RLB LLP News Feed

Organizing Info Before You Die

Sun, 25 Jul 2010 14:10:54 GMT

Do you know whether you're exposed to paying more tax than you should?

Many of us do not have a clear history of what the assets (houses, cottages, investments) we own cost. What happens when we decide to sell these assets, or we die and the assets are suddenly deemed sold?

This has become a reality for individuals, most commonly once they have died, but also for people selling assets. Think about these scenarios:

1. You buy a rental property twenty years ago and in the first couple of years you replace a roof and furnace. You choose not to expense these items – which is a reasonable decision. Then twenty years later you sell the property. The cost of the roof and furnace should be added to the cost of the property to reduce your capital gain. Do you have the receipt to prove the cost? Keeping records can save on taxes in the future. Take time to tuck records somewhere safe.

2. You die with many investments. Your son and/or daughter are the executor of your estate. Does your investment advisor have the records on the cost of your investments, or if you have managed them yourself have you left a clear record of the cost. For investments that you may have owned for a long time, the capital gains may be quite large. Without clear documents showing the cost of these investments, the result may be excess capital gains or additional cost and time to determine the cost. A few moments spent to keep records up to date could save you and your family time and money.

A little work today will save real tax dollars in the near or distant future. If you would like assistance with getting your information complete contact RLB.

Take Advantage of TFSA Versatility

Sun, 25 Jul 2010 14:09:46 GMT

A Multiple Use Tool

The recent misunderstandings regarding contribution limits on Tax-Free Savings Accounts (TFSAs) have been capturing financial headlines, but the confusion is no reason for investors and savers to avoid them. They can play a major role in your overall financial planning.

A critical element in the use of these accounts, and the one that has caused so much confusion -- not to mention

A Canadian Conundrum

   Some 70,000 or more taxpayers seem to have been caught up in the confusion over TFSA contributions and transfers.
    The rules are fairly straightforward: If you are older than 18 years of age, you can open an account and contribute $5,000 in a single year. Unused contribution room is automatically carried forward. Withdrawals increase your available room, but you cannot use that extra space until the start of the following calendar year.
    So, if you contributed the maximum $5,000 on Jan. 1 2009, when the accounts first became available, withdrew $4,500 in March and replaced it in April, you overcontributed $4,500. That means you will have to pay a one per cent penalty tax for each of the nine months the money is in the account during the remainder of that year because the additional contribution room wasn't available until Jan. 1, 2010. You will owe $405 (one percent times nine times $4,500).
The one per cent penalty is only for non-deliberate overcontributions. If the contributions are deliberate, there is an additional penalty of 100 per cent of any income or gains resulting from the overcontribution.
   There has also been some misunderstanding of how to make transfers between TFSAs. If you have more than one of these accounts, you can make a direct transfer from one to the other without tax consequences. However, if you withdraw funds from one TFSA and contribute those same funds to another TFSA, the transactions will affect your contribution room limit and you may be subject to tax on excess contributions.
    The good news is that the CRA is reviewing each of those assessments with an eye toward waiving the penalty for taxpayers who genuinely misunderstood the rules. Individuals have until Aug. 3 to plead their case. If you are one of these taxpayers, talk to your accountant to discuss your options.

Under the legislation governing TFSAs, the Finance Department can waive or cancel all or part of the tax penalty if you can persuade the government that the liability was the result of "reasonable error" and you act "without delay" to remedy the problem.

potential tax penalties -- is also one of the benefits of TFSAs: The tax-free money withdrawn from them opens up contribution room, but not until the following year. This created problems for taxpayers who used their TFSAs like a bank accounts, making withdrawals and topping up the accounts in the same year. (See right-hand box.)

