How to avoid penalty and double taxation for shareholders take benefits from private corporation

Subsection 15(1) was introduced to prevent shareholders of a corporation from directly or indirectly appropriating corporate funds or property free of tax.

Some shareholders took some personal benefits from corporation and recorded expenses for corporation.Thus, it would result in double taxation for the benefits need to be included in shareholders’ income and corporation cannot be deducted the expenses as well as penalty may be charged to 50% of the income tax payable on the taxable benefits.

Some example are as the following:

  • shareholder sells property to the corporation for a consideration greater than the fair market value (FMV) of the property transferred.
  • the corporation pays personal expenses of the shareholder, or the shareholder personally receives the benefits of the corporation without recording the transaction in the books of the corporation as income and as an advance to the shareholder.
  • property owned by the corporation is used by a shareholder for personal use, free of charge.

Case 1:

One client is a sole shareholder of ABC Ltd. ABC Ltd. owned a condominium in downtown Toronto, nearby University of Toronto. The client’s daughter is a full time student in University of Toronto and occupied the condo for the entire year in 2013. The total operating costs of condo was $15,000, and recorded expenses in the books of corporation ( property tax, utilities, insurance, condo fees, etc). However, the benefits to shareholder did not included taxable income.

For tax consequences, the client must include benefits from personal use of the condo by his daughter in his income, and ABC Ltd. cannot deduct the costs related to the condo as expenses since the expenses were not incurred to gain income purpose for the corporation.

Since there are possibilities of double taxation and heavy penalties under the rules of subsection 15(1), shareholder should aware that personal expenses are not claimed by the corporation. If the corporation pays a shareholder’s personal expenses, the amount paid should be recorded as a shareholder advance or loan that may be subject to inclusion in income under subsection 15(2) if it is not repaid within the time period provided for in that subsection.

Are your Gains and Losses Capital or Income when disposition property?

When you decide to dispose and / or deemed disposition of property, most taxpayer have gains or losses from the sale of property and are treated as capital gains or losses. This means only 50% of the gains are taxed instead of 100%. A capital losses can only be used to reduce or eliminate capital gains. On the other hand, some taxpayer who have gains or losses are determined to be business income, not capital. This means 100% of the gains are taxed, and 100% of a losses are deductible. The business losses are deductible from other income. The following factors need to be considered in determining whether a disposition is on account of income or capital:

  • relationship of the transaction to the taxpayer’s business- if the transaction is very similar to the taxpayer’s normal course of business, it will be considered business income
  • activity or organization normally associated with trade- need to consider how the transaction  was organized, nature of activity, etc. If the transaction is ” an adventure in the nature of trade”, it will be considered business income
  • nature of assets involved- sale of fixed assets (capital transaction) or inventory (business income)
  • number and frequency of transactions by the same taxpayer in a given period of time- a relatively large number of transactions may indicate that the taxpayer is involved in a business activity
  • length of period of ownership of the asset- the shorter the period, the more likely the disposition will give rise to business income
  • circumstances that caused the disposition- unsolicited offers resulting in a sale, or sales motivated by a need for fund, appear more capital in nature
  • stated objects of the organization as outlined in the articles of association or incorporation or a partnership agreement

 

What are your federal tax obligations when buying and selling property in Canada?

The Canadian real estate market is active, particularly in some major Canadian cities like Vancouver and Toronto. Questions have been raised about what federal tax obligations the buyers and sellers of real estate in Canada must meet, and how the Canada Revenue Agency (CRA) ensures tax compliance on these transactions.
This fact sheet is intended to answer these questions and address some myths about real estate transactions in Canada and the CRA’s role in administering the tax rules that apply to these transactions.

Myth – The CRA has a role to play in reducing housing costs.

Fact The CRA does not have any role to play concerning the affordability of real estate. The CRA has no influence over market-based or economic forces that influence the cost of housing, such as supply and demand, construction costs, and market speculation.

Rising real estate prices do, however, create an incentive for real estate flipping. The CRA has dedicated resources to ensure compliance with the tax rules for property sales and other real estate transactions.  The extent of our compliance activities is detailed in How does the CRA address non-compliance in the real estate sector. This work helps to maintain the fairness of our tax system.

Myth – Real estate flipping is illegal.

