completing the things he had done in carrying on his profession, even though at that point he was no longer carrying on business and could no longer act on behalf of clients.”  The claim would have to relate to an impugned act that was necessary in order to carry on a trade or profession, but may have been performed improperly.  

Unfortunately for Mr. Poulin, the court went on to determine that the damages in the circumstances related to a tort – an unlawful or deliberate act committed with the aim of causing damages – which it found was foreign to his profession, thereby ruling out deductibility.

2015-0618981E5 – Deductibility of run-off insurance premiums

The question was posed to the Canada Revenue Agency (CRA) whether a retired professional can deduct run-off insurance premiums from business income in the year the premiums are paid, even if the professional has ceased to carry on business in that year.

Citing Poulin as authority, the author of this CRA letter opines that, despite that the taxpayer may no longer be in practice, run-off insurance premiums may be deductible in the year paid.  The claim must conform with ITA deductibility requirements generally, and relate to work performed “during the ordinary course of the professional’s business operation.” in the pre-retirement timeframe.  Presumably the reference to “ordinary course” distinguishes offside activities such as in Poulin. 

Practice points

  1. Tax deductibility requires that an expense relates to producing business or property income, most often with both expense and income arising in the same year.
  2. Bearing in mind that CRA letters are not legally binding, it would appear that CRA’s administrative position is that run-off insurance premiums may be deductible when paid in a post-retirement year.
  3. Irrespective of tax deductibility, a retiring professional would be well-advised to consider run-off insurance coverage if it is available, in order to provide a degree of protection from a post-practice claim.

Depositing an employee bonus directly to RRSP

Implications of ‘no taxes withheld’

It’s February 2016, and many fortunate employees will be looking forward to the payment of their 2015 year-end bonus.  Particularly in sales roles where year-end figures dictate the amount of those bonuses, payments necessarily occur after December 31st.

Most employers will target to have those bonuses paid before the end of February, in part to enable the employee to use those funds to make an RRSP contribution that can be applied against the prior year’s income.  Often employers will go even further by offering to route the gross amount of the bonus – that is, with no federal or provincial income tax withheld – directly into an employee’s workplace group RRSP.  

For a conscientious RRSP saver, this is a great way to assure that contributions are being systematically socked away.  However, one must be careful to understand the mechanics of this process, in order not to receive a nasty tax surprise later. 

Timing and source of RRSP deposit

By the way, the 60-day deadline this year is Monday, February 29, 2016 to be able to claim against 2015 income.  For our ‘no-taxes-withheld’ bonus deposited directly to an RRSP, that means you will be using income taxable in 2016 to reduce income taxable in 2015.  

To illustrate, let’s assume for simplicity that Bonnie claimed no RRSP contributions for 2014, and her marginal tax rate is 40% at all times in this example.  She earned a base salary of $90,000 paid in 2015, and bonus of $10,000 paid in February 2016.  By making the RRSP contribution in February 2016, she reduced her 2015 taxable income to $80,000, yielding a tax refund of $4,000.  If Bonnie earns the same $90,000 base this year, her total income will be $100,000 in 2016.  

Unfortunately, Bonnie is terminated at the end of 2016, and by her employment contract is not entitled to any further bonus payment.  

Tax refund and next year’s tax return

It now comes to tax filing time in April 2017.  Bonnie’s employer perfectly withheld the tax due based on her $90,000 base, but Bonnie actually earned $100,000 in 2016.  She now owes another $4,000 in tax.  If Bonnie had the foresight to set aside the refund money when she received it in the spring of 2016, she would have the exact cash necessary to pay that difference.

Though somewhat in hindsight, this begs the question: what should Bonnie actually do with the tax refund?  A common recommendation is to make a further RRSP contribution with any refund that is generated from an RRSP contribution.  Apart from cultivating a savings habit, this enables the person to boost the RRSP each year by repeatedly applying the tax refunds to, in a sense, pre-fund the tax liability on the eventual drawdown.   