Studies appear to indicate that Canadians need to seek advice about how to use these accounts. According to one survey:

Only 41 per cent of respondents knew you can hold a broad range of investments in a TFSA;
Just 36 per cent knew that you didn't lose contribution room if you didn't use it all in one year;
A mere 22 per cent realized that you can own more than one account; and
Just 43 per cent knew that contributions to the accounts are not tax deductible as they are with Registered Retirement Savings Plans (RRSPs).

Although there is no tax deduction, withdrawals are tax free and the returns generated through interest, dividends or capital gains are not taxable, except for foreign taxes on foreign investments.

In addition to a place to park your cash, TFSAs can play vital roles in your long-term wealth-building plans. Think of them as another asset to go along with your principal residence and life insurance policy.

Here is a look at some of the ways you can use TFSAs to help accumulate wealth for you and your family:

Tax-Free Investment Accounts

You can invest your TFSA contributions in stocks, bonds and other financial assets, including short-term deposits and GICs. Bearing in mind that, unlike the TFSA, registered retirement plan withdrawals are taxed, you may consider keeping fixed income instruments in your RRSP or Registered Retirement Income Fund (RRIF). High-growth investments that may produce large capital gains could go into a TFSA to protect them from taxes.

For example, five per cent preferred shares purchased at $20 will grow to $25 eventually and pay $1.25 a year in taxable income. An RRSP will shelter that income, but only until it is withdrawn. If those securities are kept in a TFSA, there is no income tax on any of the withdrawals and the value of the account grows just as much as the value of an RRSP would. On the other hand, capital losses inside a TFSA cannot be deducted, and dividends earned inside a TFSA do not generate dividend tax credits.

Think carefully before transferring undervalued securities into your TFSA. If you trigger a capital loss, the in-kind stock transfer will be denied as a superficial loss. Talk to your adviser about whether it would be better to sell your losing shares and deposit the proceeds into the account.

While you are planning, remember you can tap TFSAs for emergency or other uses, so you may want to keep some short-term, liquid, interest-bearing investments in the accounts.

Income Splitting

You or your spouse or common-law partner can contribute to each other's account. So, if you have a lower-earning spouse or partner, you can contribute the 2010 amount of $5,000 to both accounts and the income earned from your spouse's account won't be attributed back to you. Conversely, if you contribute to a spousal RRSP, income attribution rules do apply.

During retirement, there could be enough money in the accounts to provide flexibility in how taxable withdrawals are taken from other accounts and pensions in order to minimize the household tax bill.

The spouse or partner who gets your contribution has a choice of several productive options. For example, the individual could pledge the TFSA as collateral for a loan to make investments. All the non-taxable income from the investments would belong to that spouse, and the interest charges on the investment loan would be tax deductible.

Estate Planning

You can name a beneficiary to your TFSA. If that is what you decide to do, you have two choices:

1. Name your spouse or common-law partner the successor holder. The account, but not your remaining contribution room, will transfer tax-free to the surviving spouse. The transfer will not affect the contribution room of the spouse's account. A transfer will prevent your estate from having to pay probate fees on the funds.

2. Name a designated beneficiary. This can be anyone you choose. The person named receives the proceeds of your account either in cash or in kind and the TFSA will no longer exist. Only income earned in the account before your death will be tax-free. Earnings after the date of death will be taxable to the beneficiary. This strategy also avoids probate fees.

If you do not name a beneficiary, the proceeds of the account will be paid out to your estate.

Talk to your accountant, who can come up with other ideas on how to make the most of your TFSAs as you build wealth and plan your estate.

Don't Lose the Capital Gains Exemption

Sun, 25 Jul 2010 14:08:45 GMT

Two Critical Tests

The lifetime capital gains exemption on small business corporation shares is one of the most important advantages of running a business as a corporation rather than as a proprietorship. But it's easy to lose the tax benefit if you don't closely follow the rules that determine whether a company is a small business corporation.

