Canadian taxes A to Z (2018): "S" is for Small Business Deduction

In today's Canadian Taxes A to Z, we finally get to the letter "S". Arguably the most useful of Scrabble letters, and not too shabby from a tax perspective either. S is for Small Business Deduction.

THE SMALL BUSINESS DEDUCTION REDUCES TAXES TO INCREDIBLY LOW RATES

The Small Business Deduction reduces taxes for Canadian Controlled Private Corporations (CCPCs). It unfortunately does nothing for you if you're operating as a sole proprietor or partnership. The reduction is available on the first $500,000 of income. It results in a significant tax reduction off the base corporate tax rate.

This Small Business Deduction is in addition to the already generous Federal Tax Abatement knocked off the base corporate tax rate. What this means is an incredibly low 10% federal tax rate for 2018, plus another few percent provincial tax (in Ontario the rate has dropped to 3.5%). This combined rate can make United States taxes look high by comparison.

WHAT'S THE CATCH TO THE SMALL BUSINESS DEDUCTION?

So what's the catch? First, the corporation must be private (meaning not publicly trading shares) and controlled by Canadian residents. Neither of these are very onerous requirements for incorporated small businesses.

The bigger catch is that you'll get taxed again as an individual when you withdraw income from the corporation, such as being paid as an employee. There are various ways to structure the means through which you pay yourself from the corporation to minimize the taxes paid, but there is always a risk of double taxation: once in the hands of the corporation, and then again when the money passes into your own hands.

Likely the most important factor to keep in mind in considering whether incorporating your business is going to do much for you from a tax perspective is whether you'll be in a position to shelter net income in the corporation, or will need to withdraw all the profits each year for your own living expenses. If you're able to shelter income, then you'll be able to invest those excess profits after losing only 10.5% of them to tax.

So it's kind of like an RRSP, but one where you lose a small amount off the top. Unlike an RRSP, you aren't claiming a deduction for the income you shelter in the corporation, but the effect is the same because you won't personally pay any tax on that income until you take it out of the corporation and place it in your own hands.

While there can be other legal and tax benefits to incorporation, like limiting your personal liability and taking dividends out of the corporation that are taxed at a lower rate than salaries, you should get accounting advice on whether incorporation is really going to save you any money at tax time. It's possible that it might actually cost you money (after increased legal and accounting fees are taken into account).

2016 BUDGET INTRODUCED NEW SMALL BUSINESS ANTI-AVOIDANCE MEASURES

The 2016 Federal Budget introduced a variety of anti-avoidance measures targeting corporate and partnership structures established to take advantage of the Small Business Deduction even though notionally their related incomes supposedly exceed the $500,000 Small Business Deduction threshold. There already were measures in place to address such issues, so it remains unclear how the new measures will affect not only tax planning but legitimate business structures implemented for reasons beyond purely income tax minimization. Read the government's take on the new measures here: Federal 2016 Budget .

Canadian Taxes A to Z (2018): R is for RRSP & RRIF

Today in Canadian Taxes A to Z, we come to the letter R. Unlike that stumper letter Q, R presents an embarrassment of riches when it comes to choosing tax-relevant words. I've chosen to present you with two R acronyms today, because they're very important to your taxes, and there is sometimes confusion when it comes to knowing how they save you on taxes.

Eighteen letters down, eight to go! And only four days left to tax filing deadline. Clearly I'm going to have to pick up the pace. And figure out what in the world I'll do with X, Y and Z!

RRSPS ARE REALLY ONLY A TAX DEFERRAL VEHICLE

First up, RRSP. Most know it stands for Registered Retirement Savings Plan. This is a tax deferral vehicle, not a tax free vehicle. Meaning, you get to save on tax when you deposit money to it, and the taxman gets you when you later withdraw money from the plan. 

In theory, RRSPs are supposed to save you money in two ways. First, because the dollars you deposit to your RRSP are pre-tax dollars, there are more of them to deposit, and thus more of them available to earn a return on investment. That's probably going to mean you have somewhere between 50% and close to 100% more money invested up front (depending on the level of your marginal tax rate). 

Thus if you've got $100 to invest, and you put it into an after-tax outside of RRSP investment account, you'd really only be investing $75 dollars (if you're paying tax at 25% - many of us pay at a higher rate). If you're able to invest at a 5% annual rate of return, that $75 investment would be worth only $78.75 after one year. Whereas, if you had placed it into an RRSP you'd have $105 after one year. And all the benefits of increased compounding in future years. 

The second way RRSPs may save you money is that when it comes time to withdraw from the plan, you'll be retired, and earning a lower income (and thus be in a lower tax bracket) than when you originally contributed to the plan. The important word to focus on here is "may."

