chapter 6 Tax

What is income from property?

The return received for allowing another party to use one’s property.

Does income from property include capital gains or losses?

No. ITA 16(1) excludes capital gains and losses from property income.

What generally distinguishes property income from business income?

Little or no time, labour, or attention has been expended to earn the return on invested capital.

What types of income are included in property income under Section 12?

• Dividends

• Interest

• Rental income

• Royalties

• Payments based on production or use

When must an individual include interest income?

At the earlier of:

• The date the interest is paid, or

• The anniversary date of the contract.

How do corporations, partnerships, and certain trusts report interest income?

Using the accrual method of accounting.

What should you identify when assessing an interest-income situation?

• Type of taxpayer

• Interest rate

• Maturity

• Cash payment of interest

What do you determine when analyzing an interest-income issue?

• The appropriate method to record the interest

• The amount of interest income for the year

How are payments based on production or use treated for tax purposes?

They must be included as property income.

Why are payments based on production or use included as property income?

To prevent taxpayers from characterizing property income as capital gains.

What is a dividend?

The actual amount declared and then paid by a corporation to a shareholder.

What is a taxable dividend?

An amount received from a Canadian resident corporation that is grossed up based on the classification of the dividend.

How are foreign dividends treated?

Foreign dividends are not grossed up. The Canadian value of the foreign dividend is included in income.

What types of dividends are included in income?

• Cash dividends

• Dividends in property

• Stock dividends

Who can receive dividend income?

• Individuals

• Corporations

• Trusts

What double-taxation issue arises with Canadian corporate dividends?

Corporate income is taxed at the corporate level and then dividends may be taxed again in the hands of shareholders.

Why must dividends generally flow tax-free between corporations?

To avoid multiple levels of taxation.

When are dividends received by corporations included in net income for tax purposes?

when received

What happens to dividends received from a taxable Canadian corporation when determining taxable income?

They are deducted

What is the result of the intercorporate dividend deduction?

Intercorporate dividends are generally not taxed.

Why is the intercorporate dividend deduction provided?

To remove the possibility of multiple taxation.

What are the two types of dividends from resident Canadian corporations?

• Non-eligible dividends

• Eligible dividends

What are non-eligible dividends?

Dividends generally paid by CCPCs that paid tax at small-business rates.

What is the gross-up rate for non-eligible dividends?

15%

What is the federal dividend tax credit formula for non-eligible dividends?

9/13 of the gross-up.

What are eligible dividends?

Dividends generally paid by public corporations and CCPCs taxed at general corporate rates.

What is the gross-up rate for eligible dividends?

38%

What is the federal dividend tax credit formula for eligible dividends?

6/11 of the gross-up.

When are dividends from resident Canadian corporations included in an individual's income?

when recieved

If a taxpayer receives a $10,000 non-eligible dividend, what amount is included as the grossed-up dividend?

$11,500.

What is the purpose of grossing up an eligible dividend?

To bring the dividend income back toward the corporation's pre-tax income.

Are dividends from non-resident corporations taxable in Canada?

yes

Do the Canadian dividend gross-up rules apply to foreign dividends?

no

What are the five general Section 18 tests or limitations shown in the slides?

• Income-earning test

• Capital test

• Reserve test

• Personal expense test

• Reasonableness test

What is the income-earning test?

No expense may be deducted unless it was made or incurred for the purpose of earning income.

What is the capital test?

A capital outlay cannot be deducted unless specifically allowed by the Act.

What is the reserve test?

A reserve cannot be deducted unless specifically permitted by the Act.

What is the personal expense test?

Personal expenses cannot be deducted.

What is the reasonableness test?

Expenses must be reasonable under the circumstances.

What conditions must be met for interest to be deductible?

The interest:

• Is paid or payable in the year

• Arises from a legal obligation

• Is payable on borrowed money

• Is reasonable in amount

What must borrowed money generally be used for in order for the related interest to be deductible?

To earn income from business or property.

How is interest on funds borrowed to buy vacant land limited?

The deduction is limited to the income from the land.

What happens to interest on vacant land that cannot currently be deducted?

It is added to the cost of the land.

How are interest and other soft costs relating to construction or renovation treated?

They must be capitalized during the construction or renovation period.

Is interest on money borrowed to contribute to an RRSP deductible?

no

To what extent are carrying charges on vacant land deductible?

Only to the extent of the net income on the land.

What happens to carrying charges on vacant land that are not deductible?

They are added to the cost base of the land.

To whom does the vacant-land carrying-charge rule apply?

• Property developers

• Land that is held but not used in a business

What are examples of soft costs relating to construction or ownership of land?

• Interest expense

• Legal and accounting fees

• Mortgage fees

• Insurance

• Property taxes

Are soft costs deductible during construction, renovation, or alteration of a building?

no

What other deductions from property income are identified in the slides?

• Carrying charges

• Investment counsel fees

• Foreign non-business income tax

On what accounting basis is rental income generally included in income?

accrual

When is rental income recognized under the accrual basis?

when earned

How are rent payments received in advance treated?

Recognition can be delayed until the rent is earned.

What expenses may be deductible from rental income?

• Interest expense

• Insurance

• Property taxes

• Repairs and maintenance

• Utilities paid by the owner

• Advertising

• Landscaping costs

• CCA

• Salaries and wages

• Property management fees

• Accounting costs

• Costs incurred to collect rents

Can CCA on rental property create a rental loss?

no

Can CCA increase an existing rental loss?

no

What special CCA rule applies to a rental building costing $50,000 or more?

Each building must generally be placed in a separate CCA class.

What is the effect of placing rental buildings costing $50,000 or more into separate classes?

The properties are not pooled together.

Why can separate CCA classes for rental buildings result in recapture or a terminal loss when the building is sold?

Because the individual rental building remains in its own separate class.