Commission – Doug Carroll

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.

Being an investment professional can influence tax treatment of your own investments

At issue

There is a fundamental concept in tax that determines how your investments are treated, being whether you are trading on ‘income account’ or on ‘capital account’.

It’s a concept that can cut both ways. On capital account, only half of gains are taxable, and only once realized; correspondingly, when losses are realized they can only be applied to reduce capital gains. On the other hand, income account treatment means full taxation on a year-to-year basis, while expenses in this arena are fully deductible in the year.

The ideal case for an investor would be to have all gains treated under capital account, and all expenses treated on a current/income account basis. As you might expect though, it’s not a matter of an investor simply choosing, though intention is part of the legal test.

What may surprise many people though, is that who you are – at least in terms of your professional/business profile – can influence how you are treated.

Income Tax Act (ITA) section 248 – Definitions

“business includes a profession, calling, trade, manufacture or undertaking of any kind whatever and … an adventure or concern in the nature of trade …”

Rajchgot v. the Queen, 2004 TCC 548

This is an oft-referenced authority on the legal test for income and capital treatment. The starting point is whether securities giving rise to a loss or gain are part of business activity (trading property) or investment activity (holding property). And the entrée into that analysis begins with ascertaining the taxpayer’s intention at the time of acquiring the securities.

Determining intention is understandably difficult, and is not helped much by a taxpayer’s statements, as those would be almost entirely self-serving. Intention then is derived by inquiring into and observing the taxpayer’s whole course of conduct. The framework for this analysis is arranged under the following headings:

Frequency of transactions
Duration of holdings
Nature and quantity of securities held
Time spent on the activity
Financing
Particular knowledge possessed by the individual

Foote v. the Queen, 2017 TCC 61 (released April 21, 2017)

According to the case fact summary, Mr. Foote had a sense that the markets had bottomed out in March 2009. Over the course of that year, he carried out 38 purchase transactions with an aggregate value of about $2.5 million, and generated about $3.0 million from 50 sale transactions. His total gain was about 23%. Mr. Foote reported the net result as capital gains in his 2009 income tax return. The Canada Revenue Agency (CRA) reassessed the amount as income, and Mr. Foote appealed to the Tax Court of Canada.

Mr. Foote had been in the investment industry for over 25 years, at the time working as head of institutional trading at a major investment dealer. In his role, he did not directly trade securities, but did oversee others who traded. On a personal level, he testified that his investment strategy had always been to invest in diversified securities he felt had the potential for 30% returns over a reasonable time frame.

The judge reviewed the facts under the Rajchgot heads of analysis. Trade frequency had tripled in 2009 relative to prior years, and hold periods averaged just 50 days, with some securities bought and sold within the same week. Despite not technically being a trader, his position “in common parlance and as generally described in the markets” nonetheless fell into that category. While acknowledging that the activities did not amount to “carrying on a business of trading securities”, the judge found that they handily met the requirements of “an adventure or concern in the nature of trade” under the ITA s.248 definition of business. Accordingly, the appropriate treatment of the gains was held to be income.

Practice points

Tax treatment of securities trading can vary based on the subject matter traded, the manner of trading, and the individual carrying out the trades. Frequent trades and short holding periods tend toward full income inclusion, as opposed to capital gains treatment.
Working within the investment industry does not invariably result in income treatment. For example, being the vice-president of human resources or information technology for a securities dealer would not in itself suffice. However, where a person’s job is integral to the business function of trading securities, that fact is far more influential in arriving at a determination of income treatment. And it is not a sufficient reply to merely show that the individual was not trading on insider-type information.
Still, it remains possible for even a full-time professional trader to be trading on capital account in his or her personal affairs, if the facts can support that conclusion.

Tax treatment of rebates paid by an advisor

At issue

In some provinces, licensed insurance advisors are permitted to pay a portion of earned commission to the purchaser of a life policy. If an advisor chooses to use this device, there can be tax implications for both advisor and client – and possibly even for parties extending beyond that immediate relationship.

Here are a couple of Canada Revenue Agency rulings and a Tax Court case on the issue.

CRA 2008-0271381E5 – Commission Rebates

The CRA was asked whether a rebate payment served to reduce an advisor’s commission, or if it was instead a deductible expense.

In general, where the advisor has the absolute right to the commission without restriction, the total amount of the commission would be included in income. However, the rebate would generally be a deductible expense so long as it fulfills the Income Tax Act requirements of being incurred for the purpose of earning income and being reasonable.

The recipient of such a payment will be treated as having received an amount that is income from property, the property being the life insurance policy. In fact there is a specific income inclusion section in the ITA for inducements received from someone (ie., an advisor) who has made the payment in the course of earning income.

CRA 2010-0359401C6 – Rebate Paid by an Advisor to a Policyholder

At the 2010 Conference for Advanced Life Underwriting program, the CRA was asked again about this issue. The Agency representatives referred back to the above ruling, reaffirming its position regarding the payor advisor and payee policyholder.

An additional leg of the question inquired whether the payment would reduce the policy’s adjusted cost basis. In response, the representative noted that an election is available for similar payments in respect of capital property. Life insurance is not however capital property, and there is no corresponding provision in the ITA section dealing with the ACB of a life insurance policy.

Lapalme v. R. 2011 TCC 396

A corporation purchased life insurance coverage on each of four brothers who were its shareholders and directors. Shortly thereafter, each received a cheque in his personal name from the advisor’s insurance-licensed corporation, which each claimed as a non-taxable gift. The amounts approximately equaled the respective first year policy premiums.

The court upheld the CRA assessment of a shareholder benefit having been conferred on each of the brothers. Further, it allowed the assessment despite being outside the normal assessment period, finding there to have been misrepresentation in filing the personal returns. Penalties were also upheld, attributable to a finding of gross negligence.

The case did not address what the tax implications may have been to the advisor, who was not present at the hearing.

Practice points

Obviously, verify your provincial rules on the legality of rebating.
Keep in mind the implications and complications if it is contemplated that the payment will be made to someone other than the policyholder.
With respect to advising the client, be aware of CRA’s position as stated in the first cited ruling above that “clients should be notified of the CRA’s position that the rebate received must be included in their income.”