WHY RRSPS COULD BE BAD FOR YOU

Many people don't realize that it's entirely possible they could actually be earning more money later in life than earlier in life, such as if they're collecting a pension and also still working full or part time. Additionally, the government could decide at some point to raise marginal tax rates. You'll get hit with whatever rate is in force and applicable to your current income at the time you make the withdrawal, not the rate applicable when you made the deposit. The up front tax saving may still be worth it, but be careful.

RSP investment earnings also don't benefit from Canadian dividend capital gains tax breaks, any any other kinds of breaks for special kinds of investments. Everyone gets taxed when withdrawing money from an RSP as if it is just interest income, regardless of how the profits were generated.  

RRIFS ARE FORCED RRSP WITHDRAWALS

RRIFs are essentially forced withdrawals from RRSP plans, starting at age 71. The government won't force you to withdraw too much each year, but your RRSP must be converted to a RRIF by age 71 at the latest, and the withdraws increase as you get older.

The idea seems to be to force you to pay some tax on all the RRSP accumulation while you're still alive, rather than leaving it to your heirs to be hit with the tax (which might be at the top marginal rate if all those RRSPs become income to you in the year of your death).

Thus you should think twice before deciding that the best place to stash all your excess cash (however much or little that might be) is in a RSP. 

Gordon S. Campbell is a tax lawyer practicing throughout Canada who has argued tax cases as high as the Supreme Court of Canada. He also litigates other kinds of civil, criminal and family law cases, as well as practicing immigration & citizenship law. Learn more at www.acmlawfirm.ca/gordonscottcampbell

Canadian Taxes A to Z (2018): "Q" is for Quickbooks

In today's Canadian Taxes A to Z, Q is for Quickbooks. Seventeen letters down. Nine to go!

If you're running any kind of business that takes in more than a few thousand dollars a year in revenue, you should be thinking about electronic bookkeeping. Quickbooks is likely the leading small business electronic bookkeeping program, though it certainly isn't the only one. To be frank, it's featured in my title today because there aren't a whole lot of tax terms that start with the letter Q.

Electronic bookkeeping will make your accountant and the Canada Revenue Agency happy, because you'll be able to defend any kind of later audit of your books by presenting well organized and balanced ledgers. Accountants hate the "shoebox" school of bookkeeping, because it's very difficult to figure out based on a shoebox of papers exactly how much money you made after expenses for tax purposes. With electronic bookkeeping, each expense and revenue is precisely accounted for long before the accountant starts working on your taxes.

SAGE (SIMPLY ACCOUNTING) ALSO QUALIFIES AS BOOKKEEPING

The main small business alternative to Quickbooks is Sage (previously called Simply Accounting). Sage is a Canadian product, whereas Quickbooks comes out of the U.S. Medium and larger businesses may use different (and much more expensive) bookkeeping and inventory control programs produced by other vendors, but for the small business world Quickbooks and Sage are the two leaders.

SPECIALIZED SOFTWARE ALSO QUALIFIES AS BOOKKEEPING

Some specialized businesses like law firms often use more specialized electronic bookkeeping products. I've recently switched to something called EsiLaw (whose main competitor is PCLaw), because of its built in trust accounting features. It's possible to make other bookkeeping programs do trust accounting, but it can be a pain to set up and keep working correctly. 

EXCEL SPREADSHEETS ALSO QUALIFY AS BOOKKEEPING

Good old Microsoft Excel spreadsheets can also serve you well, so long as they're properly set up for double entry bookkeeping. I used them for several years when starting my law practice and they made spot auditors happy. For any lawyers reading this, the Barreau du Quebec had a great Excel spreadsheet available for download from its website that works well for lawyers so long as you don't mind translating the French labels to English so that any auditors can read it. 

HANDWRITTEN LEDGERS STILL QUALIFY AS BOOKKEEPING

Even old school double entry handwritten ledger bookkeeping can still work, but it's a lot of hassle to find and fix mistakes. I know a few lawyers whose bookkeepers still use the method, but it comes with some inherent risks of errors which are difficult to catch. 

WHAT'S NOT BOOKKEEPING SOFTWARE & WHY

There are other software programs out there which sound like bookkeeping solutions, but aren't, even though they may have other nifty features. For instance, Canadian FreshBooks has a great cloud-based invoicing and billing program. But it's not a bookkeeping program, notwithstanding the use of the word "Books" in its name. Maybe one day it will do bookkeeping, but for now its lack of a double entry system and required ledgers means you can't get a full picture of your business financials from it.

