TaxMatters@EY – November 2021

Alan Roth, Toronto

Have you ever found yourself looking for tax savings while completing your tax return in April? If so, you’ve probably realized that at that point there’s not much you can do to reduce your balance owing or increase your refund balance. By the time you prepare your tax return, you’re looking back and simply reporting on the year that has ended.

But don’t worry. As we approach the end of the year, there’s still some time left for forward-looking planning. You can approach year-end planning by asking yourself questions, going through a checklist, considering a framework or doing all three.

Taking time out of your busy November and December to think about these questions can help you find better answers that may save you money on your 2021 tax bill and beyond.

Part I of “Asking better year-end tax planning questions” looks at the questions, topics and tax planning techniques that may apply to you each year. Part II, which will appear in next month’s edition, will focus on questions and topics that are specific to the 2021 taxation year and recent personal tax changes, including COVID-19-related relief benefits received in 2021 and claiming home office expenses as a result of working from home during the pandemic.

Are there any income-splitting techniques available to you?

You may be able to reduce your family’s overall tax burden by taking advantage of differences in your family members’ marginal income tax brackets using one or a combination of the following:

• Income-splitting loans – You can loan funds to a family member at the prescribed interest rate of 1%.¹ The family member can invest the money and the investment income will not be attributed to you (i.e., treated as your income for tax purposes), as long as the interest for each calendar year is paid no later than January 30 of the following year.
• Reasonable salaries to family members – If you have a business, consider employing your spouse or partner and/or your children to take advantage of income-splitting opportunities. Their salaries must be reasonable for the work they perform.² However, other income-splitting opportunities involving your business may be limited (see below re: income-splitting private corporation business earnings).
• Spousal RRSPs – In addition to splitting income in retirement years, spousal RRSPs may be used to split income before retirement. The higher-income spouse or partner can get the benefit of making contributions to a spousal plan at a high tax rate and, after a three-year non-contribution period, the lower- or no-income spouse can withdraw funds and pay little or no tax. For more information, see TaxMatters@EY, April 2021, “Considering splitting your retirement income? Keep these considerations in mind.”

Have you paid your 2021 tax-deductible or tax-creditable expenses yet?

• Tax-deductible expenses – A variety of expenses, including interest and child-care costs, can only be claimed as deductions in a tax return if the amounts are paid by the end of the calendar year.
• Expenditures that give rise to tax credits – Charitable donations, political contributions, medical expenses, home accessibility renovation expenses and tuition fees must be paid in the year (or, in the case of medical expenses, in any 12-month period ending in the year) in order to be creditable.

Consider whether deductions or credits may be worth more to you this year or next year – If you can control the timing of deductions or credits, consider any expected changes in your income level and tax bracket or marginal tax rate.

Remember to consider the following tax credits that were introduced in 2020:

• Digital news subscriptions – A temporary 15% non-refundable tax credit is available on amounts up to $500 paid by individuals for eligible digital news subscriptions annually (a maximum annual tax credit of $75) beginning in 2020. Certain conditions apply. For example, the subscription must entitle you to access content provided in digital form by a qualified Canadian journalism organization (QCJO).³ The content must primarily be original written news.⁴ In addition, the credit is limited to the cost of a standalone digital news subscription that’s combined digital and newsprint. If there is no such comparable subscription, you’re limited to claiming one half of the amount actually paid. The credit applies to eligible amounts paid after 2019 and before 2025.
• Tuition fees associated with training – The Canada training credit, a refundable tax credit, is available for 2020 and later taxation years. The credit assists eligible individuals who have either employment or business income to cover the cost of up to one half of eligible tuition and fees associated with training. Beginning in 2019, eligible individuals can accumulate $250 each year in a notional account which can be used to cover the training costs. A number of conditions must be met to be eligible.⁵
  
  The amount of the refundable credit that can be claimed in a taxation year is equal to the lesser of one half of the eligible tuition and fees paid in respect of the year and the individual's notional account balance. For purposes of this credit, tuition and fees do not include tuition and fees levied by educational institutions outside of Canada.
  
