Deduction – Page 3 – Doug Carroll

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.

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

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.
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.
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.

Deduction denied – Tax treatment of investment counseling on segregated funds

Segregated funds are sometimes described as the insurance industry’s version of mutual funds. This is convenient as a rough reference point, as outwardly their value tracks against an underlying pool of investment assets segregated from the offering insurer’s other assets.

In truth, however, they are a form of annuity, a type of insurance contract. This is not mere technical phrasing; a host of rights, obligations, protections and restrictions flow from this characterization.

And as became starkly apparent during the Canada Revenue Agency (CRA) roundtable at the 2014 meeting of the Conference for Advanced Life Underwriting (CALU), this can include significant tax implications.

Tax and investment advice

As a general tax principle, an amount may (note the emphasis) be deductible in computing income where that outlay is related to the generation of income. More specifically in the case of investment counselling fees, a deduction may be available if it fits within s.20(1)(bb) of the Income Tax Act (ITA).

Fees paid to investment counsel
20. (1) … in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted …
(bb) an amount, other than a commission, that
(i) is paid by the taxpayer in the year to a person or partnership the principal business of which
(A) is advising others as to the advisability of purchasing or selling specific shares or securities, or
(B) includes the provision of services in respect of the administration or management of shares or securities, and
(ii) is paid for
(A) advice as to the advisability of purchasing or selling a specific share or security of the taxpayer, or
(B) services in respect of the administration or management of shares or securities of the taxpayer;

Notably, “a commission” (eg., a classic brokerage fee for a trade) cannot be deducted under this provision, though such a charge is factored into the adjusted cost base used in calculating any eventual capital gain/loss. In CRA’s view, a charge that is computed by reference to the fair market value of a portfolio (ie., the generic sense of a commission) may nonetheless be deductible if it otherwise fits within s.20(1)(bb).

To paraphrase the section with respect to advice and securities, there are two main components to the test:

it must relate to advisability of purchasing or selling, and
the advisor’s principal business must be to provide such advice.

Critical in this determination is the scope of the definition of “securities”.

CRA roundtable at CALU 2014

The CRA was asked about its views on the deductibility of investment counselling fees on segregated funds. The question was phrased as follows:

“Can the CRA confirm that investors acquiring segregated funds may deduct fees in respect of the advisability of the entering into or redeeming out of, or the administration or management of, segregated funds under paragraph 20(1)(bb)?”

The question followed from a detailed preamble providing a variety of instances where courts have broadly interpreted the term “securities”. Courts have been called upon to do so as the term is not directly defined within the ITA.

While acknowledging the judicial review of “securities” for other purposes of the ITA, in its response the CRA noted that there is nothing on point with respect to this particular section. The agency held firm in its position that a “segregated fund policy is a contract of insurance and, in our view, is not a share or security of the taxpayer.” Accordingly, in the opinion of the CRA, no deduction could be claimed under ITA s.20(1)(bb) where the advice relates to segregated funds.

The future?

While it always bears noting that the CRA’s views are not binding on courts, they clearly show the agency’s auditing perspective. Given that challenging an audit could be a costly and time-consuming process — not to mention the uncertainty — the audit decision may be the de facto result for many taxpayers.

And the complications don’t end there. While this CRA response deals with a deduction claim on a directly charged fee, what does it mean for such fees that are embedded within a segregated fund’s management expense ratio? Do those have to be annually netted out of the investment return in order to reverse-out the imputed deduction taken at the fund level?

As a final thought, one cannot generally deduct interest under ITA s.20(1)(c) where money is borrowed to purchase a life insurance policy, but s.20(2.2)(c) allows an exception for segregated funds. Though in a different context, how does CRA’s administrative prohibition reconcile with this legislated exception?

In the CALU conference report, the editors indicate that Department of Finance officials (those who draft legislation at the behest of Parliament) have expressed some sympathy to a broader interpretation, and that industry stakeholders continue to correspond with CRA in the hopes of the agency taking a more expansive view of segregated funds.