December 2015 federal income tax changes

After recalling Parliament in the first week of December, the new government acted quickly on its key tax promises. Some introduced measures were already known from the Liberal platform, some only became clear in the announcement and still more were consequent on those other changes.

This summary draws from the published Explanatory Notes that accompanied the Notice of Ways and Means Motion to amend the Income Tax Act (Canada).

Rates for taxation years after 2015

The so-called “middle class tax cut” will be effective for the 2016 tax year. This is a reduction in the rate applying to income in the second tier, from 22% to 20.5%. Concurrently, a new top 33% tax-rate bracket is added. For 2016, the federal brackets are as follows (to be indexed in subsequent years):

• Up to $45,282        15%

• Up to $90,563        20.5%

• Up to $140,388      26%

• Up to $200,000 29%

• Over $200,000 33%

Tax-free savings accounts

There had been some uncertainty as to what the “rollback” of the $10,000 tax-free savings account (TFSA) room might mean. As it turns out, that amount will stand as the TFSA dollar limit for 2015 alone, whether or not contributions were made during 2015. That is, it will carry forward for those who had not used it in the year.

The TFSA dollar limit for 2016 will be $5,500, and the indexing formula is reinstated. The reinstated calculation refers back to the $5,000 amount in the 2009 base year, with the calculation rolling forward from then. It effectively disregards the $10,000 amount in 2015; or put another way, contributors are not penalized in future years for having been granted a large amount of TFSA limit in 2015.

Unlike registered retirement savings plan room that changes annually, the TFSA limit is indexed periodically. It is, however, based on an underlying reference figure that is indexed annually. Once that reference figure rounds up to the next $500 increment, the limit is increased that year and following. It increased to $5,500 in 2013.

Deduction by individuals for gifts

The introduction of the new 33% bracket for income in excess of $200,000 has implications for the tax credit for charitable donations. Currently, the credit is worth 15% on the first $200 of annual donations and 29% on amounts over $200. Respectively, those were the prevailing lowest and highest bracket rates.

The addition of the 33% bracket would have automatically increased the over-$200 credit rate from 29% to 33%. As the credit rate applies irrespective of the income of the donor/taxpayer, this would have made an already generous benefit even more so.

Instead, from 2016 on, the higher 33% credit rate will be available only to the extent that a taxpayer has income over $200,000. This assures that high-income taxpayers will not be deterred from donating, while preserving the value of the credit for others. To illustrate how this will work, suppose a person with taxable income of $215,000 donated $20,000. Only $15,000 would be entitled to the 33% credit rate, with $4,800 at 29% and $200 at 15%.

Corporate-personal tax integration 

The proper functioning of our tax system is based in part on the integration of personal and corporate taxes. Absent such a coordinated approach, the use of a private corporation could lead to unintended tax benefits. Integration is carried out using a number of mechanisms at the corporate level and on passing income from a corporation to an individual. The underlying theory is to impose a tax cost that roughly emulates the corporation as a top-bracket personal taxpayer.

The increase in the top personal tax rate from 29% to 33% necessitates adjustments to the rates used in these integration mechanisms. For a private corporation (including a Canadian-controlled private corporation), this includes a 4% increase to the refundable tax on investment income and a 5% increase to the refundable tax on portfolio dividends.

The changes are technical in nature and of limited value without a detailed review in context. Shareholders of private corporations should discuss these issues with a tax professional, as this could affect dividend/salary decisions and investment policies at the corporate level.

Date for the 2016 Federal Budget?

Parliament last sat on December 11, and it was adjourned until January 25, 2016.

As a final order of business before the adjournment, a motion was brought (and passed) setting forth the membership of the Standing Committee on Finance and authorizing it to commence its pre-budget consultations. The committee’s report will be due back to the House of Commons no later than February 5, 2016.

With the expectation that the government will take time to review the report, we should not expect an announcement of the tabling of the budget until the second week of February at the earliest. The Federal Budget is most often tabled in March, prior to the beginning of the government’s fiscal year on April 1st.

Transferring capital losses between spouses

Advantageous use of the superficial loss rules

Our tax system is based on each individual as a distinct taxpayer as opposed to taxing a pooled unit such as a couple or a family.

Even so, there is a built-in acknowledgement of these personal relationships in many ways; for example, the ability to transfer capital property between spouses at adjusted cost base (ACB). This defers recognition of any existing unrealized capital gains and associated taxes until there is a disposition by the recipient spouse.

But sometimes it may be preferable not to have that ACB rollover apply. One such occasion is when one spouse has capital losses and the other has capital gains. By strategically managing the superficial loss rules, the couple can transfer the loss so that it can be used by the spouse with the gain.

Superficial loss rules

A taxpayer’s capital losses in a year must first be applied against that year’s capital gains, with any remaining net capital loss allowed to be carried back up to three years or forward indefinitely. Where identical property is involved, the timing of those gains and losses is critical.

The superficial loss rules deem a capital loss to be nil if an individual purchases identical property 30 days before or after the disposition (a 61-day window) and still holds the property on the 31st day after the disposition. Concurrently, the ACB of the acquired property is increased by the amount of the denied loss, preserving the ability to claim the loss in future.

The rules also apply if certain related parties carry out a purchase, such as a trust of which that taxpayer is a major beneficiary, a controlled corporation or – perhaps most commonly and central for the purposes of this strategy – a spouse.

By strategically managing the series of transactions, the tax results can be split among taxpayers, enabling a couple to use the rules to transfer a capital loss between them.