  The portion of eligible tuition fees refunded through the Canada training credit reduces the amount that would otherwise qualify as an eligible expense for the tuition tax credit.

Do you hold passive investments in your private corporation? – A Canadian-controlled private corporation’s (CCPC’s) access to the small business deduction and, accordingly, the small business tax rate,⁶ may be limited in the preceding year. Consult your tax advisor for possible strategies to mitigate the adverse impact of these rules.

For example, if you are considering realizing accrued gains in the corporation’s investment portfolio before its 2021 taxation year end and the company is likely to cross the $50,000 income threshold by doing so, consider deferring the gains to the following year so that the 2022 taxation year is not impacted. You may also consider the pros and cons of holding a portion or all of the portfolio personally instead of in the company.

The impact of these rules on CCPCs subject to taxation in Ontario or New Brunswick is smaller because both provinces have confirmed they are not adopting them for purposes of their respective provincial small business deductions.

For more information, see TaxMatters@EY, May 2018, “Federal budget simplifies passive investment income proposals.”

Do you income-split private corporation business earnings with adult family members?

Income tax rules may limit income splitting opportunities with certain adult family members through the use of private corporations in 2018 and later years.

For example, a business is operated through a private corporation, and an adult family member in a low income tax bracket subscribes for shares in the corporation. A portion of the business’s earnings is distributed to the family member by paying dividends. These rules apply the highest marginal personal income tax rate (the tax on split income, federal rate of 33% for 2021) to the dividend income received unless the family member meets one of the legislated exceptions to the application of this tax. For example, if the adult family member is actively engaged in the business on a regular basis by working an average of at least 20 hours per week during the year (or in any five previous, not necessarily consecutive, years), the tax on split income may not apply.

Consult with your tax advisor to learn more.

For more information about these rules, see EY Tax Alert 2017 Issue No. 52, Finance releases revised income splitting measures, TaxMatters@EY, February 2018, Revised draft legislation narrows application of income sprinkling, TaxMatters@EY, February 2020, “Tax on split income: CRA provides clarifications on the excluded shares exception,” and TaxMatters@EY November 2020, “Tax on split income: The excluded business exception.”

Have you maximized your tax-sheltered investments by contributing to a TFSA or an RRSP?

• Tax-free savings account (TFSA) – Make your contribution for 2021 and catch up on prior non-contributory years. You won’t get a deduction for the contribution, but you will benefit from tax-free earnings on invested funds. Also, to maximize tax-free earnings, consider making your 2022 contribution in January.
• TFSA withdrawals and recontributions – TFSA withdrawals are tax free and any funds withdrawn in the year are added to your contribution room in the following year. But if you have made the maximum amount of TFSA contributions each year⁷ and withdraw an amount in the year, recontributions made in the same year may result in an overcontribution, which would be subject to a penalty tax. If you have no available contribution room and are planning to withdraw an amount from your TFSA, consider doing so before the end of 2021, so that it’s possible to recontribute in 2022 without affecting your 2022 contribution limit. For more information about the adverse consequences of overcontributing to your TFSA, see TaxMatters@EY, October 2021, “Overcontributions to your TFSA could result in penalties,” and TaxMatters@EY, October 2017, “TFSAs CRA compliance initiative continues.”
• Registered retirement savings plan (RRSP) – The earlier you contribute, the more time your investments have to grow. So consider making your 2022 contribution in January 2022 to maximize the tax-deferred growth. If your income is low in 2021, but you expect to be in a higher bracket in 2022 or beyond, consider contributing to your RRSP as early as possible, but holding off on taking the deduction until a future year when you will be in a higher tax bracket.

Are you considering making an RRSP withdrawal under the Home Buyers’ Plan?