In order for the shares to qualify, the company must meet the 90 per cent rule under which the business must:

Active Business

Under the law, an active business generally means any business carried on by the corporation other than a "personal services business" or a "specified investment business", and includes a venture or concern in the nature of trade.
   A personal services business is one carried on by a corporation where an employee of the corporation performs services for another entity and who, in the absence of the corporation, would reasonably be regarded as an employee or officer of the entity for which the services are provided. A corporation does not carry on a personal services business if it has more than five full-time employees throughout the year or renders its services to an associated corporation.
    A specified investment business is one whose principal purpose is to derive income from property (including interest, rents, dividends, and royalties). A specified investment business does not include the business of: a credit union, property leasing other than real property, or a corporation that employs more than five full-time employees throughout the year.
   Also excluded from the definition of specified investment business is the business of a corporation that receives managerial or similar services from an associated corporation and that would otherwise reasonably require more than five full-time employees. This exclusion only applies to situations where the associated corporation provides the services in the course of carrying on an active business itself.

1. Be a Canadian controlled private corporation that
2. Uses 90 per cent or more of the fair market value (FMV) of its assets
3. More than 50 per cent of the time and
4. Be in an active business (See right-hand box)
5. Carried on 50 per cent or more in Canada
6. By the corporation or a company related to it.

In addition, throughout the 24 months preceding the sale the company, the second requirement drops to 50 per cent or more of the assets' FMV. This is called the "50 per cent rule."

It is usually feasible to address the 90 per cent rule by "purifying" the corporation through the removal of excess assets immediately before the sale.

The 50 per cent rule can actually be a more serious problem, because the corporation must meet that rule at all times during the 24 months before the sale.

There can be problems associated with the company's assets, which makes it critical to consider each individual asset when determining if your corporation meets the 50 per cent or 90 per cent tests. For example:

Investments, rental property and leasing property, as well as excess cash balances, do not qualify as active business assets.

If an asset is used less than 50 per cent for business, it is considered entirely non-active. There is no "percentage of use" of each asset applied to the 90 per cent and 50 per cent tests. An asset either qualifies or it doesn't.

Incidental use of assets, such as the rental of land and building, rental of equipment, or personal use of corporate assets by employees or shareholders, can cause an asset to be counted as a non-business asset if the non-business use is 50 per cent or more.

If your corporation rents out a portion of a building it does not use for business, you will have difficulty meeting the 90 per cent test unless the rented portion is less than 10 per cent of the FMV of the building. In looking into this, Canada Revenue Agency (CRA) auditors factor in not only the square feet rented, but will also determine a relative value for the rented space by examining factors such as whether the space is ground floor or second story, whether parking space is included, and whether the frontage is on the main street or access is only through an alley.

Assets such as vehicles that employees and shareholders use will also count for the 90 per cent and 50 per cent test. If there is substantial amount of personal use, the vehicle may not qualify as an active business asset, unless it can be proved by a mileage log that the personal use is less than 50 per cent.

Assets that are leased, or rented on a regular basis, are not active business assets, unless they are rented to an associated small business corporation. The occasional rental of business assets such as equipment and vehicles is not a problem, however, as long as the assets are regularly used in the business.

Using a holding company can solve some of these problems. The holding company can then own the non-active assets and rent them to the operating company. Because the operating company doesn't own the assets, they do not "taint" the operating company and create a situation where the shares do not qualify for the lifetime capital gains exemption.

If you think you may want to sell your shares in the future, and want to make sure they qualify for the lifetime capital gains exemption, consult with your accountant. And remember that the corporation must qualify during the entire 24 months before the sale, not just at the date of the sale.

Take Advantage of a Special Loss

Sun, 25 Jul 2010 14:07:49 GMT

A Frequently Challenged
Tax Maneuver

Small business corporations (SBCs) form a vital part of the Canadian economy. Therefore, the government has programs to help promote investment in these enterprises and provide tax relief when companies fail.