In this case however, had Bonnie made that second RRSP contribution, it would have generated a corresponding refund of $1,600.  That certainly helps build her retirement savings, but from a cash flow perspective she would still be $2,400 short of the $4,000 she needs to pay her 2016 tax bill on that bonus payment.

Real, or could it be worse?

On a rolling annual basis, if Bonnie has a consistent income and RRSP deposit habit, this phenomenon may never even be noticed, at least not until the year (or rather the year after) she retires.  

On the negative side of things, what if Bonnie had a $40,000 one-time/exception bonus one year that she used to catch up carried forward RRSP room?  This could play havoc with her cash flow when it comes to filing her taxes the following year.

As a final note, be aware that premiums for Canada Pension Plan and Employment Insurance are applicable to bonus payments.  That means that if the full bonus is directed to an RRSP, the employer will be taking those CPP and EI deductions out of the employee’s regular pay.  Though not as substantial as the income tax implications, this helps explain the slightly lighter regular pay cheque the employee would receive at February month-end.

TFSA goes back to the future

Rollback, indexing and the next instalment

In case you missed it, last October marked a long-awaited historic event: Marty McFly’s cinematic visit to the future on October 21, 2015 in the second instalment of the 1980s’ Back to the Future trilogy.

We introduced our kids to this movie franchise over the course of three weekends recently, and it was time well spent. Apart from the amusement, there was also a fair bit of confusion as they tried to work through what came first, what changed and what remained the same.

It’s not unlike how many people may have felt about the future of the tax-free savings account (TFSA) following that other significant event last October – the Liberal party victory in the federal election.

In the beginning

The TFSA was introduced by the Conservatives in the 2008 Federal Budget. Beginning in in 2009, it provided each Canadian resident over the age of 18 with $5,000 of annual tax-sheltered investment room. 

To keep up with inflation, an indexing formula was established to enable the annual room to rise by $500 increments every few years. The first such increase occurred in 2013 when the allotment became $5,500.

A bump in the road

In the 2011 election campaign, the Conservatives included a promise to double the annual TFSA contribution limit. The promise was made contingent on the party having a full term in office and reaching a balanced budget. They won a majority, so the only remaining requirement was to balance the books.

With the intervening 2013 increase to $5,500 based on the formula, there was potential for the room to be increased to as much as $11,000. As it turned out, the Conservative government tabled a balanced budget in March 2015 that included an increase in annual TFSA room to $10,000, retroactive to the beginning of 2015.

Part and parcel with the increase, indexing was removed, setting $10,000 as the fixed figure for all years from 2015 on. For interest, if the annual index factor were to have been a consistent 2% in future (see the table for the actual past figures), it would have taken close to 30 years to build up to $10,000 – roughly the same span of time Marty McFly jumped ahead in his time-travelling DeLorean.

Back to the future

It would be a bit overreaching to cast TFSA room as a pivotal issue in the 2015 election campaign, but it likely swayed some voters and certainly was prominently discussed. While the Conservatives had proceeded to enact the increase prior to the election call, the Liberal party stated its intention to rollback the provision.

With the Liberal majority victory this past October, attention turned to what the “rollback” might mean. If it was returned to $5,500 retroactive to the beginning of 2015, that would have forced those who had used the excess room to extract the extra they had deposited. And how would any investment growth (or decline) be treated? On the other hand, would those who had not yet taken advantage of the excess room lose that opportunity?

The answer was a practical one. The indexing formula was simply reinstated for 2016, returning the annual room to $5,500. The 2015 allotment of $10,000 was allowed to stand for the purpose of any carryforward, but it was ignored in applying the index formula. This assured that there was no prejudice to those who had not used the room in 2015 and no administrative headaches for those who had.

And for those lamenting the loss of the $10,000 amount, if that same 2% indexing assumption applies, the bump to $6,000 should happen in 2018.

Annual TFSA room