If you’re a first-time home buyer,⁸ the Home Buyers’ Plan (HBP) allows you to withdraw up to $35,000⁹ from your RRSP to finance the purchase of a home. No tax is withheld on RRSP withdrawals made under this plan. If you withdraw funds from your RRSP under the HBP, you must acquire a home by October 1 of the year following the year of withdrawal, and you must repay the withdrawn funds to your RRSP over a period of up to 15 years, starting in the second calendar year after withdrawal. Therefore, if possible, consider waiting until after the end of the year before making a withdrawal under the HBP to extend both the home purchase and repayment deadlines by one year.

Have you maximized your education savings by contributing to an RESP for your child or grandchild? ¹⁰

• Contributions – Make registered education savings plan (RESP) contributions for your child or grandchild before the end of the year. With a contribution of $2,500 per child under age 18, the federal government will contribute a grant (CESG) of $500 annually (maximum $7,200 per beneficiary).
• Non-contributory years – If you have prior non-contributory years, the annual grant can be as much as $1,000 (in respect of a $5,000 contribution).

Is there a way to reduce or eliminate your non-deductible interest?

Interest on funds borrowed for personal purposes is not deductible. Where possible, consider using available cash to repay personal debt before repaying loans for investment or business purposes on which interest may be deductible.

Have you reviewed your investment portfolio?

Accrued losses to use against realized gains – While taxes should not drive your investment decisions, it may make sense to sell loss securities to reduce capital gains realized earlier in the year. If the losses realized exceed gains realized earlier in the year, they can be carried back and claimed against net gains in the preceding three years and you should receive the related tax refund. Note that the last stock trading date for settlement of a securities trade in 2021 is Wednesday, December 29, 2021 for securities listed on Canadian or US stock exchanges.

Just remember to be careful of the superficial loss rules, which may deny losses on certain related-party transactions.

Realized losses carried forward – If you have capital loss carryforwards from prior years, you might consider cashing in on some of the winners in your portfolio. As noted above, be aware of the December 29, 2021 deadline for selling securities listed on a Canadian or US stock exchange to ensure that the trade is settled in 2021. Or consider transferring qualified securities with accrued gains to your TFSA or RRSP (up to your contribution limit). The resulting capital gain will be sheltered by available capital losses, and you will benefit from tax-free (TFSA) or tax-deferred (RRSP) future earnings on these securities.

Alternatively, you could consider donating publicly traded securities (e.g., stocks, bonds, Canadian mutual fund units or shares) with accrued gains to a charitable organization or foundation. If you do, the resulting capital gain will not be subject to tax and you will also receive a donation receipt equal to the fair market value of the donated securities.

Can you improve the cash flow impact of your income taxes?

Request reduced source deductions – If you regularly receive tax refunds because of deductible RRSP contributions, child-care costs or spousal support payments, consider requesting CRA authorization to allow your employer to reduce the tax withheld from your salary (Form T1213). Although it won’t help for your 2021 taxes, in 2022 you’ll receive the tax benefit of those deductions all year instead of waiting until after your 2022 tax return is filed.

Determine requirement to make a December 15 instalment payment – If you expect your 2021 final tax liability to be significantly lower than your 2020 liability (for example, due to lower income from a particular source, losses realized in 2021 or additional deductions available in 2021) you may have already paid enough in instalments. You are not required to follow the CRA’s suggested schedule and are entitled to base your instalments on your expected 2021 liability. However, if you underestimate your 2021 balance and your instalments end up being insufficient or the first two payments were low, you will be faced with interest and possibly a penalty.

Have you thought about estate planning?

Review your will – You should review and update your will periodically to ensure that it reflects changes in your family status and financial situation, as well as changes in the law.

Consider your life insurance needs – Life insurance is an important tool to provide for the payment of various debts (including taxes) that may be payable as a result of your death, as well as to provide your dependants with money to replace your earnings. Review your coverage to ensure that it remains appropriate for your financial situation.

Consider an estate freeze to minimize tax on death and/or probate fees – An estate freeze is the primary tool used to reduce tax on death and involves the transfer of the future growth of a business, investments or other assets to family members. Consider the impact of the revised rules for the taxation of testamentary trusts and charitable planned giving, and the impact of the revised tax on split income rules (see above – Do you income-split private corporation business earnings with adult family members?) on income-splitting strategies using estate freezes.