There's also personal finance software out there, one of the most popular being Quicken from the Intuit makers of Quickbooks. It does a great job with household finances. Just don't confuse it with bookkeeping software.

Gordon S. Campbell is a tax lawyer practicing throughout Canada who has argued tax cases as high as the Supreme Court of Canada. Learn more at acmlawfirm.ca/taxlaw.

Canadian Taxes A to Z (2018): "P" is for Principal Residence Exemption

Today, "P" for for Principal Residence Exemption. Sixteen letters down. Ten to go!

PRINCIPAL RESIDENCE EXEMPTION MIGHT BE BEST TAX BREAK OUT THERE

The principal residence exemption may be the best tax break going for Canadians who own a home. As I've mentioned earlier in the alphabet, you usually must pay tax on capital gains just like on income gains (though at a lower rate). However, any capital gain on your principal residence is tax free. With home values in Canada generally rising at much faster rates than investment values, this can be a very profitable exemption!

COUPLE CAN TOGETHER ONLY HAVE ONE PRINCIPAL RESIDENCE

Prior to 1981, each spouse in a couple could designate a principal residence for the purpose of the exemption. So one could choose the cottage, and one the city home, and no one would pay tax on capital gains on either of them. However, since that time couples can only have one joint principal residence.

A couple could pick the cottage as the principal residence if they wish to avoid tax when it comes time to sell it, but for the years of its designation they would lose the exemption on their city home. So designating the cottage would probably only make sense if it had experienced a larger capital gain during the relevant period than the city home.

For a couple with a tiny city condo and a palatial waterfront cottage, picking the cottage sale to be tax free would make sense. But for most people, the city home is going to have risen more in value because it was more expensive to begin with. Picking the cottage as the principal residence would help defer tax payments for a while if it is sold prior to disposition of the city home, but if you plan to sell the city home at any time in the future the taxing of its capital gain would eventually catch up with you.

The most important requirement of the principal residence exemption is that the home must have been your principal residence for the entire time you owned it, not just at the time you are selling it. Otherwise, you'll need to take a percentage of a capital gain exemption equivalent to how long the home was your principal residence as compared to the total amount of time you owned the home.

Recent tax changes now require you to explicit claim the principal residence exemption in your tax filing.

DEATH & REBIRTH OF HOME OFFICE DEDUCTION FOR PRINCIPAL RESIDENCE

Especially controversial in recent changes was a Canada Revenue Agency fall 2016 principal residence exemption filing guide that seemed to suggest if you were claiming business use of home expense deductions for any portion of your principal residence, then the principal residence capital gains exemption would be reduced by a corresponding percentage. This could have had the effect for valuable properties of costing taxpayers hundreds of thousands in payable capital gains taxes, in exchange for only tens of thousands (at best) of home office expense deductions. 

At the end of February 2017 without any fanfare the CRA updated its website to now read: 

If only a part of your home is used as your principal residence and you used the other part to earn or produce income, whether your entire home qualifies as a principal residence will depend on the circumstances.

It remains the CRA’s practice to consider that the entire property retains its nature as a principal residence, where all of the following conditions are met:

  • the income-producing use is secondary to the main use of the property as a residence;
  • there is no structural change to the property;
  • and no capital cost allowance (CCA) is claimed on the property.

If your situation does not meet all three of the conditions above, you may have to split the selling price and the adjusted cost base between the part you used for your principal residence and the part you used for other purposes (for example, rental or business). 

Thus the home office deduction appears to have been saved! And claiming CCA on a home was always a bad idea anyway, even if legally permissible, because of the massive recapture that might be triggered at selling time. 

Gordon S. Campbell is a tax lawyer practicing throughout Canada who has argued tax cases as high as the Supreme Court of Canada. Learn more at acmlawfirm.ca/taxlaw.

Canadian Taxes A to Z (2018): "O" is for Offence

Today, "O" is for offence. We've got 15 letters down, and 11 to go in our 26 letter tax race. 

WHAT IS A TAX OFFENCE

Offence is a generic term used to refer to a lot of different contraventions of regulatory legislation in Canada which don't qualify as "crimes." Generally, you only find crimes in the Criminal Code or Controlled Drugs and Substances Act. So contraventions of the Income Tax Act are usually termed "offences."

It's important to distinguish between getting just a little too creative in your tax accounting which leads to you making statements in your tax return which the CRA won't accept but which don't amount to offences, and outright lies or obstruction which may potentially lead to offence charges against you. Make a few math errors, make an honest mistake about claiming a deduction you erroneously thought you were entitled to, have some bookkeeping errors leading to you claiming too much mileage on your vehicle? The CRA might administratively penalize you for any of these errors by charging you interest on the tax balance owing and assessing civil penalties. But it's unlikely any of these mistakes will lead to allegation of offences. 