Fact   Real estate flipping is not against the law. Flipping is a method of buying and selling real estate to earn income. Individuals may also use assignment clauses in real estate contracts to flip a property once or more before a final sale is made.

However, all the money made on real estate flips, including real estate commissions and appreciation in value (the difference between the purchase price and sale price), must be reported to the CRA.

Myth – The sale of a new or substantially-renovated home is GST/HST exempt if the home has remained vacant or has been occupied temporarily by the builder after it is completed.

Fact – In fact, generally, the GST/HST must be charged on sales of new or substantially-renovated homes that were built or substantially renovated for sale, even when the home has remained vacant or has been occupied temporarily by the builder after completion.

Myth – Non-resident real estate investors do not have to pay Canadian federal income tax.

Fact – A non-resident who sells any taxable Canadian property must notify the CRA of the sale no later than 10 days after the date of the sale and pay an amount to cover the estimated taxes on that sale.

A person’s residency status is determined on a case-by-case basis by considering a number of factors which include:

  • residential ties in Canada;
  • purpose and duration of visits outside Canada; and
  • social and economic ties outside of Canada.

(Reference from CRA at http://www.cra-arc.gc.ca/nwsrm/fctshts/2016/fs160620a-eng.html )

 

How CRA address Non-compliance in Real Estate Sector?

The Canada Revenue Agency (CRA) uses a combination of advanced risk-assessment tools, analytics, leads, and third-party data to detect and address non-compliance. The CRA audits the files of taxpayers that it identifies as being high risk.

The real estate sector is one of many sectors that the CRA addresses through its risk-based method. Audits related to real estate occur regularly across the country, including in regions of Canada where economic factors may increase the risk of non-compliance.

What are the key areas of compliance risk in the real estate sector?

There are five main areas of concern:

  • questionable source of funds
  • property flipping
  • unreported goods and services tax/harmonized sales tax (GST/HST) on the sale of a new or substantially-renovated property / GST/HST new housing rebate
  • unreported capital gains
  • unreported worldwide income

 Questionable source of funds

The source of funds used to buy or maintain Canadian properties could be an unreported source that was never taxed, either in Canada or another country. In certain circumstances, a large down payment on a home, or a property that is expensive to maintain, may indicate any of the following:

  • Unreported income, if the lifestyle of the buyer is not compatible with the income reported;
  • Tax evasion
  • Purchase of real estate by a low-income person hiding a wealthy buyer.

The CRA can establish correlations between a taxpayer’s reported income and their lifestyle. The acquisition of expensive assets, such as a high-end home, without an obvious income source, can be an indicator of potential unreported income earned from legal or illegal sources

Property flipping

People, including real estate agents, who buy and resell homes in a short period for a profit are engaged in property flipping. There are three main categories of people engaged in this:

Professional contractors or renovators – They rapidly buy and sell real estate at a profit (sometimes demolishing or renovating the property).

Speculators or middle investors – They buy a property and then, for a profit, assign the right-to-sell clause that is in the contract to another speculator or the final buyer. This is called “shadow flipping”. It can occur many times between the first sale and the final sale of a property. The original seller often does not know that their property has been assigned to another buyer until the signing date.

Individual renovators – They buy real estate, renovate it, live in it for a short time, and sell it so they can claim the principal residence exemption several times in their lifetimes.

The CRA acquires and analyzes third-party data and has found that some flips are not being reported or are being reported incorrectly. The profits from flipping real estate are generally considered to be fully taxable as business income. The facts of each case determine whether such profits should be reported as business income or as a capital gain.

Unreported GST/HST on the sale of a new or substantially-renovated home /GST/HST new housing rebate

Generally, the builder of a new or substantially-renovated home must charge and collect GST/HST when the home is sold and report that tax to the CRA. The CRA uses various analytical techniques to identify builders who are not complying.

If a builder leases a new or substantially-renovated home, the builder is deemed to have sold the home to themselves. The GST/HST is payable and collectible at once on the fair market value of the home, including the land value, and the builder must report that tax to the CRA.

Generally, the deemed sale of a new or substantially-renovated home is not considered to have occurred if both of the following are true:

  • The builder builds or substantially renovates a home to be used primarily (more than 50%) as their place of residence, or a place of residence for a relative
  • The builder has not claimed an input tax credit to recover any GST/HST payable for the construction or substantial renovation

There may also be GST/HST implications for flipping transactions, if a property is new or has been substantially renovated. In most cases, the sale of used housing is exempt from GST/HST.