For example, an estate freeze is set up where parents transfer the future growth in value of a business to the next generation. Dividends paid in 2018 or later years to an adult child may be subject to the highest marginal personal income tax rate under these rules unless the individual meets one of the legislated exceptions to the application of this tax.

For details, see EY Tax Alert 2017 Issue No. 52, Finance releases revised income splitting measures. For more on the tax on split income rules see TaxMatters@EY, February 2018, “Revised draft legislation narrows application of income sprinkling”, TaxMatters@EY, February 2020, “Tax on split income: CRA provides clarifications on the excluded shares exception”, and TaxMatters@EY November 2020, “Tax on split income: The excluded business exception.”

Consider a succession plan for your business – A succession plan involves devising a strategy to ensure that the benefit of your business assets passes to the right people at the right time.

These questions may seem familiar, but as tax rules become more complex, it becomes more important to think of the bigger tax picture continuously throughout the year, as well as from year to year as your personal circumstances change. Start a conversation with your tax advisor to find better answers.

Winnie Szeto, Toronto, and Gael Melville, Vancouver

In this case, the Tax Court of Canada dismissed the estate taxpayer’s appeal in respect of a denied charitable donation tax credit for a gift of shares to a non-arm’s-length private foundation as part of a post-mortem tax plan. More specifically, the Court found that a promissory note that was issued and repaid in cash some months later was not equivalent to cash consideration for purposes of the non-qualifying security rules and, therefore, the taxpayer was not entitled to claim a charitable donation tax credit in respect of the gift.

Facts

Mr. A was the sole shareholder and president of ACo. Immediately before Mr. A’s death, the fair market value of ACo was approximately $46 million. As a result of Mr. A’s death in November 2012, an estate (the taxpayer) was established and became the sole shareholder of ACo.

In 2013, a post-mortem tax plan was devised to distribute Mr. A’s assets in a tax-efficient manner. Under the tax plan, on December 20, 2013, the estate gifted a portion of its common shares of ACo to a non-arm’s-length private foundation (a registered charity). Three days later, on December 23, 2013, the private foundation sold the shares back to ACo by way of purchase for cancellation. In exchange, ACo issued a non-interest-bearing demand promissory note to the foundation in the principal amount of $17.71 million. ACo subsequently repaid the promissory note in cash in three installments beginning in April 2014 and ending in August 2014.

The foundation issued a charitable donation receipt to the estate taxpayer in the amount of $17.71 million, dated December 23, 2013.

On May 17, 2013, the taxpayer filed a T1 terminal return for Mr. A’s 2012 taxation year in which it reported charitable donations of approximately $17.21 million in respect of the shares gifted to the foundation.

The Canada Revenue Agency (CRA) reassessed Mr. A’s 2012 taxation year and denied the charitable donations tax credit claimed.

The Tax Court decision

Generally, individuals (including trusts) may claim a non-refundable tax credit in respect of gifts made to registered charities and other qualified donees. If an individual makes a gift of a non-qualifying security,¹ that is not an excepted gift,² the gift is deemed not to have been made under income tax law and a charitable donation tax credit cannot be claimed.³

However, if the security ceases to be a non-qualifying security within 60 months of the making of the gift⁴ or if the gift is disposed of by the donee within the same 60-month period, then the individual is deemed to have made the gift⁵ and is then able to claim a charitable donation tax credit.

At trial, the parties agreed that:

• The shares transferred from the taxpayer to the foundation were non-qualifying securities.⁶
• The transfer of the shares was not an excepted gift.⁷
• The shares did not cease being a non-qualified security at any time.

However, because the foundation disposed of the shares on December 23, 2013, three days after the making of the gift, the taxpayer was deemed to have made a gift at the time of the disposition and was eligible to claim a charitable donation tax credit.