However for more blatant actions (or inactions) like "forgetting" to file tax returns for ten years, ignoring repeated information demand letters sent to you by the CRA, or understating your real income by $100,000 are all good ways to be accused by the CRA of offences. Since the Income Tax Act is a regulatory statute, you can be liable for most of its offences (other than tax evasion) even if you didn't wilfully intend to commit the offence.

YOU CAN BE CONVICTED OF MOST TAX OFFENCES WITHOUT INTENT

Thus it's a bit like speeding on the highway: you might not have intended to drive 40 km over the limit, but if you got a bit distracted and your foot got a little heavy on the gas, saying you didn't mean to speed isn't going to help you in court. Same with taxes: saying you didn't mean to forget about filing your tax returns and ignore all those demand letters the nice people at the CRA sent to you won't really help you when you're charged with an offence. 

THE CRA HAS A HIGH CHARGING THRESHOLD FOR OFFENCES

The CRA tends to have a fairly high offence charging threshold. Meaning, they'd much rather go after you for more minor contraventions through administrative means by imposing administrative monetary penalties, rather than hauling you into court on offence charges. So not filing your returns for a year or two, or "forgetting" to report $10,000 in income on your return isn't likely to lead to you facing an "offence." But don't file for many years, or forget to report a few hundred thousand dollars on your return, and you might wind up with a court date. 

CHARGING THRESHOLD LOWER WHERE AGGRAVATING FACTORS

Sometimes the CRA's charging threshold will be lowered if there are other aggravating features of tax misconduct. For instance, if your unreported income was derived from criminal activity, the CRA might charge you with an offence even if it's only a few thousand dollars that are unreported. 

The message here is that the best way to avoid any allegations of tax offences is to avoid any hint of impropriety when filing your returns. I'm not suggesting that with sound accounting advice you shouldn't push the envelope in aggressively claiming deductions. Just be sure you can later defend those deductions when challenged, don't "forget" about any significant income, and make sure you file your returns on time, year after year, even if you can't afford to pay your full tax bill. The CRA always surprisingly accommodating in making payment arrangements, and the prescribed rate of compound interest remains a quite reasonable 5.1%. 

Gordon S. Campbell is a tax lawyer practicing throughout Canada who has argued tax cases as high as the Supreme Court of Canada. Learn more at acmlawfirm.ca/taxlaw.

Canadian Taxes A to Z (2018): "N" is for Non-Refundable Tax Credit

Today, N is for non-refundable tax credit.  Why the qualifier "non-refundable" and not just the term "tax credit"? Because some tax credits can actually result in the government sending you a cheque, such that in a way you make a profit off the credit. Non-refundable credits can at best reduce your payable tax to zero, but you'll never get a dollar back directly from the government (unless you've overpaid your tax instalments or deductions, leading to a refund).

CREDITS APPLY TO BOTH FEDERAL AND PROVINCIAL TAXES

You can receive non-refundable tax credits against both federal and provincial payable income taxes. The credit equals a "base amount" times the applicable tax rate. So, for example, the spousal credit can net you a $1771 credit federally, and an even greater $1892 credit against Alberta provincial tax, but only a tiny $523 credit against Ontario provincial tax.

SOME CREDITS ARE CLAIMABLE BY EITHER SPOUSE

Some non-refundable tax credits can be claimed by either spouse. Usually it will be the higher earning spouse who claims the credit. These include:

  1. amount for infirm dependants 18 or older;
  2. home buyer's amount;
  3. adoption expenses;
  4. caregiver amount;
  5. tuition and education amounts.

CANADIAN DIVIDENDS CAN LEAD TO A GOOD CREDIT

The Dividend Tax Credit for Canadian Dividends is an important one for investors, as it effectively reduces the tax rate payable on dividend income. But foreign dividends don't qualify for the dividend tax credit. And even within Canadian dividends, there is a split between:

  1. Canadian public corporations which are eligible for the enhanced dividend tax credit (commonly known as "eligible dividends";
  2. Canadian-controlled private corporations (CCPCs) which are eligible for the regular or small business dividend tax credit.

ACCOUNTING ADVICE RECOMMENDED WHERE SIGNIFICANT INVESTMENTS

You'll probably be able to figure out many of the available personal non-refundable tax credits yourself when completing your return, but if you have significant investments then getting the advice of an accounting professional would be prudent. In either case, make sure you carefully go over the fairly lengthy laundry list of available non-refundable credits to ensure you don't miss one you might benefit from!