As it happens, a small percentage of SBCs actually survive, but when they do fail, investors normally must

Signs That It May Be Time to Shed a Stock

   The insolvency of a small business corporation notwithstanding, there are times when it may make sense to take some stock losses. Here are six signs that could prompt you to get rid of a holding:
    1. The price isn't moving. Just because the stock sold at a much higher price in the recent past doesn't mean it will hit that price again anytime soon. You may want to sell and reinvest in a better prospect. Analyze the stock and consider if you'd buy it today at that price.
    2. The stock has hit your target sell price. You may want to sell when a stock drops to a certain price to avoid substantial losses. Don't get trapped in the emotional paralysis that can make it difficult to sell a stock at a loss. Remember, capital losses can be offset against capital gains, and remaining capital losses can be carried back and forward.
    3. The stock's fundamentals have changed. Today's market leaders may not hold that position tomorrow. Watch your portfolio so you can spot when fundamentals may be shifting.
    4. There's negative news. Don't sell at the first sign of trouble. But it may be time to reevaluate a stock if bad news continues and involves crucial events such as management shakeups, competitors stealing market share, and unwelcome mergers or acquisitions.
    5. The price rises. While price gains are generally good, it's possible for a price to increase so much that you may not think it has the potential to increase much more. At that point, you may want to sell.
   If you have difficulty implementing sell strategies, consult with your financial adviser. Discussing your thoughts with someone else can help you consider other factors and ensure the reasons for selling are valid.

shed their holdings at a loss.

The Income Tax Act has a provision to help those shareholders. The law allows for a unique capital loss called an allowable business investment loss (ABIL). This differs from a capital loss in that it may be used to reduce all sources of income, not just capital gains.

Capital gains, of course, also receive preferential tax treatment in that their taxable amount is calculated at the current 50 per cent inclusion rate. This means:

Only half of capital gains are taxable.
Half of capital losses may be used to reduce capital gains.
Unused net capital losses may be carried back three years or forward indefinitely to continue reducing net capital gains.

ABILs, on the other hand:

May be used to reduce all taxable income to zero.
Can be carried back three years or forward 10 years.
Can be carried forward indefinitely after 10 years, but only to reduce net capital gains and not other taxable amounts.
Need not result from an actual sale of the qualifying property, as is the case with a capital loss, but may result from a deemed disposition.

A deemed disposition occurs if the debt becomes noncollectable or the shares become worthless because the company goes bankrupt or becomes insolvent and goes out of business.

To qualify as a business investment loss, the property you own must be either a debt owed to you or the shares of an SBC. Canada Revenue Agency (CRA) defines an eligible small business as a Canadian Controlled Private Corporation (CCPC) that uses all or substantially all of the fair market value of its assets to carry on an active business in Canada. That means that company assets such as investments, which are not actively used to conduct the business, cannot exceed 10 per cent of total assets.

The business investment loss is the difference between the purchase price and the proceeds of the shares or debt, minus 4/3 or 2/1 of any capital gains deduction claimed in prior years. The fraction used is the inverse of the inclusion rate used to calculate the capital gains deduction in the particular year of the gain.

In the case of a deemed disposition, the sale price would be considered zero and a special election must be filed with the CRA. Then, the allowable business investment loss is that portion of the business investment loss calculated at the inclusion rate, or 50 per cent. When an ABIL is claimed, you cannot use the capital gains deduction in future tax years until taxable capital gains equal to the amount of the ABIL have been included in income.

The CRA frequently challenges allowable business investment losses because of the special tax treatment. It is critical to ensure that you have all the required documentation, especially if you and the SBC are related parties.

For example, if the ABIL was the result of a debt owed to you by the SBC, you must ensure:

You have a signed promissory note from the SBC.
The interest rate stated on the note is at market rate.
You can demonstrate that you have taken all reasonable measures to collect the debt.

Nevertheless, an allowable business investment loss and the special tax treatments allowed by the CRA make its use a valuable resource for income tax planning. Your accountant can provide more information.