According to paragraph 118.1(13)(c) of the Act, the value of the gift that can be claimed is the lesser of the following two amounts:

• The fair market value of any consideration (except a non-qualifying security of any person)⁸ received by the donee for the disposition
• The amount of the gift made at the particular time that would, but for subsection 118.1(13), have been included in the individual’s total charitable gifts […] for a taxation year.

As a result, the main issue to be decided in this case turned on the interpretation and application of paragraph 118.1(13)(c) of the Act. The Court took a textual, contextual and purposive approach in its analysis.

Textual, contextual and purposive analysis

From a textual perspective, the Court took a narrow view and found that the terms “any consideration,” “received” and “at the time of the disposition” (underlined above) must be read together and collectively indicate that the consideration must be received at the time of the disposition.

In this case, the foundation disposed of the shares to ACo on December 23, 2013 and received only the promissory note in return on the same day. The foundation did not receive the three cash installment payments until sometime in 2014. Therefore, at the time of the disposition of the shares on December 23, 2013, the only consideration received by the foundation was the promissory note, which was a non-qualifying security. As a result, the deemed value of the shares would be nil.

From a contextual and purposive perspective, the Court first noted that Parliament intended to impose the restrictions under subsection 118.1(13) on non-arm’s-length transactions due to the difficulty in assessing the fair value of the security being gifted. Therefore, according to the Court, it would be contrary to Parliament’s intention to allow the taxpayer to claim a charitable donation tax credit where a non-qualifying security (i.e., the shares) was disposed of for another non-qualifying security (i.e., the promissory note).

In addition, the Court noted that Parliament intended to restrict the donation tax credit where the donor is not yet impoverished and the charity is not yet enriched. It would appear from this decision that a promissory note between non-arm’s-length parties is not sufficient proof that the donor is impoverished and the charity is enriched because non-arm’s-length parties could arrange the transactions in such a way that no actual payments are ever made.

The Court also indicated that Parliament intended paragraph 118.1(13)(c) to be a redemptive provision for taxpayers who are ultimately able to meet a strict set of conditions. Parliament did not intend for the provision to include any disposition made at any time.

Tax consequences follow legal form

And finally, the Court reiterated that in tax law, legal form is paramount and that tax consequences follow the legal form of transactions. It was clear on the evidence that the transfer of the shares to the foundation in exchange for a promissory note was a part of the tax plan, and that the promissory note would be repaid in cash at a later date. The Court’s opinion is that the tax plan, in respect of the donation tax credits, failed because it did not meet the strict conditions under the redeeming provisions of paragraph 118.1(13)(c).

As a result, the Court concluded that the promissory note was the only consideration received at the time of the disposition (which did not include the cash repayments) and was a non-qualifying security; therefore, the fair market value of the gift was nil. The appeal was dismissed.

Lessons learned

The results of this case are particularly harsh for the taxpayer. This case serves to remind taxpayers that a court may attempt to uphold the strict letter of the law. For such large amounts at issue, seeking an advance ruling may be a prudent move.

What’s particularly interesting about this case is the contrast in the treatment of the promissory note when compared to other situations covered in past CRA technical interpretations.⁹ In Odette, the promissory note was treated as being separate from the subsequent cash settlement payments, whereas in previous CRA technical interpretations a dividend has been considered “paid” by promissory note if an agreement between the parties clearly indicated that the note was accepted as absolute payment.

It remains to be seen if this decision will have any bearing on the CRA’s position on the status of promissory notes in the future.

As of the date of writing, the taxpayer has not yet appealed the decision, but it will be interesting to see if an appeal will follow.

Tax Alerts – Canada

Tax Alert 2021 No. 30 – Finance announces targeted COVID‑19 support measures
The Canada Emergency Wage Subsidy and the Canada Emergency Rent Subsidy (including the lockdown support) expired on 23 October 2021 (end of period 21). In their place, the government announced new targeted COVID-19 support measures in addition to an extension of the Canada Recovery Hiring Program.