One of the main conditions for the new housing rebate to be available is that you must buy or build the house for use as your or your relation’s primary place of residence.

If you buy or build a new house in Canada, but your primary place of residence is outside Canada, then your house in Canada would be a secondary place of residence and would not qualify for the new housing rebate.

Also, if the intention at the outset is to flip the property, the eligibility requirement for the new housing rebate is not satisfied, as confirmed by several recent court decisions.

Unreported capital gains on the sale of property

The sale of a property for an amount greater than its cost generally leads to a capital gain. In most cases, capital gains are taxable and must be reported to the CRA. Whether the capital gain is taxable or not can vary depending on whether the property is a principal residence, or whether the seller of the property is a resident or non-resident of Canada.

If the seller of a property has lived in Canada and, if during that period the property was their main residence, they may avoid having to pay all or part of capital gains tax on the gain resulting from the sale of the property, due to theprincipal residence exemption.

A non-resident who invests in property in Canada is liable to pay tax on gains that arise from the sale of that property and is generally not eligible for the principal residence exemption. There are rules related to the disposition or acquisition of certain Canadian property that require non-residents who sell Canadian property to notify the CRA and to pay an amount to cover their estimated Canadian tax liability. This protects the Canadian government’s ability to collect tax that would otherwise be payable on the sale of a property.

Unreported worldwide income

An individual’s residency status is critical in establishing their Canadian tax liability and the tax treatment of the individual’s worldwide income. Residency status should not be confused with citizenship. For example, a citizen of a country other than Canada who has significant residential ties in Canada may be deemed to be a resident of Canada.

Residents of Canada have to report their worldwide income to the CRA. Non-residents only have to report their Canadian-source income, unless a tax treaty provides otherwise. An individual’s residency status is therefore essential in determining what income must be reported.

An individual’s residency status is determined on a case-by-case basis in light of many facts which include:

  • Residential ties in Canada
  • Purpose and duration of visits outside Canada
  • Social and economic ties outside of Canada

Getting results

The CRA regularly monitors tax compliance in real estate transactions. Transactions in the Greater Toronto Area have been the subject of greater scrutiny, including audits, for some years. More recently the CRA has been actively monitoring and auditing real estate transactions in British Columbia.

The CRA uses a comprehensive approach to dealing with suspected non-compliance in any industry, including the real estate sector:

  • The CRA studies the nature of the risk.
  • The CRA increases compliance activities where there is material risk.
  • Through experience and the use of third-party data, the CRA gains a better understanding of non-compliant behaviour, leading to more audits and compliance actions.

The CRA continuously evaluates risk as it relates to non-compliance. Resources are dedicated accordingly, and they can shift in relation to risks that develop.

Result of audit activities related to real estate in Ontario during the year ending March 31, 2016
Tax Number of files completed Audit recoveries
Income tax 1,339 $17,867,569
GST/HST 525 $32,356,529
Total 1,864 $50,224,098
Result of audit activities related to real estate in British Columbia during the year ending March 31, 2016
Tax Number of files completed Audit recoveries
Income tax 114 $4,287,367
GST/HST 225 $10,090,263
Total 339 $14,377,630

The CRA will apply a penalty equal to 50% of the additional tax payable if a taxpayer knowingly makes a false statement when filing a return. During the period April 1, 2015, to March 31, 2016, the CRA applied 447 penalties, totaling about $9,720,256. The highest penalty was almost $2.5 million.

(Reference from CRA at http://www.cra-arc.gc.ca/gncy/cmplnc/rlstt/menu-eng.html)

 

 

Employee Versus Self-Employed or Independent Contrator

Sometimes it is difficult to determine if an individual is an independent contractor (i.e. self-employed) or an employee. Many employers find it beneficial to hire contractors rather than employees. The costs of EI, CPP, and benefit packages for employer are reduced.

