Major tax changes and improvement to services.
Significant changes due to the COVID-19 pandemic, and numerous tax issues to be aware of this year
Different ways to legally smooth income over a number of years… Maximizing access to the lowest marginal tax rates.
A list of tax deductions or credits to consider in the upcoming tax season
Ensure that allowances paid are reasonable. If they are determined unreasonable, the full allowance could be taxable
In a May 15, 2020 Federal Court of Appeal case, the Court reviewed whether various allowances paid to employees of the taxpayer were subject to CPP and EI. This required determining whether the allowances were taxable. The Tax Court of Canada had previously ruled that some of the allowances were partially taxable, while others were either fully taxable or fully non-taxable. At issue in this case was whether an allowance could be partially taxable or whether being in excess of a “reasonable amount” resulted in the allowance being entirely taxable.
After reviewing the exclusion of reasonable travel allowances from income rules, the Court concluded that the entire allowance is excluded from income if it is reasonable, or fully included in income if it is unreasonable. It cannot be partially taxable. As the allowances in question exceeded a reasonable amount, they were entirely taxable.
ACTION ITEM: It is extremely important to ensure that allowances paid are reasonable. If they are determined to be unreasonable, even if by the thinnest of margins, the full allowance could go from non-taxable to taxable. Consult with a specialist to ensure that they are comfortably reasonable.
Consider if there is significant investment capital available, and a family member at a lower marginal tax rate
Special attribution rules prevent the shifting of income between certain related people (including a spouse, parent, grandparent, sibling, uncle or aunt). Consider the situation where high-earning Spouse A gives investments to low-earning Spouse B so that investment income can be taxed at Spouse B’s lower tax rate. The attribution rules prevent this by requiring the earnings to be taxed in the hands of the transferor, Spouse A. However, these rules do not apply where the low-income person pays fair market value for the capital received. One way to pay for such investment capital is with properly structured loans, commonly referred to as “loans for value”.
The loan must satisfy several conditions to facilitate income splitting:
the loan must bear interest;
the interest must be at a rate no lower than the CRA prescribed rate at the date the loan is advanced; and
the interest for every year must be paid no later than January 30 of the following year.
Missing a single interest payment invalidates the loan for the year in respect of which the interest accrued and all subsequent years. For example, interest for 2019 was required to be paid by January 30, 2020. If the interest was not paid, attribution would apply for 2019 and all subsequent years.
The borrower (commonly a trust for minor children or grandchildren) can then invest the borrowed funds and earn income. Because the borrowed funds are used to earn income, the borrower is entitled to deduct the interest incurred as a carrying charge. To the extent the return on their investments exceeds the interest, the difference will be taxable to the lower-income borrower.
This planning tool is of particular interest now as CRA’s prescribed interest rate declined to 1% (from 2%), as of July 1, 2020.
CRA has confirmed that the interest rate can be fixed at the time the loan is advanced, without further adjustment when the prescribed rate changes. However, where a pre-existing loan requires higher interest (such as the 2% rate in effect to June 30, 2020), the rate cannot be adjusted downwards as it is also locked in at initial advance. Where there is an existing loan at 2% (or higher), refinancing at the lower 1% rate would require that the borrower repay the original loan. A new loan could then be advanced at 1% interest. Where appreciated assets must be transferred or sold to repay the loan, accrued gains would need to be reported.
ACTION ITEM: Consider setting up a loan for value if there is significant investment capital available, and a family member at a lower marginal tax rate.
Consider setting up SUPPLEMENTAL UNEMPLOYMENT BENEFIT (SUB) plans as individuals transition to traditional EI
The purpose of a SUB plan is to allow an employer to make supplemental payments to Employment Insurance (EI) benefits, without eroding those EI benefits. As payments under a registered SUB plan are not insurable earnings, EI premiums are not deducted.
In order to be eligible, SUB plans must be registered with Service Canada before their effective date. Plans must:
identify the group of employees covered and the duration of the plan;
cover a period of unemployment caused by one or a combination of the following:
temporary stoppage of work,
illness, injury or quarantine;
require employees to apply for and be in receipt of EI benefits in order to receive payments under the plan;
require that the combined weekly payments from the plan and the portion of the EI weekly benefit rate does not exceed 95% of the employee’s normal weekly earnings;
require it be entirely financed by the employer;
require that on termination all remaining assets of the plan will revert to the employer or be used for payments under the plan or for its administrative costs;
require that written notice of any change to the plan be given to Service Canada within 30 days after the effective date of the change;
provide that the employees have no vested right to payments under the plan except during a period of unemployment specified in the plan; and
provide that payments in respect of guaranteed annual remuneration, deferred remuneration, or severance pay will not be reduced or increased by payments received under the plan.
