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Many small business owners are unfamiliar with the tax changes taking place in 2018, especially the changes related to the refundable dividend tax on hand (RDTOH).

What is RDTOH?

RDTOH is a tax mechanism used under the Canadian tax system that is built on the concept of “integration”. The purpose of the integration is for investment income to be taxed at the same rate, whether the income is earned personally or initially by the corporation. Generally, passive investment income, such as interest, rental income, taxable capital gains and portfolio dividends from foreign companies, earned by a Canadian controlled private corporation (CCPC) is taxed at a higher rate than active business income, and a portion of the higher tax can be refunded to the corporation when it distributes taxable dividends to the shareholders.

How Does it Work Currently?

Passive income earned by CCPC is taxed at a high combined corporate tax rate, 50.17% in Ontario. A portion of the taxes (i.e. 30.67% of investment income) is refundable and added to the corporation’s RDTOH account. A tax refund is also allowed on the taxable dividends paid out, at the rate of 38.33%, up to the balance of the RDTOH account. The refund rate on taxable dividends is the same regardless of whether the dividends paid out are eligible or non-eligible.

What are the New Rules?

Effective taxation years that begin after 2018, the existing RDTOH will be divided to two pools: eligible and non-eligible.

The eligible RDTOH account will be deemed to be the lesser of the existing RDTOH balance and 38.33% of the balance of the general rate income pool (GRIP). Any remaining amount of the existing RDTOH balance will be allocated to the non-eligible RDTOH.

The “non-eligible RDTOH” pool will track the refundable Part I tax on investment income, and Part IV tax on non-eligible intercompany dividends. The “eligible RDTOH” account will be created to track only the refundable Part VI tax on eligible dividends.

Here are some points of note:

• An RDTOH refund will only be available when the corporation pays out non-eligible dividends, with an exception for the RDTOH resulted from eligible portfolio dividends received by the corporation.
• Ordering rule: a payment of non-eligible dividend will first generate a refund from the non-eligible RDTOH account, then the eligible RDTOH account.
• Non-eligible dividend payment result in a refund from the eligible RDTOH account only when there is no balance left in the non-eligible RDTOH account.
• No dividend refund is allowed when the corporation with only the non-eligible RDTOH pays eligible dividend.

Some Tax Planning Points

• Maximize eligible dividends paid prior to changes to the highest extent possible
• Pay by way of a promissory note if the company does not have sufficient cash flow to pay out eligible dividends
• Increase investment in CCPCs to create ERDTOH
• Generate more capital gains to pay out capital dividends

If you require any assistance with your corporate tax and accounting needs, contact your Accountants Toronto.

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When running a small business in Canada, most entrepreneurs are savvy enough to know that when revenues (for taxable supplies) exceed $30,000 in any four consecutive quarters, it is time to register for and collect GST/HST. This also means that you’ll need to file GST/HST returns annually, quarterly or monthly, depending on your specific scenario and selection.

These are some common areas that we find small business owners who try to prepare or file their sales tax returns on their own make mistakes that can be costly:
 

Meals and Entertainment

A very common error that can occur is related to expenses and input tax credits (ITCs) related to meals and entertainment. For tax purposes, the allowable portion of the tax deduction for meals and entertainment expenses is 50% of the expense. Similarly, it is important to note that the ITC that can be claimed must follow suit, and only 50% of the GST/HST paid on meals and entertainment expenses are eligible to be claimed as ITCs.

Secondly, in relation to meals and entertainment expenses, when a tip is left for the server, there is no ITC related to the tip, and it is important to ensure that the ITC claim matches the actual allowable portion of the GST/HST paid.
 

Automobile Expenses

As many business owners know, when using a personal vehicle for business purposes, the prorated portion of any business-related expenses can be deducted against income. This would include items such as fuel and maintenance. However, a common oversight is that the ITC claim is not prorated by the respective business use portion as well. It is important to track this closely and ensure consistency between the prorated amount used for the tax deduction claim and the ITC claim.
 

Inter-Corporate Revenues and Expenses

There are often scenarios where a parent company or holding company will charge fees to a subsidiary (or operating company), for taxable supplies such as, for example, rent or management fees. It is common to forget that this is, after all, a commercial transaction, and there should be an agreement or invoice generated, and sales tax must be charged and paid (except for those companies that are eligible and have elected out of GST/HST in such transactions).
 

Summary and Recommendations

Software is available (such as QuickBooks Online and Xero) that can assist with calculating GST/HST collected and the ITCs to be claimed when filing. However, it is important to note that the software is not perfect and may not catch issues such as those noted above. It is always recommended to consult a professional accountant prior to filing anything with the Canada Revenue Agency to ensure that your risk of errors is minimized as much as possible. If you need any assistance with corporate tax or GST/HST filings please contact us.