Issues- Employee vs self-employed

  • The deductible of expenses is more restricted for employees. Self-employed individuals may be allowed to deduct reasonable expenses.
  • Self-employed need to pay double CPP; no EI (can opt into EI system for certain benefits);
  • GST/HST input tax credits are available for self-employed.
  • Employer must withhold source deductions (income tax, EI, and CPP) and remit to CRA;
  • Employer must make match CPP contribution and 1.4 times of EI deductions and remit to CRA;
  • Employer must file T4 summary and supplementary slips by end of February.

There is no single test or factor that is decisive in determining whether an individual is an employee or an independent contractor.

Interrelated tests:

  • Economic reality or entrepreneur test-  control ( hours, location, what and how the job is to be completed), ownership of tools, chance of profit and risk of loss
  • Integration or organization test- whether individual is economically dependent on the organization
  • Specific result test- is the person providing services for a specified period of time or on an ongoing basis?

Case 1:

One client had child care expenses and claimed it in the year of tax return. However, the situation was the babysitter who came to client’s home and took care of child. When CRA audited it, the factors for the economic reality or entrepreneur test involved the employer and employee relationship. So the client as employer must withhold source deductions and also need contribute employer’s portion of CPP and EI and remitted to CRA.  The client fail to compliance with the rules and got the penalties and interest charged.

 

 

Non-Residential Status

Non-residents

You are a non-resident for tax purposes if you:

  • normally, customarily, or routinely live in another country and are not considered a resident of Canada; or
  • do not have significant residential ties in Canada; and
    • you live outside Canada throughout the tax year; or
    • you stay in Canada for less than 183 days in the tax year.

Residential Ties – use province where you resided on December 31

  1. Home (Owned or Leased)
  2. Personal Property (Car, land, building)
  3. Spouse or common-law partner or dependent reside
  4. Other ties-social ties, driver’s licence, bank accounts or credit cards, health card

Notes:

A. If you did not maintain significant residential ties with Canada, and on December 31, you resided outside Canada and were a government employee, a member of the Canadian Forces or their overseas school staff, or working under a Canadian International Development Agency program, you may be considered a deemed resident of Canada (this also applies to your dependent children and other family members).

B. If you stayed in Canada for 183 days or more in the year, you did not establish significant residential ties with Canada, and under tax treaty, you were not considered a resident of another country, you will be considered a deemed resident of Canada. Otherwise, considered a Non-resident of Canada.

Your tax obligations

As a non-resident of Canada, you pay tax on income you receive from sources in Canada. The type of tax you pay and the requirement to file an income tax return depends on the type of income you receive.

Generally, Canadian income received by a non-resident is subject to Part XIII tax or Part I tax.

Filing your income tax return

You must file a Canadian income tax return if you:

  • have to pay tax; or
  • want to claim a refund.

Filing due date

Generally, your tax return has to be filed on or before:

  • April 30 of the year after the tax year; or
  • if you or your spouse or common-law partner carried on a business in Canada (other than a business whose expenditures are mainly in connection with a tax shelter), the return has to be filed on or before June 15 of the year after the tax year

Notes:

A balance of tax owing must be paid on or before April 30 of the year after the tax year, regardless of the due date of the tax return.

Case 1:

One client, ABC, immigrated to Canada in 2008 and a few months later, she went back home and did not set up any residential ties in Canada, and did not have any Canadian sources income from Canada. So accountant recommended that she did not need to file tax return because she was a non-resident for the time. When she came back Canada in 2013, the financial advisor suggested she open a TFSA account and contribute the  total amount of $25,500 from 2009 to 2013 to complete the TFSA contribution room. A CRA audit charged  around $2,000 in penalties because she was non-resident from 2009 to 2012 and had not qualified for contribution TFSA contribution room amounts.

Case 2:

One client, XYZ,  rented a house in Toronto and paid monthly rent by postdate cheques to the owner . The owner of the house is a non-resident and did not have any representative agent who could handle every month rental income withholding 25% tax and remittance to CRA. The owner failed to comply as a non-resident who received rental income in Canada and have to withhold 25% tax to remit to the CRA and did not file election amount. CRA charged tenant penalties and interest as the owner did not have any representative agent to do it.

Liabilities for Tax

All individuals, corporations, and trust residents in Canada have liabilities to report tax.

Non-residents – Report tax from Canadian-sources income if:

  • Employed in Canada
  • Carried on a business in Canada
  • Disposed of taxable Canadian property

Partnerships are not directly liable for the tax on income, and it should be reported by the partner.