Steps to transfer the loss

The strategy is most easily explained through an example. Let’s assume Eve has 300 XYZ Ltd. shares in in her non-registered account with an ACB of $30,000 and a fair market value (FMV) of $20,000. Her spouse Adam already has a realized capital gain of $10,000 this year. To maintain focus on the transfer of the capital loss, we’ll assume no market movements.

Step 1 – Eve sells her 300 XYZ shares on the exchange on day 0.

Step 2 – Within 30 days before or after Eve’s sale, Adam purchases 300 XYZ shares on the exchange.

Step 3 – No earlier than the 31st day after Eve’s sale, Adam sells his XYZ shares on the exchange.

As Adam’s purchase is within the 61-day window, Eve’s $10,000 loss is deemed to be nil. Adam would have spent $20,000 to acquire the XYZ shares, to which is added the $10,000 denied loss, giving him an ACB of $30,000. When Adam sells, he will incur a $10,000 capital loss.

For this to work, Adam must use his own funds for the purchase, or he could obtain (and service) a prescribed-rate spousal loan from Eve if the funds are in her hands. As well, bear in mind that if this is part of a broader series of transactions, the Canada Revenue Agency may seek to invoke the general anti-avoidance rule, or “GAAR.”

It is also possible to transfer the capital loss by transferring property between the spouses directly, for example, shares of a closely held corporation. In that case, the spouses must take the further step to elect out of the automatic ACB rollover that would otherwise apply. A detailed example of this procedure is included in our InfoPage titled “Capital loss planning.”

Mutual funds – Form matters

If the property in question is a mutual fund, remember that investment mandates are often available in trust and corporate forms. The two forms are not treated as identical property under the superficial loss rules.

This could work to a taxpayer’s benefit in trying to reduce his/her own capital gains. Let’s say that a mutual fund trust holding had lost value, but the taxpayer is confident that it is positioned well for the future. The holding could be sold and the corporate version acquired. The superficial loss rules will not apply, so the capital loss will be immediately usable by that taxpayer.

However, for the spousal capital loss transfer to succeed, the spouses actually want the superficial loss rules to apply. Hearkening back to our example, If Eve sells a mutual fund trust and Adam acquires a mutual fund corporation, Eve will have a capital loss that she has no present use for. For the capital loss to transfer, Adam must be sure to buy the same mutual fund trust as Eve held.

As a final note, be aware that a mutual fund company’s frequent trading rules could affect the timing of transactions and possibly their cost. It would be well-advised to vet the intended transactions with a tax professional to be sure that they carry out as intended.

Bruins challenge 50% meal deduction limit – What about Canada?

At issue

Generally, amounts expended to produce business income are deductible.  However, in the case of meals and entertainment, there is a potential that such outlays may be more entertainment than business. 

While arguably a tax authority could require a detailed explanation of each expense claim, the more practical approach adopted in most jurisdictions is to simply place a limit on deductibility.  

Section 67.1(1) of the Income Tax Act (ITA) Canada

Under our Income Tax Act, the current deduction limit of 50% has been in place since 1994, prior to which it was 80%.

ITA s. 67.1(1) provides that “an amount paid or payable in respect of the human consumption of food or beverages or the enjoyment of entertainment is deemed to be 50 per cent of the lesser of

(a) the amount actually paid or payable in respect thereof, and

(b) an amount in respect thereof that would be reasonable in the circumstances.”

Exceptions to this limitation are noted in the following subsections, including explicit acknowledgement given to long-haul truck drivers.

CRA IT-518R Food, Beverages and Entertainment Expenses

The Canada Revenue Agency (CRA) provides its guidance on the deduction limitation and exceptions in this archived Interpretation Bulletin.  Detailed commentary is provided on these potential exceptions: 

  • Provision of food, beverages or entertainment for compensation 
  • Fund-raising events for registered charities
  • Amounts for which the taxpayer is compensated
  • Benefits included in an employee’s income or provided to an employee at a remote work location
  • Employer-sponsored events or services available to all employees
  • Amounts included in fares for transportation, and
  • Conferences, conventions and seminars

Jacobs v. Commissioner, U.S. Tax Court Docket No. 019009-15

Hockey is an aggressive, competitive game, and the owner of the Boston Bruins appears to be taking the fight from the ice to the courts.  In July 2015, Jeremy Jaocbs filed a petition challenging the Internal Revenue Service on its interpretation of the meal deduction under the U.S. Internal Revenue Code. 

Like Canada, the United States generally limits the deduction for meals and entertainment to 50%.  The relevant provision is s.274(n) of the Code.

The core of the Bruins’ argument appears to be that the team is effectively running its business operations when stationed at each out-of-town hotel.  The players and other staff are required to attend and participate at meetings, which of course include meals.  In that view, the contention would presumably be that the provision of the meals is entirely for the benefit of the employer, and therefore should be entitled to full deductibility.

Practice points

  1. Meal and entertainment expenses are some of the most often reviewed and reassessed deduction claims.  A quick search of reported cases turns up dozens of rulings, and these of course are the ones that ended up in court, with many more being resolved administratively between the taxpayer and CRA. 
  2. The 50% limitation is not applicable in all situations, so a taxpayer could benefit from a review of the exceptions, as discussed in IT-518R. 
  3. On October 8, a Notice of Trial was served in Jacobs v. Commissioner for a hearing to be held March 7, 2016.  While foreign decisions have no precedent value in Canada, if the U.S. court finds that the arguments have merit, Canadian businesses – sports franchises or otherwise – may be emboldened to challenge the rules on this side of the border.