The post Common GST / HST Filing Errors That Can Cost You appeared first on Capstone LLP Chartered Professional Accountants.

Background and Overview

Due to significant opposition from the Canadian Small Business community, tax accountants, accounting firms, and other stakeholders, the original proposals from July 18, 2017 that the Department of Finance issued with regards to small business tax changes were subsequently revised and released on December 13, 2017.

The revised proposed rules were better accepted by the business community, but still represent a large shift in the existing tax planning methods, strategies and abilities to split income for private corporations in Canada. Nonetheless, the new rules took effect on January 1, 2018 and are applicable to the 2018 and subsequent taxation years.

A common tax minimization strategy used by many incorporated small businesses and common among professionals with Professional Corporations, was to effectively reduce the overall tax burden by issuing shares and paying dividends to family members, who often had little involvement in business operations, and minimal investment in the business as well. The new TOSI (tax on split income) rules were intended to effectively remove the ability for many small business owners to split income and thereby remove their advantage over Canadian employees who are not able to use these types of tax planning strategies.

Revised TOSI and Income Sprinkling Proposals

The revisions that were released in December provided more insight into how the government planned to police these new rules, and also included a number of potential exclusions from the new rules as well.

Some of the tests to determine when TOSI will apply are subjective; however, the overall idea of TOSI, the new definitions and the new tests all add to the complexity of tax planning and the ability of small business owners to understand what may apply to them and their small business.

The bright side for some small business corporations is that the TOSI rules will not apply in situations where payments (i.e. dividends, interest and certain capital gains) are within the specified exclusions, also known as an “Excluded Amount”.

Excluded Amount Explained

1. For all adults in Canada, any amount received from an “excluded business” will not be subject to the TOSI rules. Excluded Business is defined as:

Amounts are derived from an excluded business where the individual was actively engaged on a regular, continuous and substantial basis (“Actively Engaged”) in the activities of the business in a taxation year or in any five prior year taxation years of the individual.

In order to be considered “Actively Engaged” an individual would need to work in the business a minimum of 20 hours per week during the portion of the year when the business is operating (i.e. seasonal businesses may not operate for a full year) or has met that requirement of 20 hours per week in any of the five prior years; they do not need to be consecutive. If this test is met, the individual would be exempt from TOSI permanently on a go-forward basis under the new proposal.

If the individual does not make the 20 hours per week test, the individual may still meet this exclusion test. This would vary on a case by case basis upon further investigation by the CRA, if applicable.

2. For individuals age 25 and over, TOSI will not apply on income from (or taxable capital gains from) the disposition of Excluded Shares” or a payment that qualifies as a “Reasonable Return”.

Excluded Shares would be defined as:
Shares of a corporation owned by an individual are and all the following conditions are met:

• Less than 90% of the corporation’s business income was from the provision of services;
• The corporation is not a Professional Corporation, i.e. physician, dentist, lawyer, chiropractor, etc.;
• The shares represent 10% or more of the votes and value of the corporation; and
• All or substantially all, of the income of the corporation is not derived from another Related Business in respect of the individual.

The specific requirement of the shares to be held by an individual means that any shares held through a Family Trust structure for the benefit of the individual would not qualify as an Excluded Share.

Reasonable Return would be defined as (for individuals age 25 and over):

• The work is performed in support of the Related Business;
• The property contributed directly or indirectly in support of the Related Business;
• The risks assumed, in respect of the Related Business;
• The total amounts paid or payable by any person or partnership to, or for, the benefit of the individual, in respect of the Related Business; and
• Any other such factors that may be relevant.

In assessing a Reasonable Return, the CRA has provided the following criteria to provide some clarity on how they will evaluate the payment:

• Labour Contribution – the work performed (tasks, hours, wage in comparison to industry, education, knowledge of individual, etc.) by the individual in support of the Related Business before the amounts became paid;
• Property Contribution – the property contributed (loans, capital, any collateral, opportunity costs, past contributions, etc..) by the individual in support of the Related Business;
• Risks Incurred – the risks (exposure to the liabilities of the business, personal reputation or goodwill at risk, extent contributions made at risk, etc.) assumed by the individual in respect of the Related Business;
• Historical Payments – the total amounts paid by any company or partnership to, or for, the benefit of the individual in respect of the Related Business; and
• Such other factors that may be relevant.

3. For individuals between the ages 18 and 24, TOSI will not be applied to a return on property contributed in support of a Related Business that is a “Safe Harbour Capital Return” or, a Reasonable Return having regard only to contributions of “Arm’s Length Capital” to the business.