Taxation year of individuals – Calendar year (Jan 01 to Dec 31)

Taxation year of corporation – Fiscal year(select own fiscal year as long as it is not longer than 53 weeks)

Income Tax Filing Deadlines 

Individuals:

  • Due on or before April 30 of the next year
  • June 15 if individual or spouse carried on a unincorporated business-if owing tax, tax owing due on or before April 30

Deceased individuals:

Usual filing deadline. Exception: If an individual dies after October in the year and before the filing date (i.e. April 30/June 15), the return must be filed by the later of six months after the date of death; and usual filing date following the particular year.

Corporations-within six months after the end of the taxation year

Penalties

  • Late-filed tax return: Balance of tax owing *5%+1% for each complete month late: Maximum=17%
  • Late-filed tax return (repeat offender): Balance of tax owing *10%+2% for each complete month late: Maximum=50%
  • Failure to report income (repeat offender): Income not reported * 10%
  • Under-reporting income (knowingly or gross negligence): Minimum=$100; Maximum=increased tax liability *50%
  • Late or deficient instalments: [Interest charged-greater of (a) $1,000 and (b) 25% of interest that would have been charged if no instalments were made] *50%

Payments and Interest

  • Individuals- April 30
  • Corporations- 2 months after year-end
  • CCPC claiming Small Business Deduction with taxable income under the business limit in the previous year- 3 months after year-end
  • Trusts- Due date for trust return

Liability of directors-Corporate directors may be held liable for unremitting withholding.

Liability for GST/HST

Under the Excise Tax Act (ETA),  a person who is engaged in a commercial activity in Canada is required to register for GST/HST purposes, which include an individual, partnership, corporation, trust or estate, or a body that is society, union, club, association, commission, or other organizations of any kind. GST/HST is a tax on consumption or value added, and not on income.

Exclusions from commercial activity

Activities involve the making of exempt supplies do not constitute commercial activities. Therefore, you cannot register for the GST/HST if you provide only exempt goods and services. This means that you do not charge the GST/HST on your supplies of your goods and services, and you do not claim input tax credits.

Exempt goods and services include:

  • used residential complexes.
  • long-term residential accommodation (of one month or more), and residential condominium fees.
  • some sales of vacant land or farmland.
  • most health, medical, and dental services performed by licensed physicians or dentists for medical reasons.
  • child care services (daycare services for less than 24 hours a day) for children 14 years old and younger.
  • bridge, road, and ferry tolls (ferry tolls are taxed at 0% if the ferry service is to or from a place outside Canada).
  • legal aid services.
  • most educational services such as:
    • courses from a vocational school that lead to a certificate or a diploma to practise a trade or a vocation; or
    • tutoring services for an individual who takes a course approved for credit by a school authority or the education service follows a curriculum designated by a school authority.
  • music lessons.
  • most food or beverages sold in an elementary or secondary school cafeteria primarily to students of the school and most meal plans provided in a university or public college.
  • most services provided by financial institutions such as arrangements for a loan or mortgage.
  • arranging for and issuing insurance policies by insurance companies, agents, and brokers.
  • most goods and services provided by charities.
  • certain goods and services provided by non-profit organizations, governments, and other public service bodies, such as municipal transit services and standard residential services such as water distribution.

Case 1:

One client who provides the educational services and charged HST to their customers. When we find out their mistakes, we help them to correct the mistakes and doing the properly adjustments in adjusted trial balance, and helped them to file adjusted GST/HST return to avoid CRA penalty.

Case 2:

One client received CRA audit from the previous year and come to our firm to response the CRA audit issues. When we analysis their previous year’s financial statements, we find out the mistakes from previous allocated and charged GST/HST for rental income of residential condominium. We help them to correct it and adjust for GST/HST return and income tax return which relative it. We help the client to get couple thousands of refund of GST/HST.

Case 3: New house GST/HST rebate

One client who purchased new condominium. When the house was closed, she disclosed to lawyer about the new house for principal residence purpose. One year later, CRA audited it and find out the condominium was rent out and charged $27,000 penalty and interest for the GST/HST rebate claimed. We helped the client to correct the GST/HST New Residential Rental Property Rebate Application and solved the problem.