A plan registered with Service Canada is not required to be a trust. It could be funded from general revenues.
Income tax treatment
For income tax purposes, a SUB plan is defined more restrictively, as it is required to be a trust to which the employer makes payments. Such plans can be registered with CRA, in which case any income earned within the SUB trust is non-taxable. Whether or not registered, receipts are taxable to the employee. Payments to a registered SUB plan are deductible to the employer if made no later than 30 days after year-end. Payments to SUB plans are not otherwise deductible, so a plan structured as a trust must be registered for employer contributions to be deductible.
A SUB plan which is not a trust would not be subject to the above rules. Deductibility of payments would follow the general rules for all expenses for income tax purposes.
Interaction with the Canada Emergency Response Benefit (CERB)
The provisions that exist under the EI system for employers to make additional payments to workers through SUB plans do not apply to employees who are receiving the CERB.
Amounts received by individuals from any employer in excess of the $1,000 threshold would create an obligation for the individuals to repay CERB they received for the same benefit period.
Employers that wish to do so may continue to submit a SUB plan to Service Canada. By registering a plan, employers can make payments to employees who are currently receiving EI regular or sickness benefits and will also be prepared should employees need EI benefits at a future time.
ACTION ITEM: As CERB is scheduled to end September 26, 2020, many individuals will now begin to rely on the EI system. The time may be right to consider setting up SUB plans as individuals transition to traditional EI.
Up to $500 reimbursement to employees for the personal purchase of equipment for working remotely
In an April 14, 2020 French Technical Interpretation, CRA was asked whether amounts paid to an employee for costs of equipment for working remotely would be a taxable benefit.
Generally, a reimbursement for a personal purchase of equipment used for working remotely would be a taxable benefit. However, CRA noted that in the context of the COVID-19 pandemic, which has required many employees to work remotely, acquisition of computer equipment may be primarily for the employer’s benefit. In that context, CRA indicated that no taxable benefit would arise for a reimbursement, supported by actual invoices or receipts, of no more than $500 towards such equipment.
CRA also stated that a non-accountable allowance would always be taxable, as no provision would provide for an exclusion of such amounts.
CRA did not comment on the consequences if the equipment were used exclusively for employment and was owned by the employer, not the employee. CRA has indicated in the past that, where equipment is property of the employer, and any personal use is incidental, there would be no taxable benefit to the employee.
ACTION ITEM: Consider providing a reimbursement to employees for the personal purchase of equipment for working remotely of up to $500.
Where the 20-hour test is not met, the ongoing nature and labour requirements must be considered and still not be subject to TOSI.
CRA released the promised guidance for employment expenses incurred by shareholder-employees to be deductible:
For an employee to deduct travel or motor vehicle expenses against employment income, the employee must be normally required to work away from the employer’s place of business, be required to pay the travel expense under the contract of employment, and have a signed and completed T2200. Also, the employee cannot receive an allowance excluded from income.
In 2017, CRA began denying travel expenses claimed on the personal tax return of many employees who were also shareholders of the employer or related to a shareholder. After receiving concerns from stakeholders regarding this new assessing practice, CRA reversed their assessments, indicating that “clear guidelines for taxpayers and their representatives” were important to the Canadian self-assessment system and that additional consultation and guidance was needed in this area.
In September of 2019 CRA released the promised guidance. It noted that the following conditions had to be met for employment expenses incurred by shareholder-employees to be deductible:
The expenses were incurred as part of the employment duties and not as a shareholder.
The worker was required to pay for the expenses personally as part of their employment duties.
When the employee is also a shareholder, the written contract may not be adequate, and the implied requirements may be more difficult to demonstrate. However, CRA noted that both of these conditions may be satisfied if the shareholder-employee can establish that the expenses are comparable to expenses incurred by employees (who are not shareholders or related to a shareholder) with similar duties at the company or at other businesses similar in size, industry and services provided.
ACTION ITEM: Instead of deducting amounts against employment income, consider whether it would be better for the company to reimburse expenses of shareholder-employees, or perhaps, pay a tax-free travel allowance. If amounts will continue to be paid personally, retain support that shows how the travel expenditures are reasonable as compared to those of other similar arm’s length workers.