The Safe Harbour Capital Return is defined as a return that does not exceed a prescribed capital rate of return based on the highest prescribed rate under the Income Tax Act for the particular year. Currently this rate is at 2%, which would be applied to the Arm’s Length Capital invested by the individual to determine the maximum Safe Harbour Capital Return.

Arm’s Length Capital is property of an individual, other than property that is derived from property in respect of a Related Business, that is borrowed under a loan, or that is transferred from a related person (other than inherited property).

4. For all individuals the taxable capital gain realized on death, from the disposition of qualified farm, fishing property, or qualified small business corporation shares, will be excluded from TOSI.

5. For individuals age 65 or over, all amounts received by the individual spouse will not be subject to TOSI if the amount would have been an Excluded Amount had it been included in the individual’s income. This means that as long as the individual was active in the company in the past, once they reach the age of 65 they will be allowed to split income to their spouse and do not have to worry about the TOSI rules.

Summary

Although this draft legislation narrows the focus, and addresses many of the issues and concerns brought up by the various stakeholders, the revisions remain quite complex. The changes will certainly result in additional compliance costs for many small businesses and may result in a significantly larger tax burden for small business owners who have previously been income splitting with family members.

If you need assistance with any small business accounting or TOSI related matters, please feel free to contact us.

The post Impact of TOSI Income Sprinkling Rules on Canadian Small Business appeared first on Capstone LLP Chartered Professional Accountants.

If you are not familiar with tax-loss selling, the concept is simple: sell the stocks that you own, which are currently at a loss position, to generate a capital loss for tax purposes. This capital loss can be used in the current period to offset capital gains, carried forward indefinitely and carried back to any of the three previous tax years – and deducted against capital gains of qualifying other years.

Important: the tax-loss selling deadline for 2016 is December 23

You may be wondering why the deadline is not December 31 – the last day of the year; this is because it takes 3 business days for the share sale to settle and the sale is only complete upon settlement. Here is what you need to know about tax-loss selling:

Know the Superficial Loss Rules

Often people think they can outsmart the tax system by selling a losing stock on the tax-loss date, and simply repurchasing it in the new-year.  This makes sense, right? Get the capital loss this year, and just repurchase the stock later (hopefully at an even lower price). The Canada Revenue Agency (CRA) is well aware of these tactics, and has a rule to prevent this – the “Superficial Loss” rule.

Superficial Loss Rule: if a stock is sold at a loss and subsequently repurchased within 30 days, it is considered a superficial loss, and the capital loss is denied.

Transfers to RRSP or TFSA Accounts

If you don’t want to sell your losing stocks, and would rather simply transfer them in-kind to a registered account such as a TFSA or RRSP account, you can do that; however, any capital loss generated will be denied.

When shares are transferred from a non-registered account to a registered account, the CRA considers this a deemed sale at fair market value; if you have a gain, the capital gain will be triggered and will need to be included in your taxable income that year.  However, if the deemed sale at fair value generated a loss, that loss is denied.

What are some other tips?

Tip 1: Avoid the Superficial Loss by Purchasing a Competitor Stock

Assuming you believe that the shares you hold will eventually go up, and the sector in which they operate will do well – one method of preventing the superficial loss from causing a denial of your capital loss would be to sell your “losing” stock and replace it with a competitor’s stock.  For example, let’s assume you are in a loss position on your Telus shares, you can simply sell those shares for the tax-loss and repurchase Bell Canada shares at any point, with no superficial loss rules to worry about.
Of course, you should do your own research and work with your financial advisor to ensure this is a good investment decision, we are only providing tips from a tax perspective.

Tip 2: Be Careful with Index Exchange Traded Funds (ETFs) and the Superficial Loss rules

It is possible that you read tip 1 above and decided that you would sell one of your index ETFs and re-purchase an ETF under a different ticker, which tracks the same index – unfortunately, that is still a superficial loss and your loss will be denied.

Tip 3: Swap Sector ETFs and avoid the Superficial Loss rules

Selling and re-purchasing two different ETFs that track the same index will trigger a superficial loss; doing the same thing with ETFs that track the same sector will not be considered a superficial loss. The reason for this is that index ETFs are all essentially identical; however, sector ETFs are not as the securities they hold will vary (in proportion, and companies held) from ETF to ETF.

Tip 4: Check with your Chartered Accountant before you sell

Although we have generally outlined the rules above, there are many other tax rules to consider and it is always best to check with your Chartered Accountant before making decision that impact your income tax return.

The post Tax-Loss Selling: It Can Be a Good Idea – Know the Rules appeared first on Capstone LLP Chartered Professional Accountants.